UBS AG Annual Report 2004

Plain-text annual report

ab Financial Report 2004 Introduction Our Financial Report forms an essential part of our annual reporting portfolio. It includes the audited ﬁnancial statements of UBS for 2004 and 2003, prepared according to Interna- tional 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 2004 and 2003, prepared according to Swiss Banking Law requirements. It also contains a discus- sion and analysis of the ﬁnancial and business performance of UBS and its Business Groups, and additional disclosures required under Swiss and US regulations. The Financial Report should be read in conjunction with the other information published by UBS, described on page 4. We sincerely hope that you will find our annual reports useful and informative. We believe that UBS is one of the leaders in corporate disclosure, although we would be very interested to hear your views on how we might improve the content, information and presentation of the reporting products that we publish. Mark Branson Chief Communication Ofﬁcer UBS Introduction UBS ﬁnancial highlights UBS at a glance Sources of information Contacts Presentation of Financial Information UBS reporting structure Measurement and analysis of performance Changes in accounting and presentation in 2005 UBS Results Risk factors UBS Targets Financial Businesses Results Wealth Management & Business Banking Global Asset Management Investment Bank Wealth Management USA Corporate Center Industrial Holdings Balance Sheet and Cash Flows Balance sheet and off-balance sheet Cash ﬂows Accounting Standards and Policies Accounting principles Critical accounting policies Financial Statements UBS AG (Parent Bank) Additional Disclosure Required under SEC Regulations 1 2 3 4 6 7 8 9 10 15 16 16 19 23 24 32 41 47 52 58 65 67 68 71 73 74 76 81 191 205 1 Introduction UBS ﬁnancial highlights UBS Income Statement CHF million, except where indicated Net proﬁt Basic earnings per share (CHF) 1 Diluted earnings per share (CHF) 1 Return on shareholders’ equity (%) 2 KPI’s adjusted for signiﬁcant ﬁnancial events and pre-goodwill 3, 4 Basic earnings per share (CHF) 5 Return on shareholders’ equity (%) 6 Financial Businesses 7 Operating income Operating expenses Net proﬁt Cost / income ratio (%) 8 Net new money, wealth management businesses (CHF billion) 9 Headcount (full-time equivalents) Earnings adjusted for signiﬁcant ﬁnancial events and pre-goodwill 3, 4 Operating income Operating expenses Net proﬁt Cost / income ratio (%) 8 UBS balance sheet and capital management CHF million, except where indicated Balance sheet key ﬁgures Total assets Shareholders’ equity Market capitalization BIS capital ratios Tier 1 (%) 10 Total BIS (%) Risk-weighted assets Invested assets (CHF billion) Long-term ratings Fitch, London Moody’s, New York Standard & Poor’s, New York For the year ended 31.12.04 8,089 31.12.03 6,239 31.12.02 3,530 7.68 7.47 24.7 8.60 27.7 37,402 26,935 8,044 72.6 59.4 67,424 37,402 26,048 8,931 70.2 5.59 5.48 17.8 6.43 20.5 33,790 25,613 6,239 75.6 50.8 65,929 33,629 24,670 7,180 73.2 2.92 2.87 8.9 4.57 13.9 34,107 29,570 3,530 86.4 36.2 69,061 33,880 27,110 5,524 79.7 % change from 31.12.03 30 37 36 34 11 5 29 2 11 6 24 31.12.04 As at 31.12.03 % change from 31.12.02 31.12.03 1,734,784 1,550,056 1,346,678 34,978 103,638 11.8 13.6 264,125 2,250 AA+ Aa2 AA+ 35,310 95,401 11.8 13.3 251,901 2,133 AA+ Aa2 AA+ 38,952 79,448 11.3 13.8 238,790 1,959 AAA Aa2 AA+ 12 (1 ) 9 5 5 1 For the EPS calculation, see note 8 to the ﬁnancial statements. 4 Details of signiﬁcant ﬁnancial events can be found in the measurement and analysis of performance section on page 9. signiﬁcant ﬁnancial events (after-tax) / weighted average shares outstanding. average shareholders’ equity less dividends. Management and Wealth Management USA. Excludes interest and dividend income. 3 Excludes the amortization of goodwill and other intangible assets. 5 Net proﬁt less the amortization of goodwill and other intangible assets and 6 Net proﬁt less the amortization of goodwill and other intangible assets and signiﬁcant ﬁnancial events (after-tax) / 9 Includes Wealth 10 Includes hybrid Tier 1 capital, please refer to note 29 to the ﬁnancial statements. 8 Operating expenses / operating income less credit loss expense or recovery. 2 Net proﬁt / average shareholders’ equity less dividends. 7 Excludes results from Industrial Holdings. From third quarter 2004 onwards, Motor-Columbus has been fully consolidated in UBS’s Financial Statements. The reporting structure is split into two components: Financial Businesses and Industrial Holdings. 2 UBS at a glance UBS is one of the world’s leading ﬁnancial ﬁrms, serving a discerning global client base. As an organization, it combines ﬁnancial strength with a global culture that embraces change. As an integrated ﬁrm, UBS creates added value for clients by drawing on the combined resources and expertise of all its businesses. UBS is present in all major ﬁnancial centers worldwide, with ofﬁces in 50 countries. UBS employs 67,424 people, 39% in the Americas, 38% in Switzerland, 16% in Europe and 7% in the Asia Paciﬁc time zone. UBS is one of the best-capitalized ﬁnancial institutions in the world, with a BIS Tier 1 ratio of 11.8%, invested assets of CHF 2.25 trillion, shareholders’ equity of CHF 35.0 billion and market capitalization of CHF 103.6 billion on 31 December 2004. Businesses Wealth management With more than 140 years of experience, an extensive global network of around 180 ofﬁces and almost CHF 800 billion in invested assets, UBS is the world’s leading wealth management business. Some 3,700 client advisors provide a comprehensive range of services customized for wealthy individuals, ranging from asset management to estate planning and from corporate ﬁnance to art banking. In the US, UBS is one of the biggest pri- vate client businesses with a client base of nearly 2 million. Its American network of around 7,500 ﬁnancial advisors manages roughly CHF 640 billion in invested assets and provides sophis- ticated services to afﬂuent and high net worth clients. tently placed in the top tiers of major industry rankings, it is a leading player in the global primary and secondary markets for equity, equity-linked and equity derivative products. In ﬁxed income, it is a ﬁrst-rate global player. In foreign ex- change, it places ﬁrst in many key industry rankings. In invest- ment banking, it provides ﬁrst-class advice and execution capabilities to its corporate client base worldwide. All its businesses are sharply client-focused, providing innovative products, top-quality research and comprehensive access to the world’s capital markets. Asset management UBS, a leading asset manager with invested assets of slightly more than CHF 600 billion, provides a broad base of inno- vative capabilities stretching from traditional to alternative investment solutions for, among other clients, ﬁnancial inter- mediaries and institutional investors across the world. Swiss corporate and individual clients Depending on segment, UBS holds roughly a quarter and a third of the Swiss banking market. It offers comprehen- sive banking and securities services for approximately 3.5 mil- lion individual and around 143,000 corporate clients, including institutional investors, public entities and foun- dations based in Switzerland, as well as 3,000 ﬁnancial insti- tutions worldwide. With a total loan book of nearly CHF 140 billion, UBS leads the Swiss lending and retail mortgage markets. Investment banking and securities UBS is a global investment banking and securities ﬁrm with a strong institutional and corporate client franchise. Consis- Corporate Center The Corporate Center partners with the businesses, ensuring that the ﬁrm operates as a coherent and integrated whole with a common vision and set of values. 3 Introduction Sources of information This Financial Report contains our audited ﬁnancial statements for the year 2004 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 no. 80531-0501). Annual Review 2004 Our Annual Review contains a description of UBS and our Business Groups, as well as a summary review of our per- formance in 2004. It is available in English, German, French, Italian, Spanish and Japanese. (SAP no. 80530-0501). Handbook 2004 / 2005 The Handbook 2004 / 2005 contains a detailed description of UBS, our strategy, organization, and businesses, as well as our ﬁnancial management including credit, market and operational risk, our capital management approach and details of our corporate governance. It is available in English and German. (SAP no. 80532-0501). Quarterly reports We provide detailed quarterly ﬁnancial reporting and analy- sis, including comment on the progress of our businesses and key strategic initiatives. These quarterly reports are available in English. The compensation report Our compensation report provides detailed information on the compensation paid in 2004 to the members of UBS’s Board of Directors (BoD) and the Group Executive Board (GEB). The report is available in English and German. (SAP no. 82307-0501). The same information can also be read in the Corporate Governance chapter of the Handbook 2004 / 2005. The making of UBS A brochure published in early 2005 outlines the series of trans- formational mergers and acquisitions that created today’s UBS. It also includes brief proﬁles of the ﬁrm’s antecedent companies and their historical roots. It is available in English and German. (SAP no. 82252). How to order reports Each of these reports is available on the internet at: www.ubs.com/investors, in the Financials section. Alterna- tively, printed copies can be ordered, quoting the SAP num- ber and the language preference where applicable, from UBS AG, Information Center, P.O. Box, CH-8098 Zurich, Switzerland. Information tools for investors Website Our Analysts and Investors website at www.ubs.com/investors offers a wide range of information about UBS, ﬁnancial infor- mation (including SEC ﬁlings), corporate information, share price graphs and data, an event calendar, dividend informa- tion and recent presentations given by senior management to investors at external conferences. Our information on the in- ternet is available in English and German, with some sections in French and Italian as well. Messaging service On the Analysts and Investors 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 presents UBS’s results every quarter. These presentations are broadcast live over the internet, and can be downloaded on demand. The most recent result webcasts can be found in the Financials section of our Investors and Analysts website. Form 20-F and other submissions to the US Securities and Exchange Commission We ﬁle periodic reports and submit other information about UBS to the US Securities and Exchange Commission (SEC). Principal among these ﬁlings is 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 the Handbook 2004 / 2005 or to parts of this Financial Report 2004. However, there is a small amount of additional information in 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. 4 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. 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 next page. Corporate information The legal and commercial name of the company 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 are: Bahnhofstrasse 45, CH-8098 Zurich, Switzerland, telephone +41-44-234 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 (traded through its trading platform virt-x), on the New York Stock Exchange and on the Tokyo Stock Exchange. 5 Introduction Contacts Switchboards For all general queries. Investor Relations Our Investor Relations team supports institutional, professional and retail investors from our ofﬁce in Zurich. www.ubs.com/investors Media Relations Our Media Relations team supports global media and journalists from ofﬁces in Zurich, London, New York and Hong Kong. www.ubs.com/media Shareholder Services UBS Shareholder Services, a unit of the Company Secretary, is responsible for the registration of the Global Registered Shares. Zurich London New York Hong Kong Zurich Hotline Matthew Miller Patrick Zuppiger Caroline Ryton Fax Zurich London New York Hong Kong Hotline Fax +41-44-234 1111 +44-20-7568 0000 +1-212-821 3000 +852-2971 8888 +41-44-234 4100 +41-44-234 4360 +41-44-234 3614 +41-44-234 2281 +41-44-234 3415 +41-44-234 8500 +44-20-7567 4714 +1-212-882 5857 +852-2971 8200 +41-44-235 6202 +41-44-235 3154 US Transfer Agent For all Global Registered Share- related queries in the US. www.melloninvestor.com Calls from the US Calls outside the US Fax +1-866-541 9689 +1-201-329 8451 +1-201-296 4801 6 UBS AG Investor Relations P.O. Box CH-8098 Zurich, Switzerland sh-investorrelations@ubs.com mediarelations@ubs.com ubs-media-relations@ubs.com mediarelations-ny@ubs.com sh-mediarelations-ap@ubs.com UBS AG Shareholder Services P.O. Box CH-8098 Zurich, Switzerland sh-shareholder-services@ubs.com Mellon Investor Services Overpeck Centre 85 Challenger Road Ridgeﬁeld Park, NJ 07660, USA sh-relations@melloninvestor.com Presentation of Financial Information Presentation of Financial Information UBS reporting structure Changes to reporting structure in 2004 We implemented a new reporting structure during 2004, un- der which we separate the analysis of our ﬁnancial businesses from the impact of our industrial holdings. We adopted this new reporting structure on assuming majority ownership of the holding company Motor-Columbus after purchasing an addi- tional 20% stake on 1 July 2004. Motor-Columbus’s only signiﬁcant asset is a 59.3% interest in the Atel Group. Atel, based in Olten, Switzerland, is an energy provider focused on domestic and international power generation, electricity trans- mission, energy services as well as electricity trading and mar- keting. Due to the increased complexity that the consolidation of this energy utility adds to our ﬁnancial reporting, we have split the commentary of our results into two parts. We have pro- vided commentary and analysis of our ﬁnancial businesses – which include all our pre-existing business units – separately from the new industrial holdings unit, housing Motor- Columbus. In this way, we aim for complete continuity in the presentation and analysis of our core businesses. The new reporting structure is shown in detail in the diagram below. We also decided in 2004 to increase the transparency of our Corporate Center by splitting it into two business units: Corporate Functions and Private Banks & GAM, showing separately the performance of the holding company which contains our independently branded private banks and the specialist asset manager GAM. None of the above changes had an impact on our consoli- dated ﬁnancial statements, but we have restated our segment reporting for prior periods for all business units affected to reﬂect these changes. Changes to accounting in 2004 At the start of 2004, we implemented the following changes in accounting: – early adoption of revised IAS 32 Financial Instruments: Disclosure and Presentation and revised IAS 39 Financial Instruments: Recognition and Measurement. – change in the accounting for investment property from his- torical cost less accumulated depreciation to the fair value method. – change in accounting for credit losses on over-the- counter (OTC) derivatives which are now reported as incurred in net trading income and no longer charged to credit loss expense (and deferred over three years for internal management reporting and in the results discussion). – exclusion from invested assets of corporate client assets in the Business Banking Switzerland unit (except for pension fund assets). These changes lowered 2003 and 2002 net profit by CHF 146 million and CHF 5 million respectively. All ﬁgures and results presented in this report reﬂect these changes. Other new disclosures As part of our continuing effort to improve the transparency of our financial reporting and provide the best possible understanding of our business, we have made a number of enhancements to our disclosure. In the results discussion, we split our underwriting fee results to show equity and fixed income contributions separately. In our Business Banking Switzerland unit, we split our revenues to show the breakdown between interest income and non-interest income, giving a more distinct picture of the unit’s sources of revenue. In the Wealth Management USA Business Group, we now indicate the split between private client and municipal ﬁnance revenues, better explaining the performance of the business. To that end, we have also introduced a new key performance indicator (KPI) that shows the productivity per ﬁnancial advisor. With the launch of our IT infrastructure unit (ITI), we have also started to show a new line called ‘Services to / from other business units’. This line is a net ﬁgure consisting of all inter-business services, the majority of which relate to ITI. UBS Reporting Structure Financial Businesses Industrial Holdings Wealth Management & Business Banking Global Asset Management Investment Bank Wealth Management USA Corporate Center Motor-Columbus Wealth Management Business Banking Switzerland 8 Private Banks & GAM Corporate Functions Measurement and analysis of performance UBS’s performance is reported in accordance with Interna- tional Financial Reporting Standards (IFRS). Additionally, for several years, we have provided comments and analysis on an adjusted basis which excludes from the reported amounts certain items we term signiﬁcant ﬁnancial events (SFEs). An additional adjustment we have used in our results discussion is the exclusion of the amortization of goodwill and other acquired intangible assets. We will in future change this approach as accounting standards no longer require the amortization of goodwill, by far the largest adjustment we have been making. From 2005 onwards, we will no longer present current results on this adjusted basis. The adjustments we have made up to and including this 2004 report reﬂect our internal approach to analyzing our re- sults and managing the company, in which SFE-adjusted ﬁgures before the amortization of goodwill and intangibles have been used to assess 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 the amortization of goodwill and intangibles. All the analysis provided in our internal management accounting has been based on operational SFE-adjusted performance. This has helped us to illustrate the underlying operational perform- ance of our business, insulated from the impact of individual gain or loss items that are not relevant to our management’s business planning decisions. A policy approved by the Group Executive Board (GEB) deﬁnes which items have been classi- ﬁed as SFEs. Items have been treated as SFEs when they are event- speciﬁc, signiﬁcant for the consolidated ﬁnancial statements of UBS, UBS-speciﬁc, rather than industry-wide, and not in- dicative of or relevant for future performance. Reﬂecting that deﬁnition, we had no SFEs in 2004, one in 2003, and three in 2002. The relevant SFEs were: – A net gain of CHF 2 million (pre-tax CHF 161 million) in second quarter 2003 from the sale of the Wealth Management USA Business Group’s Correspondent Services Corporation (CSC) clearing business. A substan- tial portion of CSC’s net assets comprised goodwill stemming from the PaineWebber acquisition. After de- ducting taxes of CHF 159 million (based on the purchase price) and the writedown of the goodwill associated with CSC, the net gain from the transaction was CHF 2 mil- lion. – In fourth quarter 2002, a non-cash writedown of CHF 953 million (pre-tax CHF 1,234 million) relating to the value of the PaineWebber brand that was held as an intangible asset on our balance sheet. – In fourth quarter 2002, a net gain of CHF 60 million (pre-tax CHF 72 million) from the sale of Klinik Hirslanden, a private hospital group. – In first quarter 2002, a net gain of CHF 125 million (pre-tax CHF 155 million) from the sale of private bank Hyposwiss. Seasonal characteristics Our main businesses do not generally show signiﬁcant sea- sonal patterns – except for the Investment Bank Business Group, where revenues are impacted by the seasonal charac- teristics of general ﬁnancial market activity and deal ﬂows in investment banking. When discussing quarterly performance, we therefore compare the Investment Bank’s results of the reported quar- ter with those achieved in the same period of the previous year. Similarly, when considering the impact of the Investment Bank’s performance on UBS’s ﬁnancial statements, we discuss our overall quarterly performance on a year-on-year basis – comparing the actual quarter with the same quarter in the previous year. For all other Business Groups, results are com- pared with the previous quarter as they are only slightly impacted by seasonal components (e. g. asset withdrawals in fourth quarter or lower client activity levels during the holiday season). Targets and performance measures UBS targets At UBS we focus on a consistent set of four long-term ﬁnan- cial targets deﬁned across periods of varying market condi- tions and designed to ensure that we deliver continuously improving returns to our shareholders. We report our per- formance against these targets each quarter: – 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 in basic earnings per share (EPS), across periods of varying market condi- tions. – Through cost reduction and earnings enhancement initia- tives, we aim to reduce UBS’s cost / income ratio to a level that compares positively with best-in-class competitors. – We aim to achieve a clear growth trend in net new money in our wealth management units. The ﬁrst three targets are all reported pre-goodwill amorti- zation, and adjusted for signiﬁcant ﬁnancial events. 9 Presentation of Financial Information Key performance indicators Business Financial businesses Key performance indicators Deﬁnition Cost / income ratio Total operating expenses / total operating income before adjusted expected credit loss. Cost / income ratio before goodwill Wealth and asset management businesses and Business Banking Switzerland Invested assets Net new money Total operating expenses excluding amortization of goodwill and intangible assets / total operating income before adjusted expected credit loss. Assets managed by or deposited with UBS for investment purposes only (for further details please refer to page 11). Inﬂow of invested assets from new clients – outﬂows due to client defection +/– inﬂows / outﬂows from existing clients. (for further details please refer to page 11). Wealth and asset management businesses Gross margin on invested assets Operating income before adjusted expected credit loss / average invested assets. Wealth Management Client advisors (CAs) Expressed in full-time equivalents. Business Banking Switzerland Non-performing loans (%) Non-performing loans / gross loans. Investment Bank Impaired loans (%) Compensation ratio (%) Non-performing loans (%) Impaired loans (%) Average VaR (10-day 99%) Value creation (private equity) Impaired loans / gross loans. Personnel expenses / operating income before adjusted expected credit loss. Non-performing loans / gross loans. Impaired loans / gross loans. VaR expresses the potential loss on a trading portfolio assuming a 10-day time horizon before positions can be adjusted, and measured to a 99% level of conﬁdence. Value creation adds the increase in the unrealized portfolio gains / (losses) to realized gains / (losses) for the period. Investment (private equity) Historical cost of investment made, less divestments and impairments. Portfolio fair value (private equity) Wealth Management USA Recurring fees The fair value of a portfolio is the estimated amount for which the assets could be exchanged between willing buyers and willing sellers in an arm’s length transaction after an orderly sale process where the parties each act knowledgeably, prudently and without compulsion. Asset-based fees for portfolio management and fund distribution, account-based and advisory fees (as opposed to transactional fees). Financial advisor productivity Private client revenues divided by average number of ﬁnancial advisors. Changes in accounting and presentation in 2005 Effective 2005, we will make a number of changes in accounting and disclo- sure – some are driven by changes in accounting standards, others concern the presentation of our ﬁnancial results. The International Accounting Stan- dards Board (IASB) issued revisions to 15 of its 32 International Accounting Standards (IAS) in December 2003 in an effort to clarify and simplify them and make them more compatible with other accounting standards, notably US GAAP. All 15 revisions became ef- fective on 1 January 2005. We decided to adopt two of the revisions, IAS 32 and 39, early, at the beginning of 2004. Together these two revisions provide comprehensive guidance on recogni- tion, measurement, presentation and disclosure of ﬁnancial instruments. We adopted the remaining revisions at the beginning of 2005. As a result, we will make a number of changes to our accounting, presentation and disclosure in 2005. The IASB now calls new standards International Financial Reporting Standards (IFRS). Several of the changes will require us to restate comparative prior periods, although not all of them will have an effect on net profit or shareholders’ equity. We will release restated interim and annual financial state- ment figures for 2004 and 2003 before we publish our first quarter 2005 report. Accounting treatment and presenta- tion of private equity investments In the past we treated all our private equity investments as “Financial investments available-for-sale”. The revised IAS 27 and 28 will require us to change this approach, with some investments no longer exempt from consolidation. Depending on the size of our stake, these investments will have to be treated according to one of the three following methods: 10 Business Group key performance indicators At the Business Group or business unit level, performance is measured with carefully chosen key performance indicators (KPIs). These do not carry explicit targets, but are indicators of the business units’ success in creating value for share- holders. They reﬂect the key drivers of each unit’s core busi- ness activities and include both ﬁnancial metrics, such as the cost / income ratio, and non-ﬁnancial metrics, such as invest- ed assets or the number of client advisors. These KPIs are used for internal performance measurement and planning as well as external reporting. This ensures that management has a clear responsibility to lead businesses towards achieving success in the externally reported value drivers, avoiding the risk of management to purely internal performance measures. Client / invested assets reporting Since 2001, we have reported two distinct metrics for client funds: – Client assets are all client assets managed by or deposited with UBS including custody-only assets and assets held for purely transactional purposes. – Invested assets is a more restrictive term and includes all client assets managed by or deposited with UBS for invest- ment purposes. Invested assets is our central measure and excludes all assets held for purely transactional and or custody-only purposes. It includes, for example, discretionary and advisory wealth management portfolios, managed institutional assets, managed fund assets and wealth management securities or brokerage accounts, but excludes custody-only assets, and transactional cash or current accounts. Since 1 January 2004, corporate client assets (other than pension funds) deposited with the Business Banking Switzerland unit have been excluded, as we have a minimal advisory role for such clients and as asset ﬂows are driven more by liquidity requirements than investment reasons. Non-bankable assets (e. g. art col- lections) and deposits from third-party banks for funding or trading purposes 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, the effects of market or currency movements as well as acqui- sitions and divestments are excluded from net new money. The use of invested assets to fund interest expense on clients’ loans results in net new money outﬂows. When products are managed in one Business Group and sold in another, they are counted in both the investment management unit and the distribution unit. This results in double counting in UBS’s total invested assets as both units provide an independent service to their respective client, add value and generate revenues. Most double counting arises where mutual funds are managed by the Global Asset Man- agement business or GAM and sold by a wealth management business (Wealth Management or Wealth Management USA). Both businesses involved count these funds as invested assets. This approach is in line with industry practice and our open architecture strategy and allows us to accurately reﬂect the performance of each individual business. Overall, CHF 294 bil- lion of invested assets were double counted in 2004 (CHF 283 billion in 2003). – full consolidation (according to IAS 27) for investments in which we have a controlling interest – equity method accounting (accord- ing to IAS 28) for investments in which we have signiﬁcant inﬂuence – treatment as “Financial investments available-for-sale” for all remaining private equity investments. Under the old method, all investments were accounted for as “available- for-sale”. That means that even if the value of an investment rose or fell, corresponding gains or losses were only recognized in the income state- ment on sale, unless an impairment occurred. Changes in the fair value of the investment were booked directly in equity for the time that we held it. Once an investment was sold, the gain or loss recognized was the difference between the value of the investment at the time that it was purchased (adjusted for any impairments) and its selling price. The introduction of revised IAS 27 and 28 requires that we adopt a new approach. Now, for an investment where we have a control- ling interest or a signiﬁcant inﬂuence, we will record our share of its net proﬁt or loss directly through our income statement. Doing that will prompt corresponding changes to the carrying value of the investment – meaning its value on the balance sheet will be updated according to the accu- mulated proﬁts and losses. Then, at the time of sale, any gain or loss we record will be based on the difference between the latest carrying value and the selling price. Full consolidation according to IAS 27 The revision of IAS 27 requires compa- nies to fully consolidate subsidiaries even when control over them is only temporary. As a result, from 2005 onwards we will consolidate line by line those private equity investments in which we have a controlling interest – in total 12 investments. As a conse- 11 Changes in accounting and presentation in 2005 (continued) quence, we will debit approximately CHF 723 million to our equity (includ- ing minority interests) as at 1 January 2003. The move will add CHF 1.7 bil- lion and CHF 2.9 billion in assets to our balance sheet for year-end 2004 and 2003 respectively. It will increase total operating income in 2004 and 2003 by approximately CHF 3.8 billion and CHF 4.1 billion respectively. It will also add approximately CHF 92 million and CHF 86 million to 2004 and 2003 in operating net proﬁt. In our restatement for 2004 and 2003, we will also have to reﬂect the impact on the sale of these types of invest- ments in accordance with IFRS 5 (explained in detail below). Seven of the private equity investments in which we had a controlling interest on 1 Jan- uary 2003 were sold during 2003 or 2004 and will therefore be presented as discontinued operations in the restated ﬁnancial results for these years. Under the revised accounting method, the additional net proﬁt / (loss) from these exits, which is not included in the changes to operating proﬁt men- tioned above, totaled CHF 55 million in 2004 and CHF (8) million in 2003. Under the old method, the correspond- ing ﬁgures were CHF 90 million and CHF 194 million. Equity method according to IAS 28 Investments in companies in which we have a signiﬁcant inﬂuence must now be accounted for under the equity method, even if they are held exclu- sively for future sale. From 2005 onwards we will therefore account for 15 private equity investments in which we have a stake between 20% and 50% using the equity method. As a consequence, we will debit CHF 266 million to our equity as at 1 Janu- ary 2003. That debit is the difference between the carrying value of those private equity investments under the new and the old methods. The restat- ed carrying values will be CHF 248 mil- lion and CHF 393 million on 31 De- cember 2004 and 2003 respectively, which include equity in income of CHF (55) million and CHF 10 million recognized in the income statement in 2004 and 2003 respectively. During 2004 and 2003, we exited ﬁve of these private equity investments accounted for using the equity method. Under the new accounting method, the gains on sale were CHF 1 million and zero in 2004 and 2003 respectively, compared to CHF 70 million and CHF 34 million in 2004 and 2003 respectively under the old method. Changes in presentation From ﬁrst quarter 2005, our private equity business including all its invest- ments will be reported as part of the Industrial Holdings segment. This is in line with our ongoing strategy of dis- continuing this business. The fair value of the private equity portfolio was CHF 2.7 billion at end-December 2004, compared to CHF 6.9 billion at the end of 2000 – when it was at its highest. Current management will continue to look after the portfolio. IFRS 2 Share-based payment IFRS 2 will require entities to recognize the fair value of share-based payments made to employees as compensation expense, recognized over the service period, which is generally equal to the vesting period. The new treatment differs from our current practice in two ways. First, option awards will be expensed over their vesting period whereas currently UBS discloses the pro-forma impact of expensing the fair value of such awards at grant. Second, share awards, which are currently expensed in the performance year (generally the year before grant), will in future be expensed from the date of grant over the vesting period. We will apply the new requirements to all prior period awards that impact income statements from 2003 onwards. This includes all unvested or outstanding awards as at 1 January 2003. The opening balance of retained earnings on 1 January 2003 will be adjusted by a credit of CHF 559 million after-tax for the effects these awards have on income statements prior to 2003. With regard to our income statement, we will record zero and CHF 558 million as additional compensation expense for 2004 and 2003 respectively. The sig- niﬁcantly lower impact on the 2004 income statement is due to the fact that we have substantially raised the 12 proportion of bonus payments made in the form of restricted stock rather than cash. The CHF 1,406 million expense related to these stock awards shifts under IFRS 2 from 2004 to the vesting period starting in 2005, and signiﬁcantly exceeds the impact of prior year stock grants on 2004 expenses. We will also introduce an updated option valuation model to determine the fair value of share options granted in 2005 and beyond. The new model will better reﬂect observed exercise behavior. This will reduce the value of an option and accordingly the new model will result in lower average values per option – other factors being equal. The new model will not affect the valuation of share options granted in 2004 and earlier. UBS also has employee beneﬁt trusts that are used in connection with share-based payment arrangements and deferred compensation schemes. Henceforth, we will be required to consolidate these trusts. This will result in us recognizing assets of CHF 1.1 billion and CHF 1.3 billion and liabilities of CHF 1.1 billion and CHF 1.3 billion on our year-end 2004 and 2003 balance sheets respectively. The weighted average number of treasury shares held by these trusts was 22,995,954 in 2004 and 30,792,147 in 2003. The new stan- dard will lower the weighted average number of shares outstanding used to calculate basic earnings per share. There will be no impact on diluted earnings per share. The net impact of IFRS 2 and the trust consolidation on shareholder’s equity is a debit of CHF 166 million as at 31 December 2004 and a debit of CHF 674 million as at 31 December 2003. IFRS 3 Business Combinations, IAS 36 Impairment of Assets and IAS 38 Intangible Assets IFRS 3 requires that all business com- binations be accounted for under the purchase method. The pooling-of- interests method is eliminated. Under the new accounting standard, we will cease to amortize existing goodwill beginning in 2005 and will instead conduct annual impairment tests. Goodwill from business combinations entered into on or after 31 March 2004 – including, for UBS, the Motor- Columbus transaction – has already been accounted for under the new guidance and has not been amortized during 2004. Goodwill from business combinations closed prior to 31 March 2004 continued to be amortized until 31 December 2004. We recorded goodwill amortization expense of CHF 713 million in 2004, and CHF 756 million in 2003. There will be no restatement of prior years with regard to this standard. Following the new standard, we have also reclassiﬁed the net book value of the former PaineWebber trained workforce intangible asset to goodwill (book value CHF 1.0 billion). On 1 Jan- uary 2005, we held CHF 2.3 billion in total intangible assets and we antici- pate recording approximately CHF 300 million in related amortization expense in 2005. IFRS 5 Non-current Assets Held for Sale and Discontinued Operations The IASB issued this new standard on 31 March 2004. It requires that sub- sidiaries that are acquired exclusively for future sale be presented as discon- tinued operations at the time a sale is highly likely to occur. As certain of our private equity investments meet the criteria as discontinued opera- tions, we will reclassify them accord- ingly. Although the impact from IFRS 5 on our ﬁnancial statements will not be material, our income statement will be divided into two sections – net income from continuing operations and net income from discontinued operations. Minority interests Beginning in 2005, the revision of IAS 1 will require the presentation of net proﬁt and equity to include minority interests. Net proﬁt will be allocated to net proﬁt attributable to UBS shareholders and net proﬁt attributable to minority interests. Earnings per share and all our analysis of UBS performance will continue to be presented based on net proﬁt attributable to UBS shareholders. 13 14 UBS UBS Results In 2004, UBS reported net proﬁt of CHF 8,089 million, up 30% from CHF 6,239 million a year earlier and up 129% from CHF 3,530 million in 2002. Our ﬁnancial businesses achieved a record result in 2004, contributing CHF 8,044 million to net proﬁt, up 29% from CHF 6,239 million a year earlier. Our industrial holdings made a CHF 45 million contribution to 2004 net proﬁt. Dividend The Board of Directors will recommend at the Annual General Meeting on 21 April 2005 that UBS should pay a dividend of CHF 3.00 per share for the 2004 ﬁnancial year, an increase of 15% or CHF 0.40 from the CHF 2.60 dividend paid for the 2003 ﬁnancial year and up 50% or CHF 1.00 from the CHF 2.00 dividend paid for the 2002 ﬁnancial year. If the dividend is approved, the ex-dividend date will be 22 April 2005, with payment on 26 April 2005 for share- holders of record on 21 April 2005. Risk factors As a global ﬁnancial services ﬁrm, we are affected by the factors driving the markets in which we operate. Dif- ferent risk factors can impact our abil- ity to effectively carry out our business strategies and can directly affect our earnings. The factors described below, as well as other inﬂuences beyond our control, mean that our revenues and operating proﬁt have been and are likely to continue to be subject to a measure of variability from period to period. Our revenues and operating proﬁt for any particular period may not, therefore, be indicative of sustain- able results, they may vary from year to year and may affect our ability to achieve UBS’s strategic objectives. Interest rates, equity prices, foreign exchange levels and other market ﬂuctuations may affect earnings A substantial part of our business con- sists in taking trading positions in the interest rate, debt, currency, equity, precious metal and energy markets. The value of these assets and liabilities can be adversely affected by ﬂuctua- tions in ﬁnancial markets. Our market risks are subject to a control frame- work and to portfolio and concentra- tion limits. We avoid undue concentra- tions of risk and, where appropriate, 16 hedge exposure to stress events. Nevertheless, in the event of sudden, severe or unexpected market move- ments, we might suffer signiﬁcant losses. A description of our controls and limits, including limits on our exposure to a range of market stress events, is provided on page 43 of our Handbook 2004 / 2005. Because we prepare our accounts in Swiss francs while assets, liabilities, revenues and expenses from certain businesses are denominated in other currencies, changes in foreign ex- change rates, particularly between the Swiss franc and the US dollar (US dol- lar income representing the major part of our non-Swiss franc income), may have an effect on our reported earn- ings. Our approach to currency man- agement is explained on page 64 of our Handbook 2004 / 2005. Regulatory or political changes impact- ing ﬁnancial market structures can affect our earnings – an example was the introduction of the euro in 1999, which affected European foreign exchange markets by reducing the volume of foreign exchange business, and prompted greater harmonization between ﬁnancial products. Move- ments in interest rates can affect our net interest income and the value of our ﬁxed income trading portfolio, while movements in equity markets can affect the value of our equity trading portfolio. Changes in both can affect the investment performance of our asset management businesses. Our ﬁxed income and equity trading portfolios and our asset management businesses may also be impacted by credit events, including defaults, relat- ed to the issuers of bonds and equi- ties. Our private equity and commer- cial real estate investments can be adversely affected by economic, busi- ness and general market conditions. Furthermore, income in businesses such as investment banking, and wealth and asset management is often directly related to client activity levels. As a result, our income can be suscep- tible to adverse effects from sustained market downturns as well as any sig- niﬁcant deterioration of investor senti- ment. Asset-based revenues generated in our wealth and asset management businesses depend on the levels of client assets which can, in themselves, be adversely affected by deteriorating market valuations. Market levels and trading volumes may be affected by a broad range of geopolitical or regional issues or events beyond our control, such as Risk factors (continued) the possibility of war, terrorism, or economic developments such as low growth, inﬂation, recession or depression. Counterparty failure may lead to credit loss Credit is an integral part of many of our business activities. The results of our credit-related activities (including loans, commitments to lend, contin- gent liabilities such as letters of credit, and derivative products such as swaps and options) would be adversely af- fected by any deterioration in the creditworthiness 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 an unexpected political event. Any of these events could lead us to incur losses. We believe that impairments in the portfolio at the balance sheet date are adequately covered by our allowances and provisions. In general, we aim to avoid risk concentrations in our credit portfolio and we make active use of credit protection. If our risk management and control measures prove inadequate or ineffective, then any credit losses sustained might have a material adverse effect on both our income and the value of our assets. A discussion of our approach to man- aging credit risk can be found on page 47 of our Handbook 2004 / 2005. Operational risk may increase costs and impact revenues All our businesses are dependent on our ability to process a large number of complex transactions across many and diverse markets in different cur- rencies and subject to many different legal and regulatory regimes. Our 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, and failure of security and physical protection, are appropriately controlled. However, if our system of internal controls is ineffective in identifying and remedy- ing such risks, we will be exposed to operational failures that might result in losses. A discussion of our approach to the management and control of operational risks is provided on page 67 of our Handbook 2004 / 2005. Legal claims may arise in the conduct of our business Due to the nature of our business, we are involved in various claims, disputes and legal proceedings in Switzerland and in a number of jurisdictions out- side Switzerland, including the United States, arising in the ordinary course of business. Such legal proceedings may expose us to substantial monetary damages and legal defense costs, injunctive relief and criminal and civil penalties. Competitive forces may inﬂuence business direction We face intense competition in all aspects of our business. In our various lines of business we compete, both domestically and internationally, with asset managers, retail and commer- cial banks, and private banking, invest- ment banking, brokerage 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 compa- rable to us in size and breadth. In addition, the trend towards consoli- dation in the global ﬁnancial services industry is creating competitors with broad ranges of product and service offerings, increased access to capital, and greater efﬁciency and pricing power. We expect these trends to con- tinue and competition to increase in the future. Our competitive strength will depend on the ability of our busi- nesses to adapt quickly to signiﬁcant market and industry trends. Our global presence exposes us to other risks We operate in over 50 countries, 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 regulations 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 local market dis- ruptions, currency crises, the break- down of monetary controls or ter- rorism, may adversely affect the ability of clients or counterparties located in that country or region to obtain foreign exchange or credit and, there- fore, to satisfy their obligations towards us. As a truly global ﬁnancial services company, we are also exposed to economic instability in emerging markets. We have a system of controls and procedures to mitigate this risk. A discussion of our country risk con- trols is provided on page 54 of our Handbook 2004 / 2005. However, if our controls fail to fully identify and respond to country risk, we may suffer a negative impact on our results and ﬁnancial condition. 17 18 UBS Targets UBS Targets Performance against targets RoE (%) as reported 1 before goodwill and adjusted for signiﬁcant ﬁnancial events 2 Basic EPS (CHF) as reported 3 before goodwill and adjusted for signiﬁcant ﬁnancial events 4 Cost / income ratio of the ﬁnancial businesses (%) 5 as reported 6 before goodwill and adjusted for signiﬁcant ﬁnancial events 7 Net new money, wealth management businesses (CHF billion) 8 Wealth Management Wealth Management USA For the year ended 31.12.04 31.12.03 31.12.02 24.7 27.7 7.68 8.60 72.6 70.2 42.3 17.1 59.4 17.8 20.5 5.59 6.43 75.6 73.2 29.7 21.1 50.8 8.9 13.9 2.92 4.57 86.4 79.7 17.7 18.5 36.2 Total RoE in % 28 21 14 7 0 2004 27.7 24.7 2002 2003 20.5 17.8 13.9 8.9 Cost / income ratio of the financial businesses 5 in % 2002 2003 2004 86.4 79.7 75.6 73.2 72.6 70.2 90 80 70 60 50 As reported 1 Before goodwill and adjusted for significant financial events 2 As reported 6 Before goodwill and adjusted for significant financial events 7 Basic EPS CHF 10.00 7.50 5.00 2.50 0.00 Net new money, wealth management businesses 8 CHF billion 2002 2003 2004 2002 2003 8.60 7.68 6.43 5.59 4.57 2.92 60 45 30 15 0 50.8 36.2 2004 59.4 As reported 3 Before goodwill and adjusted for significant financial events 4 2 Net proﬁt less the amortization of goodwill and other intangible assets and signiﬁcant ﬁnancial events (after-tax) / average shareholders’ 1 Net proﬁt / average shareholders’ equity less dividends. equity less dividends. 4 Net proﬁt less the amortization of goodwill and other intangible assets and signiﬁcant ﬁnancial events (after-tax) / weighted average shares outstanding. 6 Operating expenses / operating income less credit loss expense or recovery. 7 Operating expenses less the amortization of goodwill and other intangible assets and signiﬁcant ﬁnancial events / operating income less credit loss expense or recovery and signiﬁcant ﬁnancial events. 8 Excludes interest and dividend income. 3 Details of the EPS calculation can be found in note 8 to the ﬁnancial statements. 5 Excludes results from Industrial Holdings. 20 2004 We focus on four key performance targets, designed to de- liver continually improving returns to our shareholders. These targets are evaluated before goodwill and adjusted for signif- icant ﬁnancial events. This is the ﬁrst time that, on an annual basis, we have split the commentary of our results between ﬁnancial business- es and industrial holdings. The ﬁrst two of our four targets, re- turn on equity and earnings per share, are calculated on a full UBS basis. Our cost / income ratio target is limited to our ﬁnan- cial businesses, to avoid the distortion from industrial holdings, which operates at a cost / income ratio of around 90%. Before goodwill and adjusted for significant financial events: – For full-year 2004, our return on equity was 27.7%, up from 20.5% in 2003, well above our target range of 15% to 20% and at a record level. The increase, exceeding net proﬁt growth, reﬂects the combined effects of our contin- ued buyback programs and dividend outpacing increased retained earnings. – Basic earnings per share (EPS) stood at CHF 8.60, up 34% or CHF 2.17 from CHF 6.43 in 2003. This was the highest level ever, reﬂecting the increase in net proﬁt as well as the 6% reduction in average number of shares outstanding due to our continuing repurchase programs. – The cost / income ratio of our ﬁnancial businesses stood at 70.2% in 2004, an improvement from 73.2% in 2003. Strong asset-based revenues drove fee and commission income higher, demonstrating the inherent operating lever- age in our wealth and asset management businesses. Our wealth management businesses continued to show strong inﬂows of net new money. For full-year 2004, net new money inﬂows into our wealth management businesses to- taled CHF 59.4 billion, up 17% from CHF 50.8 billion in 2003, corresponding to an annual growth rate of 4.4% of the as- set base at the end of 2003. Wealth Management attracted CHF 42.3 billion in 2004, compared to CHF 29.7 billion in 2003. This excellent performance saw gains in all geograph- ical areas, especially from Asian clients, and a particularly strong CHF 13.7 billion inﬂow into our European wealth man- agement business. In our Wealth Management USA business, Invested assets CHF billion UBS Wealth Management & Business Banking Wealth Management Business Banking Switzerland Global Asset Management Institutional Wholesale intermediary Investment Bank Wealth Management USA Corporate Center Private Banks & GAM Net new money 1 CHF billion UBS Wealth Management & Business Banking Wealth Management Business Banking Switzerland Global Asset Management Institutional Wholesale intermediary Investment Bank Wealth Management USA Corporate Center Private Banks & GAM 1 Excludes interest and dividend income. 31.12.04 2,250 As at 31.12.03 2,133 31.12.02 1,959 778 140 344 257 0 639 92 701 136 313 261 4 634 84 31.12.04 88.9 42.3 2.6 23.7 (4.5) 0.0 17.1 7.7 642 127 274 259 3 584 70 For the year ended 31.12.03 69.1 29.7 2.5 12.7 (5.0 ) 0.9 21.1 7.2 % change from 31.12.03 5 11 3 10 (2 ) (100 ) 1 10 31.12.02 36.9 17.7 3.7 (1.4 ) (6.3 ) 0.5 18.5 4.2 21 UBS Targets net new money was CHF 17.1 billion, down from CHF 21.1 bil- lion a year earlier, reﬂecting a slow asset-gathering perform- ance at the beginning of the year as well as the US dollar’s weakening against the Swiss franc. number of shares outstanding due to continued buyback activities. Without the buyback programs, which have been in place since 2000, our earnings per share would be 14% lower. 2003 Before goodwill and adjusted for signiﬁcant ﬁnancial events: – Our return on equity for 2003 was 20.5%, up from 13.9% a year earlier, and above the target range of 15% to 20%. The increase reﬂects much improved net proﬁt combined with a lower average level of equity resulting from con- tinued buyback programs. – Basic earnings per share (EPS) were CHF 6.43 in 2003, an increase of CHF 1.86 or 41% from 2002, reﬂecting the increase in proﬁt as well as the 8% reduction in average – The cost / income ratio was 73.2% in 2003, an improve- ment from 79.7% in 2002. The slight drop in income, re- ﬂecting the difﬁcult market environment in ﬁrst half 2003, was more than compensated by a 9% decline in operat- ing expenses due to ongoing cost management initiatives and the downward pressure on compensation ratios. In full-year 2003, net new money inﬂows into our wealth management businesses totaled CHF 50.8 billion compared with CHF 36.2 billion in 2002. This is an increase of 40% and corresponded to an annual growth rate of 4.2%. Both the Wealth Management and Wealth Management USA bus- nesses were able to attract more client money in 2003 than in 2002. 22 Financial Businesses Financial Businesses Results Results Income statement 1 CHF million, except where indicated 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 Additional information Headcount (full-time equivalents) 1 Excludes results from Industrial Holdings. 2004 Results Our 2004 result was the best ever. The ﬁrst quarter saw an all-time performance record and the year ended with our best- ever fourth quarter. Net proﬁt in 2004 was CHF 8,044 million, up by 29% from CHF 6,239 million in 2003. Before goodwill and excluding the sale of our Correspondent Services Corpo- ration (CSC) clearing subsidiary, completed in second quarter 2003, net proﬁt rose by 24%. The increase was driven by higher revenues in all categories, clearly outpacing cost growth. Our asset-based revenues showed particular strength, reﬂecting improved market valuations as well as strong inﬂows of net new money into our wealth and asset management businesses. Overall, we attracted CHF 88.9 billion in net new money in 2004, up 29% from CHF 69.1 billion in 2003. As a 24 For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 39,398 (27,538) 11,860 276 12,136 19,416 4,972 878 37,402 18,189 6,577 1,282 887 26,935 10,467 2,086 8,381 (337) 8,044 40,159 (27,860 ) 12,299 (72 ) 12,227 17,345 3,756 462 33,790 17,231 6,086 1,353 943 25,613 8,177 1,593 6,584 (345 ) 6,239 39,963 (29,417 ) 10,546 (115 ) 10,431 18,221 5,451 4 34,107 18,524 7,072 1,514 2,460 29,570 4,537 676 3,861 (331 ) 3,530 (2 ) (1 ) (4 ) (1 ) 12 32 90 11 6 8 (5 ) (6 ) 5 28 31 27 (2 ) 29 31.12.04 67,424 As at 31.12.03 65,929 31.12.02 69,061 % change from 31.12.03 2 result, our invested asset base rose to CHF 2.25 trillion. We also saw a strong increase in brokerage, corporate ﬁnance and underwriting fees. Overall fee and commission income now contributes 52% to total operating income. Trading income also contributed to the growth, as improved market conditions boosted opportunities, particularly in the first and fourth quarters. We also saw improving results in our private equity business, which recorded positive revenues for the ﬁrst time in three years on higher divestment gains and lower write- downs. We also reported record credit loss recoveries. Per- formance-related compensation rose in line with revenues. Higher general and administrative expenses were driven by higher legal provisions, and operational risk costs. Operating income Total operating income was CHF 37,402 million in 2004, up 11% from CHF 33,790 million in 2003. This was the highest level ever. The increase was driven by our ability to capture opportunities in increasingly active ﬁnancial markets. The in- crease in market levels positively impacted the asset base of our wealth and asset management businesses, prompting fee-based revenues to rise. Trading and brokerage income also proﬁted from the improved market environment that boosted institutional and private client transaction activity. Private equity made a positive contribution, reﬂecting lower writedowns and higher divestment gains. We also recorded higher credit loss recoveries in 2004. The overall rise in 2004’s revenues, however, was partially offset by the weakening of the US dollar against the Swiss franc. Net interest income was CHF 11,860 million in 2004, down from CHF 12,299 million in the same period a year earlier. Net trading income was CHF 4,972 million, up from CHF 3,756 million in 2003. As well as 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 dividend income). This component is volatile from period to period, depending on the composition of the trading port- folio. In order to provide a better explanation of the movements in net interest 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. At CHF 5,139 million, net income from interest margin products in 2004 was 1% higher than CHF 5,077 million a year earlier. The increase was driven by the growth in lending to wealthy US clients through our US bank, UBS Bank USA. Our domestic Swiss mortgage business and wealth manage- ment margin lending business also grew over the year. This increase was nearly offset by lower income from our shrink- ing Swiss recovery portfolio, which dropped by CHF 2.0 bil- lion compared to year-end 2003, reduced interest margin on client cash and savings accounts, as well as declining revenues from US dollar-denominated accounts. Net income from trading activities was CHF 11,102 million in 2004, up by 4% or CHF 421 million from CHF 10,681 mil- lion a year ago. At CHF 3,098 million, equities trading income in 2004 was up 27% or CHF 653 million from CHF 2,445 mil- lion in 2003. The increase reﬂects expansion in market volumes and, hence, improved trading opportunities, especially during the particularly strong ﬁrst quarter and after the US elections in November. Our proprietary trading strategies performed well. Equity ﬁnance revenues increased strongly, reﬂecting the successful integration of ABN Amro’s prime brokerage busi- ness. Fixed income trading revenues, at CHF 6,264 million in 2004, were down 3% from CHF 6,474 million in 2003. The drop was driven by declines in our principal ﬁnance, commer- cial real estate and ﬁxed income businesses, partially offset by improved revenues in our rates business. Compared to 2003, last year’s market environment saw rising interest rates and lower volatility, which drove activity from the market. We re- corded an unrealized loss of CHF 62 million relating to Credit Default Swaps (CDSs) hedging existing credit exposure in the loan book, against a mark to market loss of CHF 678 million a year earlier. Foreign exchange trading revenues increased by 2% to CHF 1,467 million in 2004 from CHF 1,436 million a year earlier, reﬂecting an outstanding performance in our derivative trading business as well as strong sales volumes. At CHF 1,298 million, net income from treasury activities in 2004 was CHF 119 million or 8% lower than CHF 1,417 million in 2003. The drop was mainly due to lower returns on invested equity as we continued to repurchase shares. The impact of falling interest rates was partially offset by the diversiﬁcation of our invested equity into currencies other than the Swiss franc. Net interest and trading income CHF million Net interest income Net trading income Total net interest and trading income Breakdown by business activity CHF million Net income from interest margin products Equities Fixed income Foreign exchange Other Net income from trading activities Net income from treasury activities Other 1 Total net interest and trading income 1 Includes external funding costs of the PaineWebber Group, Inc. acquisition. For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 11,860 4,972 16,832 12,299 3,756 16,055 10,546 5,451 15,997 (4 ) 32 5 For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 5,139 3,098 6,264 1,467 273 11,102 1,298 (707) 16,832 5,077 2,445 6,474 1,436 326 10,681 1,417 (1,120 ) 16,055 5,275 2,777 5,977 1,506 245 10,505 1,646 (1,429 ) 15,997 1 27 (3 ) 2 (16 ) 4 (8 ) 37 5 25 Financial Businesses Results Credit loss (expense) / recovery CHF million Wealth Management & Business Banking Wealth Management Business Banking Switzerland Investment Bank Wealth Management USA Corporate Center Private Banks & GAM Corporate Functions UBS For the year ended 31.12.04 31.12.03 31.12.02 91 (1) 92 240 3 (58) (58) 0 276 (67 ) 4 (71 ) (4 ) (3 ) 2 2 0 (72 ) (238 ) 1 (239 ) 126 (15 ) 12 (3 ) 15 (115 ) Other net trading and interest income was negative CHF 707 million in 2004 compared to negative CHF 1,120 million a year earlier. The improvement was due to lower goodwill funding costs, as well as declining costs for funding our pri- vate equity portfolio. In 2004, we experienced a net credit loss recovery of CHF 276 million, compared to net credit loss expense of CHF 72 million in 2003 and CHF 115 million in 2002. This favor- able result was achieved in a period which saw a very sanguine environment for credit markets globally. Economic expansion in the US provided a strong stimulus for growth worldwide. Almost without exception, credit spreads contracted in all the major developed and emerging capital markets, as healthy expansion of cash ﬂows allowed the corporate sector to de- leverage and build liquidity. Net credit loss recovery at Wealth Management & Business Banking amounted to CHF 91 million in 2004 compared to net credit loss expenses of CHF 67 million in 2003 and CHF 238 million in 2002. Our domestic credit portfolio demon- strated strong resilience in a Swiss economic environment which saw a 9.2% increase in corporate bankruptcies com- pared to 2003. The measures taken in recent years to improve the quality of our credit portfolio have resulted in lower levels of new defaults and our success in managing the impaired portfolio has resulted in a higher than anticipated level of recoveries. The Investment Bank experienced a net credit loss recov- ery of CHF 240 million in 2004, compared to net credit loss expense of CHF 4 million in 2003 and credit loss recovery of CHF 126 million in 2002. This continued strong performance was the result of minimal exposure to new defaults and strong recoveries of previously established allowances and provi- sions. Releases in country allowances and provisions were due partly to exposure reductions in the affected countries and partly to a more favorable outlook for emerging market economies. There was also a partial release of a sizeable allowance for a corporate counterparty which managed a turnaround during 2004. For further details on our risk management approach, how we measure credit risk and the development of our credit risk exposures, please see the “Financial Management” chapter of our Handbook 2004/2005. In 2004, net fee and commission income was CHF 19,416 million, up 12% from CHF 17,345 million a year earlier. The increase was driven by a strong contribution from recurring asset-based fees, higher net brokerage fees, rising corporate finance fees as well as an increase in underwriting fees. Underwriting fees, at their highest level ever, were CHF 2,544 million in 2004, up 8% from CHF 2,354 million in 2003. Both equity and fixed income underwriting fees increased. Fixed income underwriting was CHF 1,114 million in 2004, up 3% from CHF 1,084 million in 2003. Equity underwriting increased 13% to CHF 1,430 million in the same period. At CHF 1,078 million, corporate ﬁnance fees in 2004 were up 42% from CHF 761 million a year earlier. We were able to beneﬁt from the pick-up in merger and acqui- sition activity, and our strengthened advisory business, par- ticularly in the US. Net brokerage fees were CHF 4,517 mil- lion in 2004, up 10% or CHF 392 million from CHF 4,125 million in 2003, reﬂecting the improved markets and the re- sulting higher institutional and individual client activity – es- pecially in the ﬁrst and fourth quarters of 2004. Investment fund fees, at their highest level ever, were CHF 4,588 million in 2004, up 18% from CHF 3,895 million in 2003, mainly reﬂecting higher asset-based fees for our wealth and asset management businesses. At CHF 1,261 million, custodian fees in 2004 were up 5% from CHF 1,201 million in 2003. This increase was entirely due to an enlarged asset base. In- surance-related and other fees, at CHF 342 million in 2004, decreased by 4% from a year earlier. Excluding the effect of the weakening dollar, insurance-related and other fees were actually slightly higher compared to 2003. Credit-related fees and commissions increased by 7% to CHF 266 million in 2004 from CHF 249 million in 2003, reﬂecting improved market conditions which brought higher volumes. Portfolio and other management and advisory fees increased by 20% to CHF 4,611 million in 2004 from CHF 3,855 million in 2003. The increase is again the result of rising invested asset levels driven by market valuations and strong net new money inﬂows, as well as an increase in performance fees. 26 Net fee and commission income CHF million Equity underwriting fees Bond underwriting fees Total 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 Net fee and commission income For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 1,430 1,114 2,544 1,078 5,916 4,588 220 1,261 4,611 342 20,560 266 988 21,814 1,399 999 2,398 19,416 1,270 1,084 2,354 761 5,608 3,895 241 1,201 3,855 355 18,270 249 1,087 19,606 1,483 778 2,261 17,345 1,166 968 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 18,221 13 3 8 42 5 18 (9 ) 5 20 (4 ) 13 7 (9 ) 11 (6 ) 28 6 12 Other income increased by 90% to CHF 878 million in 2004 from CHF 462 million in 2003. The increase was driven by high- er disposal gains from private equity investments (up CHF 205 million) and lower impairment charges (down CHF 318 million). This was partially offset by lower gains from the divestment of associates and subsidiaries which dropped by nearly 50% to CHF 84 million in 2004 (the major disposal being the Noga Hilton hotel in Geneva) from CHF 162 million in 2003 (the ma- jor disposal being Correspondent Services Corporation (CSC)). Operating expenses We continue to tightly manage our cost base with a clear focus on improving the efﬁciency of our businesses. Total operating expenses increased by 5% to CHF 26,935 million in 2004 from CHF 25,613 million in 2003. Personnel expenses increased by CHF 958 million or 6% to CHF 18,189 million in 2004 from CHF 17,231 million in 2003. The rise was driven by higher performance-related compensation reﬂecting the better performance in most of our businesses. Personnel expenses are managed on a full-year basis with ﬁnal ﬁxing of annual performance-related payments in fourth quarter. Salary expenses rose due to the 2% increase in headcount over the year. Contractor’s expenses increased to CHF 572 million in 2004, up 6% from CHF 539 million in 2003, reﬂecting higher usage, mainly in our Investment Bank in support of increased business ﬂows. At CHF 1,299 million in 2004, other personnel expenses dropped CHF 271 million from CHF 1,570 million in 2003 due to the end of retention payments in the Wealth Management USA business and lower severance payments. For 2004, approximately 49% of personnel expenses took the form of bonus or variable com- pensation, up from 44% in 2003. Average variable compen- sation per head in 2004 was 17% higher than in 2003. At CHF 6,577 million in 2004, general and administrative expenses increased CHF 491 million from CHF 6,086 million in the same period a year ago. The increase was driven by higher provisions (up CHF 252 million) which rose due to speciﬁc operational and legal provisions (including the civil penalty levied by the Federal Reserve Board relating to our banknote trading business), higher IT and other outsourcing expenses as well as professional fees, the latter due to higher legal and project costs. This was partially offset by savings in telecommunication, rent and maintenance expenses. Depreciation was CHF 1,282 million in 2004, down 5% from CHF 1,353 million in 2003. This was the lowest level ever, reﬂecting falling IT-related charges as well as lower write- downs of equipment. At CHF 887 million, amortization of goodwill and other intangible assets was down 6% from CHF 943 million a year earlier, reﬂecting lower amortization charges and the weak- ening of the US dollar against the Swiss franc. Tax In 2004, we incurred a tax expense of CHF 2,086 million, re- ﬂecting an effective tax rate of 19.9% for full-year 2004, com- pared to last year’s full-year rate of 17.9% (before signiﬁcant ﬁnancial events). The 2003 tax rate was positively inﬂuenced by a favorable regional proﬁt mix. The higher rate for 2004 has been driven by an increase in proﬁtability in higher tax jurisdictions, mainly the US. We believe that a similar under- lying tax rate is a reasonable indicator for 2005. 27 Financial Businesses Results Indicative pre-goodwill tax rates for ﬁnancial businesses in % Wealth Management & Business Banking Wealth Management Business Banking Switzerland Global Asset Management Investment Bank Wealth Management USA For the year ended 31.12.04 31.12.03 31.12.02 18 18 19 21 30 37 18 16 20 20 32 38 19 18 20 22 38 37 Business Group tax rates Indicative Business Group and business unit tax rates are cal- culated on an annual basis based on the results and statuto- ry tax rates of the ﬁnancial year. These rates are approximate calculations, based upon the application to the year’s adjust- ed earnings of statutory tax rates for the locations in which the Business Groups operated. These tax rates, therefore, give guidance on the tax cost to each Business Group of do- ing business during 2004 on a stand-alone basis, without the beneﬁt of tax losses brought forward from earlier years. 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, calculated on the above basis, divided by the total net proﬁt before tax and goodwill. 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 necessarily indica- tive of future tax rates for the businesses or UBS as a whole. Headcount Headcount in our ﬁnancial businesses was 67,424 on 31 De- cember 2004, up 1,495 from 65,929 on 31 December 2003. The increase was driven by the expansion of UBS’s wealth management and securities businesses around the globe. Fair value disclosure of options (pre-tax: CHF 576 million) in the same period a year ago. The after-tax increase was driven by a higher UBS share price, a lower pro-forma tax beneﬁt, and adjusted assumptions for the valuation of options. In fact, signiﬁcantly fewer option grants were made in 2004 (down nearly 40% from 2003), in line with our strategy of granting options more selectively. Our option valuation model will change for 2005 due to work we are undertaking in connection with the implemen- tation of the new IFRS 2 standard. For further details, please refer to page 12. Outlook A record result is always challenging to beat. As every year, our investment banking and securities business will have to contend with the somewhat unpredictable rise and fall of the world’s ﬁnancial markets. But 2004 showed that our wealth and asset Headcount (in FTE)1: regional distribution in %, except where indicated As at 31.12.02 31.12.03 31.12.04 Total1: 69,061 5.4 65,929 5.8 67,424 6.6 39.6 14.5 40.5 38.7 15.0 40.5 38.9 16.0 38.5 100 75 50 25 0 The fair value of options granted in 2004 was CHF 508 mil- lion (pre-tax: CHF 543 million) compared to CHF 439 million Switzerland Europe (excluding Switzerland) Americas Asia Pacific 1 Total full-time equivalents (FTE). Headcount ﬁnancial businesses Full-time equivalents Switzerland Rest of Europe / Africa / Middle East Americas Asia Paciﬁc Total 28 31.12.04 25,990 10,764 26,232 4,438 67,424 As at 31.12.03 26,662 9,906 25,511 3,850 65,929 % change from 31.12.02 31.12.03 27,972 10,009 27,350 3,730 69,061 (3 ) 9 3 15 2 Headcount (in FTE1): Business Unit distribution in %, except where indicated As at 31.12.02 31.12.03 31.12.04 Total1: 69,061 65,929 67,424 5.1 2.4 3.9 5.4 2.5 4.0 5.3 2.4 3.9 13.6 22.9 24.6 27.5 13.9 23.2 24.5 26.5 15.0 24.6 23.0 25.8 100 75 50 25 0 Wealth Management USA Business Banking Switzerland Investment Bank Wealth Management Global Asset Management Private Banks & GAM Corporate Functions 1 Total full-time equivalents (FTE). management businesses can provide both growth momentum and earnings quality, even if trading conditions ﬂuctuate. We will continue re-investing in our growth businesses and expect 2005 to be the next exciting step on a journey we believe will be very rewarding for our long-term investors. 2003 Results In 2003, all businesses reported stronger results compared to 2002. Our net proﬁt in full-year 2003 was CHF 6,239 million, up from CHF 3,530 million in 2002 – an increase of 77%. In 2002, our results were negatively inﬂuenced by the CHF 953 million writedown of the value of the PaineWebber brand. At the same time, they beneﬁted from the sale of private bank Hy- poswiss, which resulted in a net gain of CHF 125 million, and the divestment of Klinik Hirslanden, a private hospital group, which contributed a net gain of CHF 60 million. Excluding these items and before the amortization of goodwill and other intan- gibles, net proﬁt increased 30% between 2002 and 2003. The gain reﬂected our tight management of costs and ability to build market share and capture revenues as ﬁnancial markets steadi- ly recovered as the year progressed. In particular, asset-based revenues recovered from the lows posted in 2002. Our result was further helped by much improved trading opportunities, a gradual improvement in investor sentiment and signiﬁcantly lower writedowns in our private equity business. At the same time, expenses remained under tight control. We recorded re- ductions in all cost categories compared to 2002, with non-per- sonnel expenses falling below their level in 2000. Operating income Total operating income, at CHF 33,790 million in 2003, was down slightly from CHF 34,107 million in 2002. Excluding the divestment gains of CHF 227 million from the sale of Hypo- swiss and Klinik Hirslanden in 2002 and CHF 161 million from the sale of Correspondent Services Corporation in 2003, to- tal operating income fell 1%. The drop was caused by lower asset-based revenues, which were impacted by low market levels in early 2003 (they only started to recover in second half). Operating income was also affected by the weakening of major currencies against the Swiss franc, including the 13% drop of the US dollar. This was partially offset by higher rev- enue from ﬁxed income trading and a signiﬁcant decline in private equity writedowns. Net interest income, at CHF 12,299 million in 2003, was 17% higher than the CHF 10,546 million in 2002. Net trad- ing income, at CHF 3,756 million in 2003, declined 31% from CHF 5,451 million a year earlier. Net income from interest margin products dropped 4% to CHF 5,077 million in 2003 from CHF 5,275 million in 2002. The result reﬂected lower interest margins on client savings and cash accounts, and declining revenues from our dimin- ishing recovery portfolio in Switzerland as well as lower inter- est revenue on margin loans in the US as we sold our Cor- respondent Services Corporation (CSC) clearing business. These effects were partially offset by higher mortgages and saving accounts volumes in Switzerland. In 2003, net income from trading activities, at CHF 10,681 million, rose 2% from CHF 10,505 million a year earlier. Equity trading income, at CHF 2,445 million, fell 12% from CHF 2,777 million a year earlier. The drop reflected the weakening of most major currencies against the Swiss franc. Excluding currency fluctuations, equity trading revenues increased as the business beneﬁted from improved trading opportunities following the strong market recovery. Fixed income trading revenue was CHF 6,474 million in 2003, up 8% from CHF 5,977 million in the same period a year earlier. This increase was due to better performances across our businesses, with very strong revenues in our principal finance, mortgage-backed securities and derivatives busi- nesses. However, results were also affected by the US dollar’s decline against the Swiss franc and negative revenues of CHF 678 million relating to Credit Default Swaps (CDSs) hedging existing credit exposure in the loan book. In 2002, we record- ed a mark to market gain of CHF 226 million on these CDS positions. Our use of CDSs as hedging instruments for our loan book is only one part of our overall management ap- proach to trading credit risk. Over the full year, foreign exchange trading revenues, at CHF 1,436 million, were slightly lower than CHF 1,506 million in 2002. Net income from treasury activities, at CHF 1,417 million in 2003, was down 14% from CHF 1,646 million a year earlier. The drop mainly reﬂected lower income from our invested equity as we continued to buy back shares, as well as a further decline in interest rates. The impact of falling interest rates was partially offset by the diversiﬁcation of our invested equity into currencies other than Swiss francs. 29 Financial Businesses Results In 2003, other net trading and interest income showed negative revenues of CHF 1,120 million compared to negative CHF 1,429 million a year earlier. The improvement was mainly due to lower goodwill funding costs related to the writedown of the value of the PaineWebber brand, and lower funding needs for our private equity portfolio. Total credit loss expense for UBS in 2003 amounted to CHF 72 million, compared to CHF 115 million in 2002. Net credit loss expense at Wealth Management & Business Bank- ing amounted to CHF 67 million compared to CHF 238 mil- lion in 2002. This exceptionally strong result was achieved de- spite the negative impact of the Erb Group, a privately held Swiss conglomerate which defaulted in fourth quarter 2003. Our domestic credit portfolio demonstrated strong resilience in a Swiss economic environment which saw an increase in the number of corporate bankruptcies by 13.4% compared to 2002. Measures taken in recent years to improve the qual- ity of our credit portfolio resulted in lower levels of new de- faults, and our success in managing the impaired portfolio resulted in a higher than anticipated level of recoveries. Be- cause of the improving economic and political environment in some emerging markets, we released country allowances relating to our correspondent banking business. Outside Switzerland, the global credit environment gradually im- proved during 2003, especially in the second half of the year, reversing the downward trend observed in the previous two years. Although some concerns regarding sustainability remained, signs pointing to a global economic recovery increased. The Investment Bank experienced net credit loss expense of CHF 4 million, compared to net credit loss recoveries of CHF 126 million in 2002 and credit loss expense of CHF 187 million in 2001. This continued strong perform- ance was the result of minimal exposures to new defaults plus the recovery of country provisions consistent with the more favorable outlook for emerging market economies. At CHF 17,345 million, net fee and commission income in 2003 was 5% lower than CHF 18,221 million in 2002. The drop was mainly due to the weakening of the US dollar and other major currencies against the Swiss franc. Excluding currency effects, net fee and commission income actually increased, with a record result in our underwriting activities. However, our asset-based revenues suffered from the low market levels in early 2003 and only started to recover in second half. Further, our brokerage revenues only started to rebound as the year progressed, following the gradual rise in market activity levels. Underwriting fees, at their highest level ever, increased 10% from CHF 2,134 million in 2002 to CHF 2,354 million in 2003. Fixed income and equities underwriting revenues increased by 12% and 9%, respec- tively, compared to a year earlier, reflecting the improved market conditions. Corporate finance fees dropped by 10% to CHF 761 million in 2003 from CHF 848 million in 2002, reflecting lower market activity and a drop in overall size of the global fee pool for mergers and acquisitions, although we were able to again improve our market share. Net bro- kerage fees dropped 11% to CHF 4,125 million in 2003 from CHF 4,638 million in 2002. The drop reflects the weaken- ing of the US dollar against the Swiss franc as well as low- er client activity, which only recovered in the second half of the year as market activity levels started to improve. The result was further impacted by the sale of our Correspon- dent Service Corporation (CSC) business. Investment fund fees dropped just 3% to CHF 3,895 million in 2003 from CHF 4,033 million in 2002, reflecting lower asset-based fees. This was partially offset by higher revenues due to the expansion of our alternative and quantitative investment business. Custodian fees, at CHF 1,201 million in 2003, were down 8% from CHF 1,302 million in 2002, principally due to low- er market values and, consequently, average asset levels. Portfolio and other management and advisory fees, at CHF 3,855 million in 2003, fell 5% from CHF 4,065 million in 2002. They mostly reflected the drop of the US dollar against the Swiss franc as well as declining management fees from the low market levels at the outset of the year. This was par- tially offset by higher performance fees. At CHF 355 million in 2003, insurance-related and other fees decreased 15% from a year earlier, mainly reflecting the weakening of the US dollar. Other income was CHF 462 million in 2003 compared with CHF 4 million a year earlier. The increase was mainly due to a drop in private equity impairment charges, as well as higher disposal gains from our private equity investments. This was partially offset by a reduction in divestment gains from other ﬁnancial investments as well as a decline in gains from dis- posals of associates and subsidiaries and a fall-off in income from Klinik Hirslanden. Operating expenses In 2003, we continued to manage our cost base tightly. Strong cost control measures remained in place and we further streamlined processes and structures across the ﬁrm. Total operating expenses fell below their level in 2000. In full-year 2003, they were CHF 25,613 million, down 13% from CHF 29,570 million a year earlier. The drop was inﬂuenced by the writedown of the value of the PaineWebber brand in fourth quarter 2002, which resulted in an amortization expense of CHF 1,234 million. Excluding the writedown, expenses de- clined 10%, with drops recorded in all categories of costs. General and administrative expenses fell 14%, reﬂecting our continuous cost-cutting initiatives, while personnel expenses dropped by 7%. The weakening of the US dollar against the Swiss franc and last year’s sale of Klinik Hirslanden helped expenses to decline. Personnel expenses dropped by 7% to CHF 17,231 million in 2003 from CHF 18,524 million in 2002. The drop was mainly due to the weakening of the US dollar against the Swiss franc. Salary expenses fell due to the 5% reduction in head- count over the period. Lower contractor’s expenses and reten- 30 tion payments accentuated the drop. This was partially offset by higher performance-related compensation expenses that increased in line with our improving revenue, as well as slightly higher contributions to retirement plans. Personnel expenses are managed on a full-year basis with ﬁnal ﬁxing of annual performance-related payments in fourth quarter. Over the full year, approximately 44% of this year’s personnel expense was paid as bonus or other variable compensation, up from 42% last year. In full-year 2003, general and administrative expenses, at CHF 6,086 million, were down 14% from CHF 7,072 million a year earlier. Strict cost control in all our businesses led to a drop in nearly all cost categories. The biggest falls were in over- all provisions, with major declines in legal and security pro- visions (the 2002 result included the global charge of CHF 111 million (USD 80 million) related to the US equity research settlement). Administration, IT and telecommunication ex- penses saw signiﬁcant drops from our continued cost-saving initiatives, partially offset by slightly higher rent and mainte- nance expenses as well as professional fees, the latter due to higher project-related costs. At CHF 1,353 million in 2003, depreciation fell 11% from 1,514 million in 2002, mainly due to lower IT-related charges, as well as the weakening of the US dollar against the Swiss franc. Amortization of goodwill and other intangible assets de- creased from CHF 2,460 million in 2002 to CHF 943 million in 2003. The main reason for the drop was the writedown of the value of the PaineWebber brand name. Excluding that charge, the drop would have been 23%, reﬂecting the full amortization of some businesses, as well as the strengthen- ing of the Swiss franc against the US dollar. Tax We incurred a tax expense of CHF 1,593 million in 2003, up from CHF 676 million in 2002. This corresponded to an effective tax rate of 19.5% in 2003. Excluding the effect of the sale of CSC (sold in second quarter 2003), our effective tax rate for the full year was 17.9%, compared to 2002’s full- year rate of 16.5% (before signiﬁcant ﬁnancial events). The particularly low 2002 rate was driven by lower progressive tax rates in Switzerland, the ability to beneﬁt from tax losses in the US and UK and a high proportion of earnings generated in lower tax jurisdictions. The 2003 tax rate was positively inﬂuenced by a continued favorable regional proﬁt mix and the successful conclusion of tax audits. 31 Financial Businesses Wealth Management & Business Banking Wealth Management & Business Banking In 2004, Wealth Management’s pre-tax proﬁt was CHF 3,435 million, a 32% increase from 2003. Strong inﬂows from most markets resulted in net new money rising to CHF 42.3 billion from CHF 29.7 billion a year earlier. Business Banking Switzerland’s 2004 pre-tax proﬁt fell 5% to CHF 2,045 million, reﬂecting lower interest income. Business Group reporting CHF million, except where indicated Income Adjusted expected credit loss 1 Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and amortization of goodwill and other intangible assets Additional information Regulatory equity allocated (average) Cost / income ratio (%) 2 Cost / income ratio before goodwill (%) 3 Fair value of employee stock options granted 4 31.12.04 12,764 (33) 12,731 4,473 1,706 862 135 75 7,251 5,480 5,555 9,400 56.8 56.2 127 For the year ended 31.12.03 12,044 (131 ) 11,913 4,350 1,694 870 170 75 7,159 4,754 4,829 8,750 59.4 58.8 64 31.12.02 12,184 (312 ) 11,872 4,338 1,922 837 198 97 7,392 4,480 4,577 8,600 60.7 59.9 92 % change from 31.12.03 6 75 7 3 1 (1 ) (21 ) 0 1 15 15 7 98 1 In management accounts, adjusted expected credit loss rather than credit loss expense is reported for the Business Groups (see note 2 to the ﬁnancial statements). 3 Operating expenses less the amortization of goodwill and other intangible assets / income. For details on the fair value calculation, refer to note 32e to the ﬁnancial statements. 2 Operating expenses / income. 4 For informational purposes only. These pre-tax amounts have not been recorded in the income statement. Marcel Rohner | Chairman & CEO Wealth Management & Business Banking 32 Wealth Management Business Unit reporting CHF million, except where indicated Income Adjusted expected credit loss 1 Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Unit performance before tax Business Unit performance before tax and amortization of goodwill and other intangible assets KPIs Invested assets (CHF billion) Net new money (CHF billion) 2 Gross margin on invested assets (bps) 3 Cost / income ratio (%) 4 Cost / income ratio before goodwill (%) 5 Cost / income ratio before goodwill and excluding the European wealth management business (%) 6 Client advisors (full-time equivalents) International clients Income Invested assets (CHF billion) Net new money (CHF billion) 2 Gross margin on invested assets (bps) 3 European wealth management (part of international clients) Income Invested assets (CHF billion) Net new money (CHF billion) 2 Client advisors (full-time equivalents) Swiss clients Income Invested assets (CHF billion) Net new money (CHF billion) 2 Gross margin on invested assets (bps) 3 Additional information Client assets (CHF billion) Regulatory equity allocated (average) Fair value of employee stock options granted 7 Headcount (full-time equivalents) For the year ended % change from 31.12.04 7,701 (8) 31.12.03 6,797 (4 ) 7,693 2,080 642 1,395 66 75 4,258 3,435 3,510 778 42.3 103 55.3 54.3 46.6 3,744 5,429 562 40.4 102 437 82 13.7 838 2,272 216 1.9 106 6,793 1,944 604 1,479 82 75 4,184 2,609 2,684 701 29.7 101 61.6 60.5 52.1 3,300 4,734 491 29.7 101 267 46 10.8 672 2,063 210 0.0 102 31.12.02 31.12.03 6,690 (26 ) 6,664 1,869 617 1,475 93 97 4,151 2,513 2,610 642 17.7 97 62.0 60.6 53.3 3,001 4,640 447 20.2 98 186 28 7.6 551 2,050 195 (2.5 ) 95 13 (100 ) 13 7 6 (6 ) (20 ) 0 2 32 31 11 2 13 15 14 1 64 78 25 10 3 4 As at or for the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 972 3,150 81 10,093 884 2,650 37 9,176 788 2,900 54 9,399 10 19 119 10 1 In management accounts, adjusted expected credit loss rather than credit loss expense is reported for the Business Groups (see note 2 to the ﬁnancial statements). income. the amortization of goodwill and other intangible assets and expenses for the European wealth management business / income less income for the European wealth management business. 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 Operating expenses less the amortization of goodwill and other intangible assets / income. 2 Excludes interest and dividend 6 Operating expenses less 7 For 3 Income / average invested assets. 4 Operating expenses / income. 33 Financial Businesses Wealth Management & Business Banking Components of operating income Wealth Management derives its operating income principally from: – fees for ﬁnancial planning and wealth management services; – fees for investment management services; – transaction-related fees; and – net interest income. Wealth Management’s fees are based on the market value of invested assets and the level of transaction-related activity. As a result, operat- ing income is affected by factors such as ﬂuctuations in invested assets, changes in market conditions, investment performance and inﬂows and outﬂows of client funds. Signiﬁcant ﬁnancial events Invested assets CHF billion There were no signiﬁcant ﬁnancial events that affected this business unit in 2004, 2003 or 2002. 2004 Key performance indicators In 2004, net new money inﬂows totaled CHF 42.3 billion, up 42% from CHF 29.7 billion in 2003, representing an annual growth rate of 6% of the underlying invested asset base at end-2003. This excellent performance was driven by gains in all geographical areas, especially from Asian clients, and a par- ticularly strong CHF 13.7 billion inﬂow into our European wealth management business. Net new money CHF billion 2002 2003 2004 42.3 29.7 17.7 48 36 24 12 0 Invested assets, at CHF 778 billion on 31 December 2004, were up 11% from CHF 701 billion a year earlier, mainly reﬂect- ing the strong inﬂow of net new money and CHF 22.6 billion in new assets gained from acquisitions we integrated in 2004. Rising equity markets also had a positive impact on asset lev- els, helping to compensate for the negative effect of the US dol- lar’s weakening against the Swiss franc. 35% of invested assets were denominated in US dollars at the end of 2004. The gross margin on invested assets was 103 basis points in 2004, up 2 basis points from 101 basis points a year earlier, as revenues increased more than the average asset base. Overall, recurring income made up 76 basis points of the margin in 2004, up from 71 basis points in 2003. Non- recurring income comprised 27 basis points of the margin in 2004, against 30 basis points in 2003. 34 31.12.02 31.12.03 31.12.04 195 447 210 491 216 562 800 600 400 200 0 International Clients Swiss Clients Gross margin on invested assets bps 2002 2003 2004 97 101 103 110 95 80 65 50 The pre-goodwill cost / income ratio improved to 54.3% in 2004 from 60.5% a year earlier, reﬂecting the strong rise in total operating income, which more than offset the gain in performance-related compensation. Excluding the European Cost / income ratio in % 2002 2003 2004 62.0 60.6 61.6 60.5 55.3 54.3 65 60 55 50 45 As reported Adjusted for goodwill and significant financial events wealth management business, the 2004 cost / income ratio fell to 46.6% from 52.1% a year earlier. European wealth management Our European wealth management business continued to make signiﬁcant progress. With a particularly good performance in the UK and Germany, the inﬂow of net new money in 2004 was CHF 13.7 billion, up 27% from the previous year’s intake of CHF 10.8 billion. The result reﬂects an annual net new money in- ﬂow rate of 30% of the underlying asset base at year-end 2003. Net new money European wealth management CHF billion 2002 2003 2004 16 12 8 4 0 13.7 10.8 7.6 The level of invested assets was a record CHF 82 billion on 31 December 2004, almost double the CHF 46 billion a year earlier, with the gain reﬂecting healthy inﬂows of net new mon- ey, and the integration of acquisitions made during the year. Invested assets European wealth management CHF billion 31.12.02 31.12.03 31.12.04 100 75 50 25 0 82 46 28 In 2004, income from our European wealth management business was CHF 437 million, up 64% from a year earlier, reﬂecting our growing asset and client base. In 2004, the number of client advisors increased by 166, including 144 client advisors who joined us through the var- ious acquisitions made during the year. Results In 2004, pre-tax proﬁt, at CHF 3,435 million, was up 32% from 2003. This increase reﬂects the recovery in major ﬁnan- cial markets that started in mid-2003, driving a 13% increase in revenues through higher asset-based fees. Rising interest income, a reﬂection of the expansion of our margin lending activities, also bolstered revenues. At the same time, our expenses, up 2% in 2004 from 2003, were kept under tight control. Personnel expenses, up 7%, rose at a slower pace than income. 2004 3,435 Performance before tax CHF million 2002 2003 2,513 2,609 3,600 2,700 1,800 900 0 Operating income Total operating income in 2004 was CHF 7,693 million, up 13% from CHF 6,793 million a year earlier. This was the highest level ever, reﬂecting a rise in recurring as well as in non-recurring revenues. Recurring income increased 19% on rising asset-based fees, beneﬁting from gains in asset levels. This was accentuated by higher interest income due to the expansion of our margin lending activities. Non-recurring in- come rose due to higher brokerage fees, reﬂecting an increase in client activity levels, which were particularly strong in the ﬁrst and fourth quarters of the year. These positive effects were somewhat offset by the weakening of the US dollar against the Swiss franc as well as lower divestment gains (in 2003 we sold a stake in Deutsche Börse). Operating expenses At CHF 4,258 million, operating expenses in 2004 were up 2% from CHF 4,184 million a year earlier, reﬂecting higher personnel expenses as well as the ongoing investment in our growth initiatives. Personnel expenses rose 7% to CHF 2,080 million in 2004 compared to CHF 1,944 million a year earlier, reﬂecting higher performance-related compensation as well as an increase in salaries due to the expansion of our business. General and administrative expenses, at CHF 642 million, were up 6% in 2004 from CHF 604 million due to higher legal and operational provisions, an increase in travel and entertainment expenses as well as a rise in marketing costs. Expenses for services from other business units, at CHF 1,395 million in 2004, were down 6% from CHF 1,479 million the previous year, mainly due to lower charges for insurance and IT services. Depreciation was CHF 66 million in 2004, down 20% from CHF 82 million a year earlier because of lower charges for information technology equipment. Goodwill 35 Financial Businesses Wealth Management & Business Banking amortization was CHF 75 million in 2004, unchanged from the previous year. from rising personnel expenses. Excluding the European wealth management business, the cost / income ratio fell to 52.1% in 2003 from 53.3% a year earlier. Headcount Headcount, at 10,093 on 31 December 2004, increased by 917 from 31 December 2003. One of the major reasons lies in the integration of acquisitions we made last year, which added 379 employees. In 2004, the number of client advisors increased to 3,744, up 13% or 444 advisors from a year earlier. 31.12.02 31.12.03 31.12.04 9,399 9,176 10,093 Headcount full-time equivalents 11,000 10,000 9,000 8,000 7,000 2003 European wealth management Our European wealth management business continued to make signiﬁcant progress. After three years of intense effort, the total level of invested assets in Germany, France, the UK, Spain and Italy reached CHF 46 billion. With a particularly good performance in the UK and Germany, the inﬂow of net new money in 2003 was CHF 10.8 billion, up 42% from the year-earlier intake of CHF 7.6 billion. The result reflects an annual net new money inﬂow rate of 39% of the underlying asset base. The level of invested assets reached a record CHF 46 billion on 31 December 2003, up from CHF 28 billion a year earlier, reﬂecting healthy inﬂows of net new money, our acquisition of the French business of Lloyds TSB, and positive markets. In 2003, income from our European wealth management business was CHF 267 million, up 44% or CHF 81 million from a year earlier, reﬂecting the growing asset and client base. The number of client advisors increased by 121 (including 21 client advisors from the French business of Lloyds TSB), bringing the total on 31 December 2003 to 672. Key performance indicators Results In 2003, net new money inﬂows totaled CHF 29.7 billion, up 68% from CHF 17.7 billion in 2002. The excellent per- formance was due to strong inﬂows into our European wealth management business as well as signiﬁcant inﬂows from clients in Asia and Eastern Europe. Invested assets, at CHF 701 billion on 31 December 2003, were up 9% from CHF 642 billion a year earlier, mainly due to the recovery in global equity markets during the second half of the year, as well as the strong inflows of net new money. That more than compensated for the 10% fall in the US dollar against the Swiss franc over 2003, which had a di- rect impact on the value of Wealth Management’s invested assets, 37% of which were denominated in US dollars at end-2003. The average asset base in 2003 was lower in comparison to 2002 as asset levels were unusually depressed at the be- ginning of the year. In contrast, revenues increased due to higher non-recurring income, which was positively inﬂuenced by higher trading and brokerage income and a gain on dis- posal of our participation in Deutsche Börse. The gross margin on invested assets was 101 basis points in 2003, up 4 basis points from 97 basis points a year earlier. The pre-goodwill cost / income ratio declined to 60.5% in 2003 from 60.6% a year earlier, reﬂecting higher non- recurring revenues, more than offsetting the increased costs Wealth Management’s 2003 pre-tax proﬁt, at CHF 2,609 mil- lion, increased 4% from 2002 on the ﬁnancial market recov- ery in the second half of the year, which resulted in higher revenues. Operating income Total operating income in 2003 was CHF 6,793 million, up 2% from CHF 6,664 million in 2002. Recurring income decreased 2% on lower asset-based revenues, reﬂecting the lower av- erage asset base in 2003. Non-recurring income increased 11% on the Deutsche Börse disposal gain and as trading and brokerage revenues went up because of higher client activi- ty levels in the second half of the year. Operating expenses At CHF 4,184 million, operating expenses for 2003 were up 1% from CHF 4,151 million a year earlier, reﬂecting our invest- ments in the European wealth management business and higher personnel expenses. Personnel expenses rose 4% to CHF 1,944 million in 2003 compared to a year earlier, main- ly due to higher severance payments as well as slightly higher performance-related compensation. General and ad- ministrative expenses in 2003, at CHF 604 million, were down 2% as our ongoing tight management of costs more than offset the investments in our European wealth management business. Expenses for services from other business units 36 remained virtually unchanged at CHF 1,479 million in 2003 compared to CHF 1,475 million in 2002. Depreciation was CHF 82 million in 2003, down 12% from a year earlier be- cause of lower charges for information technology equip- ment, which is increasingly being leased instead of bought. Goodwill amortization was CHF 75 million in 2003, down 23% from 2002 mainly due to the weakening of the US dol- lar against the Swiss franc. Headcount Headcount, at 9,176 on 31 December 2003, decreased by 223 from 31 December 2002. Although we continued to hire client advisors, we reduced headcount in non-client facing areas as we further streamlined processes and structures. In 2003, the number of client advisors increased to 3,300, up 10% from a year earlier. 37 Financial Businesses Wealth Management & Business Banking Business Banking Switzerland Business Unit reporting CHF million, except where indicated Interest income Non-interest income Income Adjusted expected credit loss 1 Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Unit performance before tax Business Unit performance before tax and amortization of goodwill and other intangible assets KPIs Invested assets (CHF billion) Net new money (CHF billion) 2 Cost / income ratio (%) 3 Cost / income ratio before goodwill (%) 4 Non-performing loans / gross loans (%) Impaired loans / gross loans (%) Additional information Deferral (included in adjusted expected credit loss) Client assets (CHF billion) Regulatory equity allocated (average) Fair value of employee stock options granted 5 Headcount (full-time equivalents) For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 3,390 1,673 5,063 (25) 5,038 2,393 1,064 (533) 69 0 2,993 2,045 2,045 140 2.6 59.1 59.1 2.3 3.0 3,542 1,705 5,247 (127 ) 5,120 2,406 1,090 (609 ) 88 0 2,975 2,145 2,145 136 2.5 56.7 56.7 3.2 4.6 3,677 1,817 5,494 (286 ) 5,208 2,469 1,305 (638 ) 105 0 3,241 1,967 1,967 127 3.7 59.0 59.0 3.6 6.0 (4 ) (2 ) (4 ) 80 (2 ) (1 ) (2 ) 12 (22 ) 1 (5 ) (5 ) 3 As at or for the period ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 411 655 6,250 46 15,508 383 622 6,100 27 16,181 240 494 5,700 38 16,967 7 5 2 70 (4 ) 1 In management accounts, adjusted expected credit loss rather than credit loss expense is reported for the Business Groups (see note 2 to the ﬁnancial statements). income. not been recorded in the income statement. For details on the fair value calculation, refer to note 32e to the ﬁnancial statements. 4 Operating expenses less the amortization of goodwill and other intangible assets / income. 3 Operating expenses / income. 2 Excludes interest and dividend 5 For informational purposes only. These pre-tax amounts have Components of operating income Business Banking Switzerland derives its operating income principally from: – net interest income from its loan portfolio and customer deposits; – fees for investment management services; and – transaction fees. As a result, operating income is affected by movements in interest rates, ﬂuctuations in invested assets, client activity levels, investment performance, changes in market conditions and the credit environ- ment. 38 Signiﬁcant ﬁnancial events There were no signiﬁcant ﬁnancial events that affected this business unit in 2004, 2003 or 2002. 2004 Key performance indicators Net new money was CHF 2.6 billion in 2004, slightly higher than the inﬂow of CHF 2.5 billion in 2003. Invested assets rose to CHF 140 billion in 2004 from CHF 136 billion a year earlier as positive market developments and net new money inﬂows were only partially offset by the weak- ening of the US dollar against the Swiss franc and the trans- fer of assets to our Wealth Management business. During the course of 2004, we transferred CHF 7 billion in assets from the Business Banking Switzerland unit to the Wealth Manage- ment unit, reﬂecting the increasing needs of clients. The cost / income ratio was 59.1%, 2.4 percentage points above the ratio of 56.7% in 2003, reﬂecting falling interest income in the low interest rate environment. Cost / income ratio in % 2002 2003 2004 59.0 59.1 56.7 60 55 50 45 40 Business Banking Switzerland’s loan portfolio was CHF 137 billion on 31 December 2004, down CHF 2 billion from the previous year. An increase in volumes of private client mortgages was offset by lower credit demand from corporate Impaired loans / gross loans in % 31.12.02 31.12.03 31.12.04 8 6 4 2 0 6.0 4.6 3.0 clients and a further reduction in the recovery portfolio, which fell to CHF 4.4 billion on 31 December 2004 from CHF 6.4 billion a year earlier. This positive development was also re- ﬂected in the key credit quality ratios: the non-performing loan ratio improved to 2.3% from 3.2%, while the ratio of impaired loans to gross loans was 3.0% compared to 4.6% in 2003. Results Pre-tax proﬁt in 2004 was CHF 2,045 million, only CHF 100 million or 5% lower than the record result achieved in 2003. It was achieved despite a CHF 184 million fall in income, driv- en mainly by lower interest income. The result shows the continued tight management of our cost base, with lower credit loss expenses reﬂecting the structural improvement in our loan portfolio in recent years. In 2004, personnel ex- penses and depreciation reached their lowest levels since the UBS-SBC merger in 1998. Performance before tax CHF million 2002 2003 2004 2,145 2,045 1,967 2,250 2,000 1,750 1,500 1,250 Operating income Total operating income in 2004 was CHF 5,038 million, down slightly from 2003’s level of CHF 5,120 million. Interest income declined by 4% to CHF 3,390 million in 2004 from CHF 3,542 million in 2003. The decline reﬂects lower revenues from our reduced recovery portfolio, as well as lower interest margins on savings and cash accounts. This was partially offset by higher private client mortgage volumes. Non-interest income dropped by CHF 32 million to CHF 1,673 million in 2004 from CHF 1,705 million in 2003, reﬂecting lower client activity levels, partially offset by the gain from the sale of a partici- pation in the Noga Hilton hotel. Adjusted expected credit loss expenses, at CHF 25 million in 2004, decreased by 80% from CHF 127 million in 2003. This fall reﬂects the deferred bene- ﬁt of the structural improvement in our loan portfolio in re- cent years. Operating expenses Operating expenses in 2004 were CHF 2,993 million, up 1% from CHF 2,975 million in 2003. Personnel expenses, at CHF 2,393 million, were down 1% from CHF 2,406 million in 2003, as falling salary costs reﬂected the 4% drop in head- 39 Financial Businesses Wealth Management & Business Banking count, partly offset by an increase in performance-related compensation. General and administrative expenses, at CHF 1,064 million in 2004, continued to drop and were 2% lower than the CHF 1,090 million recorded in 2003, reﬂect- ing our continuous tight cost controls. Drops were seen mainly in professional fees. Net charges to other business units fell to CHF 533 million in 2004 from CHF 609 million in 2003 because of lower charge-outs for IT services. Depreciation in 2004 dropped to CHF 69 million from CHF 88 million in 2003 due to lower expenses for information technology equipment. Headcount Business Banking Switzerland’s headcount was 15,508 on 31 December 2004, a decline of 673 from 31 December 2003, reﬂecting our continued investment in technology and au- tomation, as well as the ongoing streamlining of processes and structures. 31.12.02 31.12.03 31.12.04 16,967 16,181 15,508 Headcount full-time equivalents 17,500 16,500 15,500 14,500 13,500 2003 Key performance indicators Net new money was CHF 2.5 billion in 2003 compared with an inﬂow of CHF 3.7 billion in 2002. Invested assets rose to CHF 136 billion in 2003 from CHF 127 billion a year earlier as positive market developments and positive inﬂows of net new money were only partially offset by the weakening of the US dollar against the Swiss franc. In 2003, the cost / income ratio was 56.7%, 2.3 percent- age points below the ratio of 59.0% in 2002, reﬂecting low- er total operating expenses. Business Banking Switzerland’s loan portfolio was CHF 139 billion on 31 December 2003, unchanged from a year earlier. An increase in volumes of private client mortgages was offset by declining volumes in the corporate clients area and a further reduction in the recovery portfolio, which fell to CHF 40 6.4 billion on 31 December 2003 from CHF 8.6 billion a year earlier. This positive development was also reﬂected in the key credit quality ratios: the non-performing loan ratio improved to 3.2% from 3.6%, while the ratio of impaired loans to gross loans was 4.6% compared with 6.0% in 2002. Results Pre-tax proﬁt in 2003 was CHF 2,145 million, up 9% from 2002. The result was achieved despite slightly lower revenues in difﬁcult market conditions. This performance is also evi- dence of the continued tight management of our cost base, and lower credit loss expenses reﬂecting the deferred bene- ﬁt of the structural improvement in our loan portfolio in re- cent years. Operating income Operating income was CHF 5,120 million in 2003, down slightly from 2002’s level of CHF 5,208 million. Interest income declined by 4% to CHF 3,542 million in 2003 from CHF 3,677 million in 2002. The decline reﬂects lower interest margins on savings and cash accounts as well as lower revenues from our reduced recovery portfolio. This was partially offset by higher mortgage and saving account volumes. Non-interest income dropped by CHF 112 million to CHF 1,705 million in 2003 from CHF 1,817 million in 2002, reﬂecting the difﬁcult market environment at the beginning of the year. This was partially offset by lower adjusted expected credit loss ex- penses, which fell to CHF 127 million in 2003, down 56% from CHF 286 million in 2002. Operating expenses Operating expenses in 2003 were CHF 2,975 million, down 8% from CHF 3,241 million in 2002. Personnel expenses, at CHF 2,406 million, were down 3% from CHF 2,469 million in 2002, mainly due to lower salary costs reﬂecting the 5% drop in headcount. General and administrative expenses, at CHF 1,090 million in 2003, continued to drop and were 16% low- er than the CHF 1,305 million recorded in 2002. This reﬂects our continuous efforts to control our costs tightly. Net charges to other business units dropped to CHF 609 million in 2003 from CHF 638 million in 2002 due to lower charge-outs to oth- er business units. Depreciation for 2003 dropped to CHF 88 million from CHF 105 million in 2002 as information technol- ogy equipment is increasingly being leased instead of bought. Headcount Business Banking Switzerland’s headcount was 16,181 on 31 December 2003, a decline of 786 from 31 December 2002, reﬂecting our continued investment in technology and au- tomation, as well as the ongoing streamlining of processes and structures. Financial Businesses Global Asset Management Global Asset Management Pre-tax proﬁt was CHF 544 million, an increase of 64% from the 2003 pre-tax proﬁt of CHF 332 million. The increase was driven by higher operating income, which rose 16%, reﬂecting strong net new money inﬂows, a continuing change in asset mix towards higher-margin products, and a rise in market valuations resulting in increased asset levels and revenues. Business Group reporting CHF million, except where indicated Institutional fees Wholesale intermediary fees Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and amortization of goodwill and other intangible assets KPIs Cost / income ratio (%) 1 Cost / income ratio before goodwill (%) 2 Institutional Invested assets (CHF billion) of which: money market funds Net new money (CHF billion) 3 of which: money market funds Gross margin on invested assets (bps) 4 For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 1,085 937 2,022 901 299 126 23 129 1,478 544 673 73.1 66.7 344 17 23.7 (1.2) 32 922 815 1,737 806 265 156 25 153 1,405 332 485 80.9 72.1 313 14 12.7 (5.0 ) 32 865 790 1,655 763 301 164 22 186 1,436 219 405 86.8 75.5 274 19 (1.4 ) (1.8 ) 29 18 15 16 12 13 (19 ) (8 ) (16 ) 5 64 39 10 21 0 1 Operating expenses / operating income. 4 Operating income / average invested assets. 2 Operating expenses less the amortization of goodwill and other intangible assets / operating income. 3 Excludes interest and dividend income. John A. Fraser | Chairman and CEO Global Asset Management 41 Financial Businesses Global Asset Management Global Asset Management (continued) Wholesale intermediary Invested assets (CHF billion) of which: money market funds Net new money (CHF billion) 1 of which: money market funds Gross margin on invested assets (bps) 2 Additional information Client assets (CHF billion) Regulatory equity allocated (average) Fair value of employee stock options granted 3 Headcount (full-time equivalents) As at or for the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 257 64 (4.5) (20.6) 36 261 87 (5.0 ) (23.0 ) 31 259 106 (6.3 ) (6.9 ) 27 (2 ) (26 ) 16 As at or for the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 601 950 43 2,665 574 1,000 41 2,627 533 1,100 43 2,668 5 (5 ) 5 1 1 Excludes interest and dividend income. For details on the fair value calculation, refer to note 32e to the ﬁnancial statements. 2 Operating income / average invested assets. 3 For informational purposes only. These pre-tax amounts have not been recorded in the Income statement. Components of operating income Global Asset Management generates its revenue from the asset management and fund administration services it provides to ﬁnancial intermediaries and institutional investors. Fees charged to institutional clients and wholesale intermediary clients are based on the market value of invested assets and on successful investment performance. As a result, revenues are affected by changes in market and currency valuation levels, as well as ﬂows of client funds, and relative invest- ment performance. Signiﬁcant ﬁnancial events There were no signiﬁcant ﬁnancial events that affected this Business Group in 2004, 2003 or 2002. 2004 Key performance indicators For 2004, the pre-goodwill cost / income ratio was 66.7%, a decrease of 5.4 percentage points from 2003. This was a result of improving operating income combined with modest cost growth. Higher market valuations coupled with strong net new money inﬂows resulted in increased invested asset levels and, subsequently, higher asset-based fees. The con- tinuing change in asset mix towards higher-margin products increased operating income and overall proﬁtability. Institutional Institutional invested assets were CHF 344 billion on 31 De- cember 2004 – at their highest level since 2000, and up 10% from CHF 313 billion on 31 December 2003, reﬂecting both strong net new money and rising ﬁnancial markets. This in- crease was partly offset by the weakening of the US dollar against the Swiss franc. For full-year 2004, net new money inﬂows were CHF 23.7 billion, up signiﬁcantly from the CHF 12.7 billion recorded in Cost / income ratio in % Invested assets, institutional CHF billion 2002 86.8 75.5 2003 2004 31.12.02 31.12.03 31.12.04 80.9 72.1 73.1 66.7 400 300 200 100 0 14 299 17 327 19 255 As reported Adjusted for goodwill Invested assets excluding money market funds Money market funds 90 80 70 60 50 42 2003. Alternative and quantitative investments, equity and ﬁxed income mandates experienced strong inﬂows, partially offset by outflows from asset allocation mandates and money market funds. The money market outﬂow in 2004 was CHF 20.6 billion. This was partly offset by positive inﬂows of CHF 16.1 billion, recorded mainly in ﬁxed income mandates (inﬂow of CHF 7.7 billion) and to a lesser extent in asset allocation and equity funds. Net new money, institutional CHF billion 2002 2003 2004 30 20 10 0 –10 24.9 17.7 0.4 (1.8) (5.0) (1.2) Money market funds Non-money market funds Net new money, wholesale intermediary CHF billion 2002 2003 2004 30 15 0 –15 –30 0.6 (6.9) 18.0 16.1 (23.0) (20.6) The gross margin for full-year 2004 was 32 basis points, on a par with full-year 2003. Gross margin on invested assets, institutional bps 2002 2003 2004 Money market funds Non-money market funds The 2004 gross margin was 36 basis points, up by 5 basis points from a year earlier, reﬂecting the signiﬁcant improve- ment of wholesale intermediary fees as a result of the contin- uing shift to higher-margin products. 32 32 Gross margin on invested assets, wholesale intermediary bps 29 2002 2003 2004 35 30 25 20 15 Wholesale intermediary Invested assets were CHF 257 billion on 31 December 2004, down by CHF 4 billion from 31 December 2003. For full-year 2004, the net new money outﬂow was CHF 4.5 billion com- pared with a CHF 5.0 billion outﬂow in 2003. Invested assets, wholesale intermediary CHF billion 31.12.02 31.12.03 31.12.04 300 225 150 75 0 106 153 87 174 64 193 Invested assets excluding money market funds Money market funds 36 31 27 40 30 20 10 0 Money market sweep accounts Some of the money market fund assets managed by our US wholesale intermediary business represent the cash portion of private client accounts. Before launching UBS Bank USA in 2003, the cash balances of private clients in the US were swept into our money market funds. Since the bank’s launch, those cash proceeds have been automatically redirected into its FDIC-insured deposit accounts. Although there was no one- time bulk transfer of client money market assets to the bank, the funds invested in our sweep accounts are being used to complete client transactions and will therefore gradually deplete over time. Such funds are a low-fee component of invested assets. Full-year money market outﬂows in our US wholesale intermediary business were CHF 13.6 billion, of which approximately CHF 11 billion related to UBS Bank USA. 43 Financial Businesses Global Asset Management We do not expect further major outﬂows from our money market funds into UBS Bank USA in 2005. Investment capabilities and performance Financial markets experienced greater volatility in 2004 than in the previous year due to rising oil prices and continued geopolitical instability. Still, equity markets made progress, with strong gains during fourth quarter. Most of our actively managed global and regional equity strategies outperformed their benchmarks, with particularly strong performances in Eu- ropean and US asset classes. The Global Equity composite per- formed marginally below benchmark (after fees) for the year. Bond markets in the major industrialized countries were surprisingly resilient in 2004, posting solid returns. European bonds were the best performers as investors saw the surge in oil prices as a potential drag on economic growth rather than raising inﬂationary expectations. A positive economic environ- ment supported corporate bonds and drove spreads to very narrow levels. Overall, our active interest rate strategies con- tinued to outperform their benchmarks, particularly in the US; however, our Global Bond composite performed just below its benchmark (after fees) in 2004. Asset allocation portfolios outperformed their benchmarks by signiﬁcant amounts, with market allocation providing much of the added value. Stock selection was positive in US and emerging equities and US bonds. Longer-term returns against benchmarks remain positive. In alternative and quantitative investments, performance was generally positive in 2004. All key equity-oriented strate- gies recorded positive returns, while a difﬁcult macroeco- nomic environment contributed to slightly negative returns for our core “macro” trading strategy. Despite ongoing political and economic uncertainty, the multi-manager teams were able to generate positive returns from most strategies. Over- all, funds of hedge funds performance was positive, buoyed by strong fourth quarter performance. Real estate portfolios in the US, UK and Japan continued to perform strongly during 2004. In publicly traded real es- tate equities, excellent performance was achieved, with assets doubling in Europe due to a combination of inﬂows and per- formance. Results We reported a very strong full-year result in 2004. Pre-tax proﬁt was CHF 544 million, an increase of 64% from the 2003 Composite Global Equity Composite vs. MSCI World Equity (Free) Index Global Bond Composite vs. Citigroup World Government Bond Index Global Securities Composite vs. Global Securities Markets Index 44 pre-tax proﬁt of CHF 332 million. The increase was driven by higher operating income, which rose 16%, reﬂecting strong net new money inﬂows, a continuing change in asset mix to- wards higher-margin products, and a rise in market valuations resulting in increased asset levels and revenues. This was only partially offset by a slight rise in operating expenses, mainly due to higher incentive-based compensation as a result of the higher revenues. Performance before tax CHF million 2002 2003 2004 544 332 219 600 450 300 150 0 Operating income In full-year 2004, operating income was CHF 2,022 million, up 16% from CHF 1,737 million a year earlier. The increase reﬂects higher ﬁnancial market valuations and strong inﬂows into alternative and quantitative investments, and equities and ﬁxed income mandates, resulting in higher invested asset levels and, consequently, higher asset-based revenues. Per- formance-related fees, especially in alternative and quantita- tive investments, remained at the strong levels seen in 2003. Institutional revenues increased to CHF 1,085 million in full- year 2004 from CHF 922 million in 2003, driven by both the improved market environment and strong asset inflows. Wholesale intermediary revenues rose to CHF 937 million in 2004 from CHF 815 million in 2003, reﬂecting higher market valuations and an improvement in the asset mix – as low- margin money market outﬂows were mostly offset by inﬂows into higher-margin products. Operating expenses In 2004, operating expenses increased to CHF 1,478 million from CHF 1,405 million in 2003, primarily due to higher in- centive-based compensation as a result of increased proﬁta- bility. Personnel expenses were CHF 901 million in 2004, 12% above 2003. General and administrative expenses increased by 13% to CHF 299 million in 2004 from CHF 265 million in 1 year 3 years – – + – + + Annualized 5 years + + + 10 years + + + (+) above benchmark; (–) under benchmark. All after fees. 2003. This increase was mainly due to a restructuring provi- sion in our business in the Americas booked in third quarter 2004 and the damage caused by Hurricane Ivan in the Cay- man Islands. Travel and entertainment costs, IT expenses and professional fees increased year-on-year. Net charges from other business units decreased by CHF 30 million to CHF 126 million in 2004 from CHF 156 million in 2003, partly due to higher charge-outs to the wealth management businesses reﬂecting the increase in the distribution of alternative invest- ment products. Over the same period, depreciation remained virtually unchanged at CHF 23 million, down by only CHF 2 million. Amortization of goodwill decreased to CHF 129 mil- lion in 2004 from CHF 153 million a year earlier, due to the full amortization of the goodwill of some businesses and the US dollar’s decline against the Swiss franc. Headcount Headcount was 2,665 on 31 December 2004, up by 38 from 2,627 on 31 December 2003. The increase of 1% is mainly attributable to our expansion of the European real estate busi- ness as well as our growing businesses in alternative and quan- titative investments and fund services. 31.12.02 31.12.03 31.12.04 2,668 2,627 2,665 Headcount full-time equivalents 3,000 2,250 1,500 750 0 2003 Key performance indicators For 2003, the pre-goodwill cost / income ratio was 72.1%, an improvement of 3.4 percentage points from 2002. This was a result of improving operating income and operating ex- penses. The recovery in equity markets experienced in the second half of 2003 resulted in higher invested asset levels and, consequently, higher asset-based revenues. Strong in- ﬂows of net new money (excluding lower fee money market funds), combined with improved investment performance, especially in the alternative and quantitative platform, helped revenues to rise. These developments were supported by on- going cost control initiatives that drove operating expenses down by 2%. Institutional Institutional invested assets totaled CHF 313 billion on 31 De- cember 2003, up 14% from CHF 274 billion on 31 Decem- ber 2002, reﬂecting the strong market development in the second half of 2003 and strong inﬂows of net new money. The increase was partly offset by the weakening of major currencies against the Swiss franc. For full-year 2003, net new money inflows were CHF 12.7 billion, up signiﬁcantly from the outﬂows of CHF 1.4 bil- lion recorded in 2002. Equity mandates and alternative and quantitative investments experienced strong inﬂows, partial- ly offset by outﬂows from asset allocation mandates and money market funds. The full-year 2003 gross margin was 32 basis points, up from 29 basis points in 2002, reﬂecting higher performance fees and an improving asset mix. Wholesale intermediary Invested assets were CHF 261 billion on 31 December 2003, up by CHF 2 billion from 31 December 2002. The impact of adverse currency movements and the launch of UBS Bank USA, which prompted outflows from money market funds, nearly offset the positive effect from rising financial markets. For full-year 2003, the net new money outﬂow amounted to CHF 5.0 billion compared with the CHF 6.3 billion out- ﬂow in 2002. The money market outﬂow in 2003 was CHF 23.0 billion, partially offset by inﬂows of CHF 17.1 billion in- to higher-margin equity and ﬁxed income mandates. The out- ﬂows in money market funds were primarily in the Americas as a result of the launch of UBS Bank USA. The gross margin increased to 31 basis points in 2003 from 27 basis points in 2002, reﬂecting the change in the asset mix towards higher-margin assets. Results Global Asset Management reported a pre-tax proﬁt of CHF 332 million in 2003, an increase of 52% from 2002’s pre-tax proﬁt of CHF 219 million. The recovery in the second half of 2003 in equity market valuations, coupled with strong inﬂows into alternative investments, equities and ﬁxed income man- dates, resulted in higher invested asset levels and, con- sequently, increased asset-based revenues. Performance- related fees, especially in the alternative and quantitative business, showed signiﬁcant improvement over 2002. On- going cost control initiatives that systematically reduced operating expenses contributed significantly to improved proﬁtability. Lower IT and premises costs prompted general and administrative expenses to decline. Amortization ex- penses fell as the goodwill of some assets became fully amor- tized. These developments were partially offset by higher incentive-based compensation resulting from the increase in operating income. 45 Financial Businesses Global Asset Management Operating income In full-year 2003, operating income was CHF 1,737 million, up 5% from CHF 1,655 million a year earlier. It reﬂected the recovery in equity market valuations in second half 2003, cou- pled with strong inﬂows into alternative investments, equities and ﬁxed income mandates, resulting in higher invested as- set levels and consequently higher asset-based revenues. Performance-related fees, especially in the alternative and quantitative business, showed signiﬁcant improvement over 2002. Institutional revenues increased to CHF 922 million in full-year 2003 from CHF 865 million in 2002, driven by both the improved market environment and strong asset inﬂows, especially in the alternative and quantitative business. For full- year 2003, Wholesale intermediary revenues, at CHF 815 mil- lion, increased from CHF 790 million in 2002, reﬂecting the recovery in the equity markets and an improvement in the as- set mix, both of which had a positive impact on our asset- based revenues. saving initiatives and lower goodwill amortization. Personnel expenses were CHF 806 million in 2003, 6% above 2002, due to higher incentive-based compensation reﬂecting improved revenues. General and administrative expenses fell to CHF 265 million in 2003 from CHF 301 million in 2002. The de- crease is a result of ongoing cost-saving initiatives, resulting in a signiﬁcant reduction of IT and premises expenses. These savings were partly offset by non-recurring operational pro- visions. Charges from other business units decreased by CHF 8 million to CHF 156 million in 2003. Depreciation, at CHF 25 million, increased by CHF 3 million from 2002. Amortiza- tion of goodwill decreased to CHF 153 million in 2003 from CHF 186 million a year earlier. The drop was due both to the full amortization of the goodwill of some businesses and to the US dollar’s drop against the Swiss franc. Headcount Operating expenses For full-year 2003, operating expenses declined to CHF 1,405 million from CHF 1,436 million in 2002, primarily due to cost- Headcount was 2,627 on 31 December 2003, down by 41 from 2,668 on 31 December 2002. The decrease of 2% pri- marily reﬂects cost-saving efforts in the traditional invest- ments business. 46 Financial Businesses Investment Bank Investment Bank In 2004, the Investment Bank’s pre-tax proﬁt was CHF 4,540 million, up 18% from a year earlier. Results were driven by strong performances across all businesses and fueled by a pick-up in market activity. Business Group reporting CHF million, except where indicated Investment banking Equities Fixed income, rates and currencies Private equity Income Adjusted expected credit loss 1 Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and amortization of goodwill and other intangible assets KPIs Compensation ratio (%) 2 Cost / income ratio (%) 3 Cost / income ratio before goodwill (%) 4 Non-performing loans / gross loans (%) Impaired loans / gross loans (%) Average VaR (10-day 99%) For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 1,909 5,906 7,912 257 15,984 (7) 15,977 8,156 2,535 219 239 288 11,437 4,540 4,828 51 71.6 69.8 0.6 0.8 358.0 1,703 4,875 7,490 (77 ) 13,991 (55 ) 13,936 7,303 2,074 180 246 278 10,081 3,855 4,133 52 72.1 70.1 0.8 1.4 294.8 1,915 5,608 6,498 (1,602 ) 12,419 (90 ) 12,329 7,815 2,359 140 320 364 10,998 1,331 1,695 63 88.6 85.6 1.5 2.5 12 21 6 14 87 15 12 22 22 (3 ) 4 13 18 17 21 1 In management accounts, adjusted expected credit loss rather than credit loss expense is reported for the Business Groups (see note 2 to the ﬁnancial statements). 3 Operating expenses / income. 4 Operating expenses less the amortization of goodwill and other intangible assets / income. 2 Personnel expenses / income. John P. Costas | Chairman and CEO Investment Bank 47 Financial Businesses Investment Bank Investment Bank (continued) Private equity Value creation (CHF billion) Investment (CHF billion) 1 Portfolio fair value (CHF billion) Additional information Deferral (included in adjusted expected credit loss) Client assets (CHF billion) Regulatory equity allocated (average) Fair value of employee stock options granted 2 Headcount (full-time equivalents) As at or for the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 0.6 1.9 2.7 (0.3 ) 2.3 2.9 (1.4 ) 3.1 3.8 (17 ) (7 ) As at or for the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 85 147 14,100 258 16,568 29 143 12,700 391 15,277 8 133 13,100 582 15,791 193 3 11 (34 ) 8 1 Historical cost of investments made, less divestments and impairments. fair value calculation, refer to note 32e to the ﬁnancial statements. 2 For informational purposes only. These pre-tax amounts have not been recorded in the income statement. For details on the Components of operating income The Investment Bank 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 loan port- folio; and – gains and losses on market making, proprietary, and arbitrage positions. As a result, 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 acqui- sition activity. These and other factors have had, and may in the future have, a signiﬁcant impact on results of operations from year to year. Signiﬁcant ﬁnancial events There were no signiﬁcant ﬁnancial events that affected this Business Group in 2004, 2003 or 2002. 2004 Key performance indicators The pre-goodwill cost / income ratio improved to 69.8% in 2004 from 70.1% a year earlier. It reﬂected a strong revenue performance in all businesses. Our compensation ratio in 2004 was 51%, down from 52% in 2003, reﬂecting the completion of our aggressive investment banking hiring program. Payout levels are driven by the revenue mix across business areas and are managed in line with market levels. Total loans were CHF 69 billion on 31 December 2004, up 25% from CHF 55 billion a year earlier, reﬂecting our strengthened business franchise. Continued successful recovery efforts led the ratio of impaired loans to total loans to fall to 0.8% at the end of 2004 from 1.4% on 31 Decem- ber 2003. The non-performing loans to total loans ratio fell to 0.6% from 0.8% in the same period. The level of our private equity investments stood at CHF Cost / income ratio in % Compensation ratio in % 2003 2004 2002 2003 2004 2002 88.6 85.6 72.1 70.1 71.6 69.8 As reported Adjusted for goodwill 90 80 70 60 50 48 65 60 55 50 45 63 52 51 Impaired loans / gross loans in % 31.12.02 31.12.03 31.12.04 2.8 2.1 1.4 0.7 0.0 2.5 1.4 0.8 1.9 billion on 31 December 2004, a decline of 17% from CHF 2.3 billion on 31 December 2003, reﬂecting writedowns and successful divestments. Unfunded commitments fell by 47% to CHF 0.8 billion on 31 December 2004 from CHF 1.5 billion a year ago. The fair value of the portfolio on 31 De- cember 2004 was CHF 2.7 billion, down from CHF 2.9 billion on 31 December 2003, driven by exits and revaluations. 31.12.02 31.12.03 31.12.04 3.1 2.3 1.9 Investment CHF billion 4 3 2 1 0 Results Pre-tax proﬁt was CHF 4,540 million in 2004, up 18% from a year earlier and at its highest level since 2000. Our result was achieved despite the signiﬁcant weakening of the US dollar against the Swiss franc and reﬂects revenue growth across all our businesses. In particular, our ﬁxed income, rates and cur- Performance before tax CHF million 2002 2003 2004 5,000 3,750 2,500 1,250 0 4,540 3,855 1,331 rencies business posted a record result, up 6% from 2003, while the equities business reported a 21% increase in rev- enues on the strong improvement in market conditions. Pri- vate equity also contributed to our result, recording revenues of CHF 257 million, a signiﬁcant improvement. At the same time, costs increased as our businesses continued to expand, with speciﬁc operational provisions also a factor. Operating income Total operating income in 2004 was CHF 15,977 million, up 15% from CHF 13,936 million a year earlier, reﬂecting strong improvements in all businesses. Equities revenues, at CHF 5,906 million in 2004, were up 21% from CHF 4,875 million in 2003. Growth in revenues occurred around the globe, but was particularly strong in the US and Europe. Signiﬁcant increases were seen in secondary cash commissions and proprietary trading revenues. Prime brokerage saw an impressive revenue gain following the ac- quisition of ABN Amro’s prime brokerage business in the US. Fixed income, rates and currencies revenues were CHF 7,912 million, up 6% from CHF 7,490 million a year earlier. Strong gains were seen in the rates business, mainly due to the structured LIBOR and mortgage businesses. Fixed income was driven by credit derivatives, emerging markets and glob- al syndicated ﬁnance businesses, foreign exchange and cash and collateral trading. The positive result was slightly offset by negative revenues of CHF 62 million relating to Credit Default Swaps (CDSs) hedging existing credit exposure in the loan book – signiﬁcantly lower than 2003’s negative revenues of CHF 678 million. Investment banking revenues, at CHF 1,909 million in 2004, increased 12% from CHF 1,703 million a year earlier. Excluding currency ﬂuctuations and hedging costs, revenues were up 32%, reﬂecting improving corporate activity levels. It was a record year for our global advisory business, with dou- ble-digit growth seen in Europe, the US and Asia. According to a Dealogic survey1, we ranked ﬁfth for investment bank- ing fees in 2004 with a market share of 5.3%, up from sixth and a market share of 5.0% a year earlier. Private equity also contributed to our result, recording rev- enues of CHF 257 million in 2004, a signiﬁcant improvement compared to the negative revenues of CHF 77 million a year earlier, as market conditions allowed for successful divest- ments and lower writedowns. Operating expenses Higher personnel costs and general and administrative expens- es prompted total operating expenses in 2004 to rise to CHF 11,437 million, a 13% increase from CHF 10,081 million a year earlier. Personnel expenses, at CHF 8,156 million in 2004, increased 12% from a year earlier, reﬂecting higher perform- ance-related compensation which rose due to higher rev- 1 Financial Times, 26 January 2005. Table: Global fee ranking 2004 49 Financial Businesses Investment Bank Income by business area CHF million 2002 2003 1,915 5,608 6,498 1,703 4,875 7,490 16,000 12,000 8,000 4,000 0 –4,000 2004 1,909 5,906 7,912 Headcount Headcount, at 16,568 on 31 December 2004, was up 8% from a year earlier. Stafﬁng increases were driven by contin- ued business expansion and included the impact of integrat- ing personnel from the Charles Schwab Capital Markets divi- sion and the hiring of additional operational risk management and compliance staff. 2003 (1,602) (77) 257 Key performance indicators Private equity Equities Fixed income, rates and currencies Investment banking enues, as well as an increase in salaries reﬂecting the 8% additional headcount. General and administrative expenses were CHF 2,535 million in 2004, up 22% from 2003’s CHF 2,074 million. The increase reﬂected higher operational pro- visions, rising professional fees and raised IT spending. This was partially offset by a drop in administration and occupan- cy expenses. Services from other business units increased to CHF 219 million in 2004 from CHF 180 million in 2003. De- preciation eased 3% to CHF 239 million in 2004 from CHF 246 million in 2003 on a decline in writeoffs. Amortization of goodwill and other intangibles, at CHF 288 million in 2004, was up 4% from CHF 278 million a year earlier, reﬂecting the ABN Amro acquisition. 31.12.02 31.12.03 31.12.04 16,568 15,791 15,277 Headcount full-time equivalents 17,000 16,000 15,000 14,000 13,000 The pre-goodwill cost / income ratio decreased to 70.1% in 2003 from 85.6% in 2002. The fall reﬂects an increase in rev- enues, driven by our ﬁxed income, rates and currencies busi- ness and our private equity business, set against the drop in operating expenses, which reﬂected our disciplined cost con- trol. Both revenues and expenses were affected by the weak- ening of major currencies, mainly the US dollar, against the Swiss franc. Our compensation ratio in 2003 was 52%, down from 63% in 2002. The payout levels of annual performance- related payments are driven by the revenue mix across busi- ness areas and are managed in line with market levels. Total loans were CHF 55 billion on 31 December 2003, down 11% from CHF 62 billion a year earlier, mainly due to the drop in the US dollar against the Swiss franc. Contin- ued successful recovery efforts led the ratio of impaired loans to total loans to fall from 2.5% on 31 December 2002 to 1.4% at the end of 2003. The non-performing loans to total loans ratio declined from 1.5% to 0.8% in the same period. The level of our private equity investments was CHF 2.3 bil- lion on 31 December 2003, down from CHF 3.1 billion a year earlier. The decrease was mainly due to successful divestments alongside further writedowns. The decline in the level of investments was accentuated by exchange rate movements. Driven by exits and revaluations, the fair value of the port- folio decreased to CHF 2.9 billion on 31 December 2003 from CHF 3.8 billion a year earlier. Unfunded commitments con- tinued to fall, totaling CHF 1.5 billion at end-2003, down from CHF 2.1 billion a year earlier. Shift to industrial holdings From ﬁrst quarter 2005, our private equity investments will be reported within the Industrial Holdings segment. This matches our strategy of de-emphasizing and reducing exposure to this asset class while capitalizing on orderly exit opportunities when they arise. Current management will continue to look after the portfolio. 50 Results Pre-tax proﬁt was CHF 3,855 million in full-year 2003, up 190% from a year earlier. This result was achieved despite the weakening of the US dollar against the Swiss franc and reﬂects strong performances in all our businesses. In particular, the private equity business showed a marked improvement of CHF 1.5 billion, reﬂecting lower levels of writedowns and a number of successful exits. Writedowns in 2003 totaled CHF 353 million, compared to CHF 1.7 billion in 2002. This was accentuated by a strong result in our ﬁxed income, rates and currencies business, gaining 15% from 2002, reﬂecting the breadth of our capabilities and our expanding franchise. At the same time, costs were tightly controlled. Both personnel expenses and general and administrative expenses fell because of currency ﬂuctuations. Excluding the impact of currency movements, personnel expenses rose in 2003, reﬂecting im- proved revenues, while general and administrative expenses remained largely unchanged from 2002. Operating income Full-year 2003 total operating income was CHF 13,936 mil- lion, up 13% from CHF 12,329 million in 2002. Investment banking revenues, at CHF 1,703 million in 2003, dropped 11% from CHF 1,915 million a year earlier. Excluding the cur- rency impact, revenues actually rose, reﬂecting the expansion of our capabilities. Equities revenues in full-year 2003 also reﬂected negative currency impacts, falling to CHF 4,875 mil- lion from CHF 5,608 million in 2002. Excluding currency ﬂuctuations, equity results improved, reﬂecting strong per- formances in the equity finance, proprietary and primary businesses. In full-year 2003, the ﬁxed income, rates and cur- rencies business posted an excellent result. Revenues, at CHF 7,490 million in 2003, were up 15% from CHF 6,498 million in 2002. Revenues increased in all businesses, but the gains were particularly strong in ﬁxed income, principal ﬁnance, mortgages and foreign exchange. The positive result was somewhat offset by negative revenues of CHF 678 million re- lating to Credit Default Swaps (CDSs) hedging existing cred- it exposure in the loan book. Private equity income for 2003 was negative CHF 77 million, compared to negative CHF 1,602 million in 2002. The signiﬁcant improvement in per- formance was primarily driven by a sharp fall in investment writedowns. Operating expenses Total operating expenses dropped 8% to CHF 10,081 million in 2003, mainly reﬂecting the weakening of the US dollar against the Swiss franc, although our continued tight man- agement of costs helped. Personnel expenses in 2003, at CHF 7,303 million, fell 7% from 2002. Excluding currency ﬂuctu- ations, personnel expenses rose, reﬂecting higher perform- ance-related compensation, which increased along with rev- enues, and higher severance expenses. Full-year general and administrative expenses were CHF 2,074 million in 2003, down 12% from 2002’s CHF 2,359 million. Excluding the ef- fect of currencies, expenses rose slightly, reﬂecting provisions for vacant space, higher professional fees in all businesses and an increase in administration expenses. Services from other business units increased to CHF 180 million in 2003 from CHF 140 million in 2002. Depreciation declined 23% to CHF 246 million in 2003 from CHF 320 million in 2002. The de- crease is mainly due to lower depreciation on workstations, servers and other equipment. Amortization of goodwill and other intangibles, at CHF 278 million in 2003, fell 24% from CHF 364 million a year earlier, reﬂecting the full amortization of the goodwill of various businesses in 2003. Headcount Headcount, at 15,277 on 31 December 2003, fell 3% from a year earlier. The drop reﬂects ongoing, regular reviews of our cost structure and stafﬁng needs, taking into account produc- tivity gains and the automation of services. That was partial- ly offset by the acquisition of ABN Amro’s prime brokerage business and continued investment in speciﬁc areas, includ- ing our US investment banking and ﬁxed income, rates and currencies businesses. 51 Financial Businesses Wealth Management USA Wealth Management USA In 2004, Wealth Management USA reported a pre-tax gain of CHF 179 million compared to a loss of CHF 5 million in 2003. In US dollar terms, operational performance excluding acquisition costs was the best since PaineWebber became part of UBS, reﬂecting record recurring fees and increased net interest revenue. Business Group reporting CHF million, except where indicated Private client revenues Municipal ﬁnance revenues Net goodwill funding Income Adjusted expected credit loss 2 Total operating income Personnel expenses 3 General and administrative expenses Services to / from other business units Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 4,906 372 (180) 5,098 (5) 5,093 3,437 800 302 71 304 4,914 179 4,959 1 462 (231 ) 5,190 (8 ) 5,182 3,627 719 433 72 336 5,187 (5 ) 5,471 480 (390 ) 5,561 (13 ) 5,548 4,158 926 492 81 1,691 4 7,348 (1,800 ) (1 ) (19 ) 22 (2 ) 38 (2 ) (5 ) 11 (30 ) (1 ) (10 ) (5 ) Business Group reporting excluding acquisition costs and signiﬁcant ﬁnancial events CHF million, except where indicated Total operating income Add back: Net goodwill funding 6 Operating income excluding acquisition costs Total operating expenses Retention payments Amortization of goodwill and other intangible assets Operating expenses excluding acquisition costs Business Group performance before tax and acquisition costs For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 5,093 180 5,273 4,914 (99) (304) 4,511 762 5,021 5 231 5,252 5,187 (263 ) (336 ) 4,588 664 5,548 390 5,938 6,114 7 (351 ) (457 ) 5,306 632 1 (22 ) 0 (5 ) 62 10 (2 ) 15 1 Includes signiﬁcant ﬁnancial event: gain on disposal of Correspondent Services Corporation of CHF 161 million. expense is reported for the Business Groups (see note 2 to the ﬁnancial statements). payments after second quarter 2004. Correspondent Services Corporation of CHF 161 million. event: writedown of PaineWebber brand name of CHF 1,234 million. 2 In management accounts, adjusted expected credit loss rather than credit loss 3 Includes retention payments in respect of the PaineWebber acquisition. There have been no further retention 5 Excludes signiﬁcant ﬁnancial event: gain on disposal of 7 Excludes signiﬁcant ﬁnancial 6 Goodwill and intangible asset-related funding, net of risk-free return on the corresponding equity allocated. 4 Includes signiﬁcant ﬁnancial event: writedown of PaineWebber brand name of CHF 1,234 million. Mark B. Sutton | Chairman and CEO Wealth Management USA 52 Business Group reporting excluding acquisition costs and signiﬁcant ﬁnancial events (continued) KPIs Invested assets (CHF billion) Net new money (CHF billion) 1 Interest and dividend income (CHF billion) 2 Gross margin on invested assets (bps) 3 Gross margin on invested assets excluding acquisition costs and SFEs (bps) 4 Cost / income ratio (%) 5 Cost / income ratio excluding acquisition costs and SFEs (%) 6 Recurring fees 7 Financial advisor productivity (CHF thousand) 8 Additional information Client assets (CHF billion) Regulatory equity allocated (average) Fair value of employee stock options granted 9 Headcount (full-time equivalents) Financial advisors (full-time equivalents) As at or for the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 639 17.1 16.0 79 81 96.4 85.5 2,057 655 634 21.1 15.8 86 87 99.9 87.2 1,927 579 584 18.5 17.9 82 88 132.1 89.2 2,199 639 1 1 (8 ) (7 ) 7 13 As at or for the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 679 5,100 101 17,388 7,519 690 5,700 62 17,435 7,766 650 7,450 73 19,029 8,857 (2 ) (11 ) 63 0 (3 ) 1 Excludes interest and dividend income. events / average invested assets. events / income, add back net goodwill funding and less signiﬁcant ﬁnancial events. client revenues less signiﬁcant ﬁnancial events / average number of ﬁnancial advisors. For details on the fair value calculation, refer to note 32e to the ﬁnancial statements. 2 For purposes of comparison with US peers. 5 Operating expenses / income. 3 Income / average invested assets. 4 Income, add back net goodwill funding and less signiﬁcant ﬁnancial 6 Operating expenses less the amortization of goodwill and other intangible assets, retention payments and signiﬁcant ﬁnancial 8 Private 9 For informational purposes only. These pre-tax amounts have not been recorded in the income statement. 7 Asset-based fees for portfolio management and fund distribution, account-based and advisory fees. Components of operating income Wealth Management USA principally derives its operating income from: – fees for ﬁnancial planning and wealth management services; – fees for discretionary management services; – transaction-related fees; and – interest income from client loans. These fees are based on the market value of invested assets, the level of transaction-related activity and the size of the loan book. As a result, operating income is affected by such factors as ﬂuctuations in invested assets, changes in market conditions, investment per- formance, inﬂows and outﬂows of client funds, and investor activity levels. 53 Financial Businesses Wealth Management USA Signiﬁcant ﬁnancial events Net new money CHF billion There were no signiﬁcant ﬁnancial events in 2004. There was one in 2003 and one in 2002. – In second quarter 2003, a net gain of CHF 2 million (pre- tax CHF 161 million) from the sale of Wealth Management USA’s Correspondent Services Corporation (CSC) clearing business. A substantial portion of CSC’s net assets com- prised goodwill stemming from the PaineWebber acquisi- tion. After deducting taxes of CHF 159 million (based on the purchase price) and the writedown of the goodwill associated with CSC, the net gain from the transaction was CHF 2 million. – In fourth quarter 2002, a non-cash writedown of CHF 953 million (pre-tax CHF 1,234 million) relating to the value of the PaineWebber brand that was held as an intangible asset on our balance sheet. 2004 Key performance indicators 2002 2003 2004 –12% in US dollar 21.1 18.5 17.1 22 20 18 16 14 on invested assets before acquisition costs (net goodwill fund- ing costs) was 81 basis points, down from 87 basis points in 2003. The increase in average invested asset levels (up 7%) outpaced the gain in revenues (up 1% excluding the sale of CSC) as higher private client revenues were mostly offset by lower municipal ﬁnance revenues. Gross margin on invested assets bps Wealth Management USA had CHF 639 billion in invested assets on 31 December 2004, up 1% from CHF 634 billion on 31 December 2003. The increase was due to inflows of net new money and the effects of market appreciation, partly offset by the weakening of the US dollar against the Swiss franc. In US dollar terms, invested assets were 10% higher on 31 December 2004 than they were on the same date in 2003. 90 80 70 60 50 2002 2003 2004 88 82 87 86 81 79 Invested assets CHF billion 700 600 500 400 300 31.12.02 31.12.03 31.12.04 +10% in US dollar 634 639 584 As reported Adjusted for significant financial events and excluding acquisition costs The cost / income ratio before acquisition costs was 85.5% for 2004, compared to 87.2% in 2003. The improvement in the cost / income ratio reﬂects our continuous cost control as well as the excellent performance of our core private clients’ business. Cost / income ratio in % We continue to report strong inﬂows of net new money compared to peers. In 2004, inﬂows were CHF 17.1 billion, CHF 4 billion lower than the CHF 21.1 billion reported in 2003. Including interest and dividends, net new money in 2004 was CHF 33.1 billion, lower than the CHF 36.9 billion reported in 2003. The decline in net new money mainly occurred in a slow ﬁrst half-year, when investor conﬁdence lagged. The gross margin on invested assets was 79 basis points in 2004, down from 86 basis points in 2003. The gross margin 135 120 105 90 75 54 2002 132.1 2003 2004 99.9 89.2 87.2 96.4 85.5 As reported Adjusted for significant financial events and excluding acquisition costs In 2004, recurring fees were CHF 2,057 million, up 7% from CHF 1,927 million a year earlier. Excluding the impact of currency ﬂuctuations, recurring fees were up 15% in 2004 from 2003, mainly due to higher levels of managed account fees on a record level of invested assets in US dollar terms. Flows into managed account products were USD 12.4 billion in full-year 2004, comparing favorably to the USD 10.2 bil- lion ﬂow for full-year 2003. Recurring fees combined with the net interest income, principally from our lending business, now represent around half of our total revenues. 2002 2003 2004 2,199 +15% in US dollar 2,057 1,927 Recurring fees CHF million 2,250 2,000 1,750 1,500 1,250 Productivity per advisor increased in 2004 to CHF 655,000 from CHF 579,000 in 2003 as a lower number of ﬁnancial advisors were able to produce roughly the same revenues as a year earlier. The number of ﬁnancial advisors decreased to 7,519 in 2004 from 7,766 a year earlier due to attrition among less productive ﬁnancial advisors. In the second half of 2003, we resumed our trainee program and we continued to recruit ﬁnancial advisors throughout 2004, with our focus primarily on talented and highly productive advisors. As a re- sult, we expect renewed growth in our advisor force. Financial advisors full-time equivalents 31.12.02 31.12.03 31.12.04 8,857 7,766 7,519 9,000 8,500 8,000 7,500 7,000 Results In 2004, we reported a pre-tax gain of CHF 179 million com- pared to a loss of CHF 5 million in 2003. The 2003 results include a pre-tax gain of CHF 161 million from the sale of Correspondent Services Corporation (CSC) in second quarter. After the exclusion of the CSC gain and before acquisition costs, operational performance showed proﬁts of CHF 762 mil- lion in 2004 and CHF 664 million in 2003. As our business is almost entirely conducted in US dollars, comparisons of 2004 and 2003 results are affected by the depreciation of the US dol- lar versus the Swiss franc. In US dollar terms, operational per- formance (excluding acquisition costs and SFEs) in 2004 was 24% higher than in 2003. This represents the best result since PaineWebber became part of UBS, reﬂecting record recurring fees and increased net interest revenue beneﬁting from the ﬁrst full-year impact of UBS Bank USA. In municipal ﬁnance, rev- enues fell due to lower transaction and underwriting volumes and reduced derivative activity. Still, a Bloomberg article report- Performance before tax CHF million 2002 2003 2004 762 179 664 (5) +24% in US dollar 800 0 –800 –1,600 –2,400 632 (1,800) As reported Adjusted for significant financial events and excluding acquisition costs ed that we became the top-ranked ﬁrm in lead-managed ne- gotiated underwriting volume in 2004 by increasing our mar- ket share to 14.2%, up from last year’s 12.5%. Operating income In 2004, total operating income was CHF 5,093 million, down 2% compared to CHF 5,182 million in 2003. Before acquisi- tion costs and excluding the sale of our CSC business, total operating income was largely the same as a year earlier. On the same basis and excluding the currency effect, operating income increased by 8% from 2003. The increase in operat- ing income is primarily due to higher recurring fees, rising net interest income due to UBS Bank USA, and higher trans- actional revenue in the private client business. The increase is partially offset by lower municipal ﬁnance revenue due to a drop in secondary trading performance, decreased underwrit- ing volume and lower derivatives activity. Operating expenses Total operating expenses decreased 5% to CHF 4,914 million in 2004 from CHF 5,187 million in 2003. Excluding acquisi- tion costs, the drop was 2%, mainly due to the weakening of the US dollar against the Swiss franc. Excluding currency effects and acquisition costs, operating expenses were 6% higher, primarily due to an increase in general and adminis- 55 800 -800 -1600 -2400 0 Financial Businesses Wealth Management USA trative expenses as well as higher personnel expenses. Person- nel expenses dropped to CHF 3,437 million in 2004, down 5% from CHF 3,627 million a year earlier. Excluding the effects of currency translation, personnel expenses were slightly higher than in 2003, reﬂecting higher bonus and broker compensa- tion, which gained in line with performance, partially offset by lower retention payments, which ended in June. Non-per- sonnel related expenses dropped 5% to CHF 1,477 million in 2004 from CHF 1,560 million in 2003. In US dollar terms, they actually rose 2%, reﬂecting higher legal fees and settlement charges and increased consulting fees related to key initiatives in the private client business. This was partially offset by low- er depreciation due to a drop in infrastructure charges (down CHF 1 million) as well as a decline in goodwill amortization due to the sale of CSC (down CHF 32 million). Headcount Our headcount decreased by 47 during 2004 to 17,388 as ﬁnancial advisor headcount fell 3% to 7,519, principally re- ﬂecting attrition among lower producing ﬁnancial advisors. Non-financial advisor headcount increased 200 or 2% in 2004 from a year earlier due to additional personnel to sup- port key initiatives within the private clients area. 31.12.02 31.12.03 31.12.04 19,029 17,435 17,388 Headcount full-time equivalents 20,000 19,000 18,000 17,000 16,000 2003 Key performance indicators The gross margin on invested assets was 86 basis points for 2003, up from 82 basis points in 2002. The gross margin on invested assets before acquisition costs (net goodwill funding costs) was 87 basis points, down from 88 basis points in 2002. The cost / income ratio before acquisition costs and signif- icant ﬁnancial events was 87.2% for 2003, compared to 89.2% in 2002. The improvement in the cost / income ratio reﬂects our continuous cost control as well as the excellent performance of our core private client business. In 2003, recurring fees were CHF 1,927 million, down from CHF 2,199 million a year earlier, reﬂecting the weakening of the US dollar against the Swiss franc. Excluding the impact of currency ﬂuctuations, recurring fees were up 1% in 2003 from 2002, mainly as a result of increased fees from mutual fund products as well as rising asset-based fees that reflected higher asset levels in managed account products. In addition, the gain was accentuated by higher recurring fees in the municipal securities business. The number of ﬁnancial advisors decreased to 7,766 in 2003 from 8,857 a year earlier due to the curtailment of our training program and an increase in attrition rates among less experienced and less productive ﬁnancial advisors. Results As our business is almost entirely conducted in US dollars, comparisons of 2003 and 2002 results are affected by the depreciation of the US dollar versus the Swiss franc. In 2003, Wealth Management USA reported a pre-tax loss of CHF 5 million compared to a loss of CHF 1,800 million a year earlier. This change includes the writedown of the value of the PaineWebber brand in 2002 and the CSC disposal in 2003. After their exclusion and before acquisition costs, per- formance improved 5%. On this basis and in US dollar terms, performance in 2003 was 21% above that in 2002, reﬂect- ing higher recurring fee gains and improved transactional rev- enues. Client activity increased, with daily average trades ris- ing 3% above their 2002 level. In addition, conditions in the municipal securities market remained extremely buoyant, with new issues hitting an all-time high this year. At the same time, we continued to beneﬁt from cost-saving initiatives started when we became a part of UBS. Wealth Management USA had CHF 634 billion in invested assets on 31 December 2003, up 9% from CHF 584 billion on 31 December 2002. The increase was due to inﬂows of net new money and the effects of market appreciation. In US dol- lar terms, invested assets were 21% higher on 31 December 2003 than they were at the same time in 2002. We continue to report consistently strong inﬂows of net new money. In 2003, inﬂows were CHF 21.1 billion, 14% above the CHF 18.5 billion result reported for 2002. Includ- ing interest and dividends, net new money in 2003 was CHF 36.9 billion, up from CHF 36.4 billion in 2002. Operating income In 2003, total operating income was CHF 5,182 million com- pared to CHF 5,548 million in 2002. Before acquisition costs and excluding the sale of our CSC business, total operating income was 12% lower compared to a year earlier. Excluding the currency effect and acquisition costs, operating income actually increased by 2% from 2002. This increase was due to higher recurring fees as well as higher transactional rev- enue, reﬂecting the improved market conditions. Further, revenues were accentuated by much stronger revenues from our municipal securities business. 56 Operating expenses Total operating expenses decreased 29% to CHF 5,187 mil- lion in 2003 from CHF 7,348 million in 2002. Excluding ac- quisition costs and the writedown of the PaineWebber brand in 2002, the drop was 14%, mainly due to the weakening of the US dollar against the Swiss franc. Excluding currency effects, operating expenses were 1% lower, reﬂecting lower general and administrative expenses, which were nearly off- set by higher performance-related compensation. Personnel expenses dropped 13% from CHF 4,158 million in 2002 to CHF 3,627 million in 2003. Excluding the effects of currency translation, personnel expenses were actually slightly higher than in 2002, reﬂecting higher performance-related com- pensation due to an increase in revenue partially offset by low- er retention payments. General and administrative expenses fell 22% from CHF 926 million in 2002 to CHF 719 million in 2003. Excluding the impact of currency ﬂuctuations, general and administrative expenses dropped 11% compared to 2002 due to the strict cost management discipline that we have ex- erted in the past three years. Operational provisions also fell as 2002 included the equity research settlement charge of CHF 21 million. The drop was further accentuated by the sale of the CSC business. Services rendered from other business units decreased by 12% to CHF 433 million in 2003 from CHF 492 million in 2002. Depreciation decreased CHF 9 million to CHF 72 million in 2003 from CHF 81 million in 2002. Good- will and other intangible amortization decreased from CHF 1,691 million in 2002 to CHF 336 million in 2003. This de- crease was due to the writedown of the PaineWebber brand name in 2002, and the sale of CSC. Excluding the writedown and the sale of CSC, amortization charges dropped by 26% as a result of the weakening US dollar against the Swiss franc. Headcount Wealth Management USA’s headcount decreased 8% during 2003 to 17,435, reﬂecting continued cost management ini- tiatives, the curtailment of the trainee program, and the sale of CSC. Non-ﬁnancial advisor headcount was down by 503 or 5% compared to the end of 2002. 57 Financial Businesses Corporate Center Corporate Center Corporate Center reported a pre-tax loss of CHF 276 million in 2004, compared to a loss of CHF 759 million in 2003. Business Group reporting CHF million, except where indicated Income Credit loss (expense) / recovery 2 Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and amortization of goodwill and other intangible assets Business Group reporting adjusted for signiﬁcant ﬁnancial events CHF million, except where indicated Income Credit loss (expense) / recovery 2 Total operating income Total operating expenses Business Group performance before tax Business Group performance before tax and amortization of goodwill and other intangible assets Additional information Fair value of employee stock options granted 4 For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 1,258 321 1,579 1,222 1,237 (1,509) 814 91 1,855 (276) (185) 900 122 1,022 1,145 1,334 (1,639 ) 840 101 1,781 (759 ) (658 ) 2,403 1 300 2,703 1,450 1,564 (1,633 ) 893 122 2,396 307 429 40 163 55 7 (7 ) 8 (3 ) (10 ) 4 64 72 For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 1,258 321 1,579 1,855 (276) (185) 900 122 1,022 1,781 (759 ) (658 ) 2,176 3 300 2,476 2,396 80 202 40 163 55 4 64 72 For the year ended % change from 31.12.04 14 31.12.03 18 31.12.02 37 31.12.03 (22 ) 2 In order to show the relevant Business Group 1 Includes signiﬁcant ﬁnancial events: gain on disposal of Hyposwiss of CHF 155 million and gain on disposal of Klinik Hirslanden of CHF 72 million. performance over time, adjusted expected credit loss rather than credit loss expense is reported for all Business Groups. The difference between the adjusted expected credit loss and credit loss recorded at Group level is reported in the Corporate Functions (see note 2 to the ﬁnancial statements). 3 Excludes signiﬁcant ﬁnancial events: gain on disposal of Hyposwiss of CHF 155 million and gain on disposal of Klinik Hirslanden of CHF 72 million. 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. Clive Standish | UBS Chief Financial Ofﬁcer Head, Corporate Center 58 Private Banks & GAM Business Unit reporting CHF million, except where indicated Income Adjusted expected credit loss 2 Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Unit performance before tax Business Unit performance before tax and amortization of goodwill and other intangible assets KPIs Invested assets (CHF billion) Net new money (CHF billion) 3 Cost / income ratio (%) 4 Business Unit reporting adjusted for signiﬁcant ﬁnancial events CHF million, except where indicated Income Adjusted expected credit loss 2 Total operating income Total operating expenses Business Unit performance before tax Business Unit performance before tax and amortization of goodwill and other intangible assets 31.12.04 1,145 (6) 1,139 432 160 10 20 74 696 443 517 92 7.7 60.8 31.12.04 1,145 (6) 1,139 696 443 517 For the year ended % change from 31.12.03 31.12.02 31.12.03 880 (2 ) 878 381 169 11 28 81 670 208 289 84 7.2 76.1 1,038 1 (2 ) 1,036 386 120 12 40 98 656 380 478 70 4.2 63.2 30 (200 ) 30 13 (5 ) (9 ) (29 ) (9 ) 4 113 79 10 For the year ended % change from 31.12.03 31.12.02 31.12.03 880 (2 ) 878 670 208 289 883 5 (2 ) 881 656 225 323 30 (200 ) 30 4 113 79 KPIs Cost / income ratio excluding goodwill and SFEs (%) 6 54.3 66.9 63.2 Additional information CHF million, except where indicated Regulatory equity allocated (average) Headcount (full-time equivalents) As at or for the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 650 1,649 700 1,672 850 1,702 (7 ) (1 ) 1 Includes signiﬁcant ﬁnancial event: gain on disposal of Hyposwiss of CHF 155 million. Business Units (see note 2 to the ﬁnancial statements). of CHF 155 million. 3 Excludes interest and dividend income. 6 Operating expenses less the amortization of goodwill and other intangible assets / income less signiﬁcant ﬁnancial events. 2 In management accounts, adjusted expected credit loss rather than credit loss expense is reported for the 5 Excludes signiﬁcant ﬁnancial event: gain on disposal of Hyposwiss 4 Operating expenses / income. 59 Financial Businesses Corporate Center Signiﬁcant ﬁnancial events – In ﬁrst quarter 2002, we realized a pre-tax gain of CHF 155 million from the sale of the private bank Hyposwiss. There were no significant financial events in Private Banks & GAM in 2004 or 2003. 2004 Key performance indicators In 2004, Private Banks & GAM reported a record net new money inﬂow of CHF 7.7 billion, up from the previous record of CHF 7.2 billion in 2003. Performance was driven by GAM’s continued business strength. Invested assets on 31 December 2004 were CHF 92 billion, up by 10% from CHF 84 billion on 31 December 2003, re- ﬂecting the overall market recovery. Results Pre-tax proﬁt was a record CHF 443 million in 2004, up 113% from CHF 208 million a year earlier, reﬂecting improved mar- ket conditions, which produced a 10% growth in the asset base, and resulted in higher asset-based revenues. Results were helped by a 9% decline in non-personnel costs, which continued to be tightly controlled. Total operating income, at CHF 1,139 million in 2004, in- creased CHF 261 million or 30% from 2003. The result was due to record revenues from GAM, alongside growth in the private banks’ transactional revenues. Operating expenses were CHF 696 million in 2004, up 4% from CHF 670 million in 2003. The increase was driven by higher personnel expenses, up CHF 51 million to CHF 432 mil- lion in 2004 from CHF 381 million in 2003, reﬂecting higher performance-related compensation. This was partially offset by a drop in non-personnel related expenses, down 9%. Gen- eral and administrative expenses dropped 5% to CHF 160 mil- lion in 2004 from CHF 169 million in 2003, reﬂecting lower restructuring costs than in 2003, which saw the merger of the three private banks Cantrade, Bank Ehinger and Armand von Ernst. Depreciation dropped by 29%, mainly reﬂecting IT- related declines. Amortization of goodwill fell 9% because of the weakening of the US dollar against the Swiss franc. Headcount Headcount was 1,649 on 31 December 2004, down 1% from 1,672 on 31 December 2003. 31.12.02 31.12.03 31.12.04 1,702 1,672 1,649 Headcount full-time equivalents 1,750 1,700 1,650 1,600 1,550 2003 Key performance indicators Invested assets in Private Banks & GAM totaled CHF 84 bil- lion on 31 December 2003, up from CHF 70 billion on 31 De- cember 2002, reﬂecting strong net new money inﬂows, and positive ﬁnancial markets as well as the acquisition of Banque Notz Stucki S.A. by Ferrier Lullin & Cie S.A., which was com- pleted in December 2003. Net new money was CHF 7.2 billion in 2003, up from CHF 4.2 billion in 2002, driven by excellent inﬂows into GAM. Results Pre-tax proﬁt, at CHF 208 million in 2003, dropped by 45% from CHF 380 million a year earlier. Total operating income dropped to CHF 878 million in 2003 from CHF 1,036 million in 2002. This was mainly due to the divestment gain of CHF 155 million due to the sale of Hypo- swiss in 2002. Excluding the sale, total operating income remained virtually unchanged. Total operating expenses increased to CHF 670 million in 2003, up 2% from CHF 656 million in 2002. The increase mainly reﬂected higher legal provisions, as well as restructur- ing costs related to the merger of Cantrade, Bank Ehinger and Armand von Ernst to form Ehinger & Armand von Ernst. Headcount Headcount decreased by 30 to 1,672 on 31 December 2003 from 1,702 a year earlier, mainly due to the rationalization within the individual private banks. This was partially offset by the acquisition of Banque Notz Stucki S.A. as well as an increase in headcount at GAM due to the growth of the business. 60 Corporate Functions Business Unit reporting CHF million, except where indicated Income Credit loss (expense) / recovery 2 Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation Amortization of goodwill and other intangible assets Total operating expenses Business Unit performance before tax Business Unit performance before tax and amortization of goodwill and other intangible assets Business Unit reporting adjusted for signiﬁcant ﬁnancial events CHF million, except where indicated Income Credit loss (expense) / recovery Total operating income Total operating expenses Business Unit performance before tax Business Unit performance before tax and amortization of goodwill and other intangible assets Additional information CHF million, except where indicated Regulatory equity allocated (average) Headcount (full-time equivalents) For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 113 327 440 790 1,077 (1,519) 794 17 1,159 (719) (702) 20 124 144 764 1,165 (1,650 ) 812 20 1,111 (967 ) (947 ) 1,365 1 302 1,667 1,064 1,444 (1,645 ) 853 24 1,740 (73 ) (49 ) 465 164 206 3 (8 ) 8 (2 ) (15 ) 4 26 26 For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 113 327 440 1,159 (719) (702) 20 124 144 1,111 (967 ) (947 ) 1,293 3 302 1,595 1,740 (145 ) (121 ) 465 164 206 4 26 26 As at or for the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 6,950 3,553 8,450 3,561 9,400 3,505 (18 ) 0 1 Includes signiﬁcant ﬁnancial event: gain on disposal of Klinik Hirslanden of CHF 72 million. 2 In order to show the relevant Business Group performance over time, adjusted expected credit loss rather than credit loss expense is reported for all Business Groups. The difference between the adjusted expected credit loss and credit loss recorded at Group level is reported in the Corporate Functions (see note 2 to the ﬁnancial statements). 3 Excludes signiﬁcant ﬁnancial event: gain on disposal of Klinik Hirslanden of CHF 72 million. 61 Financial Businesses Corporate Center Signiﬁcant ﬁnancial events – In fourth quarter 2002, we realized a net gain of CHF 60 million (pre-tax CHF 72 million) from the sale of Klinik Hirslanden, a private hospital group. There were no signiﬁcant ﬁnancial events in Corporate Functions in 2004 or 2003. 2004 Results Corporate Functions recorded a pre-tax loss of CHF 719 mil- lion in full-year 2004, compared to a loss of CHF 967 million a year earlier. The improvement was driven by a CHF 93 mil- lion rise in income and signiﬁcantly higher credit loss recov- eries (up CHF 203 million). Operating expenses increased CHF 48 million, reﬂecting higher personnel expenses. There were lower charges to other business units, reﬂecting cost savings at the Information Technology Infrastructure unit (ITI) and lower insurance premiums. Operating income Total operating income increased to CHF 440 million in 2004 from CHF 144 million in 2003. The result was driven by higher credit recoveries as well as higher revenues. Income increased by CHF 93 million to CHF 113 million in 2004 mainly due to lower writedowns of ﬁnancial investments (in 2003 we recorded a writedown in our stake in Swiss Inter- national Airlines Ltd.). This was partially offset by lower in- terest income from invested equity as we continue to repur- chase shares. Credit loss recoveries were up in 2004 from 2003. The credit loss expense or recovery booked in Corporate Functions represents the difference between the adjusted expected credit losses charged to the business units and the credit loss recognized in the UBS ﬁnancial statements. In 2004, UBS recorded a credit loss recovery of CHF 276 million, compared to a credit loss expense of CHF 72 million in 2003. In both years, credit loss expense was lower than the adjusted expect- ed credit loss charged to the business units, resulting in cred- it loss recoveries in Corporate Functions of CHF 327 million in 2004 and CHF 124 million in 2003. Operating expenses Total operating expenses were CHF 1,159 million in 2004, up CHF 48 million from CHF 1,111 million in 2003. At CHF 790 million in 2004, personnel expenses were up 3% from CHF 764 million in 2003, reﬂecting higher performance-relat- ed compensation. In the same period, general and administra- tive expenses dropped 8% to CHF 1,077 million from CHF 1,165 million. This was mainly due to falling IT costs related to infrastructure cost savings as well as lower legal provisions. 62 Other business units were charged CHF 1,519 million for serv- ices provided by Corporate Functions in 2004, compared to CHF 1,650 million in 2003. This drop was due to reduced charges reﬂecting cost savings at our ITI unit as well as lower project-related charges. Depreciation dropped to CHF 794 million in 2004 from CHF 812 million in 2003, reﬂecting low- er IT-related charges, partially offset by higher costs for real estate. Amortization of goodwill and other intangible assets was CHF 17 million in 2004, down by CHF 3 million from 2003 due to the weakening of the US dollar against the Swiss franc. Headcount Corporate Functions headcount outside the ITI unit was 1,199 on 31 December 2004, down by 7 from 1,206 on 31 De- cember 2003. Over the same period, ITI headcount dropped 1 to 2,354. 31.12.02 31.12.03 31.12.04 3,561 3,553 3,505 Headcount full-time equivalents 3,600 3,450 3,300 3,150 3,000 2003 Results Corporate Functions recorded a pre-tax loss of CHF 967 mil- lion in full-year 2003, against a CHF 73 million loss a year earlier. Operating income Total operating income dropped by 91% from CHF 1,667 mil- lion in 2002 to CHF 144 million in 2003. Excluding the divest- ment gains of CHF 72 million from Hirslanden in 2002, the drop was 91%. This was mainly due to a fall-off in income of Klinik Hirslanden, and lower gains from ﬁnancial investments. It also reflected lower interest income from our treasury activities following a decrease in revenues from our invested equity as we continued to buy back shares and experienced low interest rates. The impact of falling interest rates was par- tially offset by the diversiﬁcation of our invested equity into currencies other than Swiss francs which led to higher returns and increased currency hedging revenues. Results also reﬂect- ed the CHF 178 million fall in credit loss recoveries. The credit loss expense or recovery booked in Corporate Functions represents the difference between the adjusted expected credit losses charged to the business units and the credit loss recognized in the UBS ﬁnancial statements. We recorded a credit loss expense of CHF 72 million in 2003, com- pared to a credit loss expense of CHF 115 million in 2002. In both periods, credit loss expense was lower than the adjust- ed expected credit loss charged to the business units, leading to a credit loss recovery of CHF 124 million in 2003 and CHF 302 million in 2002 in Corporate Functions. related expenses, partially offset by higher branding costs. Services rendered to other business units remained virtually ﬂat at CHF 1,650 million in 2003, up CHF 5 million from 2002. Depreciation dropped from CHF 853 million in 2002 to CHF 812 million in 2003. The decrease is mainly due to the absence of depreciation expenses from Klinik Hirslanden. At CHF 20 million in 2003, amortization of goodwill and other intangibles dropped by 17% from CHF 24 million in 2002, reflecting the drop of the US dollar against the Swiss franc. Operating expenses Total operating expenses fell to CHF 1,111 million in 2003, down from CHF 1,740 million in 2002. Personnel expenses de- clined 28% from CHF 1,064 million in 2002 to CHF 764 mil- lion in 2003. The drop was due to the deconsolidation of Klinik Hirslanden, but was partially offset by higher expenses for performance-related compensation. In the same period, gen- eral and administrative expenses fell to CHF 1,165 million from CHF 1,444 million. This was mainly due to lower legal pro- visions, the disposal of Klinik Hirslanden, and lower project- Headcount Corporate Functions headcount was 3,561 on 31 December 2003, an increase of 56 from the 3,505 on 31 December 2002. The increase was mainly due to the ﬁrst-time consoli- dation of Hotel Widder as well as an increase in our human resources and risk functions. This was nearly offset by a de- cline in the number of trainees, a transfer of some employees to the Business Groups, and lower headcount in the Chief Communication Ofﬁcer area. 63 64 Industrial Holdings Industrial Holdings Industrial Holdings Income statement 1 CHF million, except where indicated Income 3 Total operating income Personnel expenses General and administrative expenses Depreciation Amortization of goodwill and other intangible assets Goods and materials purchased Total operating expenses Operating proﬁt before tax and minority interests Tax expense Net proﬁt before minority interests Minority interests 4 Net proﬁt Additional information Headcount (full-time equivalents) For the year ended 31.12.04 2 3,667 3,667 326 126 70 77 2,861 3,460 207 49 158 (113) 45 As at 31.12.04 8,020 2 Results shown for the 1 Industrial Holdings consists of Motor-Columbus, a Swiss holding company, whose only signiﬁcant asset is a 59.3% interest in Atel, a Swiss-based European energy provider. six month period beginning on 1 July 2004. 3 Includes equity in income of associates of CHF 19 million. 4 Reﬂects minority interests in Motor-Columbus plus minority interests in Atel. Major participations Results The Industrial Holdings segment is a new segment, currently made up of UBS’s majority stake in Motor-Columbus, a ﬁnan- cial holding company whose only signiﬁcant asset is a 59.3% interest in the Atel Group (Aare-Tessin Ltd. for Electricity). Atel, based in Olten, Switzerland, is a European energy provider focused on electricity trading and marketing, domestic and international power generation, electricity transmission and energy services. Motor-Columbus also holds several other ﬁnance and property companies. Transfer of private equity stakes In ﬁrst quarter 2005, our private equity investments, cur- rently part of the Investment Bank, will be reported within the Industrial Holdings segment. This matches our strategy of de-emphasizing and reducing exposure to this asset class while capitalizing on orderly exit opportunities when they arise. Current management will continue to look after the portfolio. UBS’s consolidation of Motor-Columbus into its accounts at the beginning of third quarter 2004 resulted in a revaluation of the latter’s assets and liabilities. These are no longer com- parable with those previously published in Motor-Columbus’s separate consolidated ﬁnancial statements. The comparative analysis provided here is based on unaudited proforma 2003 results. For the six months ending 31 December 2004, our share of Motor-Columbus’s net proﬁt was CHF 45 million. Total operating income for the six months ending 31 De- cember 2004 was CHF 3,667 million, signiﬁcantly higher than in the same period a year earlier. The gain was due to the ﬁrst- time availability of production capacity in Southern Europe. Over the same period, total operating expenses, at CHF 3,460 million, rose at a slower pace than operating income because costs for energy purchased from third parties fell in the period as internal power production could be run at near full capac- ity. Expense levels also beneﬁted from lower project costs. 66 Balance Sheet and Cash Flows Balance Sheet and Cash Flows Balance sheet and off-balance sheet Balance sheet and off-balance sheet UBS’s total assets stood at CHF 1,734.8 billion on 31 Decem- ber 2004, up from CHF 1,550.1 billion on 31 December 2003. The increase in total assets was the net result of growth in the trading portfolio (up CHF 67.6 billion), collateral trading as- sets (up CHF 43.0 billion), derivatives (up CHF 36.4 billion) and the loan book (up CHF 19.7 billion). Total liabilities rose due to higher borrowings (up CHF 80.8 billion), derivatives (up CHF 48.9 billion), trading portfolio liabilities (up CHF 27.1 billion) and collateral trading liabilities (up CHF 15.0 billion). tially offset by early redemptions, repurchases and cancelled bonds totaling CHF 24.7 billion. We believe the maturity proﬁle of our long-term debt portfolio balances well and matches the maturity proﬁle of our assets. For further details, please refer to note 18 to the ﬁnancial statements. The due to customers line was up CHF 29.4 billion, in connection with both prime brokerage and wealth management business growth, especially in the US (additional FDIC-insured deposits of CHF 7.7 billion), Europe and Asia. Motor-Columbus The ﬁrst-time full consolidation of Motor-Columbus in third quarter 2004 had a small net impact on our end of year bal- ance sheet, adding assets of CHF 7.3 billion (0.4% of UBS’s total assets) and total liabilities of CHF 6.0 billion. The con- solidation also added ﬁnancial instruments measured at fair value of CHF 0.7 billion. Lending and borrowing Lending Cash increased by CHF 2.5 billion to CHF 6.0 billion on 31 De- cember 2004 from a year earlier as we preferred to keep com- fortable balances with different central banks towards the end of the year. At CHF 35.3 billion on 31 December 2004 the due from banks line increased by CHF 3.5 billion, driven by the ﬁrst time consolidation of Motor-Columbus as well as increased bal- ances in the private label banks. Our loans to customers in- creased to CHF 232.4 billion on 31 December 2004, up by CHF 19.7 billion from the level on 31 December 2003 as a result of higher secured lending, mainly in our Wealth Management businesses, both domestic and international. This was further accentuated by an increase in secured lending in our Invest- ment Bank’s mortgage-backed securities and prime brokerage businesses. Borrowing The due to banks line declined by CHF 8.1 billion due to a lower proportion of funding secured through the European Central Bank repo market. Total debt issued increased to CHF 183.6 billion on 31 December 2004, up by CHF 59.5 billion, reﬂecting additional outstanding positions in money market paper (CHF 21.3 billion, primarily US commercial paper). The long-term debt line (including ﬁnancial instruments designat- ed at fair value) rose by CHF 38.1 billion to CHF 104.1 billion. We issued new long-term debt of CHF 51.2 billion as a con- sequence of attractive market conditions for new issuance of bonds and structured funding products. This increase was par- Repo and securities borrowing / lending During 2004, cash collateral on securities borrowed and re- verse repurchase agreements combined increased by CHF 43.0 billion or 8% to CHF 577.4 billion, while the sum of se- curities lent and repos grew by CHF 15.0 billion or 3% to CHF 484.1 billion. The matched book (a repo portfolio comprised of assets and liabilities with equal maturities and equal value, so that substantially all the risks cancel each other out) grew, reﬂecting a favorable spread environment. Securities borrow- ing and lending increased due to the growth of our prime brokerage business. Trading portfolio Trading assets increased by CHF 67.6 billion to CHF 529.4 bil- lion on 31 December 2004 from CHF 461.8 billion on 31 De- cember 2003. Over the same period, short trading positions increased by CHF 27.1 billion to CHF 171.0 billion. A net in- crease was recorded in structured equity instruments, due to higher client demand for these products. This was accompa- nied by a net increase in ﬁxed income instruments, mainly in credit derivatives and investment grade bonds. Replacement values In 2004 positive replacement values (mainly derivative instru- ments) increased by CHF 36.4 billion to CHF 284.6 billion, while negative replacement values increased by CHF 48.9 bil- lion up to CHF 303.7 billion over the same period. Three main factors contributed to this development: a decline in long-term interest rates in all major markets, the appreciation of the Swiss franc against major currencies, and higher trading vol- umes. Other assets / liabilities and minority interests Investment in associates increased by 50% to CHF 2.4 billion on 31 December 2004, while property and equipment was up by 14% to CHF 8.7 billion, both mainly due to the consoli- dation of Motor-Columbus. Goodwill and other intangible assets at CHF 12.1 billion on 31 December 2004 were up by 5% from the same date a year ago, reﬂecting the acquisi- 68 tion of several wealth management businesses, the acqui- sition of the capital market business of Charles Schwab as well as the consolidation of Motor-Columbus. This was only partially offset by amortization charges of CHF 964 million during 2004. Minority interests increased by 31% to CHF 5.3 billion on 31 December 2004 from CHF 4.1 billion at the same date a year ago, reﬂecting the full consolidation of Motor-Columbus. This was partially offset by a currency-driven drop in the val- ue of issued trust preferred securities as well as the full acqui- sition of the previous joint venture UBS Brunswick Moscow. Shareholders’ equity At CHF 35.0 billion on 31 December 2004, shareholders’ equity declined by CHF 0.3 billion from a year earlier. The decline was due to dividend payments, share repurchases, and the weakening of the US dollar against the Swiss franc, mostly offset by strong retained earnings. Contractual obligations The table below summarizes our contractual obligations as of 31 December 2004. All contracts, with the exception of pur- chase obligations (those where we are committed to purchase determined volumes of goods and services), are either recog- nized as liabilities on our balance sheet or, in the case of op- erating leases, are disclosed in note 26 to the ﬁnancial state- ments. The following liabilities recognized on the balance sheet are excluded from the table because we do not consider these ob- ligations as contractual: provisions, current and deferred tax liabilities, liabilities to employees for equity participation plans, settlement and clearing accounts and amounts due to banks and customers. Within purchase obligations, we have excluded our obli- gation to employees under the mandatory notice period, dur- ing which we are required to pay employees contractually agreed salaries. Off-balance sheet arrangements In the normal course of business, UBS enters into arrange- ments that, under IFRS, are not recognized on the balance sheet and do not affect the income statement. These types of arrangements are kept off-balance sheet as long as UBS does not incur an obligation from them or become entitled to an asset itself. As soon as an obligation is incurred, it is recog- nized on the balance sheet, with the resulting loss recorded in the income statement. It should be noted, however, that the amount recognized on the balance sheet does not, in many instances, represent the full loss potential inherent in such arrangements. For the most part, the arrangements discussed below either meet the ﬁnancial needs of customers or offer invest- ment opportunities through entities that are not controlled by UBS. The importance of such arrangements to us, with respect to liquidity, capital resources or market and credit risk support, is minimal. We do not rely on such arrangements as a major source of revenue nor have we incurred through them signiﬁcant expenses in the past and we do not expect to do so in the future. The following paragraphs discuss three distinct areas of off-balance sheet arrangements as of 31 De- cember 2004 and any potential obligations that may arise from them. Guarantees In the normal course of business, we issue various forms of guarantees to support our customers. These guarantees, with the exception of related premiums, are kept off-balance sheet unless a provision is needed to cover probable losses. The con- tingent liabilities arising from these guarantees are disclosed in note 25 to the ﬁnancial statements. In 2004, our contin- gent liabilities from guarantees are slightly below the level compared to a year earlier. Fee income earned from issuing guarantees is not material to our total revenues. Losses in- curred under guarantees were insigniﬁcant for each of the last three years. Retained interests UBS sponsors the creation of Special Purpose Entities (SPEs) that facilitate the securitization of acquired residential and commercial mortgage loans and related securities. We also securitize customers’ debt obligations in transactions that involve SPEs which issue collateralized debt obligations. A typical securitization transaction of this kind would involve the transfer of assets into a trust or corporation in return for Contractual obligations CHF million Long-term debt Capital lease obligations Operating leases Purchase obligations Other long term liabilities Total Payment due by period Less than 1 year 17,847 104 886 10,580 173 29,590 1–3 years 26,978 163 1,524 5,545 2 34,212 3–5 years More than 5 years 23,805 44 1,231 2,075 959 28,114 31,402 0 4,060 9,398 0 44,860 69 Balance Sheet and Cash Flows Balance sheet and off-balance sheet beneficial interests in the form of securities. Generally, the beneficial interests are sold to third parties shortly after the securitization. We do not provide guarantees or other forms of credit support to these SPEs. Assets are no longer reported in our consolidated financial statements as soon as their risk or reward is transferred to a third party. For further discussion of our securitization activities, see note 34 to the financial statements. Derivative instruments recorded in shareholders’ equity We have no derivative contracts linked to our own shares that are accounted for as equity instruments. With the exception of physically settled written put options (see note 1 to the ﬁnancial statements), derivative contracts linked to our shares are accounted for as derivative instruments and are carried at fair value on the balance sheet under positive replacement values or negative replacement values. 70 Balance Sheet and Cash Flows Cash ﬂows Cash ﬂows At end-2004, the level of cash and cash equivalents rose to CHF 82.8 billion, up CHF 9.4 billion from 73.4 billion at end-2003. 2003, and because we issued CHF 21.4 billion in money market paper in 2004 after repaying CHF 14.7 billion a year earlier. Operating activities Net cash ﬂow from operating activities was negative CHF 27.9 billion in 2004 compared to positive CHF 3.4 billion in 2003. Operating cash inﬂows (before changes in operating assets and liabilities and income taxes paid) totaled CHF 10.8 billion in 2004, an increase of CHF 1.8 billion from 2003. While our net proﬁt rose by CHF 1.9 billion between 2004 and 2003, we had considerably higher non-cash expenses in 2003, which reduce net proﬁt but do not affect cash ﬂows. With our adop- tion of IAS 39 in 2004, we started to account for some of our debt issues at fair value, leading to the recognition of an ad- ditional non-cash expense item of CHF 1.2 billion, essentially comprising an add-back to operating cash ﬂows. Cash of CHF 71.4 billion was used to fund the net increase in operating assets, while a net increase in operating liabili- ties generated cash inﬂows of CHF 34.0 billion. The compar- ative amounts in 2003 were higher, primarily reﬂecting a pick-up in activities in 2003 related to the recovery seen in the ﬁnancial markets. Payments to tax authorities were CHF 1.3 billion in 2004, up CHF 232 million from a year earlier, re- ﬂecting the increase in net proﬁt between 2003 and 2002. Investing activities Investing activities generated a cash outﬂow of CHF 1.5 bil- lion, mainly due to our acquisition of new businesses, which totaled CHF 1.7 billion net of disposals. By contrast, in 2003, we saw a net cash inﬂow of CHF 3.1 billion, mainly from our divestments of ﬁnancial investments and the sale of the Correspondent Services Corporation. Disposals of property and equipment were CHF 581 million higher in 2004. Financing activities The overall increase in cash inﬂows seen in 2004 is attributa- ble to our ﬁnancing activities, which generated positive cash ﬂows of CHF 39.8 billion. This reﬂected the net issuance of money market paper of CHF 21.4 billion and the issuance of CHF 51.2 billion in long-term debt – the latter signiﬁcantly out- pacing long-term debt repayments, which totaled CHF 24.7 billion. That inﬂow was partly offset by outﬂows attributable to net movements in treasury shares and own equity deriva- tive activity (CHF 5.0 billion), and dividend payments (CHF 2.8 billion). In contrast, in 2003, we had experienced a neg- ative cash ﬂow of CHF 13.3 billion from our ﬁnancing activi- ties. The difference between the two years was mainly due to the fact that long-term debt issuance more than doubled from 2003 In the full year to 31 December 2003, cash and cash equiva- lents decreased by CHF 9.0 billion, principally as a result of ﬁnancing activities, which generated negative cash ﬂows of CHF 13.3 billion. Signiﬁcant cash outﬂows resulted from CHF 14.7 billion in repayments of money market paper, CHF 6.8 billion from movements in treasury shares and derivative ac- tivity in own equity, and CHF 2.3 billion from dividends paid. Issuance of long-term debt of CHF 23.6 billion and repayments of CHF 13.6 billion brought a net cash inﬂow of CHF 10.0 bil- lion. When compared to 2002, cash outﬂows from ﬁnancing activities fell by approximately CHF 19 billion. The main rea- sons for the reduced outﬂows were an approximate CHF 12 billion decline in repayments of money market paper and higher net inﬂows of roughly CHF 8 billion in both issuance and repayment of long-term debt. Increased buybacks of treasury shares in 2003, coupled with a higher average price for our shares, resulted in a higher cash outﬂow of approxi- mately CHF 1.2 billion in 2003. Operating cash inﬂows (before changes in operating as- sets and liabilities and income taxes paid) amounted to CHF 9.0 billion, an increase of CHF 1.4 billion from 2002. While net proﬁt in 2003 was CHF 2.7 billion higher than a year ear- lier, we had considerably higher non-cash expenses in 2002, which reduce net proﬁt but do not affect cash ﬂow. Notably, amortization of goodwill and intangible assets was CHF 1.5 billion higher in 2002 than in 2003. The main reason was the writedown of the value of the PaineWebber brand name of CHF 1,234 million, but the US dollar exchange rate, which was higher in 2002 against most currencies than it was in 2003, also contributed to the difference. The other two sig- niﬁcant items were deferred tax expense and gains or losses from investing activities included in net proﬁt. In 2003, we had deferred tax expenses of CHF 489 million, attributable to a range of sources generating taxable temporary differ- ences. In 2002, we had a deferred tax beneﬁt of CHF 511 mil- lion, to which the release of deferred tax liabilities related to the PaineWebber brand name was the largest single contrib- utor. Cash of CHF 88.1 billion was used to fund the net increase in operating assets, while a net increase in operating liabili- ties generated cash inﬂows of CHF 83.6 billion. The com- parative amounts in 2002 were much smaller, primarily re- 71 Balance Sheet and Cash Flows Cash ﬂows ﬂecting a pick-up in activities in 2003 related to the rebound of the ﬁnancial markets. Payments to tax authorities were CHF 1.1 billion, an increase of CHF 532 million compared to 2002. Investing activities generated cash inﬂow of CHF 1.5 bil- lion. Divestments of ﬁnancial investments contributed CHF 2.3 billion while the sale of the CSC clearing business and a few smaller subsidiaries and associates generated CHF 834 million. Purchases of property and equipment amounted to CHF 1.4 billion, of which the largest portion was spent for IT, software and communication equipment. Comparative amounts in 2002 did not deviate materially from 2003. 72 Accounting Standards and Policies Accounting Standards and Policies Accounting principles Accounting principles The UBS ﬁnancial statements have been prepared in accor- dance with International Financial Reporting Standards (IFRS). As a US listed company, we also provide a description in note 41 to the ﬁnancial statements of the signiﬁcant differences which would arise were our accounts to be presented under the United States Generally Accepted Accounting Principles (US GAAP), and a detailed reconciliation of IFRS shareholders’ equity and net proﬁt to US GAAP. Except where clearly identiﬁed, all of UBS’s ﬁnancial infor- mation presented in this document is presented on a con- solidated basis under IFRS. Pages 191 to 203 contain the financial statements for the UBS AG Parent Bank – the Swiss company, including branches worldwide, which owns all the UBS companies, directly or indirectly. The Parent Bank’s financial statements are prepared in order to meet Swiss regulatory require- ments and in compliance with Swiss Banking Law. Except in those pages, or where otherwise explicitly stated, all ref- erences to “UBS” refer to the UBS Group and not to the Parent Bank. All references to 2004, 2003 and 2002 refer to the UBS Group and the Parent Bank’s ﬁscal years ended 31 December 2004, 2003 and 2002. The ﬁnancial statements for the UBS Group and the Parent Bank have been audited by Ernst & Young Ltd. An explanation of the critical accounting policies applied in the preparation of our ﬁnancial statements is provided below. The basis of our accounting is given in note 1 to the ﬁnancial statements. Standards for management accounting Our management reporting systems and policies deter- mine the revenues and expenses directly attributable to each business unit. Internal charges and transfer pricing adjustments are reﬂected in the performance of each busi- ness unit. Inter-business unit revenues and expenses. Revenue- sharing agreements are used to allocate external customer revenues to business units on a reasonable basis. Transactions between business units are conducted at arm’s length. Inter- business unit charges are reported in the line “Services to / from other business units” for both business units concerned. Corporate Functions expenses are allocated to the operating business units to the extent that it is appropriate. Net interest income is allocated to each business unit based on their balance sheet positions. Assets and liabilities of the ﬁnancial businesses are funded through and invested with the central treasury departments, with the net margin reﬂected in the results of each business unit. To complete the alloca- tion, the ﬁnancial businesses are credited with a risk-free return on the regulatory equity they use. Commissions are credited to the business unit with the cor- responding customer relationship, with revenue-sharing agreements for the allocation of customer revenues where several business units are involved in value creation. For internal management reporting purposes and in the results discussion, we measure credit loss using an expected loss concept. The table below shows the adjusted expected credit loss charged to the Business Groups. Expected credit loss reﬂects the average annual costs that are expected to arise over time from positions in the current portfolio that become impaired. The adjusted expected credit loss reported for each Business Group is the expected credit loss on its portfolio plus the difference between credit loss expense and expected credit loss, amortized over a three-year period (shown as ‘de- ferral’ in the table). The difference between these adjusted ex- pected credit loss ﬁgures and credit loss expenses recorded at Group level for ﬁnancial reporting purposes is booked in Corporate Functions. Regulatory equity is allocated to business units based on their average regulatory capital requirement (per Swiss Feder- al Banking Commission (SFBC) standards) during the period. Only utilized equity is taken into account, although we add an Credit loss expense charged to the business groups CHF million For the year ended 31.12.04 Expected credit loss Deferral Adjusted expected credit loss Credit loss (expense) / recovery Wealth Management & Business Banking Investment Bank Wealth Management USA Wealth Management Business Banking CH (45 ) 37 (8 ) (1 ) (436 ) 411 (25 ) 92 (92 ) 85 (7 ) 240 (8 ) 3 (5 ) 3 Corporate Center Private Banks & GAM (2 ) (4 ) (6 ) (58 ) Balancing item charged as credit loss (expense) / recovery in Corporate Functions 74 Total (583) 532 (51) 276 327 additional buffer of 10% above the individually determined business unit regulatory equity requirement. The remaining equity, which mainly covers real estate, and any other unallo- cated equity, remains reported in the Corporate Functions unit. Headcount, which is expressed in terms of full-time equiv- alents (FTE), is measured as a percentage of the standard hours normally worked by permanent full-time staff and is used to track the number of individuals employed by UBS. FTE cannot exceed 1.0 for any particular individual. Head- count includes all staff and trainees other than short-term temporary workers (hired for less than 90 calendar days) and contractors. 75 Accounting Standards and Policies Critical accounting policies Critical accounting policies Basis of preparation and selection of policies We prepare our ﬁnancial statements in accordance with IFRS, and provide a reconciliation to US GAAP. The application of certain of these accounting principles requires a signiﬁcant amount of judgment based upon estimates and assumptions that involve signiﬁcant uncertainty at the time they are made. Changes in assumptions may have a signiﬁcant impact on the ﬁnancial statements in the periods where assumptions are changed. Accounting treatments where signiﬁcant assump- tions and estimates are used are discussed in this section, as a guide to understanding how their application affects our reported results. A broader and more detailed description of the accounting policies we employ is shown in note 1 to the ﬁnancial statements. The application of assumptions and estimates means that any selection of different assumptions would cause our report- ed results to differ. We believe that the assumptions we have made are appropriate, and that our ﬁnancial statements there- fore present our ﬁnancial position and results fairly, in all material 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 assumptions would be more appropriate. Many of the judgements we make when applying ac- counting principles depend on an assumption, which we believe to be correct, that UBS maintains sufﬁcient liquidity to hold positions or investments until a particular trading strat- egy 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 65 to 66 of the Handbook 2004 /2005. Fair value of ﬁnancial instruments Assets and liabilities in our trading portfolio, ﬁnancial assets and liabilities designated as held at fair value, and derivative instruments are recorded at fair value on the balance sheet, with changes in fair value recorded in net trading income in the income statement. Key judgments affecting this account- ing policy relate to how we determine fair value for such as- sets and liabilities. Where no active market exists, or where quoted prices are not otherwise available, we determine fair value using a vari- ety of valuation techniques. These include present value meth- ods, models based on observable input parameters, and mod- els where some of the input parameters are unobservable. Valuation models are used primarily to value derivatives transacted in the over-the-counter market, including credit derivatives and unlisted securities with embedded derivatives. All valuation models are validated before they are used as a basis for ﬁnancial reporting, and periodically reviewed there- after, by qualiﬁed personnel independent of the area that created the model. Wherever possible, we compare valuations derived from models with quoted prices of similar ﬁnancial instruments, and with actual values when realized, in order to further validate and calibrate our models. A variety of factors are incorporated into our models, including actual or estimated market prices and rates, such as time value and volatility, and market depth and liquidity. Where available, we use market observable prices and rates derived from market verifiable data. Where such factors are not market observable, changes in assumptions could affect the reported fair value of financial instruments. We apply our models consistently from one period to the next, ensuring comparability and continuity of valuations over time, but estimating fair value inherently involves a significant degree of judgment. Management therefore establishes valuation adjustments to cover the risks associated with the estima- tion of unobservable input parameters and the assumptions within the models themselves. Valuation adjustments are al- so made to reflect such elements as aged positions, deteri- orating creditworthiness (including country-specific risks), concentrations in specific types of instruments and market risk factors (interest rates, currencies etc), and market depth and liquidity. Although a significant degree of judgment is, in some cases, required in establishing fair values, manage- ment believes the fair values recorded in the balance sheet and the changes in fair values recorded in the income state- ment are prudent and reflective of the underlying econom- ics, based on the controls and procedural safeguards we em- ploy. Nevertheless, we have estimated the effect that a change in assumptions to reasonably possible alternatives could have on fair values where model inputs are not mar- ket observable. To estimate that effect on the financial state- ments, we recalculated the model valuation adjustments at higher and lower confidence levels than originally applied. For all financial instruments carried at fair value which rely on assumptions for their valuation, we estimate that fair value could lie in a range from CHF 579 million lower to CHF 927 million higher than the fair values recognized in the financial statements. Fair value option We adopted revised IAS 32 and revised IAS 39 early (at 1 Jan- uary 2004). We restated the two comparative prior years. Revised IAS 39 permits an entity to designate any ﬁnancial 76 asset or ﬁnancial liability as held at fair value and to recognize fair value changes in proﬁt and loss. We apply the fair value option primarily to compound debt instruments, which per- mits us to fair value the entire instrument instead of separat- ing the embedded derivative from the host contract and car- rying the host contract at amortized cost. In addition, ﬁnancial assets and ﬁnancial liabilities designated at fair value are pre- sented in the balance sheet in separate lines. At 31 Decem- ber 2004, we carried compound debt instruments designat- ed as held at fair value in the amount of CHF 65,756 million on the balance sheet. In 2004, the change in fair value of these instruments was an expense of CHF 1,203 million, of which CHF 402 million was attributable to changes in LIBOR and CHF 801 million was due to changes in fair value of embed- ded derivatives. Recognition of deferred Day 1 Proﬁt and Loss We have entered into transactions, some of which will ma- ture after more than ten years, where we determine fair val- ue using valuation models for which not all inputs are market observable prices or rates. We initially recognize a ﬁnancial in- strument at the transaction price, which is the best indicator of fair value, although the value obtained from the relevant valuation model may differ. Such a difference between the transaction price and the model value is commonly referred to as “Day 1 proﬁt and loss”. In accordance with applicable accounting literature, we do not recognize that initial differ- ence, usually a gain, immediately in proﬁt and loss. While ap- plicable accounting literature prohibits immediate recognition of Day 1 proﬁt and loss, it does not address when it is appro- priate to recognize Day 1 proﬁt in the income statement. It also does not address subsequent measurement of these instruments. Our decisions regarding recognizing deferred Day 1 prof- it and loss are based on the principle of prudence and are made after careful consideration of facts and circumstances to ensure we do not prematurely release a portion of the de- ferred proﬁt to income. For each transaction, we determine individually the appropriate method of recognizing the Day 1 proﬁt and loss amount in the income statement. Deferred Day 1 proﬁt and loss is amortized over the life of the transaction, deferred until fair value can be determined using market observable inputs, or realized through settlement. In all in- stances, any unrecognized Day 1 proﬁt and loss is immediate- ly released to income if fair value of the ﬁnancial instrument in question can be determined either by using market observ- able model inputs or by reference to a quoted price for the same product in an active market. After entering into a transaction, we measure the ﬁnan- cial instrument at fair value, adjusted for the deferred Day 1 proﬁt and loss. Subsequent changes in fair value are recog- nized immediately in the income statement without reversal of deferred Day 1 proﬁts and losses. Securitizations and Special Purpose Entities UBS sponsors the formation of Special Purpose Entities (SPEs) primarily to allow clients to hold investments, for asset secu- ritization transactions, and for buying or selling credit protec- tion. In accordance with IFRS we do not consolidate SPEs that we do not control. As it can sometimes be difﬁcult to deter- mine whether we exercise control over an SPE, we have to make judgments about risks and rewards as well as our abil- ity to make operational decisions for the SPE. In many in- stances, elements are present that, considered in isolation, indicate control or lack of control over an SPE, but when con- sidered together make it difﬁcult to reach a clear conclusion. When assessing whether we have to consolidate an SPE we evaluate a range of factors, including whether (a) we will obtain the majority of the beneﬁts of the activities of an SPE, (b) we retain the majority of the residual ownership risks related to the assets in order to obtain the beneﬁts from its activities, (c) we have decision-making powers to obtain the majority of the beneﬁts, or (d) the activities of the SPE are being conducted on our behalf according to our speciﬁc busi- ness needs so that we obtain the beneﬁts from the SPE’s operations. We consolidate an SPE if our assessment of the relevant factors indicates that we obtain the majority of the beneﬁts of its activities. SPEs used to allow clients to hold investments are struc- tures that allow one or more clients to invest in an asset or set of assets which are generally purchased by the SPE in the open market and not transferred from UBS. The risks and rewards of the assets held by the SPE reside with the clients. Typically, UBS will receive service and commission 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. As an example, UBS Alternative Portfolio AG pro- vides a vehicle for investors to invest in a diversiﬁed range of alternative 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 securitization are created when UBS has assets (for example a portfolio of loans) which it sells to an SPE, and the SPE in turn sells inter- ests in the assets as securities to investors. Consolidation of these SPEs depends on whether UBS retains the majority of the beneﬁts of the assets in the SPE. We do not consolidate SPEs used for securitization if UBS has no control over the assets and no longer retains any sig- niﬁcant exposure (for gain or loss) to the income or investment returns on the assets sold to the SPE or the proceeds of their liquidation. 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 asset, while if the SPE were to go bankrupt the securities holders would have no recourse to UBS. 77 Accounting Standards and Policies Critical accounting policies 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, which may or may not be held by UBS, to investors. They exist primarily 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 capi- tal and participate in the risks and rewards of the credit events that it insures. SPEs used for credit protection are generally consolidated. we believe that the estimates and assumptions made in de- termining the fair value of each investment are reasonable and supportable. In addition, the determination of when a decline in fair value below cost is not recoverable within a reasonable time period is judgmental by nature, so proﬁt and loss could be affected by differences in this judgement. We generally con- sider investments as impaired if a signiﬁcant 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 immediate loss recognition. Allowances and provisions for credit losses Financial investments – available-for-sale UBS has classiﬁed some of its ﬁnancial assets, including invest- ments not held for trading purposes, as available-for-sale, where they are not held for the purpose of generating short- term trading gains, but rather for mid-to-long-term capital ap- preciation. Changes in fair value of these ﬁnancial assets are reﬂected in shareholders’ equity rather than income. The amount of unrealized gains or losses on the balance sheet date is disclosed in the statement of changes in equity in the ﬁnan- cial statements. Companies held in our private equity portfolio are not cur- rently consolidated in the ﬁnancial statements. This treatment has been determined after considering such matters as liquid- ity, exit strategies and degree and timing of our inﬂuence and control over these investments. With the adoption of revised IAS 27 as of 1 January 2005, majority-owned entities will be consolidated retrospectively as of 1 January 2003. The effects of this consolidation on our ﬁnancial statements are disclosed in note 1(ab). We currently 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 pe- riod are recorded in our income statement as impairment charges. Since quoted market prices are generally unavailable for these companies, fair value is determined by applying recognized 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 investment-by-investment review involving the busi- ness and control functions. Our standard valuation method is to apply multiples of earnings that are observed for compa- rable companies. These multiples depend on a number of factors and may ﬂuctuate over time. The geographic and sector diversity of the investments in the portfolio and their varying stages in the investment cycle mean that the valua- tions of these positions may not move in line with the chang- ing economic environment. Although judgement is involved, Assets accounted for at amortized cost are evaluated for im- pairment and required allowances and provisions are estimat- ed in accordance with IAS 39. Impairment exists if the book value of a claim or a portfolio of claims exceeds the present value of the cash ﬂows actually expected in future periods. These cash ﬂows include scheduled interest payments, prin- cipal repayments, or other payments due (for example on guarantees), including liquidation of collateral where available. The total allowance and provision for credit losses consists of two components: speciﬁc counterparty allowances and provisions, and collectively assessed allowances. The speciﬁc counterparty component applies to claims evaluated individ- ually for impairment and is based upon management’s best estimate of the present value of the cash ﬂows which are ex- pected to be received. In estimating these cash ﬂows, manage- ment makes judgments about a counterparty’s ﬁnancial situ- ation and the net realizable value of any underlying collateral or guarantees in our favor. Each impaired asset is assessed on its merits, and the workout strategy and estimate of cash ﬂows considered recoverable are independently approved by the Credit Risk Control function. Collectively assessed credit risk allowances cover credit losses inherent in portfolios of claims with similar economic characteristics where there is objective evidence to suggest that they contain impaired claims but the individual impaired items cannot yet be identiﬁed. A compo- nent of collectively assessed allowances is for country risks. In assessing the need for collective loan loss allowances, manage- ment considers factors such as credit quality, portfolio size, con- centrations, and economic factors. In order to estimate the required allowance, we make assumptions both to deﬁne the way we model inherent losses and to determine the required input parameters, based on historical experience and current economic conditions. The accuracy of the allowances and provisions we make depends on how well we estimate future cash flows for specific counterparty allowances and provisions and the model assumptions and parameters used in determining col- lective allowances. While this necessarily involves judgment, we believe that our allowances and provisions are reasonable and supportable. 78 Further details on this subject are given in note 1(q) to the ﬁnancial statements and in the risk analysis section of the Handbook 2004 / 2005, on pages 47 to 57. Equity compensation The IFRS requirements applicable to our ﬁnancial statements have not previously speciﬁcally addressed the recognition and measurement of equity-based compensation plans, including employee option plans. IFRS 2, Share-based Payment, ad- dresses the accounting for share-based employee compensa- tion and was adopted by UBS on 1 January 2005 on a fully retrospective basis. Until the end of 2004, we recognized com- pensation expense for awards issued to employees as part of annual bonuses during the year of corresponding perform- ance, aligning with the revenue produced. Subsequent changes in intrinsic value were not recognized. For share awards, we recognized compensation expense in the amount of the fair value of the share at the grant date. For option awards granted, the exercise price is generally set either equal to or slightly higher than the fair value of the underlying share at the grant date. Accordingly, these options have no intrinsic value when granted, and therefore, we did not recognize compensation expense for these awards. Had we recognized the fair value of stock option grants on grant date as compensation expense, net income would have been low- er by CHF 508 million in 2004, CHF 439 million in 2003, and CHF 690 million in 2002. IFRS 2 requires recognition of all equity-based awards in the ﬁnancial statements based on the fair value measured at the grant date. Compensation cost will be recognized over the service period, which is consistent with the vesting period, starting at grant date of an award. As we are adopting this standard on a fully retrospective basis, we will reverse compen- sation expense recognized for share awards in 2003 and 2004 and replace it with compensation expense for the fair value of share and share option awards determined in accordance with IFRS 2. The effect of applying IFRS 2 is disclosed in note 1 (ab) to the ﬁnancial statements, and further information on UBS equity compensation plans is disclosed in note 32. 79 80 Financial Statements Financial Statements Table of Contents Financial Statements Table of Contents Report of the Group Auditors Financial Statements Income Statement Balance Sheet Statement of Changes in Equity 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 Due from Banks and Loans Non-Performing Due from Banks and Loans Securities Borrowing, Securities Lending, Repurchase and Reverse Repurchase Agreements Trading Portfolio Financial Investments (available-for-sale) Investments in Associates Property and Equipment Goodwill and Other Intangible Assets Other Assets 11 12 13 14 15 16 Balance Sheet: Liabilities 17 18 Due to Banks and Customers Financial liabilities designated at fair value and debt issued Other Liabilities Provisions 19 20 82 83 84 84 85 86 88 90 90 101 108 109 109 110 111 111 111 112 113 113 114 114 115 116 117 118 120 120 121 122 123 123 123 125 125 21 22 23 Income Taxes Minority Interests Derivative Instruments 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 e) Financial Instruments Risk Position in Motor-Columbus 30 31 32 33 34 35 36 37 38 39 40 41 42 Fair Value of Financial Instruments Pension and Other Post-Retirement Beneﬁt Plans 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 Sales of Financial Assets in Securitizations Post–Balance Sheet Events Signiﬁcant Subsidiaries and Associates Invested Assets and Net New Money Business Combinations Currency Translation Rates Swiss Banking Law Requirements Reconciliation to US GAAP Additional Disclosures Required under US GAAP and SEC Rules 125 127 127 132 132 132 134 135 135 135 135 136 136 136 138 138 138 139 141 142 144 145 150 155 155 156 157 157 158 159 161 161 162 166 167 170 171 172 183 Financial Statements Report of the Group Auditors 83 Financial Statements Financial Statements Income Statement CHF million, except per share data Note 31.12.04 31.12.03 31.12.02 31.12.03 For the year ended % change from 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 Income from industrial holdings Total operating income Operating expenses Personnel expenses General and administrative expenses Depreciation of property and equipment Amortization of goodwill and other intangible assets Goods and materials purchased 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) Diluted earnings per share (CHF) 3 3 4 3 5 6 7 14 15 21 22 8 8 39,398 (27,538) 11,860 276 12,136 19,416 4,972 897 3,648 41,069 18,515 6,703 1,352 964 2,861 30,395 10,674 2,135 8,539 (450) 8,089 7.68 7.47 40,159 (27,860 ) 12,299 (72 ) 12,227 17,345 3,756 462 39,963 (29,417 ) 10,546 (115 ) 10,431 18,221 5,451 4 33,790 34,107 17,231 6,086 1,353 943 18,524 7,072 1,514 2,460 25,613 29,570 8,177 1,593 6,584 (345 ) 6,239 5.59 5.48 4,537 676 3,861 (331 ) 3,530 2.92 2.87 (2 ) (1 ) (4 ) (1 ) 12 32 94 22 7 10 0 2 19 31 34 30 30 30 37 36 84 Balance Sheet CHF million Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Trading portfolio assets pledged as collateral Positive replacement values Financial assets designated at fair value 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 Financial liabilities designated at fair value Due to customers Accrued expenses and deferred income Debt issued Other liabilities Total liabilities Minority interests Shareholders’ equity Share capital Share premium account Net gains / (losses) not recognized in the income statement, net of tax Revaluation reserve from step acquisitions Retained earnings Equity classiﬁed as obligation to purchase own shares Treasury shares Total shareholders’ equity Note 31.12.04 31.12.03 31.12.03 % change from 9 10 10 11 11 23 9 12 13 14 15 16, 21 17 10 10 11 23 18 17 18 19, 20, 21 6,036 35,264 220,242 357,164 370,259 159,115 284,577 653 232,387 5,049 5,876 2,427 8,736 12,149 34,850 3,584 31,740 213,932 320,499 341,013 120,759 248,206 0 212,679 5,139 6,218 1,616 7,683 11,529 25,459 1,734,784 1,550,056 118,901 61,545 422,587 171,033 303,712 65,756 376,083 14,685 117,828 42,342 127,012 53,278 415,863 143,957 254,768 35,286 346,633 13,673 88,843 31,360 1,694,472 1,510,673 22 5,334 4,073 901 7,348 (1,644) 90 37,455 (96) (9,076) 34,978 946 6,935 (983 ) 0 36,641 (49 ) (8,180 ) 35,310 68 11 3 11 9 32 15 9 (2 ) (6 ) 50 14 5 37 12 (6 ) 16 2 19 19 86 8 7 33 35 12 31 (5 ) 6 (67 ) 2 (96 ) (11 ) (1 ) 12 85 Total liabilities, minority interests and shareholders’ equity 1,734,784 1,550,056 Financial Statements Statement of Changes in Equity CHF million 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 (2001 program) Cancellation of second trading line treasury shares (2002 program) Cancellation of second trading line treasury shares (2003 program) Balance at the end of the year Share premium Balance at the beginning of the year, restated Premium on shares issued and warrants exercised Net premium / (discount) on treasury share and own equity derivative activity Employee stock option plan Cancellation of second trading line treasury shares (2001 program) Cancellation of second trading line treasury shares (2002 program) Balance at the end of the year 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 Subtotal – balance at the end of the year Net unrealized gains / (losses) on available-for-sale investments, net of taxes Balance at the beginning of the year Net unrealized gains / (losses) on available-for-sale investments Impairment charges reclassiﬁed to the income statement Realized gains reclassiﬁed to the income statement Realized losses reclassiﬁed to the income statement Subtotal – balance at the end of the year Change in fair value of derivative instruments designated as cash ﬂow hedges, net of taxes Balance at the beginning of the year Net unrealized gains / (losses) on the revaluation of cash ﬂow hedges Net realized (gains) / losses reclassiﬁed to the income statement Subtotal – balance at the end of the year Balance at the end of the year Revaluation reserve from step acquisitions, net of taxes New acquisitions Balance at the end of the year Retained earnings Balance at the beginning of the year, restated Net proﬁt for the year Dividends paid 1 Cancellation of second trading line treasury shares (2003 program) 2 Balance at the end of the year Equity classiﬁed as obligation to purchase own shares Balance at the beginning of the year, restated Net movements Balance at the end of the year For the year ended 31.12.04 31.12.03 31.12.02 946 2 (47) 901 6,935 379 26 8 7,348 (1,644) (818) (2,462) 805 474 192 (353) 22 1,140 (144) (223) 45 (322) (1,644) 90 90 36,641 8,089 (2,806) (4,469) 37,455 (49) (47) (96) 1,005 2 (61 ) 946 12,641 92 (330 ) (5,468 ) 6,935 (849 ) (795 ) (1,644 ) 946 (108 ) 285 (340 ) 22 805 (256 ) 116 (4 ) (144 ) (983 ) 32,700 6,239 (2,298 ) 3,589 6 (2,509 ) (81 ) 1,005 14,408 157 285 (2,209 ) 12,641 (769 ) (80 ) (849 ) 1,035 (144 ) 635 (600 ) 20 946 (459 ) (11 ) 214 (256 ) (159 ) 29,103 3,597 36,641 32,700 (104 ) 55 (49 ) (104 ) (104 ) 1 On 10 July 2002, UBS made a distribution of CHF 2.00 per share to shareholders which reduced the par value from CHF 2.80 to CHF 0.80 per share. Dividends of CHF 2.00 per share and CHF 2.60 per 2 The cancellation of second trading line treasury shares is now made against retained earnings. In prior years it was made against share were paid on 23 April 2003 and 20 April 2004, respectively. the share premium account. 86 Statement of Changes in Equity (continued) CHF million Treasury shares, at cost Balance at the beginning of the year Acquisitions Disposals Cancellation of second trading line treasury shares (2001 program) Cancellation of second trading line treasury shares (2002 program) Cancellation of second trading line treasury shares (2003 program) Balance at the end of the year Total shareholders’ equity Shares issued Number of shares Balance at the beginning of the year Issue of share capital For the year ended 31.12.04 31.12.03 31.12.02 (8,180) (8,813) 3,401 4,516 (9,076) 34,978 (7,131 ) (8,424 ) 1,846 5,529 (8,180 ) 35,310 (3,377 ) (8,313 ) 2,269 2,290 (7,131 ) 38,952 For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 1,183,046,764 1,256,297,678 1,281,717,499 3,293,413 2,719,166 3,398,869 (6 ) 21 Cancellation of second trading line treasury shares (2001 program) Cancellation of second trading line treasury shares (2002 program) (28,818,690 ) (75,970,080 ) Cancellation of second trading line treasury shares (2003 program) (59,482,000) Balance at the end of the year 1,126,858,177 1,183,046,764 1,256,297,678 (5 ) Treasury shares Number of shares Balance at the beginning of the year Acquisitions Disposals Cancellation of second trading line treasury shares (2001 program) Cancellation of second trading line treasury shares (2002 program) For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 111,360,692 97,181,094 41,254,951 96,139,004 116,080,976 110,710,741 (44,492,725) (25,931,298 ) (25,965,908 ) (28,818,690 ) (75,970,080 ) 15 (17 ) (72 ) 100 (7 ) Cancellation of second trading line treasury shares (2003 program) (59,482,000) Balance at the end of the year 103,524,971 111,360,692 97,181,094 During the year a total of 59,482,000 shares acquired under the second trading line buyback program 2003 were cancelled. On 31 December 2004, a maximum of 3,533,012 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) dis- closure. Out of the total number of 103,524,971 treasury shares, 39,935,094 shares (CHF 3,543 million) have been re- purchased for cancellation. The Board of Directors will propose to the Annual General Meeting on 21 April 2005 to reduce the outstanding number of shares and the share capital by the number of shares purchased for cancellation. All issued shares are fully paid. 87 Financial Statements Statement of Cash Flows CHF million 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 loss / (gain) from ﬁnancing 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 and 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 For the year ended 31.12.04 31.12.03 31.12.02 8,089 6,239 3,530 1,352 964 (276) (65) 3 (475) 1,203 (11,679) (42,975) (19,834) 10,035 (6,927) 14,991 19,032 (1,336) (27,898) (2,511) 800 (1,149) 704 686 (1,470) 1,353 943 72 (123 ) 489 (63 ) 115 42,921 (101,381 ) (52,197 ) 38,638 (16,100 ) 65,413 18,188 (1,104 ) 3,403 (428 ) 834 (1,376 ) 123 2,317 1,470 1,514 2,460 115 (7 ) (511 ) 986 (446 ) (22,382 ) (944 ) 22,427 (11,446 ) 2,875 4,791 (4,754 ) (572 ) (2,364 ) (60 ) 984 (1,763 ) 67 2,153 1,381 88 Statement of Cash Flows (continued) CHF million 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, including ﬁnancial liabilities designated at fair value Repayment of long-term debt, including ﬁnancial liabilities designated at fair value Increase in minority interests 1 Dividend payments to / 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 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 Signiﬁcant non-cash investing and ﬁnancing activities 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 Provisions for reinstatement costs Property and equipment Motor-Columbus, Baden, from valuation at equity to full consolidation Financial investments Investments in associates Property and equipment Goodwill and other intangible assets Debt issued Minority interests Investment funds transferred to other liabilities according to IAS 32 Minority interests For the year ended 31.12.04 31.12.03 31.12.02 (26,206 ) (5,605 ) 6 (2,509 ) 17,132 (14,911 ) (377 ) (32,470 ) (462 ) (33,915 ) 116,259 82,344 4,271 46,183 31,890 82,344 53 18 63 3 718 15 2,322 (14,737 ) (6,810 ) 2 (2,298 ) 23,644 (13,615 ) 755 (278 ) (13,337 ) (524 ) (8,988 ) 82,344 73,356 3,584 40,599 29,173 73,356 137 21,379 (4,999) 2 (2,806) 51,211 (24,717) 102 (332) 39,840 (1,052) 9,420 73,356 82,776 6,036 45,409 31,331 82,776 644 261 2,083 1,194 727 1,742 336 1 Includes issuance of trust preferred securities of CHF 372 million for the year ended 31 December 2003. Financial investments. CHF 13,242 million, CHF 6,430 million and CHF 10,475 million were pledged at 31 December 2004, 31 December 2003 and 31 December 2002, respectively. 2 Money market paper is included in the balance sheet under Trading portfolio assets and Cash paid for interest during 2004 was CHF 18,614 million. 89 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, underwriting, ﬁnancing, market-making, asset management, 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 UBS (the “Finan- cial Statements”) are prepared in accordance with Internation- al Financial Reporting Standards ("IFRS"), issued by the Inter- national Accounting Standards Board (IASB), and stated in Swiss francs (CHF), the currency of the country in which UBS AG is incorporated. On 3 February 2005, the Board of Direc- tors approved them for issue. b) Use of estimates in the preparation of Financial Statements In preparing the Financial Statements, management is re- quired to make estimates and assumptions that affect report- ed income, expenses, assets, liabilities and disclosure of con- tingent 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 Finan- cial Statements. c) Consolidation The Financial Statements comprise those of the parent compa- ny (UBS AG), its subsidiaries and certain special purpose enti- ties, 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, with the exception of certain employee beneﬁt trusts (see also section ab). 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 con- trolled 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 minority interests are shown separately in the balance sheet and income state- ment, respectively. Investments in associates in which UBS has a signiﬁcant inﬂuence are accounted for under the equity method of ac- counting. Signiﬁcant inﬂuence is normally evidenced when 90 UBS owns 20% or more of a company’s voting rights. Invest- ments in associates are initially recorded at cost and the car- rying 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 investments. The Group sponsors the formation of entities, which may or may not be directly or indirectly 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 relationship between the Group and the company indicates that the company is controlled by the Group. Certain trans- actions of consolidated entities meet the criteria for derecog- nition of ﬁnancial assets, see section d) below. These trans- actions do not affect the consolidation status of an entity. d) Derecognition UBS enters into transactions where it transfers assets recog- nized on its balance sheet, but retains either all risks and rewards of the transferred assets or a portion of them. If all or substantially all risks and rewards are retained, the transferred assets are not derecognized from the balance sheet. Transfers of assets with retention of all or substantially all risks and rewards include, for example, securities lending and repurchase transactions described under paragraphs f) and g) below. An- other example of a transaction where all risks and rewards are retained is where assets are sold to a third party with a con- current total rate of return swap on the transferred assets. These types of transactions are accounted for as secured ﬁnancing transactions similar to repurchase agreements. In transactions where UBS neither retains nor transfers sub- stantially all the risks and rewards of ownership of a ﬁnancial asset, it derecognizes the asset if control over the asset is lost. The rights and obligations retained in the transfer are recog- nized separately as assets and liabilities as appropriate. In transfers where control over the asset is retained, the Group continues to recognize the asset to the extent of its continu- ing involvement, determined by the extent to which it is exposed to changes in the value of the transferred asset. In certain transactions, UBS retains rights to service a trans- ferred ﬁnancial asset for a fee. The transferred asset is dere- cognized in its entirety, if it meets the derecognition criteria. An asset or liability is recognized for the servicing rights, de- pending on whether the servicing fee is more than adequate to cover servicing expenses (asset) or is less than adequate for performing the servicing (liability). e) Securitizations UBS securitizes various consumer and commercial ﬁnancial assets, which generally results in the sale of these assets to special-purpose entities, which, in turn issue securities to investors. 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 inter- ests”). Retained interests are primarily recorded in Trading portfolio assets and carried at fair value. Gains or losses on securitization depend in part on the carrying amount of the transferred 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. f) Securities borrowing and lending Securities borrowing and securities lending transactions are generally entered into on a collateralized basis, with securi- ties predominantly advanced or received as collateral. Trans- fer of the securities themselves, whether in a borrowing / lend- ing transaction or as collateral, is not reﬂected on the balance sheet unless the risks and rewards of ownership are also transferred. If cash collateral is advanced or received, securi- ties borrowing and lending activities are recorded at the amount of cash collateral advanced (Cash collateral on secu- rities borrowed) or received (Cash collateral on securities lent). UBS monitors the market value of the securities borrowed and lent on a daily basis and provides or requests additional collateral in accordance with the underlying agreements. Fees and interest received or paid are recognized on an accrual basis and recorded as interest income or interest expense. g) Repurchase and reverse repurchase transactions Securities purchased under agreements to resell (reverse re- purchase agreements) and securities sold under agreements to repurchase (repurchase agreements) are generally treated as collateralized ﬁnancing transactions. In reverse repurchase agreements, the cash advanced, including accrued interest, is recognized on the balance sheet as Reverse repurchase agree- ments. In repurchase agreements, the cash received, includ- ing accrued interest, is recognized on the balance sheet as Repurchase agreements. Securities received under reverse repurchase agreements and securities delivered under repurchase agreements are not recognized on or derecognized from the balance sheet, un- less control of the contractual rights that comprise these se- curities is obtained or relinquished. UBS monitors the market value of the securities received or delivered on a daily basis and provides or requests additional collateral in accordance with the underlying agreements. Interest earned on reverse repurchase agreements and interest incurred on repurchase agreements is recognized as interest income or interest expense over the life of each agreement. The Group offsets reverse repurchase agreements and repurchase agreements with the same counterparty for trans- actions covered by legally enforceable master netting agree- ments when net or simultaneous settlement is intended. h) Segment reporting UBS’s ﬁnancial businesses are organized on a worldwide basis into four Business Groups and the Corporate Center. Wealth Management & Business Banking is segregated into two segments, Wealth Management and Business Banking Switzer- land. The Corporate Center also consists of two segments, Pri- vate Banks & GAM and Corporate Functions. The Industrial Holdings segment holds all industrial operations controlled by the Group. In total, UBS now reports eight business segments. Segment income, segment expenses and segment per- formance include transfers between business segments and between geographical segments. Such transfers are conduct- ed at arm’s length. i) 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. Ex- change 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 currency monetary assets and liabilities, are recognized in the income statement. Unrealized exchange differences on non-monetary ﬁnancial assets (investments in equity instruments) are a component of the change in their entire fair value. For a non-monetary ﬁnan- cial asset classiﬁed as held for trading, unrealized exchange dif- ferences are recognized in the income statement. For non- monetary Financial investments which are classified as available-for-sale, unrealized exchange differences are record- ed directly in Shareholder’s equity until the asset is sold. When preparing consolidated ﬁnancial statements, 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 closing 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. 91 Financial Statements Notes to the Financial Statements j) 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. k) Fee income UBS earns fee income from a diverse range of services it provides to its customers. Fee income can be divided into two broad cat- egories: income earned from services that are provided over a certain period of time, for which customers are generally billed on an annual or semi-annual basis, and income earned from pro- viding transaction-type services. Fees earned from services that are provided over a certain period of time are recognized ratably over the service period. Fees earned from providing transaction- type services are recognized when the service has been complet- ed. Fees or components of fees that are performance linked are recognized when the performance criteria are fulﬁlled. The following fee income is predominantly earned from services that are provided over a period of time: investment fund fees, ﬁduciary fees, custodian fees, portfolio and other management and advisory fees, insurance-related fees, credit- related fees and commission income. Fees predominantly earned from providing transaction-type services include under- writing fees, corporate ﬁnance fees, and brokerage fees. l) Determination of fair value The determination of fair values of ﬁnancial assets and ﬁnan- cial liabilities is based on quoted market prices or dealer price quotations for ﬁnancial instruments traded in active markets. For all other ﬁnancial instruments fair value is determined by using valuation techniques. Valuation techniques include net present value techniques, the discounted cash ﬂow method, comparison to similar instruments for which market observ- able prices exist, and valuation models. UBS uses widely rec- ognized valuation models for determining fair value of com- mon and more simple ﬁnancial instruments like options and interest rate and currency swaps. For these ﬁnancial instru- ments, inputs into models are market observable. For more complex instruments, UBS uses proprietary mod- els, which usually are developed from recognized valuation models. Some or all of the inputs into these models may not be market observable, and are derived from market prices or rates or estimated based on assumptions. When entering into a transaction, the ﬁnancial instrument is initially recog- nized at the transaction price, which is the best indicator of fair value, although the value obtained from the valuation model may differ from the transaction price. This initial dif- ference, usually an increase, in fair value indicated by valua- tion techniques is recognized in income depending upon the individual facts and circumstances of each transaction and not later than when the market data becomes observable. The value produced by a model or other valuation technique is adjusted to allow for a number of factors as appropriate, be- cause valuation techniques cannot appropriately reﬂect all fac- tors market participants take into account when entering in- to a transaction. Valuation adjustments are recorded to allow for model risks, bid-ask spreads, liquidity risks, as well as oth- er factors. Management believes that these valuation adjust- ments are necessary and appropriate to fairly state ﬁnancial in- struments carried at fair value on the balance sheet. m) Trading portfolio Trading portfolio assets consist of money market paper, other debt instruments, including traded loans, equity instru- ments, precious metals and commodities which are owned by the Group (“long” positions). Trading portfolio liabilities con- sist of obligations to deliver trading securities such as 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. Gains and losses realized on disposal or redemption and unrealized gains and losses from changes in the fair value of trading portfolio assets or liabilities are reported as Net trading income. Inter- est and dividend income and expense on trading portfolio as- sets or liabilities are included in Interest and dividend income or Interest and dividend expense, respectively. The Group uses settlement date accounting when record- ing trading portfolio transactions. It recognizes from the date the transaction is entered into (trade date) any unrealized prof- its and losses arising from revaluing that contract to fair value in the income statement. Subsequent to the trade date, when the transaction is consummated (settlement date) a resulting ﬁnancial asset or liability is recognized on the bal- ance sheet at the fair value of the consideration given or received plus or minus 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 derecognizes the asset on the day of its transfer. n) Financial instruments designated as held at fair value through proﬁt and loss UBS has a substantial portion of its compound debt instru- ments classiﬁed as held at fair value through proﬁt and loss. These liabilities are presented in a separate line on the face of the balance sheet. A small amount of ﬁnancial assets has also been classiﬁed as held at fair value through proﬁt and loss, and they are likewise presented in a separate line. A ﬁnancial in- strument may be designated at inception as held at fair value through proﬁt and loss and can subsequently not be changed. The fair value designation was made possible as part of the transition to the revised IAS 39, which UBS adopted on 1 Jan- uary 2004. The Group designated approximately CHF 35.3 bil- lion of existing compound debt instruments as held at fair val- ue through proﬁt and loss at 1 January 2004. All fair value changes related to ﬁnancial instruments held at fair value through proﬁt and loss are recognized in Net trading income. 92 o) Derivative instruments and hedging All derivative instruments are carried at fair value on the bal- ance sheet and are reported as Positive or Negative replace- ment values. Where the Group enters into derivatives for trad- ing purposes, realized and unrealized gains and losses are recognized in Net trading income. The Group also uses derivative instruments as part of its as- set and liability management activities to manage exposures to interest rate, foreign currency and credit risks, including expo- sures 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 designated as a hedge, the Group formally documents the relationship between the hedging instrument(s) and hedged item(s). Documentation includes its risk management objectives and its strategy in undertaking the hedge transaction, together with the methods that will be used to assess the effectiveness of the hedging re- lationship. Accordingly, the Group formally assesses, both at the inception of the hedge and on an ongoing basis, whether the hedging derivatives 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, and actual results in- dicate, that changes in the fair value or cash ﬂows of the hedged item are effectively 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 have a high probability of occurring and must present an exposure to variations in cash ﬂows that could ultimately affect reported net proﬁt or loss. The Group dis- continues hedge accounting when it is determined that: a de- rivative 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 in Net trading income, 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 terminated for reasons other than the derecognition of the hedged item, the difference between the carrying value of the hedged item at that point and the value at which it would have been carried had the hedge never ex- isted (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 rec- ognized in earnings. If the hedged instrument is derecog- nized, e.g. is sold or repaid, the unamortized fair value adjustment is recognized immediately in net proﬁt and loss. A fair value gain or loss associated with the effective por- tion of a derivative designated as a cash ﬂow hedge is recog- nized initially in Shareholders’ equity. When the cash ﬂows that the derivative is hedging materialize, resulting in income or expense, then the associated gain or loss on the hedging derivative is simultaneously 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 termi- nated, the cumulative gain or loss on the hedging derivative previously reported in Shareholders’ equity remains in Share- holders’ equity until the committed or forecast transaction occurs, at which point it is transferred from Shareholders’ equity to the income statement. Derivative instruments transacted as economic hedges but not qualifying for hedge accounting are treated in the same way as derivative instruments used for trading purposes, i. e. realized and unrealized gains and losses are recognized in Net trading income. In particular, the Group has entered into eco- nomic hedges of credit risk within the loan portfolio using credit default swaps to which it can not apply hedge accounting. In the event that the Group recognizes an impair- ment on a loan that is economically hedged in this way, the impairment is recognized in Credit loss expense whereas any 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 contract”. Such combinations are known as compound 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 embed- ded derivative is separated from the host contract and accounted for as a standalone derivative instrument at fair val- ue 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 embed- ded derivative actually meets the deﬁnition of a derivative. p) Loans Loans include loans originated by the Group where money is provided directly to the borrower, participation in a loan from another lender and purchased loans that are not quoted in an active market and for which no intention of immediate or short-term resale exists. Originated and purchased loans which are intended to be sold in the short term are recorded as Trad- ing portfolio assets. 93 Financial Statements Notes to the Financial Statements Loans are recognized when cash is advanced to borrow- ers. They are initially recorded at fair value, which is 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 is included in Interest earned on loans and advances and is recognized on an accrual basis. Fees and direct costs relating to loan origination, re-ﬁnancing or restruc- turing 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 effective interest rate method. Fees received for commitments 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 syndicated loan are credited to commission income. q) Allowance and provision for credit losses An allowance for credit losses is established if there is objec- tive evidence that the Group will be unable to collect all amounts due on a claim according to the original contrac- tual terms or the equivalent value. A “claim” means a loan, a commitment such as a letter of credit, a guarantee, a com- mitment to extend credit, or other credit product. An allowance for credit losses 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 provi- sion for credit 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 level and collectively 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 collect 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 ﬁnancially responsible guarantors; and, where applicable, the realizable value of any collateral. The estimated recoverable amount is the present value, using the loan’s original effective interest rate, of expected future cash ﬂows, which may result from restructuring or liq- uidation. Impairment is measured and allowances for credit losses are established for the difference between the carrying amount and the estimated recoverable amount. 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. All impaired claims are reviewed and analyzed at least an- nually. 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 collection 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. A loan is classiﬁed as non-performing when the payment of interest, principal or fees is overdue by more than 90 days and there is no ﬁrm evidence that they will be made good by later payments or the liquidation of collateral, or when insol- vency proceedings have commenced, or when obligations have been restructured on concessionary terms. Collectively: all loans for which no impairment is identiﬁed on a counterparty-speciﬁc level are grouped into economical- ly homogeneous portfolios to collectively assess whether im- pairment exists within a portfolio. Allowances from collective assessment of impairment are recognized as credit loss expense and result in an offset to the loan position. As the allowance cannot be allocated to individual loans, interest is accrued on all loans according to contractual terms. Where, in management’s opinion, it is probable that some claims may be affected by systemic crisis, transfer restrictions or non-enforceability, country allowances and provisions for probable losses are established. They are based on country- speciﬁc scenarios, taking into consideration the nature of the individual exposures, but excluding those amounts covered by counterparty-speciﬁc allowances and provisions. Such coun- try allowances and provisions are part of the collectively as- sessed loan loss allowances and provisions. r) Financial investments Financial investments are classiﬁed as available-for-sale and recorded on a settlement date basis. Available-for-sale ﬁnancial investments are instruments which, in management’s opinion, may be sold in response to or in anticipation of needs for liq- uidity or changes in interest rates, foreign exchange rates or eq- uity prices. Financial investments consist of money market pa- per, other debt instruments and equity instruments, including private equity investments. Available-for-sale ﬁnancial investments are carried at fair value. Unrealized gains or losses on available-for-sale invest- ments are reported in Shareholders’ equity, net of applicable income taxes, until such investments are sold, collected or otherwise disposed of, or until such investment is determined to be impaired. On disposal of an available-for-sale invest- ment, the accumulated unrealized gain or loss included in 94 Shareholders’ equity is transferred to net proﬁt or loss for the period and reported in Other income. Gains and losses on dis- posal are determined using the average cost method. cost can be measured reliably. Internally developed software meeting these criteria and purchased software are classiﬁed within IT, software and communication. Interest and dividend income on available-for-sale ﬁnancial investments is included in Interest and dividend income from ﬁnancial investments. If an available-for-sale investment is determined to be im- paired, 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 tech- niques. The standard method applied is based on the multiple of earnings observed in the market for comparable compa- nies. Management may adjust valuations determined in this way based on its judgement. For quoted ﬁnancial invest- ments, 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 such a level that recovery of the cost value cannot be reason- ably expected within the foreseeable future. s) Property and equipment Property and equipment includes own-used properties, invest- ment properties, leasehold improvements, IT, software and communication, plant and manufacturing equipment, and other machines and equipment. Own-used property is deﬁned as property held by the Group for use in the supply of services or for administrative purposes whereas investment property is deﬁned as property held to earn rentals and / or for capital appreciation. If a property of the Group includes a portion that is own-used 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 separate- ly. If the portions of the property can be sold separately they are accounted for as own-used property and investment property. If the portions cannot be sold separately, the whole property is clas- siﬁed as own-used 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. Leasehold improvements are investments made to cus- tomize buildings and ofﬁces occupied under operating lease contracts to make them suitable for the intended purpose. The present value of estimated reinstatement costs to bring a leased property into its original condition at the end of the lease, if re- quired, is capitalized as part of the total leasehold improvements costs. At the same time, a corresponding liability is recognized to reﬂect the obligation incurred. Reinstatement costs are rec- ognized in proﬁt and loss through depreciation of the capital- ized leasehold improvements over their estimated useful life. Software development costs are capitalized when they meet certain criteria relating to identiﬁability, it is probable that future economic beneﬁts will ﬂow to the enterprise, and the Plant and manufacturing equipment include primarily ther- mal and hydro power plants and power transmission grids and equipment. The useful life is estimated based on the econom- ic utilization of the asset, or for power plants on the end of operating life. With the exception of investment properties, 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: Properties, excluding land Leasehold improvements Other machines and equipment IT, software and communication Plant and manufacturing equipment: – Power plants – Transmission grids and equipment Not exceeding 50 years Residual lease term, but not exceeding 10 years Not exceeding 10 years Not exceeding 5 years 25 to 80 years 15 to 40 years Property formerly own-used or leased to third parties un- der an operating lease, which the Group has decided to dis- pose of, and foreclosed property are deﬁned as Properties held for resale and recorded in Other assets. They are carried at the lower of cost or recoverable value. Investment property is carried at fair value with changes in fair value recognized in the income statement in the period of change. UBS employs internal real estate experts who de- termine the fair value of investment property by applying rec- ognized valuation techniques. In cases where prices of recent market transactions of comparable properties are available, fair value is determined by reference to these transactions. t) 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 separately iden- tiﬁable intangible items arising from acquisitions and certain purchased trademarks and similar items. Goodwill and other intangible assets are recognized on the balance sheet at cost determined at the date of acquisition and are amortized using the straight-line method over their esti- mated 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 estimat- ed future beneﬁts. If such indications exist, an analysis is per- formed 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. 95 Financial Statements Notes to the Financial Statements With the introduction of IFRS 3 Business Combinations goodwill acquired in business combinations entered into af- ter 31 March 2004 is not amortized, but tested annually for impairment. The impairment test is conducted at the segment level as reported in Note 2. The segment has been determined as the cash generating unit for impairment testing purposes as this is the level at which the performance of an investment is reviewed and assessed by management. During 2004, UBS recorded goodwill of CHF 631 million from business combi- nations entered into after 31 March 2004. Intangible assets are classiﬁed into two categories: Infra- structure, and Customer relationships, contractual rights and other. Infrastructure includes one intangible asset recognized in connection with the acquisition of PaineWebber Group, Inc. Customer relationships, contractual rights and other include customer relationship intangibles from acquisition of ﬁnancial services businesses as well as from the acquisition of Motor- Columbus, where other contractual rights from delivery and supply contracts were identiﬁed. These contractual rights are amortized over the remaining contract terms, which are up to 25 years. The most signiﬁcant contract, however, is amor- tized over its remaining contract life of seven years, which is the shortest remaining life of all contractual rights recognized. u) Income taxes Income tax payable on proﬁts is recognized as an expense based on the applicable tax laws in each jurisdiction in the period in which proﬁts arise. The tax effects of income tax losses available for carry-forward are recognized as a deferred tax asset if it is probable that future taxable proﬁt will be avail- able against which those losses can be utilized. Deferred tax liabilities are recognized for temporary differ- ences between the carrying amounts of assets and liabilities in the balance sheet and their amounts as measured for tax purposes, which will result in taxable amounts in future peri- ods. Deferred tax assets are recognized for temporary differ- ences which will result in deductible amounts in future peri- ods, but only to the extent it is probable that sufﬁcient taxable proﬁts will be available against which these differences can be utilized. Deferred tax assets and liabilities are measured 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 as well as deferred tax assets and liabilities are off- set 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 invest- ments and changes in fair value of derivative instruments designated as cash ﬂow hedges, which are recorded net of taxes in Net gains or losses not recognized in the income state- ment within Shareholders’ equity. v) Debt issued Debt issued is initially measured at fair value, which is the con- sideration received, net of transaction costs incurred. Subse- quent measurement 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. Compound debt instruments that are related to non-UBS AG equity instruments, foreign exchange, credit instruments or indices are considered structured instruments. If such in- struments have not been designated at fair value through proﬁt and loss, the embedded derivative is separated from the host contract and accounted for as a standalone derivative if the criteria for separation are met. The host contract is sub- sequently measured at amortized cost. For most of its struc- tured debt instruments, UBS has designated them as held at fair value through proﬁt and loss, see section n). Debt instruments with embedded derivatives that are relat- ed to UBS AG shares or to a derivative instrument that has UBS AG shares as underlying are separated into a liability and an equity component at issue date, if they require physical settlement. Initially, a portion of the net proceeds from issuing the compound debt instrument is allocated to the debt com- ponent based on its fair value. The determination of fair value is generally based on quoted market prices for UBS debt instru- ments with comparable terms. The liability component is sub- sequently measured at amortized cost. The remaining amount is allocated to the equity component and reported in Share pre- mium account. Subsequent changes in fair value of the sepa- rated equity component are not recognized. However, if the compound instrument or the embedded derivative related to UBS AG shares is cash settled or if it contains a settlement al- ternative, then the separated derivative is accounted for as a trading instrument with changes in fair value recorded in in- come or the entire compound instrument is designated as held at fair value through proﬁt and loss. It is the Group’s policy to hedge the ﬁxed interest rate risk on debt issues (except for certain subordinated long-term note issues, see Note 30a), and apply fair value hedge accounting. When hedge accounting is applied to ﬁxed rate debt instru- ments, the carrying values of debt issues are adjusted for changes in fair value related to the hedged exposure rather than carried at amortized cost. See o) Derivative instruments and hedging for further discussion. Own bonds held as a result of market making activities or deliberate purchases in the market are treated as a redemp- tion of debt. A gain or loss on redemption is recorded depend- ing on whether the repurchase price of the bond was lower or higher than its carrying value. A subsequent sale of own bonds in the market is treated as a re-issuance of debt. Interest expense on debt instruments is included in Inter- est on debt issued. 96 w) Treasury shares and contracts on UBS shares UBS AG shares held by the Group are classiﬁed in Share- holders’ equity as Treasury shares and accounted for at weighted average cost. The difference between the proceeds from sales of treasury shares and their cost (net of tax, if any) is classiﬁed as Share premium. Contracts that require physical settlement in UBS AG shares are classiﬁed as Shareholders’ equity and reported as Share pre- mium. Upon settlement of such contracts the proceeds received, less cost (net of tax, if any), are reported as Share premium. Contracts on UBS AG shares that require net cash settle- ment or provide for a choice of settlement are classiﬁed as trading instruments, with the changes in fair value reported in the income statement. An exception to this treatment is physically settled written put options and forward share purchase contracts, including con- tracts where physical settlement is a settlement alternative. In both cases the present value of the obligation to purchase own shares in exchange for cash is transferred out of Shareholders’ equity and recognized as a liability at inception of a contract. The liability is subsequently accreted, using the effective interest rate method, over the life of the contract to the nominal purchase obligation by recognizing interest expense. Upon settlement of a contract, the liability is derecognized and the amount of equi- ty originally transferred to liability is reclassiﬁed within Sharehold- ers’ equity to Treasury shares. The premium received for writing put options is recognized directly in Share premium. x) Retirement beneﬁts UBS sponsors a number of retirement beneﬁt plans for its em- ployees worldwide. These plans include both deﬁned beneﬁt and deﬁned contribution plans and various other retirement beneﬁts such as post-employment medical beneﬁts. Contri- butions to deﬁned contribution plans are expensed when em- ployees have rendered services in exchange for such contri- butions, 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 service cost and, where applicable, past service cost. The principal actuarial assumptions used by the actuary are set out in Note 31. The Group recognizes a portion of its actuarial gains and losses as income or expense if the net cumulative unrecog- nized 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 these two values are recognized in the income state- ment over the expected average remaining working lives of the employees participating in the plans. If an excess of the fair value of the plan assets over the pres- ent value of the deﬁned beneﬁt obligation cannot be recov- ered fully through refunds or reductions in future contribu- tions, 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. y) Equity participation plans UBS provides various equity participation plans in the form of stock plans and stock option plans. UBS generally uses the in- trinsic value method of accounting for such awards. Conse- quently, compensation expense is measured as the difference between the quoted market 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 recognize compensation expense for equity awards in the performance year. z) Earnings per share (EPS) Basic earnings per share is calculated by dividing the net prof- it or loss for the period attributable to ordinary shareholders by the weighted average number of ordinary shares out- standing during the period. Diluted earnings per share is computed using the same method as for basic EPS, but the determinants are adjusted to reﬂect the potential dilution that could occur if options, war- rants, convertible debt securities or other contracts to issue or- dinary shares were converted or exercised into ordinary shares. aa) Changes in accounting policies and comparability Financial instruments On 1 January 2004, UBS adopted revised IAS 32 Financial Instruments: Disclosure and Presentation and revised IAS 39 Fi- nancial Instruments: Recognition and Measurement which were applied retrospectively to all ﬁnancial instruments affected with- in the context of the two standards with the exception of the guidance relating to derecognition of ﬁnancial assets and liabil- ities and, in part, recognition of Day 1 proﬁt and loss, which were applied prospectively. As a result of adopting the revised stan- dards, UBS has restated prior period comparative information. Revised IAS 32 amended the accounting for certain deriva- tive contracts linked to an entity’s own shares. Physically settled written put options and forward purchase contracts with UBS shares as underlying are recorded as liabilities, see section w). UBS currently has physically settled written put options linked to own shares that are now accounted for as liabilities. Liabilities of CHF 96 million at 31 December 2004, and CHF 49 million at 31 De- cember 2003 were debited to Shareholders’ equity due to writ- ten options. The impact on the income statement of all periods presented is insigniﬁcant. All other existing derivative contracts linked to own shares are accounted for as derivative instruments and are carried at fair value on the balance sheet under Positive replacement values or Negative replacement values. 97 Financial Statements Notes to the Financial Statements Revised IAS 32 provides that netting is permitted only if, in addition to all other netting conditions, normal settlement is intended to take place on a net basis. In general, that condi- tion is not met for derivative instruments and therefore replacement values are now reported on a gross basis. In the 31 December 2003 balance sheet, replacement values of CHF 165,050 million that were previously offset are now reported gross. Revised IAS 39 permits any financial instrument to be designated at inception, or at adoption of revised IAS 39, as carried at fair value through proﬁt and loss. Upon adoption of revised IAS 39, UBS made that designation for the majori- ty of its compound instruments issued. Previously, UBS sepa- rated the embedded derivative from the host contract and accounted for the separated derivative as a trading instru- ment. The amounts are now included on the balance sheet within the line item Financial liabilities designated at fair val- ue, with amounts of CHF 65,756 million at 31 December 2004 and CHF 35,286 million at 31 December 2003 being report- ed in that new line. Also, at 31 December 2004 assets in the amount of CHF 653 million are reported in the new line Financial assets designated at fair value. At 31 December 2003, no ﬁnancial assets were designated as held at fair value. The guidance governing recognition and derecognition of a ﬁnancial asset is considerably more complex under revised IAS 39 than previously and requires a multi-step decision process to determine whether derecognition is appropriate. See section d) for a discussion of the accounting policies re- garding derecognition. As a result, certain transactions are now accounted for as secured ﬁnancing transactions instead of purchases or sales of trading portfolio assets with an ac- companying swap derivative. The provisions of this guidance were applied prospectively as of 1 January 2004. The effect of restating the income statement due to the adoption of revised IAS 32 and 39 on the comparative prior periods is a reduction of net proﬁt by CHF 82 million for 2003 and a reduction of CHF 24 million for 2002. Investment properties Effective 1 January 2004, UBS changed its accounting policy for investment property from historical cost less accumulated de- preciation to the fair value model. All changes in the fair value of investment property are now recognized in the income state- ment, and depreciation expense is no longer recorded. Invest- ment property is deﬁned as property held exclusively to earn rental income and beneﬁt from appreciation in value. Fair val- ue of investment property is determined by appropriate valua- tion techniques employed in the real estate industry, taking in- to account the speciﬁc circumstances for each item. This change required restatement of the 2003 and 2002 comparative ﬁnan- cial years. The effects of the restatement were a reduction of net proﬁt by CHF 64 million in 2003, and an increase of net prof- it by CHF 19 million in 2002. Credit losses incurred on OTC derivatives Effective 1 January 2004, the method of accounting for credit losses incurred on over the counter (OTC) derivatives has been changed. All such credit losses are now reported in net trad- ing income and are no longer reported in credit loss expense. This change did not affect net proﬁt or earnings per share re- sults. It did, however, affect segment reporting, as losses report- ed as credit loss expense were previously deferred over a three- year period in the Business Group segment reporting, whereas under the changed method of accounting, losses in trading in- come are not subject to such a deferral. In the segment report, therefore, losses on OTC derivatives are now reported as they are incurred. This change in accounting method affected, to a minor extent, certain balance sheet lines at 31 December 2003, which have been restated to conform to the current year pres- entation. The changed method of accounting had the follow- ing impact on the performance before tax of our Business Groups: In 2003, it reduced Wealth Management & Business Banking’s pre-tax performance by CHF 8 million. It raised the In- vestment Bank’s by CHF 37 million while Corporate Functions’ fell by CHF 29 million. In 2002, the changed method lowered the Investment Bank’s pre-tax performance by CHF 28 million and raised Corporate Functions’ by CHF 28 million. Segment reporting On 1 July 2004, UBS purchased an additional 20% interest in Motor-Columbus AG, which increased its overall ownership stake to 55.6% percent. Motor-Columbus has been consoli- dated as of 1 July 2004, when UBS gained control over the company. Due to its size and nature of business – production, distribution and trading of electricity – a new business seg- ment, Industrial holdings, was added, in which Motor-Colum- bus is reported. As at 1 January 2003, the ﬁve private label banks (three of which were subsequently merged into one bank) owned by UBS were transferred out of Wealth Management & Business Banking into Corporate Center. At the same time, GAM was transferred out of Global Asset Management into Corporate Center. The two businesses formed the Private Banks & GAM segment, whereas the remainder of Corporate Center is reported as the Corporate Functions segment. Also, Wealth Management & Business Banking is reported as two segments, Wealth Management and Business Banking Switzerland. As at 1 January 2002, Wealth Management USA was separated from Investment Bank and became a standalone Business Group. Note 2 to these Group Financial Statements reﬂects the new segment reporting structure. In all applicable instances, prior pe- riod comparative amounts of the affected Business Groups have been restated to conform to the current year presentation. Business combinations On 1 April 2004, UBS adopted IFRS 3 Business Combinations for all business combinations entered into after 31 March 2004. Subsequent to the adoption of the new standard, UBS 98 has entered into and completed a number of business com- binations that were all accounted for under the new standard. The most signiﬁcant change under the new standard is that goodwill is no longer amortized over its estimated useful life but instead tested annually for impairment. Accordingly, no amortization expense has been recognized for goodwill of CHF 631 million recognized on the balance sheet related to business combinations entered into after 1 April 2004. Intan- gible assets may be assigned an indeﬁnite useful life, if sup- portable based on facts and circumstances. These intangibles are not amortized, but tested periodically for impairment. In a step acquisition, where control over a subsidiary is achieved in stages, or where additional shares of a subsidiary are purchased from minority owners, all assets and liabilities of that entity, excluding goodwill, are remeasured to fair value as of the acquisition date of the latest share transaction. The revaluation difference on the existing ownership interest from the carrying value to the newly established fair value is recorded directly in Shareholders’ equity. As a consequence of remeasuring all assets and liabilities to fair value, minority interests are also carried at fair value of net assets excluding goodwill. Previously, only the percentage of assets and liabili- ties was increased to fair value by which the ownership inter- est was increased. Existing ownership interests were kept at their carryover basis. Other relevant changes in accounting for business combinations are that liabilities incurred for restruc- turing and integration of newly acquired businesses must be expensed as incurred, unless they were a pre-acquisition con- tingency of the acquired business. Previously, liabilities incurred for restructuring and integration could be recognized in pur- chase accounting, if they met certain criteria, increasing good- will recognized. Contingent liabilities of an acquired business have to be recognized on the balance sheet at their fair value in purchase accounting, if fair value is determinable. Previous- ly, contingent liabilities were not recognized. The accounting for business combinations entered into be- fore 31 March 2004 was not affected by the new standard. Amended IAS 19, Employee Beneﬁts UBS adopted in 2002 the amended standard IAS 19 Em- ployee Beneﬁts. The amendments introduce an asset ceiling provision that applies for deﬁned beneﬁt plans that have a sur- plus of plan assets over beneﬁt obligations. The implementa- tion of the amended standard had no material impact. Change in treatment of corporate client assets Effective 1 January 2004, UBS re-classiﬁed corporate client assets of Business Banking Switzerland (except for pension funds) to exclude them from invested assets. This change was made because UBS has a minimal advisory role for such clients and asset ﬂows are often driven more by liquidity requirements than pure investment reasons. This change reduced invested assets at 31 December 2003 by approximately CHF 76 billion and increased net new money for 2003 by CHF 7.5 billion. ab) International Financial Reporting Standards to be adopted in 2005 IASB Improvements Project In December 2003, the IASB issued 15 revised International Accounting Standards under its Improvement Project in an attempt to clarify language, to remove inconsistencies and to achieve convergence with other accounting standards, no- tably US GAAP. All revised standards are effective for ﬁnan- cial years beginning on or after 1 January 2005. Two of these 15 improved standards, IAS 32 and IAS 39, were adopted ear- ly at the beginning of 2004. Two of the remaining 13 im- proved standards will have a signiﬁcant impact on UBS, which are IAS 27 Consolidated and Separate Financial Statements and IAS 28 Investments in Associates. IAS 27 has been amended to eliminate the exemption from consolidating a subsidiary where control is exercised temporar- ily. UBS has several private equity investments where it owns a controlling interest, which are classiﬁed and accounted for as Financial investments available-for-sale, which will be required to be consolidated. UBS will adopt IAS 27 on 1 January 2005 with retrospective restatement of comparative prior years 2004 and 2003. The effect of the adoption and consolidating these investments will be as follows: At 1 January 2003, equity includ- ing minority interests are reduced by CHF 723 million, repre- senting the difference between the carrying value as Financial investments available-for-sale and the value on a consolidated basis. Consolidation will lead to recognition of total assets in the amount of CHF 1.7 billion and CHF 2.9 billion at 31 Decem- ber 2004 and 2003, respectively. Signiﬁcant balance sheet line items affected will include Property and equipment, Intangible assets, Goodwill and Other assets. These investments gener- ated additional income of CHF 3.8 billion and CHF 4.1 billion in 2004 and 2003, respectively and additional net proﬁt of CHF 92 million and CHF 86 million in 2004 and 2003, respectively. IAS 28 has been amended in the same way as IAS 27 to elim- inate the exemption from equity method accounting for invest- ments that are held exclusively for disposal. UBS will adopt the IAS 28 amendment on 1 January 2005 with retrospective re- statement of comparative prior years 2004 and 2003. Certain private equity investments where UBS has a signiﬁcant inﬂuence will be equity accounted for commencing 1 January 2005. Ap- plying the equity method of accounting for these investments will have the following effects: At 1 January 2003, equity is deb- ited by CHF 266 million, representing the difference between the carrying value as Financial investments available-for-sale ver- sus the value on an equity method basis. The carrying value of these equity method investments will be CHF 248 million and CHF 393 million at 31 December 2004 and 2003, respectively, which includes equity in losses of CHF 55 million and gains of CHF 10 million recognized in the income statement in 2004 and 2003, respectively. Gains on sale recognized in 2004 and 2003 will be CHF 1 million and zero, respectively. When accounted for as Financial investments, gains on sale recognized were CHF 70 million in 2004 and CHF 34 million in 2003. 99 Financial Statements Notes to the Financial Statements In 2005, these entities, along with all other investments made by the Private Equity business unit, will be reclassiﬁed from the Investment Bank segment to the Industrial Holdings segment. In addition, seven of the newly consolidated invest- ments held at 1 January 2003 were sold during 2003 and 2004 and will be presented as discontinued operations in the restated comparative prior periods in accordance with IFRS 5 which is discussed below. Gain on sale in the amount of CHF 90 million and CHF 194 million have been reported related to private equity investments sold in 2004 and 2003, respective- ly. On a restated basis, the net proﬁt from discontinued oper- ations related to these entities will be CHF 145 million and CHF 186 million in 2004 and 2003, respectively. UBS also has employee beneﬁt trusts that are used in connec- tion with share-based payment arrangements and deferred com- pensation schemes. In connection with the issuance of IFRS 2, the IFRIC amended SIC 12 Consolidation – Special Purpose En- tities, an interpretation of IAS 27, to eliminate the scope exclu- sion for equity compensation plans. Therefore, pursuant to the criteria set out in SIC 12, an entity that controls an employee ben- eﬁt trust (or similar entity) set up for the purposes of a share-based payment arrangement will be required to consolidate that trust. Consolidating these trusts will have the following effects: At 1 January 2003, no adjustment to opening retained earnings is made as assets and liabilities of the trust are equal. Consolida- tion will lead to recognition of total assets in the amount of CHF 1.1 billion and CHF 1.3 billion and liabilities of CHF 1.1 billion and CHF 1.3 billion at 31 December 2004 and 2003, respectively. The amount of treasury shares will increase by CHF 2,029 million and CHF 1,474 million at 31 December 2004 and 2003, respective- ly. The weighted average number of treasury shares held by these trusts was 22,995,954 in 2004 and 30,792,147 in 2003, thus decreasing the numerator to calculate basic earnings per share. The reduction in weighted average shares outstanding will in- crease basic earnings per share, but have no impact on diluted earnings per share, as the additional treasury shares will be fully added back for calculating diluted earnings per share. All other revised standards under the Improvement Project will primarily affect presentation and disclosure, but not recognition and measurement of assets and liabilities, and will therefore not have a material impact on the ﬁnancial statements. The two most signiﬁcant presentation differences relate to minority interests and earnings per share. Beginning 2005, Net proﬁt and Equity will be presented including minority interests. Net proﬁt will be allocated to net proﬁt attributable to UBS shareholders and at- tributable to minority interests on the face of the income state- ment. Earnings per share will continue to be presented based on net proﬁt attributable to UBS shareholders, but will be allo- cated to earnings per share from continuing operations and from discontinued operations. IFRS 2 Share-based Payment In February 2004, the IASB issued IFRS 2 Share-based Payment, which requires share-based payments made to employees and non-employees to be recognized in the ﬁnancial statements based on the fair value of these awards measured at the date of grant. UBS will adopt the new standard on 1 January 2005 and fully restate the two comparative prior years. In accordance with IFRS 2, UBS will apply the new requirements of the stan- dard to all prior period awards that impact income statements commencing 2003. This includes all unvested equity settled awards and all outstanding cash settled awards at 1 January 2003. The effects of restatement are as follows: The opening balance of retained earnings at 1 January 2003 will be credit- ed by CHF 559 million. Additional compensation expense of zero and CHF 558 million will be recognized in 2004 and 2003, respectively. The change in compensation expense is attribut- able to the ﬁrst-time recognition of compensation expense for the fair value of share options, as well as the recognition of ex- pense for share awards over the vesting period. Previously, share awards were recognized as compensation expense in the performance year, which is generally the year prior to grant. The reason for the zero impact in 2004 is that a signiﬁcantly higher amount of bonus payments were made in the form of restricted stock rather than cash. The reversal of compensation expense attributable to these share payments offset the effect from recognizing options at fair value and share awards made prior to 2004 over the vesting period. UBS will introduce a new valuation model to determine the fair value of share options granted in 2005 and later. Share op- tions granted in 2004 and earlier will not be affected by this change in valuation model. As part of the implementation of IFRS 2, UBS thoroughly reviewed the option valuation model em- ployed in the past by comparing it to alternative models. As a re- sult of this review, a valuation model was identiﬁed that better reﬂects the exercise behavior of employees and the speciﬁc terms and conditions under which the share options are granted. Con- current with the introduction of the new model, UBS will use im- plied instead of historic volatility as input into the new model. IFRS 3 Business Combinations, IAS 36 Impairment of Assets and IAS 38 Intangible Assets On 31 March 2004, the IASB issued IFRS 3 Business Combina- tions, revised IAS 36 Impairment of Assets, and revised IAS 38 Intangible Assets. UBS adopted the standards on 1 April 2004. Under the transitional requirements of IFRS 3, goodwill recognized in business combinations after 31 March 2004 will no longer be amortized over its estimated useful life but be tested annually for impairment. Goodwill existing at 31 March 2004 will cease to be amortized as of 1 January 2005 and reviewed annually for impairment. UBS recorded goodwill amortization expense of CHF 713 million in 2004 and CHF 756 million in 2003. Intangible assets acquired in a business com- bination must be recognized separately from goodwill, if they meet the recognition criteria. UBS will reclassify the trained workforce intangible recognized in connection with the acqui- sition of PaineWebber with a book value of CHF 1,010 million to Goodwill at 1 January 2005. 100 IFRS 4 Insurance Contracts On 31 March 2004, the IASB issued IFRS 4 Insurance Contracts. The standard applies to all insurance contracts written and to reinsurance contracts held. It requires that insurance contracts that include a deposit component, are separated into the de- posit and the insurance component. UBS will adopt the new standard as of 1 January 2005 and apply it to its insurance con- tracts. The new standard will not have a material effect on the ﬁnancial statements. IFRS 5 Non-current Assets Held for Sale and Discontinued Operations On 31 March 2004, the IASB issued IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. The standard re- quires that non-current assets or disposal groups be classiﬁed as held for sale if their carrying amount is recovered principal- ly through a sale transaction rather than through continuing use. Such assets are measured at the lower of carrying amount and fair value less costs to sell and are classiﬁed separately from other assets in the balance sheet. Netting of assets and liabil- ities is not permitted. Discontinued operations are presented on the face of the income statement as a single amount com- prising the total of the net proﬁt or loss of discontinued oper- ations and the after tax gain or loss recognized on the sale or the measurement to fair value less costs to sell of the net as- sets constituting the discontinued operations. IFRS 5 provides certain criteria to be met for a component of an entity to be deﬁned as a discontinued operation. Cer- tain private equity investments meet this deﬁnition and will be reclassiﬁed as discontinued operations. UBS will adopt the new standard on 1 January 2005 and restate comparative prior years 2004 and 2003. While the impact on the ﬁnancial statements will not be material, the income statement will be divided into two sections; net income from continuing oper- ations and net income from discontinued operations. Note 2a Segment Reporting by Business Group UBS’s ﬁnancial businesses are organized on a worldwide basis into four Business Groups and the Corporate Center. Wealth Management & Business Banking is segregated into two segments, Wealth Management and Business Banking Switzer- land. The Corporate Center also consists of two segments, Pri- vate Banks & GAM and Corporate Functions. The Industrial Holdings segment holds all industrial operations controlled by the Group. In total, UBS now reports eight business segments. Wealth Management & Business Banking Wealth Management & Business Banking comprises two seg- ments. Wealth Management offers a comprehensive range of products and services individually tailored to afﬂuent interna- tional and Swiss clients, operating from ofﬁces around the world. Business Banking Switzerland provides individual 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-channel distribution. The two segments share technological and phys- ical infrastructure, and have joint departments supporting major functions such as e-commerce, ﬁnancial planning and wealth management, investment policy and strategy. ucts, research, advice and complete access to the world’s cap- ital markets for intermediaries, governments, corporate and institutional clients and other parts of UBS. Investment Bank also manages the private equity business, investing UBS and third-party funds, primarily in unlisted companies. Wealth Management USA Wealth Management USA is a US ﬁnancial services ﬁrm pro- viding sophisticated wealth management services to afﬂuent US clients through a highly trained ﬁnancial advisor network. Corporate Center Corporate Center comprises two segments. Corporate Functions ensures that the Business Groups operate as a coherent and ef- fective whole with a common set of values and principles in such areas as risk management and control, ﬁnancial reporting, mar- keting and communications, funding, capital and balance sheet management, management of foreign exchange earnings and information technology infrastructure. Private Banks & GAM holds our private label banks and GAM, which provide clients with a complete range of private banking services in Switzer- land and specialized asset management services, respectively. Global Asset Management Global Asset Management provides investment products and services to institutional investors and wholesale intermediaries around the globe. Clients include corporate and public pen- sion plans, ﬁnancial institutions and advisors, central banks as well as charities, foundations and individual investors. Investment Bank Investment Bank operates globally as a client-driven invest- ment banking and securities ﬁrm providing innovative prod- Industrial Holdings The Industrial Holdings segment was established in third quar- ter 2004 to house the non-ﬁnancial businesses of UBS. At this stage, results include Motor-Columbus, in which UBS acquired an additional 20% stake on 1 July 2004, bringing the total stake to 55.6%. Motor-Columbus is a ﬁnancial holding com- pany whose only signiﬁcant asset is a 59.3% interest in the Atel Group. Atel is a European energy provider focused on domes- tic and international power generation, electricity transmission, energy services as well as electricity trading and marketing. 101 Financial Statements Notes to the Financial Statements Note 2a Reporting by Business Group (continued) For the year ended 31 December 2004 Internal charges and transfer pricing adjustments are reﬂected in the performance of each business. Revenue-sharing agreements are used to allocate external cus- tomer revenues to a Business Group on a reasonable basis. Transactions between Business Groups are conducted at arm’s length. Management reporting based on expected credit loss For internal management reporting purposes, we measure credit loss using an ex- pected loss concept. This table shows Business Group performance consistent with the way in which our businesses are managed and the way Business Group per- formance is measured. Expected credit loss reﬂects the average annual costs that are expected to arise from positions in the current portfolio that become impaired. The Adjusted expected credit loss reported for each Business Group is the expect- ed credit loss on its portfolio plus the difference between Credit loss expense and expected credit loss, amortized over a three year period. The difference between these Adjusted expected credit loss ﬁgures and the Credit loss expense recorded at Group level for reporting purposes is reported in Corporate Functions. CHF million Income 2 Credit loss (expense) / recovery Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation Amortization of goodwill and other intangible assets 3 Goods and materials purchased Total operating expenses Business Group performance before tax Tax expense Net proﬁt before minority interests Minority interests Net proﬁt Additional information 4 Total assets Total liabilities and minority interests Capital expenditure Income 2 Adjusted expected credit loss Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation Amortization of goodwill and other intangible assets 3 Goods and materials purchased Total operating expenses Business Group performance before tax Tax expense Net proﬁt before minority interests Minority interests Net proﬁt 102 Financial Businesses Industrial Holdings1 UBS Wealth Management & Business Banking Corporate Center Wealth Management Business Banking Switzerland Global Asset Management Wealth Investment Bank Management USA Private Banks & GAM Corporate Functions 7,701 (1 ) 7,700 2,080 642 1,395 66 75 4,258 3,442 5,063 92 5,155 2,393 1,064 (533 ) 69 0 2,993 2,162 2,022 0 2,022 901 299 126 23 129 1,478 544 15,984 240 16,224 8,156 2,535 219 239 288 11,437 4,787 5,098 3 5,101 3,437 800 302 71 304 4,914 187 164,720 161,046 304 210,133 204,479 212 29,334 28,501 8 1,473,726 1,459,757 322 51,850 47,259 50 7,701 (8 ) 7,693 2,080 642 1,395 66 75 4,258 3,435 5,063 (25 ) 5,038 2,393 1,064 (533 ) 69 0 2,993 2,045 2,022 0 2,022 901 299 126 23 129 1,478 544 15,984 (7 ) 15,977 8,156 2,535 219 239 288 11,437 4,540 5,098 (5 ) 5,093 3,437 800 302 71 304 4,914 179 1,145 (58 ) 1,087 432 160 10 20 74 696 391 8,043 7,480 19 1,145 (6 ) 1,139 432 160 10 20 74 696 443 113 0 113 790 1,077 (1,519 ) 794 17 1,159 (1,046) (210,909 ) (216,342 ) 599 113 327 440 790 1,077 (1,519 ) 794 17 1,159 (719) 3,667 0 3,667 326 126 70 77 2,861 3,460 207 7,887 7,626 50 3,667 3,667 326 126 70 77 2,861 3,460 207 40,793 276 41,069 18,515 6,703 0 1,352 964 2,861 30,395 10,674 2,135 8,539 (450) 8,089 1,734,784 1,699,806 1,564 40,793 276 41,069 18,515 6,703 0 1,352 964 2,861 30,395 10,674 2,135 8,539 (450 ) 8,089 1 Results shown for the six-month period beginning on 1 July 2004. 2 Impairments on private equity and other ﬁnancial investments for the year ended 31 December 2004 were as follows: Wealth Management & Business Banking CHF 10 million; Global Asset Management CHF 4 million; Investment Bank CHF 170 million; Wealth Management USA CHF 39 million; Corporate Center CHF 0 million. 4 The funding surplus or requirement is reﬂected 3 For further information regarding goodwill and other intangible assets by Business Group, please see Note 15: Goodwill and Other Intangible Assets. in each Business Group and adjusted in Corporate Center. 103 Financial Statements Notes to the Financial Statements Note 2a Reporting by Business Group (continued) For the year ended 31 December 2003 Internal charges and transfer pricing adjustments are reﬂected in the performance of each business. Revenue-sharing agreements are used to allocate external cus- tomer revenues to a Business Group on a reasonable basis. Transactions between Business Groups are conducted at arm’s length. Management reporting based on expected credit loss For internal management reporting purposes, we measure credit loss using an ex- pected loss concept. This table shows Business Group performance consistent with the way in which our businesses are managed and the way Business Group per- formance is measured. Expected credit loss reﬂects the average annual costs that are expected to arise from positions in the current portfolio that become impaired. The Adjusted expected credit loss reported for each Business Group is the expect- ed credit loss on its portfolio plus the difference between Credit loss expense and expected credit loss, amortized over a three year period. The difference between these Adjusted expected credit loss ﬁgures and the Credit loss expense recorded at Group level for reporting purposes is reported in Corporate Functions. CHF million Income1 Credit loss (expense) / recovery Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation Amortization of goodwill and other intangible assets2 Total operating expenses Business Group performance before tax Tax expense Net proﬁt before minority interests Minority interests Net proﬁt Additional information3 Total assets Total liabilities and minority interests Capital expenditure Income1 Adjusted expected credit loss Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation Amortization of goodwill and other intangible assets2 Total operating expenses Business Group performance before tax Tax expense Net proﬁt before minority interests Minority interests Net proﬁt 104 Wealth Management & Business Banking Corporate Center Wealth Management Business Banking Switzerland Global Asset Management Investment Bank Wealth Management USA Private Banks & GAM Corporate Functions 6,797 4 6,801 1,944 604 1,479 82 75 4,184 2,617 5,247 (71 ) 5,176 2,406 1,090 (609 ) 88 0 2,975 2,201 150,285 147,479 167 192,517 186,185 261 6,797 (4 ) 6,793 1,944 604 1,479 82 75 4,184 2,609 5,247 (127 ) 5,120 2,406 1,090 (609 ) 88 0 2,975 2,145 1,737 0 1,737 806 265 156 25 153 1,405 332 21,929 20,917 17 1,737 0 1,737 806 265 156 25 153 1,405 332 13,991 (4 ) 13,987 7,303 2,074 180 246 278 10,081 3,906 1,316,897 1,303,281 518 13,991 (55 ) 13,936 7,303 2,074 180 246 278 10,081 3,855 5,190 (3 ) 5,187 3,627 719 433 72 336 5,187 0 46,837 41,732 68 5,190 (8 ) 5,182 3,627 719 433 72 336 5,187 (5) 880 2 882 381 169 11 28 81 670 212 9,084 8,406 17 880 (2 ) 878 381 169 11 28 81 670 208 20 0 20 764 1,165 (1,650 ) 812 20 1,111 (1,091) UBS 33,862 (72 ) 33,790 17,231 6,086 0 1,353 943 25,613 8,177 1,593 6,584 (345) 6,239 (187,493 ) (193,254 ) 427 1,550,056 1,514,746 1,475 20 124 144 764 1,165 (1,650 ) 812 20 1,111 (967) 33,862 (72 ) 33,790 17,231 6,086 0 1,353 943 25,613 8,177 1,593 6,584 (345 ) 6,239 1 Impairments on private equity and other ﬁnancial investments for the year ended 31 December 2003 were as follows: Wealth Management & Business Banking CHF 18 million; Global Asset Management CHF 2 million; Investment Bank CHF 371 million; Wealth Management USA CHF 1 million; Corporate Center CHF 149 million. 2 For further information regarding goodwill and other intangible assets by Business Group, please see Note 15: Goodwil and Other Intangible Assets. 3 The funding surplus or requirement is reﬂected in each Business Group and adjusted in Corporate Center. 105 Financial Statements Notes to the Financial Statements Note 2a Reporting by Business Group (continued) For the year ended 31 December 2002 Internal charges and transfer pricing adjustments are reﬂected in the performance of each business. Revenue-sharing agreements are used to allocate external cus- tomer revenues to a Business Group on a reasonable basis. Transactions between Business Groups are conducted at arm’s length. Management reporting based on expected credit loss For internal management reporting purposes, we measure credit loss using an ex- pected loss concept. This table shows Business Group performance consistent with the way in which our businesses are managed and the way Business Group per- formance is measured. Expected credit loss reﬂects the average annual costs that are expected to arise from positions in the current portfolio that become impaired. The Adjusted expected credit loss reported for each Business Group is the expect- ed credit loss on its portfolio plus the difference between Credit loss expense and expected credit loss, amortized over a three year period. The difference between these Adjusted expected credit loss ﬁgures and the Credit loss expense recorded at Group level for reporting purposes is reported in Corporate Functions. CHF million Income1 Credit loss (expense) / recovery Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation Amortization of goodwill and other intangible assets2 Total operating expenses Business Group performance before tax Tax expense Net proﬁt before minority interests Minority interests Net proﬁt Additional information3 Total assets Total liabilities and minority interests Capital expenditure Income1 Adjusted expected credit loss Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation Amortization of goodwill and other intangible assets2 Total operating expenses Business Group performance before tax Tax expense Net proﬁt before minority interests Minority interests Net proﬁt 106 Wealth Management & Business Banking Corporate Center Wealth Management Business Banking Switzerland Global Asset Management Investment Bank Wealth Management USA Private Banks & GAM Corporate Functions 6,690 1 6,691 1,869 617 1,475 93 97 4,151 2,540 5,494 (239 ) 5,255 2,469 1,305 (638 ) 105 3,241 2,014 189,061 186,346 156 121,661 115,926 224 6,690 (26 ) 6,664 1,869 617 1,475 93 97 4,151 2,513 5,494 (286 ) 5,208 2,469 1,305 (638 ) 105 3,241 1,967 1,655 0 1,655 763 301 164 22 186 1,436 219 4,428 2,937 20 1,655 1,655 763 301 164 22 186 1,436 219 12,419 126 12,545 7,815 2,359 140 320 364 10,998 1,547 1,099,410 1,087,019 473 12,419 (90 ) 12,329 7,815 2,359 140 320 364 10,998 1,331 5,561 (15 ) 5,546 4,158 926 492 81 1,691 7,348 (1,802) 39,610 33,225 466 5,561 (13 ) 5,548 4,158 926 492 81 1,691 7,348 (1,800) 1,038 (3 ) 1,035 386 120 12 40 98 656 379 7,004 6,270 37 1,038 (2 ) 1,036 386 120 12 40 98 656 380 1,365 15 1,380 1,064 1,444 (1,645 ) 853 24 1,740 (360) UBS 34,222 (115 ) 34,107 18,524 7,072 0 1,514 2,460 29,570 4,537 676 3,861 (331 ) 3,530 (114,496 ) (123,997 ) 668 1,346,678 1,307,726 2,044 1,365 302 1,667 1,064 1,444 (1,645 ) 853 24 1,740 (73) 34,222 (115 ) 34,107 18,524 7,072 0 1,514 2,460 29,570 4,537 676 3,861 (331 ) 3,530 1 Impairments on private equity and other ﬁnancial investments for the year ended 31 December 2002 were as follows: Wealth Management & Business Banking CHF 32 million; Global Asset Management CHF 1 million; Investment Bank CHF 1,703 million; Corporate Center CHF 208 million. 2 For further information regarding goodwill and other intangible assets by Business Group, please see Note 15: Goodwill and Other Intangible Assets. 3 The funding surplus or requirement is reﬂected in each Business Group and adjusted in Corporate Center. 107 Financial Statements Notes to the Financial Statements 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 ﬁnan- cial markets the Group’s business is managed on an integrat- ed 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. Man- agement believes that analysis by Business Group, as shown in Note 2a to these Financial Statements, is a more meaning- ful representation of the way in which the Group is managed. For the year ended 31 December 2004 Switzerland Rest of Europe / Africa / Middle East Americas Asia Paciﬁc Total For the year ended 31 December 2003 Switzerland Rest of Europe / Africa / Middle East Americas Asia Paciﬁc Total For the year ended 31 December 2002 Switzerland Rest of Europe / Africa / Middle East Americas Asia Paciﬁc Total Total operating income Total assets Capital expenditure CHF million Share % CHF million Share % CHF million Share % 14,949 10,379 13,615 2,126 41,069 37 25 33 5 189,019 564,336 829,845 151,584 11 32 48 9 799 388 293 84 51 25 19 5 100 1,734,784 100 1,564 100 Total operating income Total assets Capital expenditure CHF million Share % CHF million Share % CHF million Share % 13,176 5,977 12,923 1,714 33,790 39 18 38 5 182,280 535,501 738,189 94,086 12 34 48 6 689 242 510 34 47 16 35 2 100 1,550,056 100 1,475 100 Total operating income Total assets Capital expenditure CHF million Share % CHF million Share % CHF million Share % 14,327 6,816 11,055 1,909 34,107 42 20 32 6 176,544 363,706 719,703 86,725 13 27 54 6 885 199 916 44 43 10 45 2 100 1,346,678 100 2,044 100 108 Income Statement Note 3 Net Interest and Trading Income Accounting standards require separate disclosure of net inter- est income and net trading income (see the second and the third table). This required disclosure, however, does not take into account that net interest and trading income are gener- ated by a range of different business activities. In many cases, a particular business activity can generate both net interest and trading income. Fixed income trading activity, for example, gen- erates both trading proﬁts and coupon income. UBS manage- ment therefore analyzes net interest and trading income ac- cording to the business activity generating it. The ﬁrst table be- low (labeled Net interest and trading income) provides infor- mation that corresponds to this management view. For exam- ple, net income from trading activities is further broken down into the four sub-components of Equities, Fixed income, For- eign exchange and Other. These activities generate both types of income (interest and trading revenue) and therefore this analysis is not comparable to the breakdown provided in the third table on the next page (Net trading income only). Net interest and trading income CHF million Net interest income Net trading income Total net interest and trading income Breakdown by business activity CHF million Net income from interest margin products Equities Fixed income Foreign exchange Other Net income from trading activities Net income from treasury activities Other 1 Total net interest and trading income 1 Includes external funding costs of the PaineWebber Group, Inc. acquisition. Net interest income CHF million 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 ﬁnancial liabilities designated at fair value Interest on debt issued Total Net interest income For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 11,860 4,972 16,832 12,299 3,756 16,055 10,546 5,451 15,997 (4 ) 32 5 For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 5,139 3,098 6,264 1,467 273 11,102 1,298 (707) 16,832 5,077 2,445 6,474 1,436 326 10,681 1,417 (1,120 ) 16,055 5,275 2,777 5,977 1,506 245 10,505 1,646 (1,429 ) 15,997 1 27 (3 ) 2 (16 ) 4 (8 ) 37 5 For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 9,021 11,006 93 19,278 39,398 5,529 10,014 7,993 1,168 2,834 27,538 11,860 10,542 11,148 75 18,394 40,159 5,072 9,623 9,925 751 2,489 27,860 12,299 11,600 11,184 165 17,014 39,963 6,383 10,081 8,226 341 4,386 29,417 10,546 (14 ) (1 ) 24 5 (2 ) 9 4 (19 ) 56 14 (1 ) (4 ) 109 Financial Statements Notes to the Financial Statements Note 3 Net Interest and Trading Income (continued) Net trading income1 CHF million Equities Fixed income 2 Foreign exchange and other Net trading income For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 2,254 131 2,587 4,972 1,660 396 1,700 3,756 2,621 997 1,833 5,451 36 (67 ) 52 32 1 Please refer to the table “Net Interest and Trading Income” on the previous page for the Equities, Fixed income, Foreign exchange and Other business results (for an explanation, read the corresponding introductory comment). 2 Includes commodities trading income. Included in the Net trading income table are fair value changes of CHF (1,203) million for the year ended 31 December 2004, CHF (115) million for the year ended 31 December 2003, and CHF 446 million for the year ended 31 December 2002 relat- ed to financial liabilities designated as held at fair value through proﬁt and loss. For 2004, CHF (801) million of the to- tal fair value change was attributable to changes in fair value of embedded derivatives, while CHF (402) million was attrib- utable to changes in LIBOR. The exposure from embedded de- rivatives is economically hedged with derivatives whose change in fair value is also reported in Net trading income, off- setting the fair value changes related to ﬁnancial liabilities des- ignated as held at fair value. Note 4 Net Fee and Commission Income CHF million Equity underwriting fees Bond underwriting fees Total 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 Net fee and commission income For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 1,430 1,114 2,544 1,078 5,916 4,588 220 1,261 4,611 342 20,560 266 988 21,814 1,399 999 2,398 19,416 1,270 1,084 2,354 761 5,608 3,895 241 1,201 3,855 355 18,270 249 1,087 19,606 1,483 778 2,261 17,345 1,166 968 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 18,221 13 3 8 42 5 18 (9 ) 5 20 (4 ) 13 7 (9 ) 11 (6 ) 28 6 12 110 Note 5 Other Income CHF million 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 1 Equity in income of associates Gains / (losses) from investment properties 2 Other Total other income For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 83 1 84 557 46 (223) 380 65 65 11 292 897 160 2 162 352 90 (541 ) (99 ) 75 123 (42 ) 243 462 228 0 228 273 457 (1,944 ) (1,214 ) 90 7 17 876 4 (48 ) (50 ) (48 ) 58 (49 ) 59 (13 ) (47 ) 20 94 1 Includes net rent received from third parties and net operating expenses. 2 Includes unrealized and realized proﬁt from investment properties at fair value. Note 6 Personnel Expenses CHF million Salaries and bonuses Contractors Insurance and social contributions Contribution to retirement plans Other personnel expenses Total personnel expenses 31.12.04 14,835 572 1,093 707 1,308 18,515 For the year ended 31.12.03 13,478 539 923 721 1,570 17,231 31.12.02 14,219 579 939 676 2,111 18,524 % change from 31.12.03 10 6 18 (2 ) (17 ) 7 Note 7 General and Administrative Expenses For the year ended % change from CHF million 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 31.12.04 1,274 31.12.03 1,304 686 835 660 442 634 705 953 514 708 864 599 398 526 589 844 254 Total general and administrative expenses 6,703 6,086 31.12.02 31.12.03 1,354 665 1,019 819 453 600 568 1,036 558 7,072 (2 ) (3 ) (3 ) 10 11 21 20 13 102 10 111 Financial Statements Notes to the Financial Statements Note 8 Earnings per Share (EPS) and Shares Outstanding For the year ended % change from 31.12.04 31.12.03 31.12.02 31.12.03 Basic earnings (CHF million) Net proﬁt Diluted earnings (CHF million) Net proﬁt Less: Proﬁt on equity derivative contracts Net proﬁt for diluted EPS Weighted average shares outstanding Weighted average shares outstanding 8,089 6,239 3,530 8,089 (5) 8,084 6,239 1 6,240 3,530 (20 ) 3,510 1,052,914,417 1,116,953,623 1,208,586,678 Potentially dilutive ordinary shares resulting from options and warrants outstanding 1 29,046,943 21,847,002 14,796,264 Weighted average shares outstanding for diluted EPS 1,081,961,360 1,138,800,625 1,223,382,942 Earnings per share (CHF) Basic Diluted 7.68 7.47 5.59 5.48 2.92 2.87 30 30 30 (6 ) 33 (5 ) 37 36 1 Total equivalent shares outstanding on options that were not dilutive for the respective periods but could potentially dilute earnings per share in the future were 18,978,199, 37,234,538 and 75,385,368 for the years ended 31 December 2004, 31 December 2003 and 31 December 2002, respectively. Shares outstanding Total ordinary shares issued Second trading line treasury shares 2002 ﬁrst program 2002 second program 2003 program 2004 program Other treasury shares Total treasury shares Shares outstanding 31.12.04 As at 31.12.03 % change from 31.12.02 31.12.03 1,126,858,177 1,183,046,764 1,256,297,678 (5 ) 39,935,094 63,589,877 56,707,000 54,653,692 103,524,971 111,360,692 67,700,000 6,335,080 23,146,014 97,181,094 1,023,333,206 1,071,686,072 1,159,116,584 16 (7 ) (5 ) 112 Balance Sheet: Assets Note 9a Due from Banks and Loans By type of exposure CHF million Banks 1 Allowance for credit losses Net due from banks Loans Residential mortgages Commercial mortgages Other Loans Subtotal Allowance for credit losses Net loans Net due from banks and loans 1 Includes due from banks from Industrial Holdings in the amount of CHF 764 million. By geographic region (based on the location of the borrower) CHF million Switzerland Rest of Europe / Africa / Middle East Americas Asia Paciﬁc 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 31.12.04 35,520 (256) 35,264 117,731 18,950 98,081 234,762 (2,375) 232,387 267,651 31.12.04 152,433 45,712 61,751 10,386 270,282 (2,631) 267,651 31.12.04 138,692 38,872 18,973 73,745 270,282 (2,631) 267,651 31.12.03 32,024 (284 ) 31,740 109,980 19,162 86,829 215,971 (3,292 ) 212,679 244,419 31.12.03 152,358 43,842 42,653 9,142 247,995 (3,576 ) 244,419 31.12.03 130,740 28,062 18,295 70,898 247,995 (3,576 ) 244,419 113 Financial Statements Notes to the Financial Statements Note 9b Allowances and Provisions for Credit Losses CHF million Balance at the beginning of the year1 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 As a reduction of other balance sheet positions Subtotal Included in other liabilities related to commitments and contingent liabilities Total allowances and provisions for credit losses Speciﬁc allowances and provisions Collective loan loss provision Total 31.12.04 3,692 (854) 59 (251) 30 2,676 262 (3) (25) (27) 207 3,954 (857) 59 (276) 3 2,883 Total 31.12.03 2 5,232 (1,436 ) 87 72 (1 ) 3,954 31.12.04 31.12.03 256 2,375 41 2,672 211 2,883 284 3,292 88 3,664 290 3,954 1 Includes country provisions of CHF 183 million and CHF 262 million at 31 December 2004 and 31 December 2003 respectively. derivatives to the trading portfolio as a reduction of fair value, following the revised treatment of OTC derivatives credit losses. 2 Restated to reﬂect transfers of allowances and provisons for OTC 31.12.04 31.12.03 4,861 239 2,266 2,505 6,038 7,209 245 3,213 3,458 8,594 2 Interest income on impaired due from banks and loans was CHF 172 million for 2004 and CHF 279 million for 31.12.04 31.12.03 4,861 1,758 3,103 2,505 7,209 2,465 4,744 3,458 Note 9c Impaired Due from Banks and Loans CHF million Total gross impaired due from banks and loans 1, 2 Allowance for impaired due from banks Allowance for impaired loans Total allowances for credit losses related to impaired due from banks and loans Average total gross impaired due from banks and loans 3 1 All impaired due from banks and loans have a speciﬁc allowance for credit losses. 2003. 3 Average balances were calculated from quarterly data. CHF million Total gross impaired due from banks and loans Estimated liquidation proceeds of collateral Net impaired due from banks and loans Speciﬁc allowances and provisions 114 Note 9d Non-Performing Due from Banks and Loans A loan (included in due from banks or loans) is classiﬁed as non-performing: 1) when the payment of interest, principal or fees is overdue by more than 90 days and there is no ﬁrm evidence that they will be made good by later payments or CHF million Total gross non-performing due from banks and loans Total allowances for credit losses related to non-performing due from banks and loans Average total gross non-performing due from banks and loans 1 1 Average balances are calculated from quarterly data. CHF million Non-performing due from banks and loans at the beginning of the year Net additions / (reductions) Write-offs and disposals Non-performing due from banks and loans at the end of the year By type of exposure CHF million Banks Loans Mortgages Other Total loans Total non-performing due from banks and loans By geographic region (based on the location of borrower) CHF million Switzerland Rest of Europe / Africa / Middle East Americas Asia Paciﬁc Total non-performing due from banks and loans the liquidation of collateral; 2) when insolvency proceedings have commenced; or 3) when obligations have been restruc- tured on concessionary terms. 31.12.04 31.12.03 3,696 2,264 4,338 4,901 2,764 5,410 31.12.04 31.12.03 4,901 (496) (709) 3,696 6,000 317 (1,416 ) 4,901 31.12.04 242 31.12.03 253 1,011 2,443 3,454 3,696 31.12.04 2,772 607 220 97 3,696 1,470 3,178 4,648 4,901 31.12.03 4,012 488 366 35 4,901 115 Financial Statements Notes to the Financial Statements 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 securi- ties 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 cred- it risk associated with these activities by monitoring counter- party credit exposure and collateral values on a daily basis and requiring additional collateral to be deposited with or re- turned 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 31.12.04 Reverse repurchase agreements 31.12.04 Cash collateral on securities borrowed 31.12.03 Reverse repurchase agreements 31.12.03 167,567 52,675 220,242 243,890 113,274 357,164 172,783 41,149 213,932 Cash collateral on securities lent 31.12.04 Repurchase agreements 31.12.04 Cash collateral on securities lent 31.12.03 40,580 20,965 61,545 252,151 170,436 422,587 39,587 13,691 53,278 237,148 83,351 320,499 Repurchase agreements 31.12.03 263,905 151,958 415,863 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 2004 and 31 December 2003 were as follows: CHF million Securities received under reverse repurchase and / or securities borrowing arrangements which can be repledged or resold thereof repledged / transferred to others in connection with ﬁnancing activities or to satisfy commitments under short sale transactions 31.12.04 949,570 639,865 31.12.03 827,602 593,049 116 Note 11 Trading Portfolio The Group trades in debt instruments (including money mar- ket paper and tradeable loans), equity instruments, precious metals, commodities and derivatives to meet the ﬁnancial needs of its customers and to generate revenue. Note 23 pro- vides a description of the various classes of derivatives togeth- er with the related notional amounts, while Note 10 provides further details about cash collateral on securities borrowed and lent and repurchase and reverse repurchase agreements. CHF million Trading portfolio assets Money market paper thereof pledged as collateral with central banks thereof pledged as collateral and can be repledged or resold by counterparty 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 counterparty Equity instruments Listed Unlisted Total thereof pledged as collateral thereof can be repledged or resold by counterparty Traded loans Precious metals, commodities 1 Total trading portfolio assets 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 Total trading portfolio liabilities 1 Commodities basically consist of energy. 31.12.04 31.12.03 44,842 4,706 12,580 776 92,330 79,340 140,500 35,646 348,592 147,525 120,317 90,594 18,119 108,713 27,140 26,218 16,077 11,150 40,003 6,208 0 1,011 92,250 69,755 152,413 8,457 323,886 130,093 104,402 64,116 10,507 74,623 16,426 16,357 12,650 10,610 529,374 461,772 511 54,848 49,512 27,413 2,600 134,884 36,149 171,033 586 52,377 38,369 13,537 10,851 115,720 28,237 143,957 117 Financial Statements Notes to the Financial Statements Note 12 Financial Investments (available-for-sale) CHF million Money market paper Other debt instruments Listed Unlisted Total Equity instruments Listed Unlisted Total Private equity investments Total ﬁnancial investments thereof eligible for discount at central banks 31.12.04 31.12.03 567 261 21 282 504 687 1,191 3,009 5,049 86 596 189 72 261 387 630 1,017 3,265 5,139 196 The following tables show the unrealized gains and losses not recognized in the income statement for the years ended 2004 and 2003: CHF million 31 December 2004 Money market paper Debt securities issued by 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 CHF million 31 December 2003 Money market paper Debt securities issued by 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 Unrealized gains / losses not recognized in the income statement Fair value Gross gains Gross losses Net, before tax Tax effect Net, after tax 567 10 20 0 40 140 72 0 1,191 3,009 5,049 0 1 1 0 0 7 0 0 455 979 1,443 0 0 0 0 0 (4 ) 0 0 (5 ) (44 ) (53) 0 1 1 0 0 3 0 0 0 0 0 0 0 0 0 0 0 1 1 0 0 3 0 0 450 935 1,390 (83 ) (89 ) (172) 367 846 1,218 Unrealized gains / losses not recognized in the income statement Fair value Gross gains Gross losses Net, before tax Tax effect Net, after tax 596 14 25 0 54 156 0 12 1,017 3,265 5,139 0 2 0 0 0 3 0 0 296 781 1,082 0 0 0 0 0 (8 ) 0 0 (7 ) (216 ) (231) 0 2 0 0 0 (5 ) 0 0 289 565 851 0 0 0 0 0 (1 ) 0 0 (58 ) 0 (59) 0 2 0 0 0 (6 ) 0 0 231 565 792 118 Note 12 Financial Investments (available-for-sale) (continued) The unrealized losses not recognized in the income statement are considered to be temporary on the basis that the invest- ments are intended to be held for a period of time sufﬁcient to recover their cost, and UBS believes that the evidence in- dicating that the cost of the investments should be recover- able within a reasonable period of time outweighs the evi- dence to the contrary. This includes the nature of the investments, valuations and research undertaken by UBS, the current outlook for each investment, offers under negotiation at favourable prices and the duration of the unrealized losses. The following table shows the duration of unrealized losses not recognized in the income statement for the year ended 2004: Fair Value Unrealized Losses Investments Investments with unrealized with unrealized loss more than 12 months loss less than 12 months CHF million 31 December 2004 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 0 0 0 0 0 0 0 0 1 424 425 0 0 0 0 0 0 0 0 24 82 106 Investments Investments with unrealized with unrealized loss more than 12 months loss less than 12 months 0 0 0 0 0 0 0 0 (1 ) (5 ) (6) 0 0 0 0 0 (4 ) 0 0 (4 ) (39 ) (47) Total 0 0 0 0 0 0 0 0 25 506 531 Total 0 0 0 0 0 (4 ) 0 0 (5 ) (44 ) (53) Contractual maturities of the investments in debt instruments 1 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 2004 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 1 10 36 57 3 0 107 5.50 3.97 2.13 2.74 2.50 0 2 10 4 50 0 0 66 4.29 4.14 1.25 2.92 0 0 6 0 0 0 5 0 11 3.80 0 0 0 3.21 0 1 0 0 33 64 0 98 4.00 0 0 0 4.36 0 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 31.12.04 31.12.03 277 49 (4) 1,379 112 (23 ) 119 Financial Statements Notes to the Financial Statements Note 13 Investments in Associates CHF million Carrying amount at the beginning of the year Additions Disposals Transfers Income Dividend paid Foreign currency translation Carrying amount at the end of the year 1 Additions of CHF 1,022 million due to the consolidation of Motor-Columbus. 31.12.04 31.12.03 1,616 1,896 1 (684) (378) 65 (32) (56) 2,427 705 88 (142 ) 1,001 123 (30 ) (129 ) 1,616 Note 14 Property and Equipment CHF million Historical cost Balance at the beginning of the year Additions Additions from acquired companies Disposals / write-offs 1 Reclassiﬁcations Foreign currency translation Balance at the end of the year Accumulated depreciation Balance at the beginning of the year Depreciation Disposals / write-offs 1 Reclassiﬁcations Foreign currency translation Balance at the end of the year Fair value Net book value at the end of the year 2 Own used properties Investment properties Leasehold IT, software and com- improve- ments munication Other machines and equipment Plant and manu- facturing equipment Projects in progress 31.12.04 31.12.03 9,408 232 179 (436 ) (60 ) 6 9,329 4,365 247 (7 ) (42 ) 0 4,563 4,766 2,545 4,241 1,425 235 0 (175 ) 85 (100 ) 2,590 460 0 (619 ) 5 (107 ) 3,980 0 29 1,880 (11 ) 0 38 123 0 (46 ) (63 ) (40 ) 1,399 1,936 1,570 3,334 1,165 201 (53 ) 2 (61 ) 775 (636 ) 0 (98 ) 68 (43 ) 1 (21 ) 1,659 3,375 1,170 0 61 (10 ) 0 2 53 266 149 34 (52 ) (153 ) (2 ) 242 4 0 (4 ) 0 0 17,885 1,228 2,093 17,390 1,352 24 (1,339) (1,030 ) (186) (205) 457 (308 ) 19,476 17,885 10,438 1,352 (749) (43) (178) 9,870 1,353 (936 ) 330 (179 ) 10,820 10,438 41 41 931 605 229 1,883 39 281 80 8,736 236 7,683 1 Includes write-offs of fully depreciated assets. 2 Fire insurance value of property and equipment is CHF 15,873 million (2003: CHF 14,021 million). 120 Note 15 Goodwill and Other Intangible Assets CHF million Historical cost Balance at the beginning of the year Additions and reallocations Disposals and other reductions Write-offs 1 Foreign currency translation 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 Net book value at the end of the year Goodwill Other intangible assets Total Infrastructure Customer relationships, contractual rights and other Total 31.12.04 31.12.03 12,032 960 (62 ) (105 ) (966 ) 11,859 2,684 713 (9 ) (105 ) (271 ) 3,012 8,847 958 0 0 0 (78 ) 880 152 53 0 0 (21 ) 184 696 1,915 1,531 14 (1 ) (154 ) 3,305 540 198 0 (1 ) (38 ) 699 2,873 1,531 14 (1 ) (232 ) 4,185 692 251 0 (1 ) (59 ) 883 2,606 3,302 14,905 2,491 (48) (106) (1,198) 16,044 3,376 964 (9) (106) (330) 3,895 12,149 17,022 340 (371 ) (508 ) (1,578 ) 14,905 3,326 943 (70 ) (508 ) (315 ) 3,376 11,529 1 Represents write-offs of fully amortized goodwill and other intangible assets. The following table presents the disclosure of goodwill and other intangible assets by business unit for the year ended 31 December 2004. CHF million Goodwill Wealth Management Business Banking Switzerland Global Asset Management Investment Bank Wealth Management USA Private Banks & GAM Corporate Functions Industrial Holdings UBS Other intangible assets Wealth Management Business Banking Switzerland Global Asset Management Investment Bank Wealth Management USA Private Banks & GAM Corporate Functions Industrial Holdings UBS Balance at the beginning of the year Additions and reallocations Disposals and other reductions Amortization Foreign currency translation Balance at the end of the year 837 0 1,401 3,372 3,315 421 2 0 9,348 4 0 0 324 1,805 4 44 0 2,181 486 0 2 352 0 0 0 120 960 169 0 0 158 0 0 0 1,204 1,531 (5 ) 0 (1 ) (16 ) (16 ) (15 ) 0 0 (53) 0 0 0 0 0 15 0 (1 ) 14 (67 ) 0 (129 ) (252 ) (197 ) (68 ) 0 0 (713) (8 ) 0 0 (36 ) (107 ) (6 ) (17 ) (77 ) (251) (75 ) 0 (84 ) (257 ) (250 ) (27 ) (2 ) 0 (695) (6 ) 0 0 (28 ) (138 ) 1 (3 ) 1 (173) 1,176 0 1,189 3,199 2,852 311 0 120 8,847 159 0 0 418 1,560 14 24 1,127 3,302 For further information about disclosure by Business Group, including the amortization of goodwill and other intangible as- sets of previous years, please see Note 2a: Segment Reporting by Business Group. 121 Financial Statements Notes to the Financial Statements Note 15 Goodwill and Other Intangible Assets (continued) The estimated, aggregated amortization expenses for other intangible assets are as follows: CHF million Estimated, aggregated amortization expenses for: 2005 2006 2007 2008 2009 2010 and thereafter Total Other intangible assets 284 273 264 252 219 1,000 2,292 Due to the issuance of IFRS 3 Business Combinations, good- will amortization will cease from 1 January 2005. In addition, certain intangible assets will be reclassiﬁed to goodwill at 1 January 2005 and have been excluded for the purpose of calculating estimated (aggregated) amortization expenses for Other intangible assets. See Notes 1aa) and 1ab) for further details. Note 21 31.12.04 31.12.03 2,663 4,747 326 804 534 19,224 6,486 66 34,850 2,276 2,874 338 862 754 13,544 4,811 0 25,459 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 Life insurance assets Other receivables Accounts receivable trade Total other assets 122 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 31.12.04 118,901 101,081 275,002 376,083 494,984 31.12.03 127,012 94,914 251,719 346,633 473,645 Note 18 Financial liabilities designated at fair value and debt issued The Group issues both CHF and non-CHF denominated ﬁxed and ﬂoating rate debt. Floating rate debt generally pays in- terest based on the three-month or six-month London Inter- bank Offered Rate (LIBOR). Subordinated debt securities are unsecured obligations of the Group and are subordinated in right of payment to all pres- ent and future senior indebtedness and certain other obliga- tions of the Group. At 31 December 2004 and 31 December 2003, the Group had CHF 8,605 million and CHF 8,061 mil- lion, respectively, in subordinated debt. Subordinated debt usually pays interest annually and provides for single principal payments upon maturity. At 31 December 2004 and 31 December 2003, the Group had CHF 91,427 million and CHF 57,953 million, respective- ly, in unsubordinated debt (excluding money market paper). The Group issues debt with returns linked to equity, in- terest rates, foreign exchange and credit instruments or in- dices. As described in Note 1m), most of these debt instru- ments have been designated as held at fair value through profit and loss and are presented in a separate line in the bal- ance sheet. For compound debt instruments not designat- ed as held at fair value, derivatives embedded in these in- struments are separated from the host debt contract and re- ported as stand alone derivatives, as described in Note 1o). The amount recorded within Debt Issued represents the host contract after the separation of the embedded deriva- tive. At 31 December 2004 and 31 December 2003, the Group had CHF 148 million and CHF 427 million, respective- ly, in bonds with attached warrants on UBS shares outstand- ing. All warrants related to those bonds issued in prior years have expired. In addition, the Group uses interest rate and foreign ex- change 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 account- ing, at 31 December 2004 and 31 December 2003, the carrying value of debt issued is CHF 349 million higher and CHF 411 million higher, respectively, reﬂecting changes in fair value due to interest rate movements. The contractual redemption amount at maturity of ﬁnan- cial liabilities designated at fair value approximates the car- rying value at 31 December 2004. 123 Financial Statements Notes to the Financial Statements Note 18 Financial Liabilities Designated at Fair Value and Debt Issued (continued) Financial liabilities designated at fair value CHF million Unsecuritized compound debt instruments Bonds and compound debt instruments Total Debt issued (held at amortized cost) CHF million Short-term debt: Money market paper issued Long-term debt: Bonds Senior Subordinated Shares in bond issues of the Swiss Regional or Cantonal Banks’ Central Bond Institutions Medium-term notes Subtotal long-term debt Total 31.12.04 31.12.03 4,110 61,646 65,756 0 35,286 35,286 31.12.04 79,442 31.12.03 58,115 28,035 8,605 60 1,686 38,386 117,828 19,883 8,061 210 2,574 30,728 88,843 The following table shows the split between fixed and float- ing rate debt issues based on the contractual terms. How- ever 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 that of floating rate debt. Contractual maturity dates CHF million, except where indicated 2005 2006 2007 2008 2009 2010–2014 Thereafter UBS AG Parent Bank Senior debt Fixed rate Interest rates (range in %) Floating rate Subordinated debt Fixed rate Interest rates (range in %) Floating rate Subtotal Subsidiaries Senior debt Fixed rate Interest rates (range in %) Floating rate Subordinated debt Fixed rate Interest rates (range in %) Floating rate Subtotal Total 35,193 0–19 6,662 7,220 0–16.5 1,369 1,488 1,573 4–8.75 4.25–7.25 0 0 8,879 0–11 1,047 1,379 5.75–8 0 4,367 0–20 527 5,239 0–13.5 1,622 7,405 0–15 2,435 0 0 524 5.88 0 1,902 3.13–4.5 0 1,110 0–10 8,923 1,381 7–8.75 342 43,343 10,162 11,305 4,894 7,385 11,742 11,756 100,587 Total 31.12.04 Total 31.12.03 69,413 52,174 22,585 12,542 8,247 7,514 342 506 72,736 53,099 0–10 718 0 0 3,632 0–10 265 0 0 1,418 0–10 314 0 0 5,628 0–10 810 4,671 0–18.5 426 0 0 0 0 1,532 0–35 2,121 0 0 1,010 0–35 3,227 16 9 0 70,990 43,579 7,881 7,773 16 0 41 0 53,817 97,160 3,897 14,059 1,732 13,037 6,438 11,332 5,097 12,482 3,653 15,395 4,253 78,887 51,393 16,009 179,474 124,129 The table above indicates ﬁxed interest rate coupons ranging from 0 up to 35 percent on the Group’s bonds. These high or low coupons generally relate to structured debt issues prior to the separation of embedded derivatives. As a result, the stated interest rate on such debt issues generally does not re- ﬂect the effective interest rate the Group is paying to service its debt after the embedded derivative has been separated and, where applicable, the application of hedge accounting. 124 Note 19 Other Liabilities CHF million Provisions Provision for commitments and contingent liabilities Current tax liabilities Deferred tax liabilities VAT and other tax payables Settlement and clearing accounts Obligations under life insurance policies Accounts payable Other payables Total other liabilities Note 20 Provisions CHF million Balance at the beginning of the year Additions from acquired companies New provisions charged to income Capitalized reinstatement costs Recoveries Provisions applied Foreign currency translation Balance at the end of the year Note 31.12.04 31.12.03 20 9b 21 1,947 211 2,298 2,984 520 2,185 22,057 1,241 8,899 42,342 1,361 290 1,754 2,208 544 2,608 13,544 0 9,051 31,360 Operational / Other 1 Litigation 855 698 127 66 14 (270 ) (37 ) 1,453 506 0 414 0 26 (415 ) (37 ) 494 Total 31.12.04 1,361 Total 31.12.03 1,375 698 541 66 40 (685) (74) 1,947 0 330 155 40 (452 ) (87 ) 1,361 1 Comprises provisions for: contract risk related to international electricity trading business; annual cost liabilities related to power purchases from joint venture companies where production costs exceed market prices; reinstatement costs; subleases; and transaction process losses. Note 21 Income Taxes CHF million Domestic Current Deferred Foreign Current Deferred Total income tax expense For the year ended 31.12.04 31.12.03 31.12.02 1,336 37 796 (34) 2,135 810 118 294 371 1,593 938 (34 ) 249 (477 ) 676 The Group made net tax payments, including domestic and foreign taxes, of CHF 1,336 million, CHF 1,104 million and CHF 572 million for the full years of 2004, 2003 and 2002, respectively. 125 Financial Statements Notes to the Financial Statements 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 are as follows: CHF million Operating proﬁt before tax Domestic Foreign Income taxes at Swiss Statutory rate of 24% in 2004, 24% in 2003 and 25% in 2002, respectively 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 31.12.04 10,674 6,219 4,455 2,561 139 103 (249) (660) 262 219 (296) 56 For the year ended 31.12.03 31.12.02 8,177 5,384 2,793 1,962 (233 ) 42 (291 ) (366 ) 386 186 (191 ) 98 4,537 6,542 (2,005 ) 1,134 (341 ) 51 (349 ) (378 ) 291 301 (122 ) 89 676 2,135 1,593 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 31.12.04 31.12.03 1,716 12 2,246 483 874 5,331 (2,668) 2,663 773 343 313 408 1,147 2,984 1,538 4 2,626 306 685 5,159 (2,883 ) 2,276 307 390 401 348 762 2,208 The change in the balance of net deferred tax assets and de- ferred tax liabilities does not equal the deferred tax expense in those years. This is mainly due to the impact of the acqui- sition of Motor-Columbus, as well as the effect of foreign cur- rency rate changes on tax assets and liabilities denominated in currencies other than CHF. 126 Note 21 Income Taxes (continued) Certain foreign branches and subsidiaries of the Group have de- ferred 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 2,668 million (CHF 2,883 million at 31 December 2003). For compa- nies that suffered tax losses in either the current or preceding year an amount of CHF 431 million (CHF 542 million at 31 De- cember 2003) has been recognized as deferred tax assets based on expectations that sufﬁcient taxable income will be generat- ed in future years to utilize the tax loss carry forwards. The Group provides deferred income taxes on undistrib- uted earnings of non-Swiss subsidiaries except to the extent that such earnings are indeﬁnitely invested. In the event these earnings were distributed, additional taxes of approximately CHF 18 million would be due. At 31 December 2004 net operating loss carry forwards to- taling CHF 5,832 million (not recognized as a deferred tax asset) are available to reduce taxable income of certain branch- es 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 1 Includes 1,742 million CHF related to the acquisition of Motor-Columbus. Note 23 Derivative Instruments 31.12.04 46 106 5,680 5,832 31.12.03 3,529 372 573 (357 ) (389 ) 345 4,073 31.12.04 4,073 0 1,922 1 (668) (443) 450 5,334 A derivative is a ﬁnancial instrument, the value of which is de- rived from the value of another (‘underlying’) ﬁnancial instru- ment, an index or some other variable. Typically, the underly- ing is a share, commodity or bond price, an index value or an exchange or interest rate. The majority of derivative contracts are negotiated as to amount (‘notional’), tenor and price between UBS and its counterparties, 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 mar- kets (exchange traded). The ‘notional’ amount of a derivative is generally the quan- tity of the underlying instrument on which the derivative con- tract is based and is the basis upon which changes in the val- ue of the contract are measured. It provides an indication of the underlying volume of business transacted by the Group but does not provide any measure of risk. Derivative instruments are carried at fair value, shown in the balance sheet as separate totals of Positive replacement values (assets) and Negative replacement values (liabilities). Positive replacement values represent the cost to the Group of replacing all transactions with a fair value in the Group’s favor if all the relevant counterparties of the Group were to default at the same time, assuming transactions could be re- placed instantaneously. Negative replacement values represent the cost to the Group’s counterparties of replacing all their transactions with the Group with a fair value in their favor if the Group were to default. Positive and negative replacement values on different transactions are only netted if the trans- actions are with the same counterparty and the cash ﬂows will 127 Financial Statements Notes to the Financial Statements be settled on a net basis. Changes in replacement values of derivative instruments are recognized in trading income un- less they qualify as hedges for accounting purposes, as ex- plained in Note 1 Summary of Signiﬁcant Accounting Policies, section o) Derivative instruments and hedging. Types of derivative instruments The Group uses the following derivative ﬁnancial instruments for both trading and hedging purposes: Forwards and futures are contractual obligations to buy or sell ﬁnancial instruments or commodities on a future date at a speciﬁed price. Forward contracts are tailor-made agree- ments that are transacted between counterparties in the over- the-counter (OTC) market, whereas futures are standardized contracts transacted on regulated exchanges. Swaps are transactions in which two parties exchange cash ﬂows on a speciﬁed notional amount for a predetermined period. Most swaps are traded OTC. The major types of swap transactions undertaken by the Group are as follows: – Interest rate swap contracts generally entail the contrac- tual exchange of ﬁxed and ﬂoating rate interest payments in a single currency, based on a notional amount and a reference interest rate, e. g. LIBOR. – Cross currency swaps involve the exchange of interest pay- ments based on two different currency principal balances and reference interest rates and generally also entail exchange of principal amounts at the start and / or end of the contract. – Credit default swaps (CDSs) are the most common form of credit derivative, under which the party buying protection makes one or more payments to the party selling protection in exchange for an undertaking by the seller to make a pay- ment to the buyer following a credit event (as deﬁned in the contract) with respect to a third party. Settlement following a credit event may be a net cash amount, or cash in return for physical delivery of one or more obligations of the credit entity (as deﬁned in the contract) and is made regardless of whether the protection buyer has actually suffered a loss. Af- ter a credit event and settlement, the contract is terminated. – Total rate of return swaps give the total return receiver ex- posure to all of the cash ﬂows and economic beneﬁts and risks of an underlying asset, without having to own the as- set, in exchange for a series of payments, often based on a reference interest rate, e. g. LIBOR. The total return pay- er has an equal and opposite position. Options are contractual agreements under which, typical- ly, 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 speciﬁed quantity of a ﬁnancial instru- ment or commodity at a predetermined price. The purchaser pays a premium to the seller for this right. Options involving more complex payment structures are also transacted. Options may be traded OTC or on a regulated exchange, and may be traded in the form of a security (warrant). Derivatives transacted for trading purposes Most of the Group’s derivative transactions relate to sales and trading activities. Sales activities include the structuring and marketing of derivative products to customers to enable them to take, transfer, modify or reduce current or expected risks. Trading includes market-making, positioning and arbitrage ac- tivities. Market making involves quoting bid and offer prices to other market participants with the intention of generating revenues based on spread and volume. Positioning means managing market risk positions with the expectation of prof- iting from favorable movements in prices, rates or indices. Ar- bitrage activities involve identifying and proﬁting from price differentials between the same product in different markets or the same economic factor in different products. Derivatives transacted for hedging purposes The Group enters into derivative transactions for the purpos- es of hedging assets, liabilities, forecast transactions, cash flows and credit exposures. The accounting treatment of hedge transactions varies according to the nature of the instrument hedged and whether the hedge qualiﬁes as such for accounting purposes. Derivative transactions may qualify as hedges for account- ing purposes if they are fair value hedges or cash ﬂow hedges. These are described under the corresponding headings below. The Group’s accounting policies for derivatives designated and accounted for as hedging instruments are explained in Note 1 o), Derivative instruments and hedging, where terms used in the following sections are explained. The Group also enters into derivative transactions which provide economic hedges for credit risk exposures but do not meet the requirements for hedge accounting treatment: the Group uses CDSs as economic hedges for credit risk exposures in the loan and traded product portfolios but cannot apply hedge accounting to such positions. 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 val- ue of ﬁxed rate long-term debt due to movements in market interest rates. For the year ended 31 December 2004, the Group recognized a net gain of CHF 22 million and in 2003 a net gain of CHF 21 million, representing the ineffective por- tions, as deﬁned in Note 1 o), of fair value hedges. The fair values of outstanding derivatives designated as fair value hedges were a CHF 438 million net positive replacement val- ue at 31 December 2004 and a CHF 797 million net positive replacement value at 31 December 2003. Cash ﬂow hedges of forecast transactions The Group is exposed to variability in future interest cash ﬂows on non-trading assets and liabilities which bear inter- est at variable rates or which are expected to be re-funded or reinvested in the future. The amounts and timing of fu- 128 ture cash flows, representing both principal and interest ﬂows, are projected for each portfolio of ﬁnancial assets and liabilities, based on their contractual terms and other relevant factors including estimates of prepayments and defaults. The aggregate principal balances and interest cash flows across all portfolios over time form the basis for identifying the non-trading interest rate risk of the Group, which is hedged with interest rate swaps, the maximum maturity of which is twenty-two years. The schedule of forecast principal balances on which the expected interest cash ﬂows arise as at 31 December 2004 is as follows. CHF billion Cash inﬂows (Assets) Cash outﬂows (Liabilities) Net cash ﬂows < 1 year 1–3 years 3–5 years 5–10 years over 10 years 135 88 47 255 142 113 180 87 93 153 91 62 8 72 (64) Gains and losses on the effective portions of derivatives des- ignated as cash ﬂow hedges of forecast transactions are ini- tially recorded in Shareholders’ equity as Gains / losses not rec- ognized in the income statement and are transferred to current period earnings when the forecast cash ﬂows affect net proﬁt or loss. The gains and losses on ineffective portions of such derivatives are recognized immediately in the income statement. In 2004, a gain of CHF 13 million was recognized due to hedge ineffectiveness, whereas in 2003 and 2002 no gains or losses from hedge ineffectiveness arose. As at 31 December 2004 and 2003, the fair values of out- standing derivatives designated as cash ﬂow hedges of fore- cast transactions were a CHF 818 million net negative replace- ment value and a CHF 871 million net negative replacement value, respectively. Swiss franc hedging interest rate swaps ter- minated during 2003 had a positive replacement value of CHF 867 million. No interest rate swaps designated as cash ﬂow hedges were terminated during 2004. At year-end 2004, un- recognized income of CHF 501 million associated with these swaps has remained deferred in Shareholders’ equity. It will be removed from equity when the hedged cash ﬂows impact net proﬁt or loss. Amounts reclassiﬁed from Realized gains / losses not recognized in the income statement to current period earnings due to discontinuation of hedge accounting were a CHF 304 million net gain in 2004 and a CHF 7 million net gain in 2003. These amounts were recorded in net inter- est income. Risks of derivative instruments Derivative instruments are transacted in many trading portfo- lios, which generally include several types of instruments, not just derivatives. The market risk of derivatives is managed and controlled as an integral part of the market risk of these port- folios. The Group’s approach to market risk is described in Note 29, Financial Instruments Risk Position, part a) Market risk. Derivative instruments are transacted with many different counterparties, most of whom are also counterparties for oth- er types of business. The credit risk of derivatives is managed and controlled in the context of the Group’s overall credit ex- posure to each counterparty. The Group’s approach to cred- it risk is described in Note 29, Financial Instruments Risk Po- sition, part b) Credit Risk. It should be noted that although the positive replacement values shown on the balance sheet can be an important component of the Group’s credit expo- sure, the positive replacement values for any one counterpar- ty are rarely an adequate reﬂection of the Group’s credit ex- posure on its derivatives business with that counterparty. This is because, on the one hand, replacement values can increase over time (‘potential future exposure’), while on the other hand, exposure may be mitigated by entering into master net- ting agreements and bilateral collateral arrangements with counterparties. Both the exposure measures used by the Group internally to control credit risk and the capital require- ments imposed by regulators reﬂect these additional factors. In Note 29, part b) Credit Risk, the Derivatives positive re- placement values shown under Traded products, and in Note 29 part d) Capital Adequacy, the Positive replacement values shown under Balance sheet assets are lower than those shown in the balance sheet and in the tables on the next two pages because they reﬂect legally enforceable close-out net- ting arrangements. Conversely, there are additional capital requirements shown in Note 29 part d) Capital Adequacy under off-balance sheet and other positions as Forward and swap contracts and Purchased options, which reflect the additional potential future exposure. 129 Financial Statements Notes to the Financial Statements Note 23 Derivative Instruments (continued) As at 31 December 2004 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 Within 3 months 3–12 months 1–5 years Over 5 years PRV 1 NRV 2 PRV NRV PRV NRV PRV NRV Total PRV Total NRV Total notional amount CHF bn 440 4,305 806 495 112 144 58 34 90 166 700 839 843.6 4,002 11,015 11,921 65,419 64,487 76,470 75,287 157,209 155,697 9,871.0 722 1,845 2,239 6,553 8,292 5,942 6,479 15,146 17,732 1,181.4 86 87 133 103 5 5 224 195 817.9 5,637 5,306 13,105 14,407 72,035 72,818 82,502 81,932 173,279 174,463 14,786.9 2,073.0 7 31 38 10 15 25 51 57 108 99 69 3,819 433 168 4,252 5,409 1,076 6,485 2,401 376 1,501 6,278 272 897 2,777 1,773 7,175 7,019 1,432 8,451 639.2 27.1 666.3 Forward contracts 3,496 4,585 807 1,316 186 449 68 240 4,557 6,590 355.6 Interest and currency swaps 27,587 28,094 15,101 14,907 20,897 15,484 7,189 7,240 70,774 65,725 2,811.4 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 2,224 2,202 2,809 2,553 508 503 4 4 5,545 5,262 559.2 9 9 81 79 11 10 101 98 2.9 5.9 33,316 34,890 18,798 18,855 21,602 16,446 7,261 7,484 80,977 77,675 3,735.0 130 156 215 501 113 115 237 465 150 281 195 626 201 251 447 683 259 711 18 1,148 192 615 33 840 9 34 24 28 736 530 1,154 1,009 428 529 13.5 43.4 0.8 2.5 43 52 2,318 2,068 60.2 795 2,017 506 7,807 572 2,057 419 7,245 1,912 7,367 928 16,290 1,212 4,024 1,040 9,353 947 1,142 1,711 1,979 3,576 8,806 10,990 19,197 129 455 98 682 24 3,408 1,877 2,144 11,896 33,486 109 3,968 4,270 2,277 19,272 39,633 338 76 414 343 73 416 519 85 604 491 79 570 420 118 538 379 57 436 1,277 1,213 279 209 0 0 1,556 1,422 103.6 223.6 8.1 401.6 736.9 35.4 4.7 40.1 Total derivative instruments 43,930 50,455 36,817 43,517 110,565 116,222 93,265 93,518 284,577 303,712 1 PRV: Positive replacement value. 2 NRV: Negative replacement value. 3 Exchange-traded products include proprietary trades only. 130 Note 23 Derivative Instruments (continued) As at 31 December 2003 Term to maturity Within 3 months 3–12 months 1–5 years Over 5 years PRV 1 NRV 2 PRV NRV PRV NRV PRV NRV Total PRV Total NRV Total notional amount CHF bn 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 424 3,831 464 586 4,388 978 258 8,698 868 312 71 130 5 4 758 1,032 1,128.4 5,991 64,216 65,075 52,019 50,517 128,764 125,971 8,065.4 992 4,686 5,967 4,223 5,334 10,241 13,271 815.4 7 9 2 8 9 17 243.7 63.4 4,726 5,961 9,826 7,303 68,973 71,172 56,247 55,855 139,772 140,291 10,316.3 109 27 136 102 2 104 39 29 68 61 576 637 3,443 197 3,536 470 1,928 112 1,880 5,519 305 365 3,640 4,006 2,040 2,185 5,884 5,579 1,353 6,932 289.3 12.0 301.3 Forward contracts 3,045 3,879 1,978 2,573 161 317 15 12 5,199 6,781 298.4 Interest and currency swaps 24,929 25,242 14,258 12,428 17,780 14,394 6,002 5,250 62,969 57,314 2,254.4 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 3,232 3,348 3,211 2,550 513 356 9 1 6,965 6,255 576.8 3 3 119 116 122 119 5.0 13.2 31,209 32,472 19,566 17,667 18,454 15,067 6,026 5,263 75,255 70,469 3,147.8 246 304 9 559 247 193 40 480 377 308 21 706 305 386 333 668 63 754 3 1,004 270 629 4 903 18 116 23 54 974 845 1,396 1,262 33 107 15.9 35.1 1.1 2.3 134 77 2,403 2,214 54.4 509 1,841 529 2,788 763 3,482 583 917 449 7,847 11,111 13,646 1,408 1,328 501 3,597 2,062 4,560 17,762 28,841 708 858 892 1,363 883 768 54 117 2,537 3,106 57.9 213.8 8.6 62.6 3,058 4,175 5,137 9,793 12,911 14,863 2,790 5,178 23,896 34,009 342.9 206 168 374 181 153 334 456 73 529 424 53 477 93 93 42 42 755 241 996 647 206 853 10.6 1.6 12.2 0 0 Total derivative instruments 40,062 43,526 35,832 36,631 105,075 106,053 67,237 68,558 248,206 254,768 1 PRV: Positive replacement value. 2 NRV: Negative replacement value. 3 Exchange-traded products include proprietary trades only. 131 Financial Statements Notes to the Financial Statements 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 31.12.04 39,588 57 39,645 31.12.03 37,851 74 37,925 The Group also acts in its own name as trustee or in ﬁduciary capacities for the account of third parties. 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-compliance with 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 ﬁnancial instru- ments in order to meet the financial needs of its cus- tomers. The Group issues commitments to extend credit, standby and other letters of credit, guarantees, commitments to enter into repurchase agreements, note issuance facilities 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 commitments to extend credit in the form of credit lines which are available to secure the liq- uidity 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 maxi- mum 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 2004, 2003 and 2002 the Group recog- nized a CHF 31 million credit loss expense, CHF 23 million credit loss recovery and CHF 13 million credit loss expense, re- spectively, related to obligations incurred for contingencies and commitments. The Group generally enters into sub-participations to mit- igate the risks from commitments and contingencies. A sub- participation is an agreement with another party to fund a por- tion 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. 132 Note 25 Commitments and Contingent Liabilities (continued) CHF million Contingent liabilities Credit guarantees and similar instruments 1 Sub-participations Total Performance guarantees and similar instruments 2 Sub-participations Total Irrevocable commitments and 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 Market value guarantees in form of written put options 31.12.04 31.12.03 10,252 (621) 9,631 2,536 (415) 2,121 2,106 (272) 1,834 14,894 (1,308) 13,586 53,168 (7) 53,161 19 53,187 (7) 53,180 68,081 (1,315) 66,766 352,509 10,832 (765 ) 10,067 2,760 (276 ) 2,484 1,971 (373 ) 1,598 15,563 (1,414 ) 14,149 46,623 (235 ) 46,388 337 46,960 (235 ) 46,725 62,523 (1,649 ) 60,874 218,638 1 Credit guarantees in the form of bills of exchange and other guarantees, including guarantees in the form of irrevocable letters of credit, endorsement liabilities from bills rediscounted, advance payment guarantees and similar facilities. 2 Bid bonds, performance bonds, builders’ guarantees, letters of indemnity, other performance guarantees in the form of irrevocable letters of credit and similar facilities. As part of its trading and market-making activities, UBS writes put options on a broad range of underlyings. For writing put options, UBS receives a premium, which is recognized as neg- ative replacement value on the balance sheet. The contract volume of a written put option, which is the number of units of the underlying multiplied by the exercise price per unit, is considered a market price guarantee issued, because the op- tion holder is entitled to make UBS purchase the underlying at the stated exercise price. The fair value of all written put options is recognized on the balance sheet as negative replace- ment value, which is signiﬁcantly lower than the underlying total contract volume that represents the maximum potential payment UBS could be required to make upon exercise of the puts. The exposure from writing put options is managed through UBS’s standard risk management process at a level that is within the set risk limits. Accordingly, neither the un- derlying total contract volume nor the negative replacement value are indicative of the actual risk exposure arising from written put options. 133 Financial Statements Notes to the Financial Statements Note 25 Commitments and Contingent Liabilities (continued) CHF million Overview of collateral Gross contingent liabilities Gross irrevocable commitments Liabilities for calls on shares and other equities Total 31.12.04 Total 31.12.03 Mortgage collateral Other collateral Unsecured Total 347 3,252 0 3,599 2,637 7,661 22,384 0 30,045 30,870 6,886 27,532 19 34,437 29,016 14,894 53,168 19 68,081 62,523 Other commitments The Group enters into commitments to fund external private equity funds and investments, which typically expire within ﬁve years. The commitments themselves do not involve credit or market risk as the funds purchase investments at market value at the time the commitments are drawn. The maximum amount available to fund these investments at 31 December 2004 and 31 December 2003 was CHF 1,019 million and CHF 1,537 million, respectively. Note 26 Operating Lease Commitments At 31 December 2004, 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 2005 2006 2007 2008 2009 2010 and thereafter Subtotal commitments for minimum payments under operating leases Less: Sublease rentals under non-cancellable leases Net commitments for minimum payments under operating leases 31.12.04 886 805 719 647 584 4,060 7,701 547 7,154 Operating expenses include CHF 1,214 million and CHF 1,233 million of gross operating lease rentals which were reduced by CHF 43 million and CHF 43 million of sublease income for the years ended 31 December 2004 and 31 December 2003, respectively. Operating expenses for the year ended 31 December 2002 include CHF 1,193 million in respect of operating lease rentals. 134 Additional Information Note 27 Pledged Assets Assets are pledged as collateral for collateralized credit lines with central banks, loans from central mortgage institutions, de- posit guarantees for savings banks, security deposits relating to stock exchange membership and mortgages on the Group’s property. No ﬁnancial assets are pledged for contingent liabilities. The following table shows additional information about assets pledged or assigned as security for liabilities and assets subject to reservation of title for the years ended 31 December 2004 and 31 December 2003. CHF million Mortgage loans Securities Property and equipment Total pledged assets Note 28 Litigation Carrying amount Related liability 31.12.04 31.12.04 Carrying amount 31.12.03 Related liability 31.12.03 175 193,028 320 193,523 60 131,462 0 131,522 428 157,639 0 158,067 209 121,984 0 122,193 Due to the nature of their business, the bank and other com- panies 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 ad- visors, it is probable that a payment 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 UBS’s exposure to and its management and control of risks, in particular the primary risks associated with its use of ﬁnancial instruments: – market risk (part a) is exposure to market variables such as interest rates, exchange rates and equity markets – credit risk (part b) is the risk of loss resulting from client or counterparty default and arises on credit exposure in all forms, including settlement risk – liquidity and funding risk (part c) is the risk that UBS is un- able to meet its payment obligations when due, or that it is unable, on an ongoing basis, to borrow funds in the mar- ket on an unsecured, or even secured basis at an accept- able price to fund actual or proposed commitments. Part d) presents and explains the Group’s regulatory capi- tal position. Sections a) to d) generally refer only to UBS’s ﬁnancial busi- nesses, while section e) covers the ﬁnancial instruments risk positions of the industrial holding Motor-Columbus through its operating subsidiary Atel. The tables in this note which are based on risk information include only the ﬁnancial business- es of the Group. Those which present an analysis of the whole balance sheet include the positions of Motor-Columbus. It should be noted that, in management’s view, any repre- sentation of risk at a speciﬁc date offers only a snapshot of the risks taken, since both trading and non-trading positions can vary signiﬁcantly on a daily basis, because they are active- ly managed. As such, it may not be representative of the lev- el of risk at other times. 135 Financial Statements Notes to the Financial Statements Note 29 Financial Instruments Risk Position (continued) a) Market Risk (i) Overview Market risk is the risk of loss arising from movements in mar- ket variables including observable variables such as interest rates, exchange rates and equity markets, and others which may be only indirectly observable such as volatilities and cor- relations. The risk of price movements on securities and oth- er obligations in tradable form resulting from general credit and country risk factors and events speciﬁc to individual issuers is also considered market risk. Market risk is incurred in UBS primarily through trading ac- tivities, which are centered in the Investment Bank but also arise, to a much lesser extent, in the Wealth Management businesses. It arises from market making, client facilitation and proprietary positions in equities, ﬁxed income and interest rate products, foreign exchange and, to a lesser extent, precious metals and energy. Additionally, Group Treasury assumes material non-trading market risk positions that arise from its balance sheet and cap- ital management activities. There are also smaller non-trad- ing market risk positions, predominantly interest rate risks, in the other Business Groups. Each Business Group has a Chief Risk Ofﬁcer (CRO), report- ing functionally to the Group CRO, responsible for independ- ent risk control of market risk. Market risk authority, including both approval of market risk limits and approval of market risks in large or complex transactions and securities underwritings, is exercised by the Chairman’s Ofﬁce and the GEB and is further delegated on an ad personam basis to the Group CRO and Market Risk Of- ﬁcers within the Business Groups. Market risk measures and controls are applied to all trad- ing activities, to foreign exchange, precious metal and ener- gy exposures wherever they arise, and to interest rate risk in the banking books of all Business Groups including Group Treasury and the independent private banks. The principal portfolio risk measures and limits on market risk are Value at Risk (VaR) and stress loss. VaR is an estimate of the potential loss on the current portfolio from adverse mar- ket movements, based on historical market movements, as- suming a speciﬁed time horizon before positions can be ad- justed (holding period), and expressed as the maximum potential loss that, with a speciﬁed level of conﬁdence (prob- ability), will not be exceeded. Stress loss is assessed against a set of forward-looking scenarios using stress moves in mar- ket variables, which are regularly reviewed. Complementary controls are also applied, where appropriate, to prevent un- due concentrations, taking into account variations in price volatility and market depth and liquidity. They include controls on exposure to individual market risk variables, such as indi- vidual interest or exchange rates, and on positions in the se- curities of individual issuers (’issuer risk’). (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 struc- ture described in (a) (i) above. Exposure to interest rate move- ments can be expressed for all interest rate sensitive positions, whether marked to market or subject to amortized cost ac- counting, 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. The table sets out the extent to which UBS was exposed to interest rate risk at 31 December 2004 and 2003. It shows the net impact of a one basis point (0.01%) increase in mar- ket interest rates across all time bands on the fair values of in- terest rate sensitive positions, both on- and off-balance sheet. The impact of such an increase in interest rates depends on UBS’s net asset or net liability position in each category, cur- rency and time band in the table. A negative amount in the table reﬂects a potential reduction in fair value, while a posi- tive amount reﬂects a potential increase in fair value. 136 Note 29 Financial Instruments Risk Position (continued) a) Market Risk (continued) Interest rate sensitivity position 1 Interest rate sensitivity by time bands at 31.12.04 CHF thousand gain / (loss) per basis point increase Within 1 month 1 to 3 months CHF USD EUR GBP JPY Other Trading Non-trading Trading Non-trading Trading Non-trading Trading Non-trading Trading Non-trading Trading Non-trading 65 (203 ) 49 30 192 (8 ) (19 ) (1 ) (17 ) (1 ) 75 (1 ) 69 (13 ) (236 ) (158 ) (276 ) 1 52 (7 ) 630 1 (121 ) 1 3 to 12 months (83 ) (313 ) (1,184 ) (121 ) 342 (22 ) 60 (34 ) 1 to 5 years 24 (3,575 ) 886 (2,010 ) (366 ) (180 ) (380 ) (290 ) (562 ) (1,804 ) (1 ) (8 ) 1 (4 ) 5 (1 ) Over 5 years 120 (2,641 ) 127 (2,472 ) (814 ) (200 ) (32 ) 270 781 (1 ) 145 (2 ) Interest rate sensitivity by time bands at 31.12.03 CHF thousand gain / (loss) per basis point increase Within 1 month 1 to 3 months 3 to 12 months CHF USD EUR GBP JPY Other Trading Non-trading Trading Non-trading Trading Non-trading Trading Non-trading Trading Non-trading Trading Non-trading 1 Positions in Industrial Holdings are excluded. 19 (38 ) (17 ) 50 (84 ) 4 24 0 59 (4 ) (43 ) (1 ) (185 ) (99 ) (690 ) (55 ) (206 ) 6 31 (10 ) (326 ) 3 22 0 (6 ) (359 ) (638 ) (92 ) 398 (21 ) 131 (55 ) (34 ) (1 ) 80 (6 ) 1 to 5 years 311 (4,288 ) (941 ) (2,213 ) (1,018 ) (131 ) (736 ) (40 ) 410 (5 ) (464 ) (1 ) Over 5 years (91 ) (3,587 ) 1,190 (1,702 ) 649 (196 ) 536 481 (273 ) (2 ) 335 (3 ) Total 195 (6,745) (358) (4,731) (922) (409) (319) (62) (972) (6) 96 (2) Total 48 (8,371) (1,096) (4,012) (261) (338) (14) 376 (164) (9) (70) (11) 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 ac- counting purposes (as explained in Note 23) and off balance sheet commitments on which an interest rate has been fixed. This distinction differs somewhat from the account- ing classification of trading and non-trading assets and lia- bilities. Details of money market paper and debt instruments de- ﬁned as trading portfolio for accounting purposes are includ- ed in Note 11 and of debt instruments deﬁned as ﬁnancial investments for accounting purposes in Note 12. Details of de- rivatives are shown in Note 23, but it should be noted that in- terest rate risk arises not only on interest rate contracts but also on other forwards, swaps and options, in particular on forward foreign exchange contracts. Off-balance sheet com- mitments on which an interest rate has been ﬁxed are prima- rily forward starting ﬁxed term loans. Trading The major part of this risk arises in the Investment Bank’s Fixed Income Rates and Currencies business. Non-trading Interest rate risk is inherent in many of UBS’s businesses and arises from factors such as differences in timing between contractual maturity or re-pricing of assets, liabilities and de- rivative instruments. Most non-trading interest rate risk is captured at the point of business origination and transferred to a risk management unit – primarily the Cash and Collateral Trading unit of the In- vestment Bank or Group Treasury – where it is managed with- 137 Financial Statements Notes to the Financial Statements Note 29 Financial Instruments Risk Position (continued) a) Market Risk (continued) in the market risk limits described in (a)(i). The margin risks em- bedded in retail products remain with, and are subject to ad- ditional analysis and control by, 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 – portfo- lios of revolving transactions between the originating business unit and Group Treasury at market rates designed to approx- imate their average cash ﬂow and re-pricing behavior. The structure and parameters of the replication portfolios are set in accordance with long-term observations of market and client behavior, and are reviewed periodically. Interest rate risk also arises from balance sheet items such as the ﬁnancing of bank property and investments in equity of associated companies, and from the investment of the Group’s equity. The risk on these items is also transferred to Group Treasury, through replicating portfolios designed to ap- proximate the desired funding or investment proﬁle. The Group’s equity is invested at longer-term ﬁxed interest rates in CHF, USD, EUR and GBP with an average duration of between three and four years, in line with strategic investment targets set by the Group Executive Board (GEB). These invest- ments account for CHF 12.6 million of the non-trading inter- est rate sensitivity, with CHF 6.6 million arising in CHF, CHF 5.0 million in USD and the remainder in EUR and GBP. The in- terest rate sensitivity of these investments is directly related 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 sensitivi- ty, it would lead to higher volatility in interest earnings. (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 cur- rency risk from these trading activities, conducted primarily in the Investment Bank. These trading exposures are subject to VaR, stress and concentration limits as described in (a)(i). De- tails of foreign exchange contracts, most of which arise from trading activities and contribute to currency risk, are shown in Note 23. Non-Trading UBS’s reporting currency is the Swiss franc but its assets, lia- bilities, income and expense are denominated in many cur- rencies, 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 subse- 138 quent changes in exchange rates. Group Treasury also, from time to time, proactively hedges signiﬁcant expected foreign currency earnings / costs (mainly USD, EUR and GBP) within a time horizon up to one year, in accordance with the instruc- tions of the GEB and subject to its VaR limit. Economic hedg- ing strategies employed include a cost-efﬁcient option strat- egy, providing a safety net against unfavorable currency ﬂuctuations while preserving upside potential. The Group’s equity is invested in a diversiﬁed portfolio broadly reﬂecting the currency distribution of its risk-weight- ed assets in CHF, USD, EUR and GBP. This creates structural foreign currency exposures, the gains or losses on which are recorded through equity, leading to ﬂuctuations in UBS’s cap- ital base in line with the ﬂuctuations in risk-weighted assets, thereby protecting the BIS Tier 1 capital ratio. At 31 December 2004, the largest combined trading and non-trading currency exposures against the Swiss franc were in USD (short USD 224 million), EUR (short EUR 664 million) and GBP (long GBP 221 million). At 31 December 2003 the largest exposures were in USD (short USD 723 million), EUR (long EUR 71 million) and GBP (short GBP 40 million). (iv) Equity Risk Equity risk is the risk of loss resulting from changes in the lev- els of equity indices and values of individual stocks. The Investment Bank is a signiﬁcant player in major equi- ty 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 equities deﬁned as trading portfolio for account- ing purposes are given in Note 11. Details of equity deriva- tives contracts (on indices and individual equities), which arise primarily from the Investment Bank’s trading activities, are shown in Note 23. (v) Issuer Risk The values of tradable assets – equities, bonds and other debt instruments (including money market paper and trad- able loans) held for trading – are affected by factors specif- ic to individual issuers as well as general market moves. This can include short-term factors influencing price but also more fundamental causes including severe financial deteri- oration. As an active trader and market maker in equities, bonds and other securities, the Investment Bank holds positions in tradable assets, which are not only included in VaR but also subject to concentration limits on exposure to individual is- suers. This includes both exposures arising from physical holdings, and exposures from derivatives based on such assets. Note 29 Financial Instruments Risk Position (continued) 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 traditional banking products – loans, commitments to lend and other contingent liabilities, such as letters of cred- it – and in traded products – derivative contracts such as for- wards, swaps and options, and repo and securities borrowing and lending transactions. Some of these products are account- ed for on an amortized cost basis while others are recorded in the ﬁnancial statements at fair value. Banking products are generally carried at amortized cost, but loans which have been originated by the Group for subsequent syndication or distri- bution through the cash markets, are carried at fair value. With- in traded products, OTC derivatives are carried at fair value, while repos and securities borrowing and lending transactions are accounted for on an amortized cost basis. Regardless of the accounting treatment, all banking and traded products are controlled under the same credit risk framework. All Business Groups taking material credit risk have inde- pendent credit risk control functions headed by Chief Credit Ofﬁcers (CCOs) reporting functionally to the Group CCO. They are responsible for the independent control of credit risk in- cluding counterparty ratings and credit risk assessment. Cred- it risk authority, including authority to establish allowances and provisions and credit valuation adjustments for impaired claims, is exercised by the Chairman’s Ofﬁce and the GEB and is further delegated on an ad personam basis to the Group CCO and to Credit Ofﬁcers within the Business Groups. For credit control purposes, credit exposure is measured for banking products as the face value amount. For traded prod- ucts, credit exposure is measured as the current replacement value of contracts plus potential future changes in replace- ment value, taking account of master netting agreements with individual counterparties where they are considered enforce- able in insolvency. UBS is an active user of credit derivatives to hedge credit risk on individual names and on a portfolio basis in banking and traded products. In line with general mar- ket trends, UBS has also entered into bilateral collateral agree- ments with market participants to mitigate credit risk on OTC derivatives. Individual hedges and collateral arrangements are reﬂected in our internal credit exposure measurement, and credit limits are applied on this basis. In the table, the amounts shown as credit exposure differ somewhat from the internal credit view. For banking products, they are based on the accounting view, which, for example, does not reﬂect risk reduction resulting from credit hedges and collateral received, but does include cash collateral posted by UBS against negative replacement values on derivatives. For traded products, positive and negative replacement values are shown net only where permitted for regulatory capital purpos- es (consistent with the table in part d) Capital Adequacy), and potential future exposure is not included. This in turn differs from the accounting treatment of traded products in several respects. OTC derivatives are represented on the balance sheet by positive and negative replacement values, which are netted only if the cash ﬂows will actually be settled net, which is not generally the case – for details see Note 23. Securities borrow- ing and lending transactions are represented on the balance sheet by the gross values of cash collateral placed with or re- ceived from counterparties while repos / reverse repos are rep- resented by the gross amounts of the forward commitments – for details see Note 10 – the credit exposure generally being only a small percentage of these balance sheet amounts. Breakdown of credit exposure 1 Amounts for each product type are shown gross before allowances and provisions. CHF million Banking products Loans to customers and due from banks 2 Contingent liabilities (gross – before participations) 3 Undrawn irrevocable credit facilities (gross – before participations) 3 Traded products 4 Derivatives positive replacement values (before collateral but after netting) 5 Securities borrowing and lending, repos and reverse repos 6, 7 Allowances and provisions 8 Total credit exposure net of allowances and provisions 31.12.04 31.12.03 269,518 14,894 53,168 78,317 24,768 (2,883) 437,782 247,995 15,563 46,623 84,334 30,833 (3,954 ) 421,394 1 Positions in Industrial Holdings are excluded. 3 See Note 25 – Commitments and Contingent Liabilities for further information. 4 Does not include potential future credit exposure arising from changes in value of products with variable value. Potential future credit exposure is, however, included in internal measures of credit exposure for risk management and control purposes. 5 Replacement values are shown net where netting is permitted for regulatory capital purposes. See also Note 23 – Derivative Instruments for further information. 6 This ﬁgure represents the difference in value between the cash or securities lent or given as collateral to counterparties, and the value of cash or securities borrowed or taken as collateral from the same counterparties under stock borrow / lend and repo / reverse repo transactions. 7 See Note 10 – Securities Borrowing, Securities Lending, Repurchase and Reverse Repurchase Agreements for further information about these types of transactions. 8 See Note 9b – Allowances and Provisions for Credit Losses for further information. 2 See Note 9a – Due from Banks and Loans for further information. 139 Financial Statements Notes to the Financial Statements Note 29 Financial Instruments Risk Position (continued) b) Credit Risk (continued) UBS manages and controls concentrations of credit risk wher- ever they are identiﬁed, in particular to individual counterpar- ties and groups, and to industries and countries. UBS sets lim- its on its credit exposure to both individual counterparties and counterparty groups. Concentrations of credit risk exist if clients are engaged in similar activities, or are located in the same geographic region or have comparable economic char- acteristics such that their ability to meet contractual obliga- tions would be similarly affected by changes in economic, po- litical or other conditions. Stress measures are applied to assess the impact of variations in default rates and asset val- ues, taking into account risk concentrations in each portfo- lio. Stress loss limits are applied where considered necessary, including limits on credit exposure to all but the best-rated countries. With the exceptions of private households (CHF 135,397 million), banks and ﬁnancial institutions (CHF 75,311 million) and real estate and rentals in Switzerland (CHF 11,466 million), there are no material concentrations of loans at 31 December 2004, and the vast majority of those to private households and to real estate and rentals are secured. Deriv- atives exposure is predominantly to investment grade banks and ﬁnancial institutions. Impaired claims UBS classiﬁes a claim as impaired if it considers that it will suf- fer a loss on that claim as a result of the obligor’s inability to meet its commitments (including interest payments, principal repayments or other payments due, for example on a deriva- tive product or under a guarantee) according to the contrac- tual terms, and after realization of any available collateral. Loans are further classiﬁed as non-performing where payment of interest, principal or fees is overdue by more than 90 days and there is no ﬁrm evidence that they will be made good by later payments or the liquidation of collateral, or where insol- vency proceedings have commenced or obligations have been restructured on concessionary terms. The recognition of impairment in the ﬁnancial statements depends on the accounting treatment of the claim. For prod- ucts accounted for on an amortized cost basis, impairment is recognized through the creation of a provision or allowance, which is charged to the income statement as credit loss ex- pense. Allowances or provisions are determined such that the carrying values of impaired claims are consistent with the prin- ciples of IAS 39. For products recorded at fair value, impair- ment is recognized through a credit valuation adjustment, which is charged to the income statement through the net trading income line. UBS also assesses portfolios of claims with similar credit risk characteristics for collective impairment in accordance with IAS 39 (amortized cost products only). A portfolio is consid- ered impaired on a collective basis if there is objective evidence to suggest that it contains impaired obligations but the indi- vidual impaired items cannot yet be identiﬁed. For further information about accounting policy for al- lowances and provisions for credit losses see Note 1q). 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). It should be noted that allowances and provi- sions for collective impairment are included in the total of al- lowances and provisions in the table on the previous page, and in notes 9a and 9b, but that portfolios against which collec- tive loan loss provisions have been established are not includ- ed in the totals of impaired loans in Note 9c. The occurrence of credit losses is erratic in both timing and amount and those that arise usually relate to transactions en- tered into in previous accounting periods. In order to reﬂect the fact that future credit losses are implicit in the current port- folio, and to encourage risk-adjusted pricing for products car- ried at amortized cost, UBS uses the concept of ’expected loss’ for management purposes. Expected loss is a forward look- ing, statistically based concept which is used to estimate the annual costs that will arise, on average over time, from posi- tions in the current portfolio that become impaired. It is de- rived from the probability of default (given by the counterpar- ty rating), current and likely future exposure to the counterparty and the likely severity of the loss should default occur. Note 2a includes two tables: the ﬁrst shows Credit loss expense, as recorded in the Financial Statements, for each Business Group; the second reﬂects an ’Adjusted expected credit loss’ for each Business Group, which is the expected credit loss on its portfolio, plus the difference between Cred- it loss expense and expected credit loss, amortized over a three-year period. The difference between the total of these Adjusted expected credit loss ﬁgures and the Credit loss ex- pense recorded at Group level for ﬁnancial reporting is report- ed in Corporate Functions. 140 Note 29 Financial Instruments Risk Position (continued) c) Liquidity Risk UBS’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 quickly to strategic market opportunities. A central- ized approach is adopted, based on an integrated frame- work incorporating the assessment of expected cash flows and the availability of high-grade collateral which could be used to secure additional funding if required. The liquidity position is assessed and managed under a variety of scenar- ios, giving due consideration to stress factors. Scenarios en- compass not only normal market conditions but also 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 unutilized credit lines. The breakdown by contractual maturity of assets and lia- bilities, which is the basis of the “normal market conditions” scenario, at 31 December 2004 is shown in the table below. Maturity analysis of assets and liabilities CHF billion Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets 2 Trading portfolio assets pledged as collateral Positive replacement values 2 Financial assets designated at fair value Loans Financial investments Accrued income and prepaid expenses Investments in associates Property and equipment Goodwill and other intangible assets Other assets Total 31.12.04 Total 31.12.03 Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities 2 Negative replacement values 2 Financial liabilities designated at fair value Due to customers Accrued expenses and deferred income Debt issued Other liabilities Total 31.12.04 Total 31.12.03 On demand Subject to notice 1 Due within 3 months Due between 3 and 12 months Due between 1 and 5 years Due after 5 years 6.0 20.0 0.0 0.0 370.3 159.1 284.6 0.7 23.1 4.1 5.9 0.0 0.0 0.0 15.6 889.4 832.4 30.8 0.0 0.0 171.0 303.7 0.0 119.1 14.7 0.0 20.3 659.6 795.0 0.4 186.0 49.6 0.0 0.0 0.0 0.0 35.8 0.0 0.0 0.0 0.0 0.0 19.2 291.0 260.6 6.5 51.7 20.2 0.0 0.0 0.0 112.0 0.0 0.0 22.1 212.5 188.0 10.5 32.0 255.0 0.0 0.0 0.0 0.0 47.3 0.6 0.0 0.0 0.0 0.0 0.0 345.4 271.2 77.8 9.8 363.2 0.0 0.0 2.3 135.4 0.0 74.9 0.0 663.4 338.5 1.1 2.1 46.0 0.0 0.0 0.0 0.0 30.2 0.1 0.0 0.0 0.0 0.0 0.0 79.5 82.6 1.5 0.0 37.8 0.0 0.0 9.0 5.2 0.0 12.1 0.0 65.6 130.4 2.1 0.1 5.5 0.0 0.0 0.0 0.0 79.6 0.2 0.0 0.0 0.0 0.0 0.0 87.5 72.2 1.9 0.0 1.2 0.0 0.0 46.4 1.5 0.0 5.0 0.0 56.0 36.5 1.2 0.0 1.1 0.0 0.0 0.0 0.0 16.4 0.1 0.0 2.4 8.7 12.1 0.0 42.0 31.1 0.4 0.0 0.2 0.0 0.0 8.1 2.9 0.0 25.8 0.0 37.4 22.3 Total 6.0 35.3 220.2 357.2 370.3 159.1 284.6 0.7 232.4 5.1 5.9 2.4 8.7 12.1 34.8 1,734.8 1,550.1 118.9 61.5 422.6 171.0 303.7 65.8 376.1 14.7 117.8 42.4 1,694.5 1,510.7 1 Deposits without a ﬁxed term, on which notice of withdrawal or termination has not been given (such funds may be withdrawn by the depositor or repaid by the borrower subject to an agreed period of notice which can be from 2 days to 6 months). 2 Trading and derivative positions are shown within ’on demand’ which management believes most accurately reﬂects the short-term nature of trading activities. The contractual maturity of the instruments may however extend over signiﬁcantly longer periods. 141 Financial Statements Notes to the Financial Statements Note 29 Financial Instruments Risk Position (continued) d) Capital Adequacy The adequacy of UBS’s capital is monitored using, among oth- er measures, the rules and ratios established by the Basel Committee on Banking Supervision (“BIS rules / ratios”). The BIS ratios compare the amount of eligible capital (in total and Tier 1) with the total of risk-weighted assets (RWAs). While UBS monitors and reports its capital ratios under BIS rules, it is the rules established by the Swiss regulator, the EBK, which ultimately determine the regulatory capital required to underpin 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 under the BIS rules. BIS Eligible capital BIS eligible capital consists of two parts. Tier 1 capital com- prises share capital, share premium, retained earnings includ- ing current year proﬁt, foreign currency translation and mi- nority interests less accrued dividends, net long positions in own shares and goodwill. Certain adjustments are made to IFRS-based proﬁt and reserves, in line with BIS recommenda- tions, as prescribed by the EBK. Tier 2 capital includes subor- dinated long-term debt. Tier 1 capital is required to be at least 4% and Total eligible capital at least 8% of RWAs. BIS Risk-Weighted Assets (RWAs) Total RWAs are made up of three elements – credit risk, oth- er 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 out- lined below, and weighted according to type of counterpar- ty and collateral at 0%, 20%, 50% or 100%. The least risky claims, such as claims on OECD governments and claims col- lateralized by cash, are weighted at 0%, meaning that no cap- ital support is required, while the claims deemed most risky, including unsecured claims on corporates and private cus- tomers, are weighted at 100%, meaning that 8% capital sup- port is required. Securities not held for trading are included as claims, based on the net long position in the securities of each issuer, includ- ing both physical holdings and positions derived from other transactions such as options. UBS’s investment in Motor- Columbus is treated for regulatory capital purposes as a po- sition in a security not held for trading. Claims arising from derivatives transactions include two components: the current positive replacement values and ’add- ons’ to reﬂect their potential future exposure. Where UBS has entered into a master netting agreement which is accepted by the EBK as being legally enforceable in insolvency, positive and negative replacement values with individual counterparties can be netted and therefore the on-balance sheet component of RWAs for derivatives transactions shown in the table on the next page (Positive replacement values) is less than the balance sheet value of Positive replacement values. The add-ons com- ponent of the RWAs is shown in the table on the next page under Off-balance sheet exposures and other positions – For- ward and swap contracts, and Purchased options. Claims arising from contingent commitments and irrevo- cable facilities granted are converted to credit equivalent amounts based on speciﬁed percentages of nominal value. There are other types of asset, most notably property and equipment and intangibles, which, while not subject to cred- it risk, represent a risk to the bank in respect of their poten- tial for writedown and impairment and which therefore re- quire capital underpinning. Capital is required to support market risk arising in all for- eign exchange, precious metals and commodity (including en- ergy) 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 (VaR) model approved by the EBK, from which the market risk capital requirement is derived. Unlike the calculations for credit risk and other assets, this produces the capital requirement itself rather than the RWA amount. In or- der to compute a total capital ratio, the market risk capital re- quirement is converted to a ’RWA equivalent’ (shown in the table as Market risk positions) such that the capital requirement is 8% of this RWA equivalent, i.e. the market risk capital require- ment derived by VaR is multiplied by 12.5. 142 Note 29 Financial Instruments Risk Position (continued) d) Capital Adequacy (continued) Risk-weighted assets (BIS) CHF million Balance sheet exposures Due from banks and other collateralized lendings 2 Net positions in securities 3, 4 Positive replacement values 5 Loans, net of allowances for credit losses and other collateralized lendings 2 Accrued income and prepaid expenses Property and equipment Other assets Off-balance sheet exposures Contingent liabilities Irrevocable commitments Forward and swap contracts 6 Purchased options 6 Market risk positions 7 Total risk-weighted assets Exposure 31.12.04 Risk-weighted amount 31.12.04 Exposure 1 31.12.03 Risk-weighted amount 31.12.03 556,947 8,227 78,317 429,186 5,790 8,772 32,725 14,894 53,187 14,419,106 2,306,605 531,098 7,277 84,334 359,154 6,218 9,611 24,918 15,563 46,960 11,746,880 1,183,708 7,820 6,914 17,121 164,620 3,573 8,772 8,949 7,569 11,764 8,486 386 18,151 264,125 8,565 6,182 22,324 153,537 4,284 9,611 7,673 8,167 6,863 4,710 1,716 18,269 251,901 1 Prior year numbers have been adjusted to conform with current year’s presentation. trading assets. These positions have not been included in the market risk position. not consolidated for capital adequacy purposes. contracts and Purchased options, where positive but after netting, where applicable. calculated using the approved Value at Risk model, multiplied by 12.5 to give the “risk-weighted asset equivalent”. 4 Excluding positions in the trading book, which are included in market risk positions. 6 Represents the “add-ons” for these contracts. 2 Includes gross securities borrowing and reverse repo exposures, as well as traded loans which are included in 3 Includes security positions which are not included in the market risk position, including Motor-Columbus, which is 5 Represents the mark to market values of Forward and swap 7 Regulatory capital adequacy requirements for market risk, BIS capital ratios Tier 1 of which hybrid Tier 1 Tier 2 Total BIS Capital CHF million 31.12.04 31,051 2,963 4,815 35,866 Ratio % 31.12.04 11.8 1.1 1.8 13.6 Capital CHF million 31.12.03 29,765 3,224 3,816 33,581 Ratio % 31.12.03 11.8 1.3 1.5 13.3 The Tier 1 capital includes CHF 2,963 million (USD 2,600 million) in trust preferred securities at 31 December 2004 and CHF 3,224 million (USD 2,600 million) at 31 December 2003. 143 Financial Statements Notes to the Financial Statements Note 29 Financial Instruments Risk Position (continued) e) Financial Instruments Risk Position in Motor-Columbus The Atel Group, the operating arm of Motor-Columbus, is ex- posed to electricity price risk, interest rate risk, currency risk, credit risk, and other business risks. Risk limits are allocated to individual risk categories and compliance with these limits is continuously monitored, the limits being periodically adjusted in the broad context of the company’s overall risk capacity. A risk policy has been established and is monitored by a risk committee composed of executive management. It was approved by the Board of Directors of Atel and is reviewed and ratiﬁed by them annually. The policy sets out the principles for Atel’s business. It speciﬁes requirements for entering into, measuring, managing and limiting risk in its business and the organization and responsibilities of risk management. The ob- jective of the policy is to provide a reasonable balance between the business risks entered into and Atel’s earnings and risk- bearing shareholders’ equity. A ﬁnancial risk policy sets out the context of ﬁnancial risk management in terms of content, organization and systems, with the objective of reducing ﬁnancial risk, balancing the costs of hedging and the risks assumed. The responsible units manage their ﬁnancial risks within the framework of this pol- icy and limits deﬁned for their area. Energy price risk Price risks in the energy business arise from, among others, price volatility, changing market prices and changing correla- tions between markets and products. Derivative ﬁnancial in- struments are used to hedge underlying physical transac- tions, subject to the risk policy. Interest rate risk Interest rate swaps are permitted to hedge capital markets in- terest rate exposure, with changes in fair value being report- ed in the income statement. Currency risks To minimize currency risk, Atel tries to offset operating income and expenses in foreign currencies. Any surplus is hedged through currency forwards and options within the framework of the ﬁnancial risk policy. Net investment in foreign subsidiaries is also subject to ex- change rate movements, but differences in inﬂation rates tend to cancel out these changes over the longer term and for this reason Atel does not hedge investment in foreign subsidiaries. Credit risk Credit risk management is based on assessment of the cred- itworthiness of new contracting parties before entering into any transaction, giving rise to credit exposure, and continu- ous monitoring of creditworthiness and exposures thereafter. In the energy business, Atel only enters into transactions lead- ing to credit exposure with counterparties that fulﬁll the cri- teria laid out in the risk policy. Concentration risk is minimized by the number of customers and their geographical distribu- tion. Financial assets reported in the balance sheet represent the maximum loss to Atel in the event of counterparty default at the balance sheet date. 144 Note 30 Fair Value of Financial Instruments 30a Fair Value of Financial Instruments The following table presents the fair value of ﬁnancial instruments, including those not reﬂected in the ﬁnancial statements at fair value. It is accompanied by a discussion of the methods used to determine fair value for ﬁnancial instruments. CHF billion Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Trading portfolio assets pledged as collateral Positive replacement values Financial assets designated at fair value Loans Financial investments Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Financial liabilities designated at fair value 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 31.12.04 Fair value 31.12.04 Unrealized gain / (loss) 31.12.04 Carrying value 31.12.03 Fair value 31.12.03 Unrealized gain / (loss) 31.12.03 6.0 35.3 220.2 357.1 370.3 159.1 284.6 0.7 232.4 5.0 118.9 61.5 422.6 171.0 303.7 65.8 376.1 117.8 6.0 35.3 220.2 357.1 370.3 159.1 284.6 0.7 233.8 5.0 118.9 61.5 422.6 171.0 303.7 65.8 376.1 118.9 3.6 31.7 213.9 320.5 341.0 120.8 248.2 0.0 212.7 5.1 127.0 53.3 415.9 144.0 254.8 35.3 346.6 88.8 3.6 31.7 213.9 320.5 341.0 120.8 248.2 0.0 214.0 5.1 127.0 53.3 415.9 144.0 254.8 35.3 346.6 90.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.4 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (1.1) 0.3 1.4 (0.4) 1.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (1.2 ) 0.1 0.8 (0.2 ) 0.7 Fair value is the amount for which an asset could be ex- changed, or a liability settled, between knowledgeable, will- ing parties in an arm’s length transaction. For ﬁnancial instru- ments carried at fair value, market prices or rates are used to determine fair value where an active market exists (such as a recognized stock exchange), as it is the best evidence of the fair value of a ﬁnancial instrument. Market prices are not, however, available for certain ﬁnan- cial assets and liabilities held and issued by UBS. Therefore, where no active market price or rate is available, fair values are estimated using present value or other valuation tech- niques, using inputs based on market conditions existing at the balance sheet dates. Valuation techniques are generally applied to OTC deriva- tives, unlisted trading portfolio assets and liabilities, and un- listed ﬁnancial investments. The most frequently applied pric- ing models and valuation techniques include forward pricing and swap models using present value calculations, option models such as the Black-Scholes model or generalizations of it, and credit models such as default rate models or credit spread models. The values derived from applying these techniques are sig- niﬁcantly affected by the choice of valuation model used and the underlying assumptions made concerning factors such as the amounts and timing of future cash ﬂows, discount rates, volatility, and credit risk. The following methods and signiﬁcant assumptions have been applied in determining the fair values of ﬁnancial instru- ments presented in the above table, both for ﬁnancial instru- ments carried at fair value, and those carried at cost (for which fair values are provided as a comparison): (a) trading portfolio assets and liabilities, trading portfolio as- sets pledged as collateral, ﬁnancial assets and liabilities designated at fair value, derivatives, and other transactions 145 Financial Statements Notes to the Financial Statements Note 30 Fair Value of Financial Instruments (continued) 30a Fair Value of Financial Instruments (continued) undertaken for trading purposes are measured at fair val- ue by reference 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 rec- ognized valuation techniques. Fair value is equal to the car- rying amount for these items; (b) ﬁnancial investments classiﬁed as available-for-sale are measured at fair value by reference 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. Fair value is equal to the carrying amount for these items, and unrealized gains and losses, excluding impairment writedowns, are recorded in Shareholders’ equity until an asset is sold, collected or otherwise disposed of; (c) the carrying amount of liquid assets and other assets ma- turing 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 assumed to be the amount payable on demand at the balance sheet date; (f) (e) the fair value of variable rate ﬁnancial instruments is as- sumed 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 carrying and fair values; the fair value of ﬁxed rate loans and mortgages carried at amortized cost is estimated by comparing market in- terest 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 im- pact of credit risk is recognized separately by deducting the amount of the allowance for credit losses from both carrying and fair values. Where applicable, for the purposes of the fair value disclosure on the previous page, the interest accrued to date on ﬁnan- cial instruments is included in the carrying value of the ﬁnan- cial instruments. These valuation techniques and assumptions provide a consistent measurement of fair value for UBS’s assets and li- abilities as shown in the table. However, because other insti- tutions may use different methods and assumptions when es- timating fair value using a valuation technique, and when estimating the fair value of ﬁnancial instruments not carried at fair value, such fair value disclosures cannot necessarily be compared from one ﬁnancial institution to another. The table does not reﬂect the fair values of non-ﬁnancial assets and liabilities such as property, equipment, goodwill, prepayments and non-interest accruals. Substantially all of UBS’s commitments to extend credit are at variable rates. Accordingly, UBS has no signiﬁcant exposure to fair value ﬂuctuations resulting from interest rate move- ments related to these commitments. The fair values of UBS’s ﬁxed rate loans, long- and medi- um-term notes and bonds issued are predominantly hedged by derivative instruments, mainly interest rate swaps, as ex- plained in Note 23. The interest rate risk inherent in balance 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. Derivative instruments used for hedging are carried on the balance sheet at fair values, which are included in the Positive or Negative replacement values in the table. When the interest rate risk on a ﬁxed rate ﬁnancial instrument is hedged with a de- rivative in a fair value hedge, the ﬁxed rate ﬁnancial instrument (or hedged portion thereof) is reﬂected in the table at fair value only in relation to the interest rate risk, not the credit risk, as ex- plained in (f). Fair value changes are recorded in net proﬁt. The treatment of derivatives designated as cash ﬂow hedges is ex- plained in Note 1o). The amount shown in the table as “Deriv- ative instruments designated as cash ﬂow hedges” is the net change in fair values on such derivatives that is recorded in Share- holders’ equity and not yet transferred to income or expense. 146 Note 30 Fair Value of Financial Instruments (continued) 30b Determination of Fair Values from Quoted Market Prices or Valuation Techniques For trading portfolio securities and ﬁnancial investments which are listed or otherwise traded in an active market, for ex- change traded derivatives, and for other ﬁnancial instruments for which quoted prices in an active market are available, fair value is determined directly from those quoted market prices. For ﬁnancial instruments which do not have directly avail- able quoted market prices, fair values are estimated using val- uation techniques, or models, based wherever possible on as- sumptions supported by observable market prices or rates existing at the balance sheet date. This is the case for the ma- jority of OTC derivatives, most unlisted instruments, and oth- er items which are not traded in active markets. For a small portion of ﬁnancial instruments, fair values can- not be obtained directly from quoted market prices, or indi- rectly using valuation techniques or models supported by ob- servable market prices or rates. This is generally the case for private equity investments in unlisted securities, and for cer- tain exotic or structured ﬁnancial instruments. In these cases fair value is estimated indirectly using valuation techniques or models for which the inputs are reasonable assumptions, based on market conditions. The following table presents the valuation methods used to determine fair values of ﬁnancial instruments carried at fair value: CHF billion Trading portfolio assets Trading portfolio assets pledged as collateral Positive replacement values Financial assets designated at fair value Financial investments Total assets Trading portfolio liabilities Negative replacement values Financial liabilities designated at fair value Total liabilities Quoted market price Valuation technique – market observable inputs Valuation technique – non- market observable inputs 209.6 156.0 6.2 0.7 1.1 373.6 161.3 9.8 0.0 171.1 159.7 3.1 265.2 0.0 0.4 428.4 9.7 270.1 65.8 345.6 1.0 0.0 13.2 0.0 3.5 17.7 0.0 23.8 0.0 23.8 Total 370.3 159.1 284.6 0.7 5.0 819.7 171.0 303.7 65.8 540.5 30c Sensitivity of Fair Values to Changing Signiﬁcant Assumptions to Reasonably Possible Alternatives Included in the fair value of ﬁnancial instruments carried at fair value on the balance sheet are those estimated in full or in part using valuation techniques based on assumptions that are not supported by observable market prices or rates. Mod- els used in these situations undergo an internal validation process before they are certiﬁed for use. Any related model valuation uncertainty is quantiﬁed, and deducted from the fair values produced by the models. Based on the controls and pro- cedural safeguards we employ, management believes the re- sulting estimated fair values recorded in the balance sheet and the changes in fair values recorded in the income statement are reasonable, and are the most appropriate at the balance sheet date. The potential effect of using reasonably possible alterna- tive assumptions as inputs to valuation models from which the fair values of these financial instruments are determined has been quantiﬁed as a reduction of approximately CHF 579 million using less favorable assumptions, and an increase of approximately CHF 927 million using more favorable assump- tions. The determination of reasonably possible alternative assumptions is itself subject to considerable judgment, but for this purpose was determined using the same technique as for the model valuation adjustments. This was based on increas- ing and decreasing the conﬁdence level applied to determine the original model valuation adjustments. The resulting effect on fair values reﬂects the application of less favorable and more favorable assumptions. In changing the assumptions it was assumed that the impact of correlation between differ- ent ﬁnancial instruments and models is minimal. 147 Financial Statements Notes to the Financial Statements Note 30 Fair Value of Financial Instruments (continued) 30d Changes in Fair Value Recognized in Proﬁt or Loss during the Period which were Estimated using Valuation Techniques Total Net trading income for the year ended 31 December 2004 was CHF 4,972 million, which represents the net result from a range of products traded across different business ac- tivities, including the effect of foreign currency translation, and including both realized and unrealized income. Unrealized in- come is determined from changes in fair values, using quot- ed prices in active markets when available, and is otherwise estimated using valuation techniques. Included in the unrealized portion of Net trading income are net losses from changes in fair values of CHF 7,123 mil- lion on ﬁnancial instruments for which fair values were esti- mated using valuation techniques. These valuation techniques included models such as those described above, which range from relatively simple models with market observable inputs, to those which are more complex and require the use of as- sumptions or estimates based on market conditions. Net trading income is often generated in transactions in- volving several ﬁnancial instruments, or subject to hedging or other risk management techniques, which may result in dif- ferent portions of the transaction being priced using differ- ent methods. Consequently, the changes in fair value recognized in proﬁt or loss during the period which were estimated using valuation techniques represent only a portion of Net trading income, and in many cases these amounts were offset by oth- er ﬁnancial instruments or transactions, which were priced in active markets using quoted market prices or rates, or which have been realized. The amount of such income in the current year, including the effect of foreign currency transla- tion on unrealized transactions, was a gain of CHF 12,095 million. Changes in fair value estimated using valuation techniques are also recognized in net proﬁt, in situations of unrealized impairments on ﬁnancial investments available-for-sale. The total of such impairment amounts recognized in net proﬁt during the period was CHF 218 million. 148 Note 30 Fair Value of Financial Instruments (continued) 30e Continuing Involvement in Assets that have been Transferred The following table presents details of assets which have been sold or otherwise transferred, but which continue to be rec- ognized, either in full or to the extent of UBS’s continuing involvement: CHF billion Nature of transaction Securities lending agreements Repurchase agreements Other collateralized securities trading Total 31.12.04 Continued asset recognition in full Total assets Associated liability 37.3 121.8 2.9 162.0 13.8 117.6 2.1 133.5 The assets in the above table continue to be recognized to the extent shown, due to transactions which do not qualify for derecognition of the assets from the balance sheet. Derecog- nition criteria are discussed in more detail in Notes 1 d) and aa). In each situation of continued recognition, whether in full, or to the extent of continuing involvement, UBS retains the risks of the relevant portions of the retained assets. These in- clude credit risk, settlement risk, country risk, and market risk. In addition, the nature of an associated transaction which gives rise to the continued involvement may modify existing risks, or introduce risks such as credit exposure to the coun- terparty to the associated transaction. The majority of retained assets relate to repurchase agree- ments and securities lending agreements. Repurchase agree- ments are nearly always concluded with debt instruments, such as bonds, notes or money market paper; the majority of securities lending agreements are concluded with shares, and the remainder typically with bonds and notes. Both types of transactions are transacted using standard agreements em- ployed by ﬁnancial market participants, and are undertaken with counterparties subject to UBS’s normal credit approval processes. The resulting credit exposures are controlled by dai- ly monitoring and collateralization of the positions. The amounts for repurchase agreements and securities lending agreements are shown in the above table. A small portion of retained assets relate to transactions in which UBS has transferred assets, but continues to have in- volvement in the transferred assets, for example through pro- viding a guarantee, writing put options, acquiring call options, or entering into a total return swap or other type of swap linked to the performance of the asset. If control is retained due to these types of associated transactions, UBS continues to recognize the transferred asset in its entirety, otherwise to the extent of its continuing involvement. In particular, transactions involving the transfer of assets in conjunction with entering into a total rate of return swap are accounted for as secured ﬁnancing transactions, instead of sales of trading portfolio assets with an accompanying swap derivative. These transactions are included in the above table within Trading portfolio assets. 149 Financial Statements Notes to the Financial Statements Note 31 Pension and Other Post-Retirement Beneﬁt Plans a) Deﬁned beneﬁt plans The Group has established various pension plans inside and outside of Switzerland. The major plans are located in Switzer- land, the UK, the US and Germany. The pension funds of Atel Ltd. and some of its Group companies in Switzerland and Ger- many are included in the disclosure as of 31 December 2004. Independent actuarial valuations are performed for the plans in these locations. The measurement date of these plans is the 31 December for each year presented. The overall investment policy and strategy for the Group’s deﬁned beneﬁt pension plans is guided by the objective to achieve an investment return which, together with the con- tributions paid, is sufﬁcient to maintain reasonable control over the various funding risks of the plans. The investment advisors appointed by plan trustees are responsible for de- termining the mix of asset types and target allocations which are reviewed by the plan trustees on an ongoing basis. Ac- tual asset allocation is determined by a variety of current eco- nomic and market conditions and in consideration of specif- ic asset class risk. The expected long-term rates of return on plan assets are based on long-term expected inﬂation, interest rates, risk premiums and targeted asset class allocations. These estimates take into consideration historical asset class returns and are determined together with the plans’ investment and actuar- ial advisors. Swiss pension plans The pension fund of UBS covers practically all UBS employees in Switzerland and exceeds the minimum beneﬁt requirements under Swiss law. Contributions to the pension fund of UBS are paid for by employees and the employer. For the main plan, the employee contributions are calculated as a percent- age of insured annual salary and are deducted monthly. The percentages deducted from salary for full beneﬁt coverage (in- cluding risk beneﬁts) depend on age and vary between 7% and 10%. The employer pays a variable contribution that ranges between 150% and 220% of the sum of employees’ contributions. The computation of the beneﬁts is based on the ﬁnal covered salary. The beneﬁts covered include retirement beneﬁts, disability, death and survivor pensions, and employ- ment termination beneﬁts. Additional employee and employer contributions are made to the other plans of the pension fund of UBS. These plans provide beneﬁts which are based on annual contributions as a percentage of salary and accrue at a minimum interest rate annually. The employer contributions expected to be made in 2005 to the Swiss pension plans are CHF 385 million. The accumu- lated beneﬁt obligation (which is the current value of accrued beneﬁts without allowance for future salary increases) for these pension plans was CHF 18,566 million as of 31 Decem- ber 2004 (2003 CHF 16,817 million, 2002 CHF 15,853 million). Foreign pension plans The foreign locations of UBS operate various pension plans in accordance with local regulations and practices. Among these plans are deﬁned contribution plans as well as deﬁned bene- ﬁt plans. The locations with deﬁned beneﬁt plans of a mate- rial 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. The amounts shown for foreign plans reﬂect the net funded positions of the major foreign plans. The retirement plans provide beneﬁts in the event of re- tirement, death, disability or employment termination. The plans’ retirement beneﬁts depend on age, contributions and level of compensation. The principal plans are ﬁnanced in full by the Group. The employer contributions expected to be made in 2005 to these pension plans are CHF 55 million. The funding policy for these plans is consistent with local govern- ment and tax requirements. The assumptions used in foreign plans take into account local economic conditions. The accumulated beneﬁt obligation for these pension plans was CHF 4,118 million as of 31 December 2004 (2003 CHF 3,609 million, 2002 CHF 3,376 million). For pension plans with an accumulated beneﬁt obligation in excess of plan assets, the aggregate projected beneﬁt ob- ligation and accumulated beneﬁt obligation was CHF 3,755 million and CHF 3,735 million as of 31 December 2004 (2003 CHF 944 million and CHF 930 million, 2002 CHF 3,436 mil- lion and CHF 3,376 million). The fair value of plan assets for these plans was CHF 3,166 million as of 31 December 2004 (2003 CHF 677 million, 2002 CHF 2,382 million). 150 Note 31 Pension and Other Post-Retirement Beneﬁt Plans (continued) a) Deﬁned beneﬁt plans CHF million 31.12.04 31.12.03 31.12.02 31.12.04 31.12.03 31.12.02 Deﬁned beneﬁt obligation at the beginning of the year (18,216) (19,204 ) (17,879 ) (3,663) (3,436 ) (3,553 ) Swiss Foreign Service cost Interest cost Special termination beneﬁts Actuarial gain / (loss) Beneﬁts paid Curtailment / settlement Acquisitions Foreign currency translation (564 ) (703 ) (70 ) 1,395 930 (554 ) (699 ) (209 ) (681 ) 818 (548) (672) (35) (1,392) 910 (272) (83) (212) (296) 125 (159) 146 Deﬁned beneﬁt obligation at the end of the year (20,225) (18,216 ) (19,204 ) (4,142) Fair value of plan assets at the beginning of the year Actual return on plan assets Employer contributions Plan participant contributions Beneﬁts paid Acquisitions Foreign currency translation 17,619 980 411 203 (910) 272 16,566 1,411 370 202 (930 ) 18,289 (1,350 ) 236 209 (818 ) Fair value of plan assets at the end of the year 18,575 17,619 16,566 3,402 370 65 (91 ) (197 ) (201 ) 124 138 (3,663 ) 2,382 429 831 (108 ) (210 ) (177 ) 111 74 427 (3,436 ) 2,887 (240 ) 164 (125) (124 ) (111 ) (132) 3,580 (562) 1,046 1 (116 ) 3,402 (261 ) 970 1 Funded status Unrecognized net actuarial (gains) / losses Unrecognized prior service cost Unrecognized asset (Accrued) / prepaid pension cost Movement in the net (liability) or asset (Accrued) / prepaid pension cost at the beginning of the year Net periodic pension cost Employer contributions Acquisitions Foreign currency translation (Accrued) / prepaid pension cost Amounts recognized in the Balance Sheet Prepaid pension cost Accrued pension liability (Accrued) / prepaid pension cost (1,650) 3,006 (597 ) 1,716 (2,638 ) 3,892 (1,356) (1,119 ) (1,221 ) 0 0 (411) 411 0 0 0 33 485 710 33 (403 ) 370 356 (559 ) 236 0 0 33 33 33 710 (105) 65 (159) (26) 485 805 (320) 485 73 (168 ) 831 (26 ) 710 862 (152 ) 710 (318 ) 2,382 (1,054 ) 1,126 1 73 9 (83 ) 164 (17 ) 73 220 (147 ) 73 151 Financial Statements Notes to the Financial Statements Note 31 Pension and Other Post-Retirement Beneﬁt Plans (continued) a) Deﬁned beneﬁt plans (continued) CHF million for the year ended Components of net periodic pension cost Service cost Interest cost Expected return on plan assets Increase / (decrease) of unrecognized assets Special termination beneﬁts Amortization of unrecognized prior service cost Amortization of unrecognized net (gains) / losses Curtailment / settlement Employee contributions Net periodic pension cost Principal weighted average actuarial assumptions used (%) Assumptions used to determine deﬁned beneﬁt obligations at the end of the year Discount rate Expected rate of salary increase Rate of pension increase Assumptions used to determine net periodic pension cost for the year ended Swiss Foreign 31.12.04 31.12.03 31.12.02 31.12.04 31.12.03 31.12.02 548 672 (878) 237 35 (203) 411 3.3 2.5 1.0 3.8 5.0 2.5 1.0 564 703 (818 ) (102 ) 70 188 (202 ) 403 3.8 2.5 1.0 3.8 5.0 2.5 1.5 554 699 (900 ) 206 209 (209 ) 559 3.8 2.5 1.5 4.0 5.0 2.5 1.5 935 951 967 990 1,015 5,252 43 41 12 4 100 39 43 12 6 100 35 47 13 5 100 83 212 (248) 91 197 (178 ) 58 58 105 168 5.5 4.4 1.9 5.7 7.2 4.6 1.9 116 112 121 131 140 864 54 41 2 3 100 5.7 4.6 1.9 5.8 7.1 4.4 1.5 52 30 1 17 100 108 210 (199 ) 1 22 (59 ) 83 5.8 4.4 1.5 6.2 7.3 4.4 1.5 57 36 1 6 100 Discount rate Expected rate of return on plan assets Expected rate of salary increase Rate of pension increase CHF million Expected future beneﬁt payments 2005 2006 2007 2008 2009 2010–2014 Plan assets Actual plan asset allocation (%) Equity instruments Debt instruments Real estate Other Total 152 Note 31 Pension and Other Post-Retirement Beneﬁt Plans (continued) a) Deﬁned beneﬁt plans (continued) Long-term target plan asset allocation (%) Equity instruments Debt instruments Real estate Other Actual return on plan assets (%) CHF million 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 Foreign 31.12.04 31.12.03 31.12.02 31.12.04 31.12.03 31.12.02 49–55 44–47 1–2 0–6 10.8 17.8 (8.7 ) 34–49 30–53 12–19 0 5.5 1,239 238 3,778 73 8.6 (7.5 ) 1,005 246 2,930 84 814 206 2,645 90 1 The numbers of UBS AG shares were 2,493,173, 2,908,699 and 3,072,500 as of 31 December 2004, 31 December 2003 and 31 December 2002, respectively. The amounts of capital repayment and dividend received on UBS AG shares for the years ended 31 December 2004, 31 December 2003 and 31 December 2002 were CHF 7 million for each year. b) Post-retirement medical and life plans In the US and the UK the Group offers retiree medical bene- ﬁts that contribute to the health care coverage of employees and beneﬁciaries after retirement. In addition to retiree med- ical beneﬁts, the Group in the US also provides retiree life in- surance beneﬁts. The beneﬁt obligation in excess of fair value of plan assets for those plans amounts to CHF 166 million as of 31 Decem- ber 2004 (2003 CHF 179 million, 2002 CHF 164 million) and the total accrued post-retirement cost to CHF 136 million as of 31 December 2004 (2003 CHF 137 million, 2002 CHF 130 million). The net periodic post-retirement costs for the years ended 31 December 2004, 31 December 2003 and 31 De- cember 2002 were CHF 16 million, CHF 22 million and CHF 25 million, respectively. The employer contributions expected to be made in 2005 to the post-retirement medical and life plans are CHF 7 mil- lion. The expected future beneﬁt payments are CHF 7 million for each of the years 2005, 2006 and 2007, CHF 8 million for each of the years 2008 and 2009 and CHF 46 million in total for the years 2010–2014. 153 Financial Statements Notes to the Financial Statements Note 31 Pension and Other Post-Retirement Beneﬁt Plans (continued) b) Post-retirement medical and life plans CHF million Post-retirement beneﬁt obligation at the beginning of the year Service cost Interest cost Plan amendments Actuarial gain / (loss) Beneﬁts paid 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 31.12.04 31.12.03 31.12.02 (179) (6) (9) 8 8 12 (166) 0 0 8 (8) 0 (166 ) (11 ) (10 ) (14 ) 6 16 (179 ) 2 0 4 (6 ) 0 (145 ) (8 ) (9 ) (3 ) (31 ) 4 26 (166 ) 3 0 3 (4 ) 2 The assumed average health care cost trend rate used in determining post-retirement beneﬁt expense is assumed to be 11% for 2004 and to decrease to an ultimate trend rate of 5% in 2011. Assumed health care cost trend rates have a signiﬁcant ef- fect 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 peri- odic 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 3 22 (3) (18) c) Deﬁned contribution plans The Group also sponsors a number of deﬁned contribution plans primarily in the UK and the US. Certain plans permit em- ployees to make contributions and earn matching or other contributions from the Group. The contributions to these plans recognized as expense for the years ended 31 Decem- ber 2004, 31 December 2003 and 31 December 2002 were CHF 187 million, CHF 141 million and CHF 133 million, respec- tively. 154 Note 32 Equity Participation Plans a) Equity Participation Plans Offered UBS has established several equity participation plans to fur- ther align the long-term interests of executives, managers, staff and shareholders. The plans are offered to eligible em- ployees 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 be- low describe the most signiﬁcant plans in general, but specif- ic plan rules and investment offerings may vary by country. Equity Plus (EP): This voluntary plan gives eligible employ- ees the opportunity to purchase UBS shares at fair market val- ue on the purchase date and receive at no additional cost two UBS options for each share purchased, up to a maximum an- nual limit. The options have a strike price equal to the fair mar- ket 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 Equity Plus are restricted from sale for two years from the time of purchase, and the options granted have a two year vesting requirement and generally expire from ten years to ten and one-half years after the date of grant. Discounted purchase plans: Selected employees in Switzer- land are entitled to purchase a specified number of UBS shares at a predetermined discounted price each year. The number of shares that can be purchased depends on rank. Any such shares purchased must be held for a speciﬁed period of time. The discount is recorded as compensation expense. The last share purchase opportunity will take place in 2005. Equity Ownership Plan (EOP): Selected personnel receive between 10% and 45% of their performance-related com- pensation in UBS shares or notional UBS shares instead of cash, on a mandatory basis. Up to and including 2004, par- ticipants in certain countries were eligible to receive a por- tion of their award in UBS shares with a matching contribu- tion in UBS options or in Alternative Investment Vehicles (AIVs) (generally money market funds, UBS and non-UBS mu- tual funds and other UBS sponsored funds). In 2002 and 2003, certain employees received UBS options instead of UBS shares for a portion of their EOP award. In 2005, AIVs and options will no longer be granted as part of EOP. EOP awards vest in one-third increments over a three-year vesting peri- od. Under certain conditions, these awards are fully for- feitable 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. Option grants generally vest in one-third increments over a three-year period. Expiration of the options is generally from ten to ten and one-half years. One option gives the right to purchase one registered UBS share at the option’s strike price. Other deferred compensation plans: UBS sponsors other deferred compensation plans for selected eligible employees. Generally, contributions are made on a tax deferred basis, and participants are allowed to notionally invest in AIVs. No addi- tional company match is granted, and the plan is generally not forfeitable. In addition, UBS also grants deferred compensa- tion awards to new recruits, senior management and other key employees in the form of UBS shares or options. 155 Financial Statements Notes to the Financial Statements Note 32 Equity Participation Plans (continued) b) UBS Share Awards i) Stock compensation plans Movements in shares granted under various equity participation plans mentioned on the previous page are as follows: Stock compensation plans Unvested shares outstanding, at the beginning of the year Shares awarded during the year Vested during the year Forfeited during the year Unvested shares outstanding, at the end of the year Weighted-average fair market value of shares awarded (in CHF) Fair market value of outstanding shares at the end of the year (CHF billion) 31.12.04 31,383,890 11,713,406 31.12.03 48,136,561 11,023,553 31.12.02 52,299,332 13,511,655 (17,996,498) (26,915,860 ) (16,333,832 ) (463,979) (860,364 ) (1,340,594 ) 24,636,819 31,383,890 48,136,561 95 2.3 61 2.7 71 3.2 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 through discounted purchase plans Weighted-average purchase price (in CHF) Share quantity purchased through EP at fair market value Weighted-average purchase price (in CHF) Weighted-average purchase price (in USD) 31.12.04 1,035,079 45 31.12.03 1,722,492 31 31.12.02 1,339,223 40 2,448,231 2,593,391 2,483,684 93 73 61 49 77 46 156 Note 32 Equity Participation Plans (continued) c) UBS Option Awards Movements in options granted under various equity participation plans mentioned on the previous page are as follows: Weighted- average exercise price (in CHF) 31.12.04 1 Number of options 31.12.04 Outstanding, at the beginning of the year 109,040,026 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 24,113,252 (29,396,959) (2,692,824) (156,141) 100,907,354 37,941,280 63 91 58 66 76 69 65 Weighted- average exercise price (in CHF) 31.12.03 1 67 59 54 64 76 63 59 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 Weighted- average exercise price (in CHF) 31.12.02 1 66 71 54 71 77 67 51 Number of options 31.12.03 88,164,227 38,969,319 (14,782,471 ) (2,721,970 ) (589,079 ) 109,040,026 34,726,720 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 the purposes of this table. The following table summarizes additional information about stock options outstanding at 31 December 2004: 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 53.37–70.00 70.01–85.00 85.01–103.75 53.37–103.75 USD 7.65–35.00 35.01–45.00 45.01–55.00 55.01–81.97 7.65–81.97 18,600,149 16,437,141 17,577,171 52,614,461 3,185,982 11,460,304 19,076,401 14,570,206 48,292,893 d) Compensation Expense CHF 61.19 78.01 96.82 78.35 USD 21.00 43.13 47.57 71.11 51.86 Years 6.7 6.6 7.7 7.0 Years 1.6 8.1 6.2 8.7 7.1 6,781,903 8,820,175 5,277,876 20,879,954 3,185,982 1,868,770 10,590,462 1,416,112 17,061,326 CHF 63.74 77.90 99.54 78.77 USD 21.00 43.33 47.41 58.13 42.92 Generally under IFRS, for all equity participation instruments (shares, cash-settled warrants and other cash-settled deriva- tives for which the underlying is UBS shares) except options, UBS accrues expense in the performance year and deter- mines the number of instruments granted to employees based on the instrument’s market price at the grant date, which is generally in the year following the performance year. For op- tions, the amount of expense recognized is equal to the in- trinsic value at grant date (i. e. the difference between the strike price and fair market value of shares at the date of grant. This difference is generally zero, as option strike prices are gen- erally at or above the market prices of the shares). For dis- counted purchase plans, the expense is equal to the difference between the fair market value and the discounted value and is accrued for in the performance year. Management’s esti- mate of the accrued expense before tax for share-based com- pensation for the years ended 31 December 2004, 2003 and 2002 was CHF 1,406 million, CHF 833 million and CHF 592 million, respectively. 157 Financial Statements Notes to the Financial Statements Note 32 Equity Participation Plans (continued) e) Pro-Forma Net Income The following table presents IFRS Net proﬁt and Earnings per share for 2004, 2003 and 2002 as if UBS had applied the fair value method of accounting for its equity participation plans. The fair value method would recognize expense equal to the fair value of option awards at grant, which is higher than the intrinsic value because of the time value of options. CHF million, except per share data Net proﬁt, 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 proﬁt, pro-forma Earnings per share Basic, as reported Basic, pro-forma Diluted, as reported Diluted, pro-forma 31.12.04 8,089 31.12.03 6,239 31.12.02 3,530 1,131 630 493 (1,639) (1,069 ) (1,183 ) 7,581 5,800 2,840 7.68 7.20 7.47 7.00 5.59 5.19 5.48 5.09 2.92 2.35 2.87 2.31 The fair value of options granted was determined using a proprietary option pricing model, substantially 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) 31.12.04 31.12.03 31.12.02 34% 2.03% 3.70% 3.87% 5.6 35% 1.70% 3.17% 4.43% 4.5 35% 3.28% 4.65% 3.35% 4.5 The weighted-average fair value of options granted in 2004, 2003 and 2002 was CHF 25, CHF 15 and CHF 20 per share, respectively. 158 Note 33 Related Parties The Group deﬁnes related parties as Associated companies, private equity investees, the Board of Directors, the Group Ex- ecutive Board, close family members and enterprises which are controlled by these individuals through their majority share- holding or their role as chairman and / or CEO in those com- panies. This deﬁnition is based on the requirements of the “Di- rective on Information Relating to Corporate Governance” issued by the SWX Swiss Exchange and effective from 1 July 2002 for all listed companies in Switzerland. a) Remuneration and equity holdings The executive members of the Board of Directors have top- management employment contracts and receive pension ben- eﬁts upon retirement. Total remuneration to the executive members of the Board of Directors and Group Executive Board recognized in the income statement including cash, shares and accrued pension beneﬁts amounted to CHF 165.3 million in 2004, CHF 144.6 million in 2003 and CHF 131.8 million in 2002. Total compensation numbers exclude merger-related re- tention payments for the two ex-PaineWebber executives of CHF 21.1 million (USD 17.0 million) in 2003 and CHF 20.6 mil- lion (USD 14.9 million) in 2002. These retention payments were committed to at the time of the merger in 2000 and ful- ly disclosed at the time. No additional payments were due in 2004. 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 individuals for their services as external board members amounted to CHF 5.7 million in 2004, CHF 5.4 million in 2003 and CHF 3.5 mil- lion in 2002. The number of long-term stock options outstanding to the executive members of the Board of Directors and Group Ex- ecutive Board from equity participation plans was 6,004,997 (equivalent to the same number of shares) at 31 December 2004, 6,218,011 options (equivalent to the same number of shares) and 120,264 warrants (equivalent to 7,214 shares) at 31 December 2003 and 5,410,172 options (equivalent to the same number of shares) and 24,558,529 warrants (equivalent to 1,473,217 UBS shares) at 31 December 2002. These plans are further explained in Note 32, Equity Participation Plans. The total number of shares held by members of the Board of Directors, the Group Executive Board and parties closely linked to them was 3,506,610 at 31 December 2004, 3,150,217 at 31 December 2003 and 2,139,371 at 31 Decem- ber 2002. No member of the Board of Directors or Group Ex- ecutive Board is the beneﬁcial owner of more than 1% of the Group’s shares at 31 December 2004. b) Loans and advances to Board of Directors and senior executives The outstanding balance of loans to the members of the Board of Directors, the Group Executive Board and close family mem- bers amounted to CHF 15.8 million at 31 December 2004 and CHF 25.2 million at 31 December 2003. Executive members of the Board and GEB members have been granted loans, ﬁxed advances and mortgages at the same terms and conditions that are available to other employees, based on terms and condi- tions granted to third parties adjusted for reduced credit risk. In 2002, a thorough review of outstanding loans to senior ex- ecutives was performed to ensure compliance with the US Sar- banes-Oxley Act of 2002. Non-executive Board members are granted loans and mortgages at general market conditions. 159 Financial Statements Notes to the Financial Statements Note 33 Related Parties (continued) c) Loans to signiﬁcant associated companies CHF million Balance at the beginning of the year Additions Reductions Balance at the end of the year 31.12.04 31.12.03 63 38 (36) 65 40 48 (25 ) 63 All loans to associated companies are transacted at arm’s length. At 31 December 2004 and 2003, there were commitments and contingent liabilities to signiﬁcant associated companies of CHF 55 million and CHF 14 million, respectively. In addition, the Group routinely receives services from associated companies at arm’s length terms. For the years ended 31 December 2004, 31 December 2003 and 31 December 2002, the amount paid to signiﬁcant associates for these services was CHF 248 million, CHF 106 million and CHF 60 million, respectively. Fees received for services provided to associated companies for the years ended 31 December 2004, 31 December 2003 and 31 December 2002 was CHF 180 million, CHF 122 million and CHF 2 million, respectively. During 2003, UBS sold its VISA acquiring business to Telekurs Holding AG, an associated company. UBS realized a CHF 90 million gain from this divestment. Note 36 provides a list of signiﬁcant associates. d) Loans to private equity investees CHF million Balance at the beginning of the year Additions Reductions Balance at the end of the year 31.12.04 31.12.03 366 46 (222) 190 338 153 (125 ) 366 At 31 December 2004 and 31 December 2003, there were commitments and contingent liabilities to private equity compa- nies of CHF 36 million and CHF 23 million, respectively. In addition the Group purchased services from private equity compa- nies at arm’s length terms for the years ended 31 December 2004, 31 December 2003 and 31 December 2002 in the amount of CHF 0 million, CHF 14 million and CHF 116 million, respectively. e) Other related party transactions During 2004 and 2003, UBS entered into the following transactions at arm’s length with companies whose Chairman and / or CEO is an external member of the Board of Directors of UBS or of which an external director is a controlling shareholder. In 2004 and 2003 these companies included Bertarelli & Cie. (Switzerland), Kedge Capital Partners Ltd. (Jersey), J. Sains- bury plc. (UK), Serono Group (Switzerland), Team Alinghi (Switzerland), Unisys Corporation (USA). In addition to those men- tioned, related parties in 2004 also included BMW Group (Germany) and Stadler Rail Group (Switzerland). In 2003, related parties also included Sika AG (Switzerland). Other related party transactions 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 UBS1 2004 34 10 294 2003 43 7 79 1 In 2004, includes loans, guarantees and contingent liabilities of CHF 32 million and unused committed facilities of CHF 262 million but excludes unused uncommitted working capital facilities and unused guarantees of CHF 110 million. In 2003, includes loans, guarantees, contingent liabilities and committed credit facilities of CHF 58.5 million, but excludes uncommitted working capital facilities of CHF 119.6 million. As part of its sponsorship of Team Alinghi, defender for the “America’s Cup 2007”, UBS paid CHF 8.5 million (EUR 5.5 mil- lion) as sponsoring fee for 2004 and CHF 1.4 million (EUR 0.9 million) as sponsoring fee for the UBS Trophy in New Port, RI, USA. Team Alinghi’s controlling shareholder is UBS board member Ernesto Bertarelli. UBS also engages in trading and risk management activities (e.g. swaps, options, forwards) with related parties. These trans- actions may give rise to credit risk either for UBS or for a related party towards UBS. As part of its normal course of business, UBS is also a market maker in equity and debt instruments and at times may hold positions in instruments of related parties. 160 Note 34 Sales of Financial Assets in Securitizations During the years ended 31 December 2004, 2003 and 2002, UBS securitized (i.e., transformed owned ﬁnancial assets into securities through sales transactions) residential mortgage loans and securities, commercial mortgage loans and other ﬁnan- cial assets, acting as lead or co-manager. UBS’s continuing involvement in these transactions was primarily limited to the tem- porary retention of various security interests. Proceeds received at the time of securitization were as follows: CHF billion Residential mortgage securitizations Commercial mortgage securitizations Other ﬁnancial asset securitizations Proceeds received 31.12.04 31.12.03 31.12.02 91 3 9 131 4 2 143 4 6 Related pre-tax gains (losses) recognized, including unrealized gains (losses) on retained interests, at the time of securitiza- tion were as follows: CHF million Residential mortgage securitizations Commercial mortgage securitizations Other ﬁnancial asset securitizations Pre-tax gains / (losses) recognized 31.12.04 31.12.03 31.12.02 197 141 21 338 214 2 524 206 (5 ) At 31 December 2004 and 2003, UBS retained CHF 2.4 billion and CHF 3.8 billion, respectively, in agency residential mort- gage securities, backed by the Government National Mortgage Association (GNMA), the Federal National Mortgage Associ- ation (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC). The fair value of retained interests in residential mortgage securities is generally determined using observable market prices. Retained interests in other residential mortgage, commercial mortgage and other securities were not material at 31 December 2004 and 2003. Note 35 Post-Balance Sheet Events There have been no material post-balance sheet events which would require disclosure or adjustment to the 31 December 2004 Financial Statements. Bond issues have increased by CHF 991 million from the balance sheet date to 3 February 2005. On 3 February 2005, the Board of Directors reviewed the Financial Statements and authorized them for issue. These Fi- nancial Statements will be submitted to the Annual General Meeting of Shareholders to be held on 21 April 2005 for ap- proval. 161 Financial Statements Notes to the Financial Statements Note 36 Signiﬁcant Subsidiaries and Associates The legal entity group structure of UBS is designed to support the Group’s businesses within an efﬁcient legal, tax, regulato- ry and funding framework. Neither the Business Groups of UBS (namely Investment Bank, Wealth Management USA, Wealth Management & Business Banking and Global Asset Management) nor Corporate Center are replicated in their own individ- ual legal entities 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 cap- ital, comprehensive risk management and straightforward funding processes. Where, usually due to local legal, tax or regulatory 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 Banco UBS SA BDL Banco di Lugano BDL Banco di Lugano (Singapore) Ltd Brunswick UBS Ltd Cantrade Private Bank Switzerland (CI) Limited Crédit Industriel SA Ehinger & Armand von Ernst AG Factors AG Ferrier Lullin & Cie SA GAM Holding AG GAM Limited Giubergia UBS SIM SpA Noriba Bank BSC PaineWebber Capital Inc PT UBS Securities Indonesia SBC Wealth Management AG SBCI IB Limited SG Warburg & Co International BV Thesaurus Continentale Effekten-Gesellschaft in Zürich UBS (Bahamas) Ltd UBS (France) SA UBS (Italia) SpA UBS (Luxembourg) SA UBS (Monaco) SA UBS (Trust and Banking) Limited UBS Advisory and Capital Markets Australia Ltd UBS Alternative and Quantitative Investments LLC UBS Americas Inc UBS Asesores SA UBS Australia Limited UBS Bank (Canada) UBS Bank USA UBS Belgium SA / NV Jurisdiction of incorporation Rio de Janeiro, Brazil Lugano, Switzerland Singapore, Singapore George Town, Cayman Islands St. Helier, Jersey Zurich, Switzerland Zurich, Switzerland Zurich, Switzerland Geneva, Switzerland Zurich, Switzerland Hamilton, Bermuda Milan, Italy Manama, Bahrain Delaware, USA Jakarta, Indonesia Zug, Switzerland London, Great Britain Amsterdam, the Netherlands Zurich, Switzerland Nassau, Bahamas Paris, France Milan, Italy Luxembourg, Luxembourg Monte Carlo, Monaco Tokyo, Japan Sydney, Australia Delaware, USA Delaware, USA Panama, Panama Sydney, Australia Toronto, Canada Utah, USA Brussels, Belgium UBS Beteiligungs-GmbH & Co KG Frankfurt am Main, Germany UBS Capital (Jersey) Ltd UBS Capital AG St. Helier, Jersey Zurich, Switzerland Business Group 1 IB CC CC IB CC WM&BB CC WM&BB CC CC CC IB WM&BB WM-US IB CC IB IB WM&BB WM&BB WM&BB WM&BB WM&BB WM&BB Global AM IB Global AM IB WM&BB IB WM&BB WM-US WM&BB IB IB IB Share capital in millions Equity interest accumulated in % BRL CHF SGD USD GBP CHF CHF CHF CHF CHF USD EUR USD USD IDR CHF GBP GBP CHF USD EUR EUR CHF EUR JPY AUD USD USD USD AUD CAD USD EUR EUR GBP CHF 52.9 50.0 25.0 25.0 0.7 10.0 21.0 5.0 30.0 50.0 2.0 15.1 10.0 25.8 2 50,000.0 290.1 100.0 40.5 0.1 4.0 10.7 42.0 150.0 9.2 11,150.0 580.8 2 0.0 4,550.8 2 0.0 50.0 8.5 1,700.0 2 16.0 498.8 226.0 5.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 51.7 100.0 100.0 96.7 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 1 WM&BB: Wealth Management & Business Banking, Global AM: Global Asset Management, IB: Investment Bank, WM-US: Wealth Management USA, CC: Corporate Center, IH: Industrial Holdings. 2 Share Capital and Share Premium. 162 Business Group 1 Share capital in millions Equity interest accumulated in % Note 36 Signiﬁcant Subsidiaries and Associates (continued) Signiﬁcant subsidiaries (continued) Company 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 SpA UBS Card Center AG Jurisdiction of incorporation Delaware, USA George Town, Cayman Islands George Town, Cayman Islands Amsterdam, the Netherlands Delaware, USA George Town, Cayman Islands Delaware, USA Milan, Italy IB IB IB IB IB IB IB IB Glattbrugg, Switzerland WM&BB UBS Corporate Finance Italia SpA Milan, Italy UBS Corporate Finance South Africa (Proprietary) Limited Sandton, South Africa UBS Derivatives Hong Kong Limited UBS Employee Beneﬁts Trust Limited UBS Energy Canada Ltd. UBS Energy LLC Hong Kong, China St. Helier, Jersey Calgary, Canada Delaware, USA UBS Equity Research Malaysia Sdn Bhd Kuala Lumpur, Malaysia UBS España SA UBS Fiduciaria SpA UBS Fiduciary Trust Company UBS Finance (Cayman Islands) Ltd UBS Finance (Curação) NV UBS Finance (Delaware) LLC UBS Financial Services Inc. Madrid, Spain Milan, Italy New Jersey, USA George Town, Cayman Islands Willemstad, Netherlands Antilles Delaware, USA Delaware, USA UBS Financial Services Incorporated of Puerto Rico Hato Rey, Puerto Rico UBS Fund Advisor LLC UBS Fund Holding (Luxembourg) SA UBS Fund Holding (Switzerland) AG UBS Fund Management (Switzerland) AG UBS Fund Services (Cayman) Ltd UBS Fund Services (Ireland) Limited UBS Fund Services (Luxembourg) SA UBS Global Asset Management (Americas) Inc UBS Global Asset Management (Australia) Ltd UBS Global Asset Management (Canada) Co UBS Global Asset Management (France) SA Delaware, USA Luxembourg, Luxembourg Basel, Switzerland Basel, Switzerland George Town, Cayman Islands Dublin, Ireland Luxembourg, Luxembourg Delaware, USA Sydney, Australia Toronto, Canada Paris, France UBS Global Asset Management (Hong Kong) Limited Hong Kong, China UBS Global Asset Management (Italia) SIM SpA UBS Global Asset Management (Japan) Ltd Milan, Italy Tokyo, Japan UBS Global Asset Management (Singapore) Holdings Pte Ltd Singapore, Singapore UBS Global Asset Management (Taiwan) Ltd UBS Global Asset Management (US) Inc UBS Global Asset Management Holding Ltd UBS Global Life AG UBS Global Trust Corporation UBS International Holdings BV UBS International Inc UBS International Life Limited Taipei, Taiwan Delaware, USA London, Great Britain Vaduz, Liechtenstein St. John, Canada Amsterdam, the Netherlands New York, USA Dublin, Ireland IB IB IB CC IB IB IB WM&BB WM&BB WM-US CC CC IB WM-US WM-US WM-US Global AM Global AM Global AM Global AM Global AM Global AM Global AM Global AM Global AM WM&BB Global AM Global AM Global AM Global AM Global AM Global AM Global AM WM&BB WM&BB CC WM&BB WM&BB USD USD USD EUR USD USD USD EUR CHF EUR ZAR HKD CHF USD USD MYR EUR EUR USD USD USD USD USD USD USD CHF CHF CHF USD EUR CHF USD AUD CAD EUR HKD EUR JPY SGD TWD USD GBP CHF CAD EUR USD EUR 130.0 2 61.1 2 5.0 118.8 2 2.6 2 113.0 2 378.5 2 0.8 40.0 1.9 0.0 60.0 0.0 11.3 0.0 0.5 54.2 0.2 4.4 2 0.5 0.1 37.3 2 1,672.3 2 31.0 2 0.0 42.0 18.0 1.0 5.6 0.5 2.5 0.0 8.0 117.0 2.1 25.0 2.0 2,200.0 4.0 340.0 35.2 2 33.0 5.0 0.1 6.8 34.3 2 1.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 70.0 100.0 100.0 99.6 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 97.1 100.0 100.0 100.0 100.0 100.0 100.0 100.0 1 WM&BB: Wealth Management & Business Banking, Global AM: Global Asset Management, IB: Investment Bank, WM-US: Wealth Management USA, CC: Corporate Center, IH: Industrial Holdings. 2 Share Capital and Share Premium. 163 Financial Statements Notes to the Financial Statements Note 36 Signiﬁcant Subsidiaries and Associates (continued) Signiﬁcant subsidiaries (continued) Company UBS Invest Kapitalanlagegesellschaft mbH UBS Investment Bank AG UBS Investment Bank Nederland BV UBS Laing and Cruickshank Limited UBS Leasing AG UBS Life AG UBS Limited UBS Loan Finance LLC UBS Mortgage Holdings LLC UBS New Zealand Limited UBS O’Connor LLC 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 Preferred Funding Company LLC IV UBS Principal Finance LLC UBS Private Clients Australia Ltd UBS Real Estate Investments Inc UBS Real Estate Securities Inc UBS Realty Investors LLC UBS Securities (Thailand) Ltd UBS Securities Asia Limited UBS Securities Australia Ltd UBS Securities Canada Inc UBS Securities España Sociedad de Valores SA UBS Securities France SA UBS Securities Hong Kong Limited UBS Securities India Private Limited UBS Securities International Limited UBS Securities Japan Ltd UBS Securities Limited UBS Securities Limited Seoul Branch UBS Securities LLC UBS Securities Philippines Inc UBS Securities Singapore Pte Ltd UBS Services USA LLC UBS Securities South Africa (Proprietary) Limited UBS Trust (Canada) UBS Trust Company National Association UBS Trustees (Bahamas) Ltd UBS Trustees (Cayman) Ltd UBS Trustees (Jersey) Ltd UBS Trustees (Singapore) Limited UBS UK Holding Limited UBS Wealth Management AG Jurisdiction of incorporation Frankfurt am Main, Germany Frankfurt am Main, Germany Amsterdam, the Netherlands London, Great Britain Brugg, Switzerland Zurich, Switzerland London, Great Britain Delaware, USA Delaware, USA Auckland, New Zealand Delaware, USA California, USA Delaware, USA Delaware, USA Delaware, USA Delaware, USA Delaware, USA Delaware, USA Business Group 1 Global AM IB IB WM&BB WM&BB WM&BB IB IB WM-US IB Global AM WM-US IB CC CC CC CC IB Melbourne, Australia WM&BB Delaware, USA Delaware, USA Connecticut, USA Bangkok, Thailand Hong Kong, China Sydney, Australia Toronto, Canada Madrid, Spain Paris, France Hong Kong, China Mumbai, India London, Great Britain George Town, Cayman Islands London, Great Britain Seoul, South Korea Delaware, USA Makati City, Philippines Singapore, Singapore Delaware, USA Sandton, South Africa Toronto, Canada New York, USA Nassau, Bahamas George Town, Cayman Islands St. Helier, Jersey Singapore, Singapore London, Great Britain Frankfurt, Germany IB IB Global AM IB IB IB IB IB IB IB IB IB IB IB IB IB IB IB WM-US IB WM&BB WM-US WM&BB WM&BB WM&BB WM&BB IB WM&BB Share capital in millions 7.7 155.7 10.9 2.5 10.0 25.0 21.2 16.7 0.0 7.5 1.0 39.3 2 0.1 0.0 0.0 0.0 0.0 0.1 53.9 0.3 0.4 9.3 400.0 20.0 209.8 2 10.0 15.0 22.9 230.0 237.8 18.0 60,000.0 140.0 0.0 2,141.4 2 150.0 55.0 0.0 87.1 2 12.5 5.0 2 2.0 2.0 0.0 3.3 5.0 51.0 EUR EUR EUR GBP CHF CHF GBP USD USD NZD USD USD USD USD USD USD USD USD AUD USD USD USD THB HKD AUD CAD EUR EUR HKD INR GBP JPY GBP KRW USD PHP SGD USD ZAR CAD USD USD USD GBP SGD GBP EUR Equity interest accumulated in % 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 50.0 100.0 100.0 100.0 75.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 1 WM&BB: Wealth Management & Business Banking, Global AM: Global Asset Management, IB: Investment Bank, WM-US: Wealth Management USA, CC: Corporate Center, IH: Industrial Holdings. 2 Share Capital and Share Premium. 164 Note 36 Signiﬁcant Subsidiaries and Associates (continued) Signiﬁcant subsidiaries (continued) Company Motor-Columbus AG Aare-Tessin AG für Elektrizität 3 Atel Energia S. r. l. 3 Atel Installationstechnik AG 3 Entrade GmbH 3 GAH Beteiligungs AG 3 Società Elettrica Sopracenerina SA 3 Jurisdiction of incorporation Baden, Switzerland Olten, Switzerland Milan, Italy Olten, Switzerland Schaffhausen, Switzerland Heidelberg, Germany Locarno, Switzerland Business Group 1 IH IH IH IH IH IH IH Share capital in millions Equity interest accumulated in % CHF CHF EUR CHF CHF EUR CHF 253.0 303.6 20.0 30.0 0.4 25.0 27.5 55.6 33.0 32.3 33.0 24.7 33.0 19.6 1 WM&BB: Wealth Management & Business Banking, Global AM: Global Asset Management, IB: Investment Bank, WM-US: Wealth Management USA, CC: Corporate Center, IH: Industrial Holdings. 2 Share Capital and Share Premium. 3 Not wholly owned subsidiary controlled by Motor-Columbus which itself is only 55.6% owned by UBS. Consolidated companies: changes in 2004 Signiﬁcant new companies UBS Alternative and Quantitative Investments LLC – Delaware, USA UBS Energy Canada Limited – Calgary, Canada UBS Energy LLC – Delaware, USA UBS Fund Services (Ireland) Limited – Dublin, Ireland UBS Global Life AG – Vaduz, Liechtenstein UBS Laing and Cruickshank Limited – London, Great Britain UBS Securities Limited Seoul Branch – Seoul, South Korea UBS Services USA LLC – Delaware, USA Motor-Columbus AG – Baden, Switzerland Aare-Tessin AG für Elektrizität – Olten, Switzerland Atel Energia S.r.l. – Milan, Italy Atel Installationstechnik AG – Olten, Switzerland Entrade GmbH – Schaffhausen, Switzerland GAH Beteiligungs AG – Heidelberg, Germany Società Elettrica Sopracenerina SA – Locarno, Switzerland Deconsolidated companies Signiﬁcant deconsolidated companies UBS Finanzholding AG – Zurich, Switzerland Aventic AG – Zurich, Switzerland Signiﬁcant associates Company Electricité d’Emosson SA – Martigny, Switzerland Engadiner Kraftwerke AG – Zernez, Switzerland Kernkraftwerk Gösgen-Däniken AG – Däniken, Switzerland Kernkraftwerk Leibstadt AG – Leibstadt, Switzerland SIS Swiss Financial Services Group AG – Zurich, Switzerland Telekurs Holding AG – Zurich, Switzerland Azienda Energetica Municipale S.p.A. – Milan, Italy UBS Currency Portfolio Ltd – George Town, Cayman Islands UBS Global Equity Arbitrage Ltd – George Town, Cayman Islands O’Connor Proprietary Series – Currency and Rates, Fundamental Long / Short and Convertible Arbitrage Limited – George Town, Cayman Islands O’Connor Proprietary Series – Currency and Rates, Fundamental Long / Short and Convertible Arbitrage (EURO) Limited – George Town, Cayman Islands Volbroker.com Limited – London, Great Britain 1 Thereof paid in CHF 290.0 millions. 2 For Hedge Funds Net Asset Value instead of share capital. Industry Electricity Electricity Electricity Electricity Financial Financial Electricity Private Investment Company Private Investment Company Private Investment Company Private Investment Company Financial Reason for deconsolidation Merged Merged Equity interest in % Share capital in millions 16 7 13 9 33 33 2 18 37 44 51 21 CHF CHF CHF CHF CHF CHF EUR 140 140 350 1 450 26 45 930 USD 1 ,831 2 USD 929 2 USD 506 2 EUR GBP 153 2 18 165 Financial Statements Notes to the Financial Statements Note 37 Invested Assets and Net New Money Invested assets include all client assets managed by or deposit- ed with UBS for investment purposes only. They therefore ex- clude all assets held for purely transactional purposes. Assets included are, for example, managed fund assets, managed in- stitutional assets, discretionary and advisory wealth manage- ment portfolios, ﬁduciary deposits, time deposits, savings ac- counts and wealth management securities or brokerage accounts. Custody-only assets and transactional cash or cur- rent accounts as well as non-bankable assets (e. g. art collec- tions) and deposits from third-party banks for funding or trading purposes are excluded. Discretionary assets are deﬁned as those where the bank decides on how a client’s assets are invested. Other invested assets are those where the client decides on how the assets are invested. When a single product is created in one Business Group and sold in another, it is counted in both the Business Group that does the investment management and the one that distributes it. This results in double counting within UBS total invested assets, as both Business Groups are providing a service independently to their respective clients, and both add value and generate revenue. Net new money is the net amount of invested assets that are acquired by the bank from new clients, invested assets that are lost when clients terminate their relationship with UBS and the inﬂows and outﬂows of invested assets from existing UBS clients. Interest and dividend income from invested assets is not included in the net new money result. Market and currency movements are also excluded, as are the effects resulting from any acquisition or divestment of a UBS subsidiary or business. Interest expense on loans results in net new money outﬂows. CHF billion Fund assets managed by UBS Discretionary assets Other invested assets Total invested assets thereof double count Net new money 31.12.04 31.12.03 354 570 1,326 2,250 294 88.9 339 507 1,287 2,133 283 69.1 166 Note 38 Business Combinations During 2004, UBS completed several acquisitions that were ac- counted for as business combinations. Except Motor-Colum- bus, which is discussed separately, none of the acquisitions was individually signiﬁcant to the ﬁnancial statements, and there- fore, they are presented aggregated per Business Group. Wealth Management In the ﬁrst quarter of 2004, UBS acquired the private banking operations of Lloyds Bank S.A., France, and the private client business of Merrill Lynch in Germany and Austria. The two businesses together had invested assets of approximately CHF 3.3 billion at the date of acquisition. Both businesses have been integrated into the local UBS Wealth Management op- erations and helped to signiﬁcantly increase the client base in France and Germany. In the second quarter of 2004, UBS acquired Laing & Cruickshank and Scott Goodman Harris, both British ﬁrms. Laing & Cruickshank, acquired for a consideration of approx- imately CHF 363 million, provides comprehensive wealth man- agement services to high net worth investors and charities. 75 client advisors looked after invested assets of approximately CHF 11.4 billion, which doubled the size of UBS’s wealth man- agement operations in the United Kingdom. Scott Goodman Harris provides advice on pension and retirement benefit products, serving primarily executives and company directors with 28 employees. Subsequent to the acquisition both ﬁrms have been integrated into the UBS wealth management op- erations in the UK. In fourth quarter 2004, UBS acquired Sauerborn Trust AG (Sauerborn), an independent German ﬁrm providing ﬁnancial advisory services to individuals in the ultra-high net worth seg- ment. Sauerborn has approximately CHF 9.4 billion of assets under management. UBS has merged its ultra-high net worth segment within the German wealth management business with the operations of Sauerborn to provide an expanded range of services and products to its clients and reap the ben- eﬁts of synergies. UBS paid a cash consideration of approxi- mately CHF 140 million (EUR 91 million) at closing, and will pay a further CHF 65 million (EUR 42 million) in three equal installments over the next two years. The aggregate purchase price for the ﬁve acquisitions is ap- proximately CHF 696 million and has been allocated to ac- quired net assets at fair value of CHF 175 million. The differ- ence of CHF 521 million to the purchase price has been recognized as goodwill. Details of assets and liabilities recog- nized are as follows: CHF million Assets Intangible assets Property and equipment Financial Investments Goodwill All other assets Total assets Liabilities Provisions Deferred tax liabilities All other liabilities Total liabilities Net assets Total liabilities and equity Book value Step-up to fair value Fair value 0 3 5 0 260 268 5 0 178 183 85 268 162 (1 ) 0 521 2 684 19 54 0 73 611 684 162 2 5 521 262 952 24 54 178 256 696 952 Intangible assets recognized relate to the businesses’ existing customer relationships and have been assigned useful lives of twenty years, over which they will be amortized. 167 Financial Statements Notes to the Financial Statements Note 38 Business Combinations (continued) Investment Bank In fourth quarter 2004, UBS acquired Charles Schwab Sound- View Capital Markets, the capital markets division of Charles Schwab Corp. (Schwab), for an aggregate cash consideration of approximately CHF 304 million. The business comprises eq- uities trading and sales, including a third-party execution busi- ness, along with Schwab’s NASDAQ trading system. This busi- ness handles over 200 million shares a day in trade volume and makes a market in over 11,000 stocks. As part of the ac- quisition, UBS and Schwab have entered into multi-year exe- cution service agreements for the handling of Schwab’s equi- ties and listed options orders. The business was integrated in the Equities business of UBS’s Investment Bank. Also in fourth quarter 2004, UBS acquired Brunswick Cap- ital’s 50% stake in Brunswick UBS, an equity brokerage and trading, investment banking and custody joint venture in Rus- sia in which UBS and Brunswick Capital were equal partners. The total purchase price has been estimated at approximate- ly CHF 203 million, of which UBS paid at closing a cash con- sideration to the sellers of CHF 113 million (USD 99 million) and will pay a further CHF 75 million (USD 66 million) at the end of 2005 plus 20% of Brunswick UBS’s net proﬁts for 2005. Formed in 1997, Brunswick UBS has developed a signiﬁcant franchise in the Russian securities market, employing 120 peo- ple in Moscow. UBS has already consolidated Brunswick, so that the effects of this acquisition on the ﬁnancial statements are minor. The aggregate purchase price for the two businesses is ap- proximately CHF 507 million, a portion of which includes a de- ferred component linked to future results of operations. Ac- cordingly, a revision of the current purchase price estimate will be made, if necessary, once ﬁnal payments have been deter- mined. The purchase price has been allocated to net assets acquired of CHF 198 million, which includes a revaluation of CHF 27 million related to UBS’s existing interest in Brunswick. The difference of CHF 336 million to the purchase price has been recognized as goodwill. Details of assets and liabilities recognized are as follows: CHF million Assets Intangible assets Property and equipment Financial investments Deferred tax assets Goodwill All other assets Total assets Liabilities Deferred tax liabilities All other liabilities Total liabilities Minority interests Equity Total liabilities, minority interests and equity Book value Step-up to fair value Fair value 21 20 99 37 – 361 538 – 364 364 40 134 538 133 (13 ) (2 ) (37 ) 336 (1 ) 416 23 32 55 (39 ) 400 416 154 7 97 – 336 360 954 23 396 419 1 534 954 Intangible assets recognized relate to the businesses’ existing customer relationships and have been assigned useful lives of ﬁve years in the case of Brunswick and eight years in the case of Schwab over which they will be amortized. 168 Note 38 Business Combinations (continued) Notz Stucki In the ﬁrst quarter of 2004, Ferrier Lullin, one of UBS’s private label banks, acquired Notz Stucki & Co., a small private bank in Geneva. The activities have been integrated into the oper- ations of Ferrier Lullin. The purchase price of CHF 42 million was allocated to net tangible assets of CHF 22 million, and Notz Stucki’s customer base of CHF 21 million, less deferred taxes of CHF 5 million. The difference of CHF 4 million to the purchase price was recognized as goodwill. Motor-Columbus On 1 July 2004, UBS acquired from RWE, a German utilities company, its 20% ownership interest in Motor-Columbus AG (Motor-Columbus) for a cash consideration, including inciden- tal acquisition costs, of approximately CHF 379 million. UBS now holds a 55.6% majority interest in Motor-Columbus, a Swiss holding company whose most signiﬁcant asset is an ap- proximate 59.3% ownership interest in Aare-Tessin AG für Elektrizität (Atel), a Swiss group engaged in the production, distribution and trading of electricity. UBS now consolidates Motor-Columbus and treated the acquisition of the 20% ownership interest as a business com- bination. The purchase price was allocated to acquired net as- sets of approximately CHF 260 million and the difference of CHF 119 million to the purchase price was recognized as goodwill. In accordance with IFRS 3, the existing 35.6% in- terest in Motor-Columbus was revalued to the valuation ba- sis established at 1 July 2004, resulting in a revaluation amount of approximately CHF 81 million (CHF 63 million net of de- ferred tax liabilities), which was recorded directly in equity. The minority interests were also revalued to the new valuation ba- sis, so that assets acquired and liabilities assumed are carried at full fair value. Details of assets, liabilities and minority in- terests, for which a step-up to fair value was recognized in pur- chase accounting, and all other assets and liabilities recog- nized at carryover basis are as follows: CHF million Assets Intangible assets Property and equipment Investments in associates Financial investments Deferred tax assets All other assets Total assets Liabilities Provisions Debt issued Deferred tax liabilities All other liabilities Total liabilities Minority interests Equity Total liabilities, minority interests and equity The CHF 75 million step-up to fair value of provisions relates to contingent liabilities arising from guarantees and certain contractual obligations. UBS’s share in the equity at fair value of CHF 1,299 million is CHF 723 million, while the remaining CHF 576 million is recognized as additional minority interests, bringing total minority interest as of the acquisition date to CHF 1,742 million. Book value Step-up to fair value Fair value 444 1,939 655 621 113 2,629 6,401 835 700 293 3,045 4,873 784 744 6,401 750 144 367 19 67 – 1,347 75 27 308 – 410 382 555 1,347 1,194 2,083 1,022 640 180 2,629 7,748 910 727 601 3,045 5,283 1,166 1,299 7,748 Useful economic lives between 4 and 25 years have been assigned to amortizable and depreciable assets based on con- tractual lives, where applicable, or estimates of the period dur- ing which the assets will beneﬁt the operations. 169 Financial Statements Notes to the Financial Statements Note 38 Business Combinations (continued) Pro-forma information (unaudited) The following pro-forma information shows UBS’s total oper- ating income, net proﬁt and basic earnings per share as if all of the above acquisitions had been made as at 1 January 2004 and 2003, respectively. Adjustments have been made to re- ﬂect additional amortization and depreciation of assets and liabilities, which have been assigned fair values different from their carryover basis in purchase accounting. CHF million, except where indicated Total operating income Net proﬁt Basic earnings per share (CHF) Note 39 Currency Translation Rates For the year ended 31.12.04 44,812 8,112 7.71 31.12.03 39,536 6,277 5.62 The following table shows the principal rates used to translate the ﬁnancial statements of foreign entities into Swiss francs: Spot rate As at Average rate Year ended 31.12.04 31.12.03 31.12.04 31.12.03 31.12.02 1.14 1.55 2.19 1.11 1.24 1.56 2.22 1.15 1.24 1.54 2.27 1.15 1.34 1.54 2.20 1.16 1.54 1.46 2.33 1.24 1 USD 1 EUR 1 GBP 100 JPY 170 Note 40 Swiss Banking Law Requirements The consolidated ﬁnancial statements of UBS are prepared in accordance with International Financial Reporting Standards. Set out below are the signiﬁcant differences regarding recog- nition and measurement between IFRS and the provisions of the Banking Ordinance and the Guidelines of the Swiss Banking Commission governing ﬁnancial statement reporting pursuant to Article 23 through Article 27 of the Banking Ordinance. 1. Consolidation Under IFRS, entities which are directly or indirectly controlled by the Group are consolidated. Temporarily controlled entities that are acquired and held with a view to their subsequent disposal, are recorded as Financial investments. der 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 Shareholders’ 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 ef- fective portion of the derivative instruments used to hedge cash ﬂow exposures are deferred on the balance sheet as as- sets or liabilities. The deferred amounts are released to income when the hedged cash ﬂows occur. 4. Investment property Under IFRS, investment properties are carried at fair value. Under Swiss law, only entities that are active in the ﬁeld of banking and ﬁnance as well as real estate entities are subject to consolidation. Entities which are held temporarily are recorded as Financial investments. Under Swiss law, investment properties are carried at the lower of cost less accumulated depreciation or market value. Depreciations on investment properties are continued until a sale is executed. 2. Financial investments Under IFRS, available-for-sale ﬁnancial investments are carried at fair value. Changes in fair value are recorded directly in 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 determined to be impaired, the cumulative unrealized loss previously recognized in Shareholders’ equity is included in net proﬁt or loss for the period. On disposal of a ﬁnancial invest- ment, the difference between the net disposal proceeds and the carrying amount plus any attributable unrealized gain or loss balance recognized in 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 be- low cost and reversals of such reductions as well as gains and losses on disposal are included in Other income. 3. Cash ﬂow hedges The Group uses derivative instruments to hedge against the exposure from varying cash ﬂows receivable and payable. Un- 5. Fair value option Under IFRS, the Group applies the fair value option to hybrid instruments issued. As a result the embedded derivative as well as the host contract related to the hybrid instrument are marked to market. Under Swiss law, the fair value option is not available. Hy- brid instruments are bifurcated: while the embedded deriva- tive is marked to market, the host contract is accounted for on an accrued cost basis. 6. Goodwill Under IFRS, goodwill acquired in business combinations en- tered into after 31 March 2004 is not amortized, but tested annually for impairment. Intangible assets acquired in business combinations entered into after 31 March 2004 to which an indeﬁnite useful life has been assigned, are not amortized but tested annually for impairment. Under Swiss law, goodwill and intangible assets with in- deﬁnite useful lives must be amortized over a period not ex- ceeding ﬁve years, unless a longer useful life, which may not exceed twenty years, can be justiﬁed. 171 Financial Statements Notes to the Financial Statements Note 41 Reconciliation of International Financial Reporting Standards (IFRS) to United States Generally Accepted Accounting Principles (US GAAP) Note 41.1 Valuation and Income Recognition Differences between IFRS and US GAAP The consolidated ﬁnancial statements of UBS have been pre- pared in accordance with IFRS. The principles of IFRS differ in certain respects from United States Generally Accepted Ac- counting Principles (“US GAAP”). The following is a summa- ry of the relevant signiﬁcant accounting and valuation differ- ences between IFRS and US GAAP. a. Purchase accounting (merger of Union Bank of Switzerland and Swiss Bank Corporation) due to recognition of deferred tax assets of Swiss Bank Cor- poration which had previously been subject to valuation re- serves. 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. Under IFRS, the 1998 merger of Union Bank of Switzerland and Swiss Bank Corporation was accounted for under the uniting of interests method. The balance sheets and income statements of the banks were combined, and no adjustments were made to the carrying values of the assets and liabilities. Under US GAAP, the business combination creating UBS AG is accounted for under the purchase method with Union Bank of Switzerland being considered the acquirer. Under the pur- chase method, the cost of acquisition is measured at fair val- ue and the acquirer’s interests in identiﬁable tangible assets and liabilities 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 iden- tiﬁable intangible assets based on their fair values, if deter- minable, with the remainder allocated to goodwill. Goodwill and intangible assets For US GAAP purposes, the excess of the consideration paid for Swiss Bank Corporation over the fair value of the net tan- gible assets received has been recorded as goodwill and was amortized on a straight-line basis using a weighted average life of 13 years from 29 June 1998 to 31 December 2001. Under US GAAP until 31 December 2001, goodwill ac- quired before 30 June 2001 was capitalized and amortized over its estimated useful life with adjustments for any impair- ment. On 1 January 2002, UBS adopted SFAS 141, “Business Combinations” and SFAS 142, “Goodwill and Other Intan- gible Assets”. SFAS 141 requires reclassiﬁcation of intangi- ble assets to goodwill which no longer meet the recognition criteria under the new standard. SFAS 142 requires that goodwill and intangible assets with indeﬁnite lives no longer be amortized but be tested annually for impairment. Identi- ﬁable intangible assets with ﬁnite lives will continue to be amortized. Upon adoption, the amortization charges relat- ed to the 1998 business combination of Union Bank of Switzerland and Swiss Bank Corporation ceased to be record- ed under US GAAP. In 2004 and 2003, goodwill recorded under US GAAP was reduced by CHF 78 million and CHF 39 million respectively, b. Reversal of IFRS goodwill amortization The adoption of SFAS 142 “Goodwill and Intangible 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 1 January 2002 were reclassiﬁed to Goodwill for US GAAP; 2) The amortization of IFRS Goodwill and the Intangible as- sets reclassiﬁed to Goodwill for US GAAP (CHF 778 million, CHF 831 million and CHF 1,017 million for the years ended 31 December 2004, 31 December 2003 and 31 December 2002, respectively) was reversed. With the adoption of IFRS 3 Business Combinations, UBS will cease amortizing pre-existing Goodwill under IFRS begin- ning 1 January 2005. Goodwill will be subject to an annual impairment test as it is under US GAAP, and there will no longer be a difference between the two sets of standards re- garding goodwill amortization. Goodwill from business com- binations entered into on or after 31 March 2004 has already been accounted for under the provisions of IFRS 3, and no Goodwill amortization has been recorded for these transac- tions under IFRS or US GAAP. c. Purchase accounting under IFRS 3 and FAS 141 With the adoption of IFRS 3 on 31 March 2004, the account- ing for business combinations generally converged with US GAAP with the exception of the measurement of minority in- terests and the recognition of a revaluation reserve in the case of a step acquisition. Under IFRS, minority interests are recognized at the per- centage of fair value of identiﬁable net assets acquired at the acquisition date whereas under US GAAP they are recognized at the percentage of book value of identiﬁable net assets ac- quired at the acquisition date. In most cases, minority inter- ests would tend to have a higher measurement value under IFRS than under US GAAP. Furthermore, IFRS requires that in a step acquisition the ex- isting ownership interest in an entity be revalued to the new valuation basis established at the time of acquisition. The in- crease in value is recorded directly in equity as a revaluation 172 reserve. Under US GAAP, the existing ownership interest re- mains at its original valuation. d. Derivative instruments Under IAS 39, UBS hedges interest rate risk based on forecast cash inﬂows and outﬂows on a Group basis. For this purpose, UBS accumulates information about non-trading ﬁnancial as- sets and ﬁnancial liabilities, which is then used to estimate and aggregate cash ﬂows and to schedule the future periods in which these cash ﬂows are expected to occur. Appropriate de- rivative instruments are then used to hedge the estimated fu- ture cash ﬂows against repricing risk. SFAS 133 does not per- mit hedge accounting for hedges of future cash flows determined by this methodology. Accordingly, for US GAAP such hedging instruments continue to be carried at fair value with changes in fair value recognized in Net trading income. In addition, amounts deferred under hedging relationships prior to the adoption of IAS 39 on 1 January 2001 that do not qualify as hedges under current requirements under IFRS are amortized to income over the remaining life of the hedging relationship. Such amounts have been reversed for US GAAP as they have never been treated as hedges. e. Financial investments and private equity Financial investments available-for-sale Three exceptions exist between IFRS and US GAAP in account- ing for ﬁnancial investments available-for-sale: 1) Non-mar- ketable equity ﬁnancial investments (excluding private equi- ty investments discussed below), which are classified as available-for-sale and carried at fair value under IFRS, contin- ue to be carried at cost less “other than temporary” impair- ments under US GAAP. The opening adjustment and subse- quent changes in fair value recorded directly in Shareholders’ equity on non-marketable equity ﬁnancial instruments due to the implementation of IAS 39 have been reversed under US GAAP to reﬂect the difference between the two standards in measuring such investments. 2) Writedowns on impaired debt instruments can be fully or partially reversed under IFRS if the value of the impaired assets increases. Such reversals of im- pairment writedowns are not allowed under US GAAP. Rever- sals under IFRS were not signiﬁcant in 2004, 2003 or 2002. 3) Private equity investments, as described in the next section. Private equity investments UBS accounts for private equity investments as available-for- sale securities in its primary Financial Statements under IFRS, with changes in fair value recognized in Shareholders’ equi- ty. Under US GAAP, all of these investments were accounted for at cost less “other than temporary” impairments prior to 1 January 2002. On 1 January 2002, UBS adopted the provisions of 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 previously con- tained in Accounting Research Bulletin 51 “Consolidated Fi- nancial Statements” as amended by SFAS 94 “Consolidation of All Majority-Owned Subsidiaries”. Therefore, on adopting SFAS 144, UBS changed its US GAAP accounting for certain private equity investments by accounting for those invest- ments 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 purposes is that certain private equity invest- ments are now recorded at fair value, with changes in fair val- ue recognized in US GAAP net proﬁt. The remaining private equity investments continue to be accounted for at cost less “other than temporary” impairment. For the IFRS to US GAAP reconciliation, fair value adjust- ments on certain private equity investments recorded direct- ly 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 in- crease of CHF 639 million, after tax. For the years ended 31 December 2004, 31 December 2003 and 31 December 2002, the effect of applying the new standard on the reconciliation of IFRS net proﬁt to US GAAP was to increase US GAAP net proﬁt by CHF 154 million after tax, decrease US GAAP net proﬁt by CHF 119 million, after tax and to increase US GAAP net proﬁt by CHF 83 million, after tax, respectively. The pro-forma Net proﬁt assuming that the change in ac- counting principle were applied retroactively would be as fol- lows: CHF million, except for per share data For the year ended Net proﬁt under US GAAP Basic earnings per share Diluted earnings per share 31.12.04 31.12.03 8,818 8.56 8.15 6,513 5.83 5.72 Pro-forma 31.12.02 4,907 4.06 3.99 See Note 2 for information regarding impairment charges recorded for private equity investments. 173 Financial Statements Notes to the Financial Statements f. Pension plans Under IFRS, UBS recognizes pension expense based on a spe- ciﬁc method of actuarial valuation used to determine the pro- jected plan liabilities for accrued service, including future ex- pected salary increases, and expected return on plan assets. Plan assets are recorded at fair value and are held in a sepa- rate trust to satisfy plan liabilities. Under IFRS the recognition of a prepaid asset is subject to certain limitations, and any un- recognized prepaid asset is recorded as pension expense. US GAAP does not allow a limitation on the recognition of pre- paid assets recorded in the balance sheet. Under US GAAP, pension expense is based on the same ac- tuarial method of valuation of liabilities 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 beneﬁt obligation (which is the cur- rent 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 prior service cost. Any amount not recognized as an intangible asset is reported in Other com- prehensive income. The additional minimum liability required un- der US GAAP amounts to CHF 1,125 million, CHF 306 million and CHF 1,225 million as at 31 December 2004, 2003 and 2002, respectively. The amount recognized in intangible assets was CHF 0 million, CHF 0 million and CHF 2 million and the amount rec- ognized in Other comprehensive income before tax was CHF 1,125 million, CHF 306 million and CHF 1,223 million as at 31 December 2004, 2003 and 2002, respectively. g. Other post-retirement beneﬁt plans Under IFRS, UBS has recorded expenses and liabilities for post-retirement medical and life insurance beneﬁts, deter- mined under a methodology similar to that described above under pension plans. Under US GAAP, expenses and liabilities for post-retirement medical and life insurance beneﬁts are determined under the same methodology as under IFRS. Differences in the levels of ex- penses and liabilities have occurred due to different transition date rules and the treatment of the merger of Union Bank of Switzer- land and Swiss Bank Corporation under the purchase method. h. Equity participation plans As of the reporting date, IFRS does not have any standard in effect that speciﬁcally addresses the recognition and measure- ment requirements for equity participation plans. US GAAP permits the recognition of compensation cost based on the grant date fair value of equity instruments is- sued (SFAS 123) or based on the intrinsic value of equity in- struments issued (Accounting Principles Board “APB” No. 25). If an entity elects to apply the APB 25 intrinsic value method they must provide pro forma disclosures of net prof- it and earnings per share, as if the fair value based method described in SFAS 123 had been applied. Under IFRS, UBS rec- ognizes the intrinsic value of equity instruments issued meas- ured at the grant date. No subsequent changes in value are recognized. Under US GAAP, UBS applies the APB No. 25 in- trinsic value method, which requires adjustments to intrinsic values subsequent to the grant date in certain circumstances. Prior to January 2004, certain equity compensation trusts were consolidated under US GAAP. With the adoption of FIN 46-R, “Consolidation of Variable Interest Entities” on 1 Jan- uary 2004, the remaining unconsolidated employee equity compensation trusts formed before 1 February 2003 were consolidated for US GAAP purposes for the ﬁrst time. The ef- fect of the trust consolidations is to increase assets by CHF 1,175 million and CHF 460 million and liabilities by CHF 1,175 million and CHF 483 million at 31 December 2004 and 31 De- cember 2003 respectively. With the consolidation of the additional trusts under FIN 46-R, UBS has re-evaluated its accounting for share-based compensation plans under APB 25 by taking into considera- tion the settlement methods and activities of the trusts. Based on this review, most share plans issued prior to 2001 are now treated as variable awards under APB 25. There were no changes to the accounting for option plans. On 1 January 2004, a CHF 6 million expense reduction was recorded as a cumulative adjustment due to a change in accounting. For the year ended 31 December 2004, CHF 67 million in expense was recorded in the US GAAP income statement for these variable plans. In addition, prior to the adoption of FIN 46-R, certain of UBS’s option awards had been determined to be variable pur- suant to APB No. 25, primarily because they may be settled in cash or because UBS has offered to hedge the value of the award. The effect of applying variable accounting to these op- tion awards in the US GAAP reconciliation for the years end- ed 31 December 2004, 2003 and 2002, is a CHF 10 million increase in compensation expense, CHF 28 million increase in compensation expense and CHF 51 million decrease in com- pensation expense, respectively. In addition, certain of UBS’s share plans have been deemed variable under APB No. 25. Ad- ditional expense was also recorded related to social tax pay- ments on equity instruments recorded directly in Sharehold- ers’ equity for IFRS. For US GAAP, the net effect of these transactions is an increase to compensation expense of CHF 27 million, an increase to compensation expense of CHF 118 million and a decrease to compensation expense of CHF 12 million, for the years ended 31 December 2004, 2003 and 2002, respectively. 174 i. Software capitalization Under IFRS, effective 1 January 2000, certain costs associat- ed with the acquisitions or development of internal-use soft- ware had to be capitalized. Once the software was ready for its intended use, the costs capitalized were amortized to the income statement over the estimated life of the software. Un- der US GAAP, the same principle applied, however this stan- dard was effective 1 January 1999. For US GAAP, the costs as- sociated with the acquisition or development of internal-use software that met the US GAAP software capitalization crite- ria in 1999 were reversed from Operating expenses and amor- tized over a life of two years from the time that the soft- ware was ready for its intended use. From 1 January 2000, the only remaining reconciliation item was the amortization of software capitalized in 1999 for US GAAP purposes. At 31 December 2002, this amount was fully utilized and there is no longer a difference between IFRS and US GAAP. j. Consolidation of Variable Interest Entities (VIEs) and deconsolidation of trust preferred securities IFRS and US GAAP generally require consolidation of entities on the basis of controlling a majority of voting rights. How- ever, in certain situations, there are no voting rights, or con- trol of a majority of voting rights is not a reliable indicator of the need to consolidate, such as when voting rights are sig- niﬁcantly disproportionate to risks and rewards. There are dif- ferences in the approach of IFRS and US GAAP to those situ- ations. Under IFRS, when control is exercised through means oth- er than controlling a majority of voting rights, the consolida- tion assessment is based on the substance of the relationship. Indicators of control in these situations include: predetermi- nation of the entity’s activities; the entity’s activities being con- ducted on behalf of the enterprise; decision-making powers being held by the enterprise; the right to obtain the majority of the beneﬁts or be exposed to the risks inherent in the ac- tivities of the entity; or retaining the majority of the residual or ownership risks related to the entity’s assets in order to ob- tain beneﬁts from its activities. Under US GAAP, consolidation considerations are subject to FASB interpretation No. 46, “Consolidation of Variable In- terest Entities (revised December 2003)”, an interpretation of Accounting Research Bulletin No. 51 (FIN 46-R). FIN 46-R re- quires that when voting interests do not exist, or differ signif- icantly from economic interests, an entity is considered to be a “Variable Interest Entity” (“VIE”). An enterprise holding vari- able interests that will absorb a majority of a VIE’s “expected losses”, receive a majority of a VIE’s “expected residual re- turns”, or both, is known as the “primary beneﬁciary”, and must consolidate the VIE. From 1 January 2004 UBS has fully applied FIN 46-R con- solidation requirements to its US GAAP ﬁnancial statements. At 31 December 2003, the consolidation requirements of the predecessor standard, FIN 46, only applied to VIEs created after 31 January 2003. In many cases the assessment of consolidation under IFRS and US GAAP is the same, however, there are certain differ- ences. The entities consolidated for US GAAP purposes at 31 De- cember 2004, which were not otherwise consolidated in UBS’s primary consolidated Financial Statements under IFRS, are mostly investment fund products, securitization VIEs, and employee equity compensation trusts. These are discussed in more detail in Note 42.1. The entities not consolidated for US GAAP purposes, which UBS consolidates under IFRS, are certain trusts which have is- sued trust preferred securities. Under IFRS these are equity in- struments held by third parties and are treated as minority in- terests, with dividends paid also reported in minority interests; under US GAAP the securities are treated as debt, with inter- est paid reported in interest expense. A discussion of FIN 46-R measurement requirements and disclosures is set out in Note 42.1. k. Financial liabilities held at fair value through proﬁt and loss Revised IAS 39 provides the election to designate at initial recognition any ﬁnancial asset or liability as held at fair value through proﬁt and loss. UBS applies this fair value designa- tion election to a signiﬁcant portion of its issued debt. Many debt issues are in the form of hybrid instruments, consisting of a debt host with an embedded derivative. Regular debt in- struments as well as hybrid instruments are carried in their en- tirety at fair value with all changes in fair value recorded in proﬁt and loss. Under US GAAP, debt instruments have to be carried at amortized cost. Derivatives embedded in hybrid in- struments are separated from the debt hosts and accounted for as if they were freestanding derivatives. l. Physically settled written puts With the adoption of revised IAS 32 and IAS 39 at 1 January 2004, the accounting for physically settled written put options on UBS shares changed. Previously, such put options were ac- counted for as derivatives whereas now the present value of the contractual amount is recorded as a liability, while the pre- mium received is credited to equity. Subsequently, the liabili- ty is accreted over the life of the put option to its contractu- al amount recognizing interest expense in accordance with the effective interest method. Under US GAAP, physically settled written put options on UBS shares continue to be accounted for as derivative instruments. All other outstanding derivative contracts, except written put options with the UBS share as underlying, are treated as derivative instruments under both sets of accounting standards. 175 Financial Statements Notes to the Financial Statements m. Investment properties As at 1 January 2004, UBS changed its accounting for in- vestment properties from the cost less depreciation method to the fair value method. Under the fair value method, changes in fair value are recognized in the income statement, and depreciation is no longer recognized. Under US GAAP, in- vestment properties continue to be carried at cost less accu- mulated depreciation. Note 41.2 Recently Issued US Accounting Standards In December 2003, the “Medicare Prescription Drug, Im- provement and Modernization Act of 2003” (the Act) was passed in the US. Commencing 1 January 2006, the Act in- troduces a prescription drug beneﬁt for individuals eligible un- der Medicare (Medicare Part D) as well as a federal subsidy equal to 28% of certain post-65 prescription drug claims for sponsors of retiree health care plans with drug beneﬁts that are at least actuarially equivalent to those to be offered un- der Medicare Part D. Pursuant to the guidance included in FASB Staff Position FAS 106-1 (FSP 106-1), the Group chose to defer recognition of the potential effects of the Act in its 2003 Financial State- ments due to the lack of authoritative accounting guidance concerning certain technical matters. In May 2004, the FASB issued FASB Staff Position FAS 106- 2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (FSP 106-2) which supersedes FSP 106-1. FSP106- 2 requires plan sponsors to account for the effect of the sub- sidy on beneﬁts attributable to past service as an unrecognized actuarial gain and as a reduction of the service cost compo- nent of the net periodic post-retirement costs for amounts at- tributable to current service if prescription drug beneﬁts avail- able under the plan are actuarially equivalent to those under Medicare Part D for 2006. UBS believes that the US health care plans will be eligible for the subsidy and prospectively adopt- ed FSP 106-2 on 1 July 2004. The adoption of FSP 106-2 did not have a material effect on UBS’s Financial Statements. In December 2003, the FASB issued revised SFAS 132 “Em- ployers’ Disclosures about Pensions and Other Postretirement Beneﬁts” (SFAS 132-R). SFAS 132-R retains the disclosure re- quirements included in SFAS 132, Employers’ Disclosures about Pensions and Other Postretirement Beneﬁts, which it replaces. SFAS 132-R requires additional disclosures to those in SFAS 132 regarding the assets, obligations, cash ﬂows and net periodic beneﬁt cost of deﬁned beneﬁt pension plans and other deﬁned beneﬁt postretirement plans. Except for certain disclosures relating to foreign plans and disclosures regarding the estimated future beneﬁt payments prescribed in SFAS 132-R, SFAS 132-R was effective for ﬁnancial statements with ﬁscal years ending after 15 December 2003. The remaining additional disclosures regarding foreign plans and the estimat- ed future beneﬁt payments disclosures are effective for ﬁnan- cial statements with ﬁscal years ending after 15 June 2004. 176 UBS elected to adopt early the additional disclosures required for foreign plans as well as the prescribed SFAS 132-R disclo- sures in its 2003 Financial Statements. Pursuant to the tran- sitional disclosure requirements, UBS included the disclosure of the estimated future beneﬁt payments for the year ended 31 December 2004 in Note 31, Pension and Other Post-Re- tirement Beneﬁt Plans. In November 2003, the FASB’s Emerging Issues Task Force (EITF) issued EITF 03-1, “The Meaning of Other-Than-Tempo- rary Impairment and Its Application to Certain Investments”. The EITF reached a consensus regarding certain qualitative and quantitative disclosures for debt and marketable equity secu- rities classiﬁed as available-for-sale or held to maturity under SFAS 115 and 124 that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. UBS provided the required EITF 03-1 disclo- sures in Note 12 of the 2003 Financial Statements. In March 2004, the EITF reached a consensus on an other- than-temporary impairment model for debt and equity secu- rities classiﬁed as available-for-sale or held to maturity under SFAS 115 and 124 and equity securities held under the cost method. This EITF consensus would have been effective for interim and annual reporting periods beginning after 15 June 2004. In September 2004, the FASB staff issued FSP 03-1-1, “Effective Date of Paragraphs 10-20 of EITF 03-1, The Mean- ing of Other Than Temporary Impairment”, which delayed the effective date for the recognition and measurement guidance included in EITF 03-1. The EITF 03-1 disclosure requirements were not delayed and are included in Note 12. In December 2003, the FASB issued FASB Interpretation No. 46 “Consolidation of Variable Interest Entities (revised Decem- ber 2003), an Interpretation of ARB No. 51” (FIN 46-R) which addresses how an enterprise should evaluate whether it has a controlling ﬁnancial interest in an entity through means oth- er than voting rights and accordingly wether it should consol- idate the entity. This consolidation evaluation under FIN 46-R reduces the impact of a decision maker in the calculation of expected losses and expected residual returns compared to the consolidation evaluation under the original FIN 46. FIN 46-R also changed the deﬁnition of a variable interest. As an SEC foreign registrant, UBS applied the consolida- tion requirements for VIEs created before 1 February 2003 for the ﬁrst time on 1 January 2004. To VIEs created after 31 Jan- uary 2003, the original FIN 46 was applied for the ﬁrst time at 31 December 2003. Under FN 46-R, at 1 January 204, sev- eral of UBS’s employee equity compensation trusts were con- solidated for the ﬁrst time, while trust preferred security ve- hicles were deconsolidated. The adoption of FIN 46-R is discussed in more detail in Note 42. Recently issued US accounting standards not yet adopted In December 2004, the FASB issued SFAS 123 (revised 2004), “Share-Based Payment”, (SFAS 123-R) which is a revision of SFAS 123, “Accounting for Stock-Based Compensation” (SFAS 123) and supersedes APB Opinion 25, “Accounting for Stock Issued to Employees” (APB Opinion 25). SFAS 123-R re- quires all share-based payments to employees, including grants of employee stock options, to be recognized in the in- come statement based on their fair values at date of grant, eliminating the pro-forma disclosure alternative. Further, SFAS 123-R introduces the notion of a requisite service period, which indicates that the service period for awards with future vesting may not be deﬁned as a prior period. For UBS this will result in a change in the expense attribution period for awards. SFAS 123-R is effective for interim or annual reporting pe- riods beginning after 15 June 2005 with earlier application permitted. UBS will adopt SFAS 123-R effective 1 January 2005 using the modiﬁed prospective method. Under this method, SFAS 123-R applies only to new awards that are granted, mod- iﬁed or settled after the Standard is adopted. Compensation cost for prior awards shall be based on the grant date fair val- ue and expense attribution method used for recognition or disclosure purposes under SFAS 123. Prior periods will not be restated. UBS currently accounts for share-based payments using the intrinsic value method under APB 25, and as such, generally recognizes no compensation cost for employee stock op- tions. Under this approach UBS recognized the fair value of share awards granted as part of annual bonuses in the year of corresponding performance, aligning with the revenue produced. For disclosure purposes, UBS recognized the fair val- ue of option awards on the date of grant. Thus, for recogni- tion and disclosure purposes, expense for share and option awards issued prior to but outstanding at the date of adop- tion of SFAS 123-R has been fully attributed to prior periods. Further, share awards issued in 2005 as part of the 2004 per- formance year, have been fully recognized in 2004. Therefore under SFAS 123-R, only option awards and certain share awards granted, modiﬁed or settled after the effective date are to be recognized in the 2005 ﬁnancial statements. These awards will be recognized over the requisite service period as newly deﬁned in SFAS 123-R, which is expected to result in a ramp-up of compensation expense over the next several years as these awards move through their vesting periods. There- fore, compensation expense is expected to decrease in 2005 compared to 2004 as the ramp-up effect for the share awards will offset the ﬁrst-time recognition of the fair value of option awards. However, compensation cost will increase as awards to which the new measurement and attribution requirements apply move through their vesting period. Once these initial awards are fully vested (generally three years), compensation expense under SFAS 123-R is not expected to be materially dif- ferent than what would be disclosed in the pro-forma disclo- sures under SFAS 123. In 2005 UBS will be introducing a new valuation model to determine the fair value of share options granted. Share op- tions granted in 2004 and earlier will not be affected by this change in valuation model. This new valuation model better reﬂects the exercise behavior of employees and the speciﬁc terms and conditions under which the share options are granted. Concurrent with the introduction of the new mod- el, UBS will use implied instead of historic volatility as input into the new model. 177 Financial Statements Notes to the Financial Statements Note 41.3 Reconciliation of IFRS Shareholders’ Equity and Net proﬁt to US GAAP CHF million Amounts determined in accordance with IFRS Adjustments in respect of: SBC purchase accounting goodwill and other purchase accounting adjustments Reversal of IFRS goodwill amortization Purchase accounting under IFRS 3 and FAS 141 Derivative instruments Financial investments and private equity Pension plans Other post-retirement beneﬁt plans Equity participation plans Software capitalization Consolidation of variable interest entities (VIEs) and deconsolidation of trust preferred securities Financial liabilities held at fair value through proﬁt and loss Physically settled written puts Investment properties Other adjustments Tax adjustments Total adjustments Amounts determined in accordance with US GAAP Note 41.4 Earnings per Share Note 41.1 Shareholders’ equity Reference 31.12.04 31.12.03 31.12.04 34,978 35,310 8,089 Net proﬁt 31.12.03 6,239 31.12.02 3,530 a b c d e f g h i j k l m 15,152 2,603 (88) (75) (266) 372 (1) (80) 0 47 197 93 (8) (50) (206) 15,196 1,825 0 (94 ) (84 ) 1,303 (1 ) (112 ) 0 (10 ) 117 48 (24 ) 0 (300 ) 17,690 52,668 17,864 53,174 (44) 778 3 (217) 304 (110) 0 (98) 0 18 100 9 14 (50) 22 729 8,818 (89 ) 808 0 188 (159 ) (235 ) 0 (152 ) 0 (10 ) 78 5 88 0 (248 ) 274 6,513 (128 ) 1,017 0 342 767 (156 ) 7 63 (60 ) 0 39 3 (23 ) 0 145 2,016 5,546 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 2004, 31 December 2003 and 31 Decem- ber 2002 are presented in the following table. For the year ended Net proﬁt available for ordinary shares (CHF million) Net proﬁt for diluted EPS (CHF million) Weighted average shares outstanding 31.12.04 31.12.03 31.12.02 US GAAP 8,818 8,813 IFRS 8,089 8,084 US GAAP 6,513 6,514 IFRS 6,239 6,240 US GAAP 5,546 5,520 IFRS 3,530 3,510 1,029,895,610 1,052,914,417 1,116,602,289 1,116,953,623 1,208,055,132 1,208,586,678 Diluted weighted average shares outstanding 1,081,961,360 1,081,961,360 1,138,800,625 1,138,800,625 1,222,862,165 1,223,382,942 Basic earnings per share (CHF) Diluted earnings per share (CHF) 8.56 8.15 7.68 7.47 5.83 5.72 5.59 5.48 4.59 4.51 2.92 2.87 178 Note 41.5 Presentation Differences between IFRS and US GAAP In addition to the differences in valuation and income recog- nition, 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 useful to understand them to interpret the ﬁnancial statements presented in accor- dance with US GAAP. The following is a summary of presen- tation differences that relate to the basic IFRS ﬁnancial state- ments. 1. Settlement date vs. trade date accounting UBS’s transactions from securities activities are recorded un- der IFRS on the settlement date. This results in recording a for- ward transaction during the period between the trade date and the settlement date. Forward positions relating to trad- ing activities are revalued to fair value and any unrealized prof- its and losses are recognized in Net proﬁt. Under US GAAP, trade date accounting is required for spot purchases and sales of securities. Therefore, all such transac- tions 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 re- ceivables and payables to broker-dealers and clearing organ- izations recorded in Other assets and Other liabilities in the US GAAP balance sheet. liability is presented in the line “Obligation to return securi- ties received as collateral”. 4. Reverse repurchase, repurchase, securities borrowing and securities lending transactions UBS enters into certain types of reverse repurchase, repurchase, securities borrowing and securities lending transactions that re- sult in a difference between IFRS and US GAAP. Under IFRS, they are considered borrowing and lending transactions which are not reﬂected in the balance sheet except to the extent of cash col- lateral advanced or received. Under US GAAP, however, they are considered purchase and sale transactions due to the fact that the contracts do not meet speciﬁc collateral or margining require- ments under SFAS 140. Due to the different treatment of these transactions under IFRS and US GAAP, interest income and ex- pense recorded under IFRS must be reclassiﬁed to Net trading income for US GAAP. Additionally under US GAAP, the securi- ties received are recognized on the balance sheet as a spot pur- chase (Trading portfolio assets) with a corresponding forward sale transaction (Replacement values) and a receivable (Cash col- lateral on securities borrowed) is reclassiﬁed, as applicable. The securities delivered are recognized as a spot sale (Trading port- folio liabilities) with a corresponding forward repurchase trans- action (Replacement values) and a liability (Cash collateral on se- curities lent) is reclassiﬁed, as applicable. 2. Financial investments Under IFRS, UBS’s private equity investments and non-mar- ketable equity ﬁnancial investments are included in Financial investments. For US GAAP presentation, non-marketable eq- uity ﬁnancial investments are reclassiﬁed to Other assets, and private equity investments are shown separately on the bal- ance sheet. 3. Securities received as proceeds in a securities for securities lending transaction When UBS acts as the lender in a securities lending agreement and receives securities as collateral that can be pledged or sold, it recognizes the securities received and a corresponding ob- ligation to return them. These securities are reﬂected on the US GAAP balance sheet in the line “Securities received as col- lateral” on the asset side of the balance sheet. The offsetting 5. Recognition/derecognition of ﬁnancial assets The guidance governing recognition and derecognition of a ﬁnancial asset is considerably more complex under revised IAS 39 than previously and requires a multi-step decision process to determine whether derecognition is appropriate. UBS dere- cognizes ﬁnancial assets for which it transfers the contractu- al rights to the cash ﬂows and no longer retains any risk or re- ward coming from them nor maintains control over the ﬁnancial assets. The provisions of this guidance were applied prospectively as at 1 January 2004. As a result of the new re- quirements, certain transactions are now accounted for as se- cured ﬁnancing transactions instead of purchases or sales of trading portfolio assets with an accompanying swap deriva- tive. Under US GAAP, these transactions continue to be shown as purchases and sales of trading portfolio assets and were reclassiﬁed accordingly. 179 Financial Statements Notes to the Financial Statements Note 41.6 Consolidated Income Statement The following is a Consolidated Income Statement of the Group, for the years ended 31 December 2004, 31 December 2003 and 31 December 2002, 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) Net fee and commission income Net trading income Other income 1 Income from Industrial Holdings Total operating income Operating expenses Personnel expenses General and administrative expenses Depreciation of property and equipment Amortization of goodwill Amortization of other intangible assets Goods and materials purchased 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 Cumulative adjustment of accounting for certain equity based compensation plans as cash settled, net of tax 31.12.04 31.12.03 31.12.02 Reference US GAAP IFRS US GAAP IFRS US GAAP IFRS a, d, j, 4, 5 a, j, k, 4, 5 39,124 39,398 (27,306) (27,538) 11,818 11,860 276 12,094 19,416 4,879 1,188 3,648 276 12,136 19,416 4,972 897 3,648 d, h, j, k, l, 4, 5 b, c, e, j, m 39,940 (27,700 ) 12,240 (72 ) 12,168 17,345 4,021 380 40,159 (27,860 ) 12,299 (72 ) 12,227 17,345 3,756 462 39,679 (29,334 ) 10,345 (115 ) 10,230 18,221 5,940 96 39,963 (29,417 ) 10,546 (115 ) 10,431 18,221 5,451 4 41,225 41,069 33,914 33,790 34,487 34,107 f, g, h 18,729 18,515 j a, i, m b b 6,705 1,385 0 186 2,861 29,866 11,359 2,112 9,247 6,703 1,352 713 251 2,861 30,395 10,674 2,135 8,539 j (435) (450) 0 6 0 0 17,615 6,086 1,396 0 112 0 17,231 6,086 1,353 756 187 0 18,610 7,072 1,613 0 1,443 0 18,524 7,072 1,514 930 1,530 0 25,209 25,613 28,738 29,570 8,705 1,842 6,863 (350 ) 0 0 8,177 1,593 6,584 (345 ) 0 0 5,749 511 5,238 (331 ) 639 0 5,546 4,537 676 3,861 (331 ) 0 0 3,530 Net proﬁt 8,818 8,089 6,513 6,239 1 The CHF 304 million gain, CHF 159 million loss and CHF 108 million gain included in US GAAP Other income at 31 December 2004, 31 December 2003 and 31 December 2002, respectively are due to UBS’s adoption of the “AICPA Audit and Accounting Guide, Audits of Investment Companies” on certain private equity investments for its US GAAP ﬁnancial statements. These amounts represent the change in fair value of these investments during 2004, 2003 and 2002. Note: References above coincide with the discussions in Note 41.1 and Note 41.5. These references indicate which IFRS to US GAAP differences affect an individual ﬁnancial statement caption. Certain prior year US GAAP amounts in 2003 and 2002 have been adjusted to conform to the current year’s presentation. 180 Note 41.7 Condensed Consolidated Balance Sheet The following is a Condensed Consolidated Balance Sheet of the Group, as at 31 December 2004 and 31 December 2003, restated to reﬂect the impact of valuation and income recognition principles and presentation differences between IFRS and US GAAP. CHF million Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Trading portfolio assets pledged as collateral Positive replacement values Financial assets designated at fair value 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 Total 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 Financial liabilities designated at fair value Due to customers Accrued expenses and deferred income Debt issued Other liabilities Total liabilities Minority interests Total shareholders’ equity Reference US GAAP IFRS US GAAP IFRS 31.12.04 31.12.03 h, j 4 c, h, j,1, 4, 5 j, k, 1, 4, 5 c a, j, 5 e, j, 2 3 h, j c a, c, m a, b b, c 2 6,036 35,286 218,414 357,164 449,389 159,115 284,468 228,968 1,455 12,950 5,882 2,153 9,045 26,977 1,722 3,094 6,036 35,264 220,242 357,164 370,259 159,115 284,577 653 232,387 5,049 5,876 2,427 8,736 8,847 3,302 c, d, f, h, j, 1, 2, 5 101,068 1,903,186 34,850 1,734,784 h, 1 4 j j, 1, 4, 5 3 j, k, l, 1, 4, 5 j, k, 5 j, 5 j a, c, d, j, k, 1 c, d, f, g, h, j, l, m, 1 119,021 57,792 423,513 190,907 12,950 360,345 386,913 14,830 164,744 117,743 118,901 61,545 422,587 171,033 303,712 65,756 376,083 14,685 117,828 42,342 3,584 31,758 211,058 320,499 423,733 120,759 248,924 212,729 1,303 13,071 6,219 1,616 8,116 26,775 1,174 3,308 64,381 1,699,007 127,385 51,157 415,863 149,380 13,071 326,136 347,358 13,673 123,259 74,044 3,584 31,740 213,932 320,499 341,013 120,759 248,206 212,679 5,139 6,218 1,616 7,683 9,348 2,181 25,459 1,550,056 127,012 53,278 415,863 143,957 254,768 35,286 346,633 13,673 88,843 31,360 1,848,758 1,694,472 1,641,326 1,510,673 c ,j 1,760 52,668 5,334 34,978 4,507 53,174 4,073 35,310 Total liabilities, minority interests and shareholders’ equity 1,903,186 1,734,784 1,699,007 1,550,056 Positive and Negative replacement values under US GAAP are presented on a gross basis for all periods presented. Note: References above coincide with the discussions in Note 41.1 and Note 41.5. These references indicate which IFRS to US GAAP differences affect an individual ﬁnancial statement caption. 181 Financial Statements Notes to the Financial Statements Note 41.8 Comprehensive Income Comprehensive income under US GAAP is deﬁned as the change in shareholders’ equity excluding transactions with share- holders. 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 securities, 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 2004, 31 December 2003 and 31 December 2002 are as follows: Unrealized gains / (losses) on available- for-sale translation investments Foreign currency Unrealized gains / (losses) on cash ﬂow hedges Additional minimum pension liability Accumu- lated other compre- hensive income / (loss) Deferred income taxes Compre- hensive income / (loss) (769) 469 9 (303) (7) (601) CHF million Balance at 1 January 2002 Net proﬁt Other comprehensive income: Foreign currency translation Net unrealized gains on available-for-sale investments Impairment charges reclassiﬁed to the income statement Reclassiﬁcation of gains on available-for- sale investments realized in net proﬁt Net unrealized losses on cash ﬂow hedges Reclassiﬁcation of gains on cash ﬂow hedges realized in net proﬁt Additional minimum pension liability Other comprehensive income / (loss) Comprehensive income Balance at 31 December 2002 Net proﬁt Other comprehensive income: Foreign currency translation Net unrealized losses on available-for-sale investments Impairment charges reclassiﬁed to the income statement Reclassiﬁcation of gains on available-for- sale investments realized in net proﬁt Reclassiﬁcation of losses on cash ﬂow hedges realized in net proﬁt Additional minimum pension liability Other comprehensive income / (loss) Comprehensive income Balance at 31 December 2003 Net proﬁt Other comprehensive income: Foreign currency translation Net unrealized gains on available-for-sale investments Impairment charges reclassiﬁed to the income statement Reclassiﬁcation of gains on available-for- sale investments realized in net proﬁt Additional minimum pension liability Other comprehensive income / (loss) Comprehensive income Balance at 31 December 2004 182 5,546 (80 ) 109 95 (368 ) (1 ) (8 ) (827 ) (1,080 ) 4,466 6,513 (795 ) (81 ) 93 (58 ) 2 835 (4 ) 6,509 8,818 (80 ) 143 121 (470 ) (4 ) (8 ) (80 ) (206 ) (12 ) (920 ) (920 ) (34 ) (26 ) 102 3 0 93 138 (80 ) 109 95 (368 ) (1 ) (8 ) (827 ) (1,080 ) (849) 263 (3) (1,223) 131 (1,681) (795 ) (130 ) 111 (69 ) (795 ) (88 ) (1,644) 175 (818 ) (818 ) 32 10 (5 ) 37 (2,462) 212 3 3 0 0 0 49 (18 ) 11 (1 ) (82 ) (41 ) (795 ) (81 ) 93 (58 ) 2 835 (4 ) 917 917 (306) 90 (1,685) (818 ) (818 ) (15 ) (2 ) 1 21 5 95 17 8 (4 ) (798 ) (1,595 ) (3,280) 17 8 (4 ) (798 ) (1,595 ) 7,223 (819 ) (819 ) (1,125) Note 42 Additional Disclosures Required under US GAAP and SEC Rules Note 42.1 Variable interest entities Introduction For the ﬁnancial year 2004 UBS fully applied Financial Ac- counting Standards Board (FASB) Interpretation No. 46, “Con- solidation of Variable Interest Entities (revised December 2003)”, an interpretation of Accounting Research Bulletin No. 51 (FIN 46-R). At 31 December 2003 the predecessor stan- dard, FIN 46, had application to UBS only with respect to tran- sitional disclosure requirements, and consolidation require- ments for certain VIEs created after 31 January 2003. Identiﬁcation of variable interest entities (VIEs) and measurement of variable interests Qualifying special purpose entities (QSPEs) per Statement of Financial Accounting Standards (SFAS) No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguish- ments of Liabilities” are excluded from the scope of FIN 46- R. In most other cases, FIN 46-R requires that control over an entity be assessed for US GAAP ﬁrst based on voting interests; if voting interests do not exist, or differ signiﬁcantly from eco- nomic interests, the entity is considered a VIE, and control is assessed based on its variable interests. Speciﬁcally, VIEs are entities in which no equity investors exist, or the equity in- vestors: – do not have sufﬁcient equity at risk for the entity to ﬁnance its activities without additional subordinated ﬁnancial sup- port from other parties; or – do not have the characteristics of a controlling ﬁnancial in- terest; or – have voting rights that are not proportionate to their eco- nomic interests, and the activities of the entity involve or are conducted on behalf of investors with disproportion- ately small or no voting interests. Variable interests are interests held in a VIE that change with changes in the fair value of a VIE’s net assets, exclusive of variable interests. Interests of related parties (including management, employees, afﬁliates and agents) are included in the evaluation as if owned directly by the enterprise. A primary beneﬁciary is an enterprise which absorbs a ma- jority of a VIE’s expected losses, expected residual returns, or both – it must consolidate the VIE and provide certain disclo- sures. The holder of a signiﬁcant variable interest in a VIE is required to make disclosures only. UBS treats variable inter- ests of more than 20% of a VIE’s expected losses, expected residual returns, or both, as signiﬁcant. The FASB Emerging Issues Task Force (EITF) has summarized four different general approaches to the application of FIN 46- R in EITF issue No. 04-7. In applying FIN 46-R, UBS has adopt- ed a quantitative approach, particularly for derivatives, which is known as “View A”, and is based on variability in the fair value of the net assets in the VIE, exclusive of variable inter- ests. Under View A, investments or derivatives in a VIE either cre- ate (increase), or absorb (decrease) variability in the fair value of a VIE’s net assets. The VIE counterparty is a risk creator (risk maker), or risk absorber (risk taker), respectively. Only risk ab- sorption (risk taker) positions are assessed; risk creation inter- ests are deemed not to be variable interests. VIEs often contain multiple risk factors, such as credit, eq- uity, foreign currency and interest rate risks, which require quantiﬁcation by variable interest holders. UBS analyzes these risks into components, identiﬁes the parties absorbing them, and uses models to quantify and compare them. These mod- els are based on internally approved valuation models and in some cases require the use of Monte Carlo simulation tech- niques. They are applied when UBS ﬁrst becomes involved with a VIE, or after a major restructuring. Measurement of maximum exposure to loss Maximum exposure to loss is disclosed for VIEs in which UBS has a signiﬁcant variable interest. UBS’s maximum exposure to loss is generally measured as its net investment in the VIE, plus any additional amounts it may be obligated to invest. If UBS receives credit protection from credit derivatives it is measured as any positive replace- ment value of the derivatives. If UBS has provided guarantees or other types of credit protection to a VIE it is measured as the notional amount of the credit protection instruments or credit derivatives. In other derivative transactions exposing UBS to potential losses, there is no theoretical limit to the max- imum loss which could be incurred before considering offset- ting positions or hedges entered into outside of the VIE. How- ever, UBS’s general risk management process involves the hedging of risk exposures for VIEs, on the same basis as for non-VIE counterparties. See Note 29 for a further discussion of UBS’s risk mitigation strategies. VIEs in which UBS is the primary beneﬁciary VIEs in which UBS is the primary beneﬁciary require consoli- dation, which may increase both total assets and liabilities of the US GAAP ﬁnancial statements, or in other cases may re- sult in a reclassiﬁcation of existing assets or liabilities. In certain cases, an entity not consolidated under IFRS, is consolidated under FIN 46-R because UBS is the primary ben- eﬁciary. Signiﬁcant groups of these include CHF 4.3 billion of investment fund products, and CHF 1.1 billion of securitiza- tion VIEs, which includes some third-party VIEs mentioned be- low. The other signiﬁcant group of VIEs consolidated for US GAAP, but not under IFRS, are employee equity compensation trusts, for which UBS is the primary beneﬁciary because of the variable interests of employees. These trusts have a total size prior to US GAAP consolidation of approximately CHF 2.8 bil- 183 Financial Statements Notes to the Financial Statements lion, including approximately CHF 2.0 billion in UBS shares and CHF 0.8 billion in alternative investment vehicles. Upon con- solidation, the UBS shares are treated as treasury shares, which increases the weighted average number of treasury shares at 31 December 2004 by 23 million shares, and de- creases the basic EPS denominator by 2%. UBS has reviewed the population of potential third-party VIEs it is involved with. Those identiﬁed in which UBS is the primary beneﬁciary, and are consolidated for US GAAP pur- poses, have combined assets of approximately CHF 5.5 billion and are included in the table below. Many entities consolidated under US GAAP due to FIN 46-R are already consolidated under IFRS, based on the determina- VIEs in which UBS is the primary beneﬁciary (CHF million) Nature, purpose and activities of VIEs Total assets Securitizations Investment fund products Investment funds managed by UBS Passive intermediary to a derivative transaction Trust vehicles for awards to UBS employees Private equity investments Other miscellaneous structures Total 31.12.04 1,363 4,648 4,303 174 2,798 300 36 13,622 tion of exercise of control under IFRS. The total size of this population is approximately CHF 4.7 billion, mostly compris- ing investment funds managed by UBS, other investment fund products, and securitization vehicles. Certain VIEs in which UBS is the primary beneﬁciary, but for which UBS also holds a majority voting interest, are con- solidated, but do not require disclosure in the table below. In most cases such VIEs, or their ﬁnancial position and perform- ance, are already consolidated under IFRS. The creditors or beneﬁcial interest holders of VIEs in which UBS is the primary beneﬁciary do not have any recourse to the general credit of UBS. Consolidated assets that are collateral for the VIEs’ obligations Classiﬁcation Amount Loan receivables, government debt securities, corporate debt securities 1,363 Investment funds Debt, equity Loan receivables, corporate debt securities UBS shares and alternative investment vehicles Private equity investments – 4,648 4,270 174 2,798 152 – 13,405 Entities which are de-consolidated for US GAAP purposes In certain cases, an entity consolidated under IFRS is not con- solidated under FIN 46-R. UBS consolidates under IFRS sever- al trusts that have issued trust preferred securities amounting to CHF 3.0 billion, which are de-consolidated for US GAAP purposes. Under IFRS the trust preferred securities are treat- ed as minority interests, with dividends paid reported in mi- nority interests; under US GAAP the securities are treated as debt, with interest paid reported in interest expense. VIEs in which UBS holds a signiﬁcant variable interest VIEs in which UBS holds a signiﬁcant variable interest are most- ly used in securitizations, or as investment fund products, in- cluding funds managed by UBS. UBS has reviewed the population of potential third party VIEs it is involved with. Those identiﬁed in which UBS holds a signiﬁcant variable interest have combined assets of approx- imately CHF 11.7 billion, for which UBS has a maximum ex- posure to loss of approximately CHF 4.4 billion. Disclosures for these are included in the table below. VIEs in which UBS holds a signiﬁcant variable interest (CHF million) Nature, purpose and activities of VIEs Securitizations Investment fund products Investment funds managed by UBS Credit protection vehicles Other miscellaneous structures Total 31.12.04 Total assets Nature of involvement Maximum exposure to loss 7,075 4,863 1,978 1,449 114 15,479 UBS acts as swap counterparty UBS holds notes or units UBS acts as investment manager SPE used for credit protection – UBS sells credit risk on portfolios to investors UBS acts as swap counterparty 2,700 1,744 742 800 54 6,040 184 Third-party VIEs not otherwise classiﬁed FIN 46-R requires UBS to consider all VIEs for consolidation, including VIEs which UBS has not created, but in which it holds variable interests as a third-party counterparty, either through direct or indirect investment, or through derivative trans- actions. UBS has identiﬁed that it holds variable interests in 56 third- party VIEs that in some cases could result in UBS being con- sidered the primary beneﬁciary, but the information necessary to make this determination or perform the accounting re- quired to consolidate the VIE, was held by third parties, and was not available to UBS. Additional disclosures for these VIEs are provided in the table below. VIEs not originated by UBS – information unavailable from third parties (CHF million) Nature, purpose and activities of VIEs Securitizations Investment fund products Total 31.12.04 Total assets Nature of involvement 4,083 480 4,563 UBS acts as swap counterparty UBS acts as swap counterparty Net income from VIE in current period 114 24 138 Maximum exposure to loss 3,561 457 4,018 Future developments As the guidance for FIN 46-R has seen considerable contin- ued development, it is possible UBS may be required to apply a different approach in the future, which would impact the US GAAP ﬁnancial position, results, and reporting. However, it is not possible at this time to predict the impact this might have. 185 Financial Statements Notes to the Financial Statements Note 42.2 Industrial Holdings’ Income Statement1 Following an additional percentage acquisition of Motor-Columbus, UBS now holds a majority ownership interest in the com- pany. As a result, UBS has fully consolidated Motor-Columbus in its ﬁnancial statements, housing it within a separate seg- ment. “Industrial Holdings” consists of Motor-Columbus, a Swiss holding company, whose most signiﬁcant asset is a 59.3% interest in Atel, a Swiss-based European energy provider. The following table provides information required by Regulation S-X for commercial and industrial companies, including a condensed income statement and certain additional balance sheet information: CHF million Operating income Net sales Operating expenses Cost of products sold Marketing expenses General and administrative expenses Other intangible assets amortization Other operating expenses Total operating expenses Operating proﬁt Non-operating proﬁt Interest income Interest expense Other non-operating income, net Non-operating proﬁt Net proﬁt before tax and minority interests Income taxes Net proﬁt before minority interests Equity in income of associates, net of tax Minority interests Net proﬁt Accounts receivables trade, gross Allowance for doubtful receivables Accounts receivables trade, net 31.12.04 2 3,632 3,200 44 131 77 8 3,460 172 4 (38) 50 16 188 47 141 17 (113) 45 1,681 (18) 1,663 1 Industrial Holdings consists of Motor-Columbus, a Swiss holding company, whose most signiﬁcant asset is a 59.3% interest in Atel, a Swiss-based European energy provider. six-month period beginning on 1 July 2004. 2 Results shown for the 186 Note 42.3 Indemniﬁcations In the normal course of business, UBS provides representa- tions, warranties and indemniﬁcations to counterparties in connection with numerous transactions. These provisions are generally ancillary to the business purposes of the contracts in which they are embedded. Indemniﬁcation clauses are generally standard contractual terms related to the Group’s own performance under a contract and are entered into based on an assessment that the risk of loss is remote. Indem- niﬁcations may also protect counterparties in the event that additional taxes are owed due either to a change in applica- ble tax laws or adverse interpretations of tax laws. The pur- pose of these clauses is to ensure that the terms of a contract are met at inception. The most signiﬁcant business where UBS provides repre- sentations and warranties are asset securitizations. UBS gen- erally represents that certain securitized assets meet speciﬁc requirements, for example documentary attributes. UBS may be required to repurchase the assets and/or indemnify the pur- chaser of the assets against losses due to any breaches of such representations or warranties. Generally, the maximum amount of future payments the Group would be required to make under such repurchase and/or indemniﬁcation provi- sions would be equal to the current amount of assets held by such securitization-related SPEs as at 31 December 2004, plus, in certain circumstances, accrued and unpaid interest on such assets and certain expenses. The potential loss due to such repurchase and/or indemnity is mitigated by the due dili- gence UBS performs to ensure that the assets comply with the requirements set forth in the representations and warranties. UBS receives no compensation for representations and war- ranties, and it is not possible to determine their fair value be- cause they rarely, if ever, result in a payment. Historically, loss- es incurred on such repurchases and/or indemniﬁcations have been insigniﬁcant. Management expects the risk of material loss to be remote. No liabilities related to such representations, warranties, and indemniﬁcations are included in the balance sheet at 31 December 2004 and 2003. Note 42.4 Supplemental Guarantor Information Guarantee of PaineWebber securities Following the acquisition of Paine Webber Group Inc., UBS AG made a full and unconditional guarantee of the senior and subordinated notes and trust preferred securities (“Debt Se- curities”) of PaineWebber. Prior to the acquisition, PaineWeb- ber was an SEC Registrant. Upon the acquisition, Paine Web- ber 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 proceeding against UBS Americas Inc. UBS’s obligations under the subor- dinated 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 2004, the amount of senior liabili- ties of UBS to which the holders of the subordinated debt se- curities would be subordinated is approximately CHF 1,685 billion. The information presented in this note is prepared in ac- cordance with IFRS and should be read in conjunction with the Consolidated Financial Statements of UBS of which this information is a part. At the bottom of each column, Net prof- it and Shareholders’ equity has been reconciled to US GAAP. See Note 41 for a detailed reconciliation of the IFRS ﬁnancial statements to US GAAP for UBS on a consolidated basis. 187 Financial Statements Notes to the Financial Statements Supplemental Guarantor Consolidating Income Statement CHF million For the year ended 31 December 2004 UBS AG Parent Bank 1 UBS 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 Income from industrial holdings Total operating income Operating expenses Personnel expenses General and administrative expenses Depreciation of property and equipment Amortization of goodwill and other intangible assets Goods and materials purchased Total operating expenses Operating proﬁt / (loss) before tax and minority interests Tax expense / (beneﬁt) Net proﬁt / (loss) before minority interests Minority interests Net proﬁt / (loss) Net proﬁt / (loss) US GAAP 2 29,423 21,732 7,691 334 8,025 7,830 4,204 1,364 449 0 13,364 10,009 3,355 1 3,356 7,119 386 0 737 0 21,872 11,598 9,699 1,994 769 46 0 12,508 9,364 1,275 8,089 0 8,089 6,426 6,577 2,719 155 750 0 10,201 1,397 153 1,244 (35 ) 1,209 1,977 14,486 13,672 (17,875 ) (17,875 ) 814 (59 ) 755 4,467 382 0 (289 ) 3,648 8,963 2,239 1,990 428 168 2,861 7,686 1,277 707 570 (415 ) 155 415 0 0 0 0 0 (1,364 ) 0 0 (1,364 ) 0 0 0 0 0 0 (1,364 ) 0 (1,364 ) 0 (1,364 ) 0 39,398 27,538 11,860 276 12,136 19,416 4,972 0 897 3,648 41,069 18,515 6,703 1,352 964 2,861 30,395 10,674 2,135 8,539 (450 ) 8,089 8,818 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. 41 for a description of the differences between IFRS and US GAAP. 2 Refer to Note 188 Supplemental Guarantor Consolidating Balance Sheet UBS AG Parent Bank 1 UBS Americas Inc. Subsidiaries Consolidating Entries UBS Group CHF million For the year ended 31 December 2004 Assets Cash and balances with central banks Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Trading portfolio assets pledged as collateral Positive replacement values Financial assets designated at fair value 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 Financial liabilities designated at fair value 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 Total shareholders’ equity – US GAAP 2 4,152 94,881 87,198 213,080 205,075 107,944 287,786 0 252,342 839 3,129 28,915 5,475 528 8,536 7 11,194 185,741 171,447 138,015 39,998 1,985 0 29,440 937 1,846 14 511 9,664 3,728 1,299,880 594,527 157,889 85,053 119,826 98,019 309,809 47,116 366,762 7,588 56,658 9,378 1,258,098 0 41,782 1,299,880 29,116 87,736 45,362 332,513 59,867 2,105 0 47,265 6,233 5,214 2,442 588,737 144 5,646 594,527 7,760 1,877 132,730 95,334 229,558 27,169 11,173 138,451 653 36,509 3,273 3,546 1,307 2,750 1,957 24,922 711,209 76,817 79,161 227,169 13,147 135,443 18,640 47,960 3,509 55,956 32,858 690,660 5,190 15,359 711,209 15,792 0 (203,541 ) (148,031 ) (256,921 ) 0 0 (143,645 ) 0 (85,904 ) 0 (2,645 ) (27,809 ) 0 0 (2,336 ) (870,832 ) (203,541 ) (148,031 ) (256,921 ) 0 (143,645 ) 0 (85,904 ) (2,645 ) 0 (2,336 ) (843,023 ) 0 (27,809 ) (870,832 ) 0 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. 41 for a description of the differences between IFRS and US GAAP. 6,036 35,264 220,242 357,164 370,259 159,115 284,577 653 232,387 5,049 5,876 2,427 8,736 12,149 34,850 1,734,784 118,901 61,545 422,587 171,033 303,712 65,756 376,083 14,685 117,828 42,342 1,694,472 5,334 34,978 1,734,784 52,668 2 Refer to Note 189 Financial Statements Notes to the Financial Statements Supplemental Guarantor Consolidating Cash Flow Statement CHF million For the year ended 31 December 2004 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 Dividends paid Issuance of long-term debt, including ﬁnancial liabilities designated at fair value Repayment of long-term debt, including ﬁnancial liabilities designated at fair value Increase in minority interests Dividend payments to / 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 UBS AG Parent Bank 1 (6,652 ) UBS Americas Inc. Subsidiaries UBS Group (1,636 ) (19,610 ) (27,898 ) (2,511 ) 800 (555 ) 64 39 (2,163 ) 5,758 (4,999 ) 2 (2,806 ) 35,426 (11,944 ) 0 0 (4,799 ) 16,638 (1,282 ) 6,541 43,309 49,850 4,152 31,262 14,436 49,850 0 0 (164 ) 249 145 230 199 0 0 0 (26 ) (1,869 ) (969 ) (1 ) 866 (1,800 ) 401 (2,805 ) 18,811 16,006 7 13,450 2,549 16,006 0 0 (430 ) 391 502 463 15,422 0 0 0 15,811 (10,904 ) 1,071 (331 ) 3,933 25,002 (171 ) 5,684 11,236 16,920 1,877 697 14,346 16,920 (2,511 ) 800 (1,149 ) 704 686 (1,470 ) 21,379 (4,999 ) 2 (2,806 ) 51,211 (24,717 ) 102 (332 ) 0 39,840 (1,052 ) 9,420 73,356 82,776 6,036 45,409 31,331 82,776 2 Money 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. market paper is included in the Balance sheet under Trading portfolio assets and Financial investments. CHF 13,242 million was pledged at 31 December 2004. 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 is- sued an additional USD 800 million (CHF 1.3 billion at is- suance) of such securities (USD 300 million at 7.25% and USD 500 million at 7.247%). In May 2003, UBS issued USD 300 million of Floating Rate Noncumulative Trust Preferred Secu- rities (CHF 390 million at issuance) at 0.7% above one-month LIBOR of such securities. UBS AG has fully and uncondition- ally guaranteed these securities. UBS’s obligations under the trust preferred securities guarantee are subordinated to the prior payment in full of the deposit liabilities of UBS and all other liabilities of UBS. At 31 December 2004, the amount of senior liabilities of UBS to which the holders of the subordi- nated debt securities would be subordinated is approximate- ly CHF 1,685 billion. 190 UBS AG (Parent Bank) 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 Commitments and Contingent Liabilities Derivative Instruments Fiduciary Transactions Due to UBS Pension Plans, Loans to Corporate Bodies / Related Parties Headcount Report of the Statutory Auditors Report of the Capital Increase Auditors 193 194 194 195 196 197 198 198 198 199 199 199 199 200 200 200 200 201 201 201 202 203 192 UBS AG (Parent Bank) Parent Bank Review Parent Bank Review Income Statement Balance Sheet The Parent Bank UBS AG net proﬁt increased by CHF 1,749 million from CHF 4,197 million to CHF 5,946 million. Income from investments in associates decreased to CHF 461 million from CHF 1,914 million in 2003 mainly due to less distribu- tion received. The increase in Extraordinary income and ex- penses is explained on page 198. Total assets increased by CHF 141 billion to CHF 1,136 billion at 31 December 2004. This movement is mainly caused by in- creased positions in Due from banks of CHF 28 billion and Due from customers of CHF 29 billion. A considerable increase re- sulted in Trading balances in securities and precious metals of CHF 52 billion (thereof debt instruments CHF 25 billion and equities CHF 37 billion) as well as in Positive replacement val- ues of CHF 17 billion. The decrease in ﬁnancial investments of CHF 4.5 billion is mainly due to the reclassiﬁcation of own shares to Trading balances in securities and precious metals. The Investments in associated companies expanded by almost CHF 6 billion which is mainly due to new investments or ad- ditional ﬁnancing of subsidiaries abroad, the establishment of new fund companies and the step acquisition of Motor- Columbus. 193 UBS AG (Parent Bank) Financial Statements Financial Statements Income Statement CHF million 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 194 For the year ended % change from 31.12.04 31.12.03 31.12.03 18,902 10,457 13 19,417 9,325 11 (21,659) (20,034 ) 7,713 228 8,002 735 (1,135) 7,830 3,469 87 461 46 1,418 (26) 1,986 20,998 9,699 3,833 13,532 7,466 1,021 184 6,261 1,016 49 1,282 5,946 8,719 228 6,998 826 (1,180 ) 6,872 521 (69 ) 1,914 43 1,213 (96 ) 3,005 19,117 8,889 3,943 12,832 6,285 919 658 4,708 92 1 602 4,197 (3 ) 12 18 (8 ) (12 ) 0 14 (11 ) 4 14 566 (76 ) 7 17 73 (34 ) 10 9 (3 ) 5 19 11 (72 ) 33 113 42 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 Fixed assets Accrued income and prepaid expenses Positive replacement values Other assets Total assets Total subordinated assets Total amounts receivable from Group companies Liabilities Money market paper issued Due to banks Due to customers on savings and deposit accounts Other amounts due to customers Medium-term bonds 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 for the period Total liabilities Total subordinated liabilities Total amounts payable to Group companies 31.12.04 31.12.03 % change from 31.12.03 4,152 31,262 350,055 159,988 132,941 288,170 4,503 20,547 4,212 3,129 128,300 8,550 1,135,809 4,970 446,850 29,637 428,371 83,976 316,467 1,686 60,125 7,588 158,811 5,951 3,929 901 7,572 9,056 15,793 5,946 1,135,809 12,695 357,311 2,895 21,233 321,796 130,814 131,900 236,096 8,955 14,757 4,367 3,666 111,612 6,585 994,676 4,450 397,410 23,879 377,447 84,360 274,408 2,403 45,968 7,060 127,885 6,802 3,894 946 7,212 8,024 20,191 4,197 994,676 12,471 257,955 43 47 9 22 1 22 (50 ) 39 (4 ) (15 ) 15 30 14 12 12 24 13 0 15 (30 ) 31 7 24 (13 ) 1 (5 ) 5 13 (22 ) 42 14 2 39 195 UBS AG (Parent Bank) Financial Statements 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 2004 as per the Parent Bank’s Income Statement Appropriation to general statutory reserve Appropriation to other reserves Proposed dividends Total appropriation Dividend Distribution 5,946 322 2,363 3,261 5,946 The Board of Directors will recommend to the Annual General Meeting on 21 April 2005 that UBS should pay a dividend of CHF 3.00 per share of CHF 0.80 par value. If the dividend is approved, the payment of CHF 3.00 per share, after deduction of 35% Swiss withholding tax, would be made on 26 April 2005 for shareholders who hold UBS shares on 21 April 2005. 196 UBS AG (Parent Bank) Notes to the Financial Statements Notes to the Financial Statements Accounting Principles The Parent Bank’s accounting policies are in compliance with Swiss banking law. The accounting policies are principally the same as for the Group Financial Statements outlined in Note 1, Summary of Signiﬁcant Accounting Policies. Major dif- ferences between the Swiss banking law requirements and International Financial Reporting Standards are described in Note 40 to the Group Financial Statements. In addition, the following principles are applied for the Assets and liabilities of foreign branches are translated into CHF at the exchange rates at the balance sheet date, while income and expense items are translated at weighted aver- age rates for the period. Exchange differences arising on the translation of each of these foreign branches are credited to a provision account (other liabilities) in case of a gain, while any losses are ﬁrstly debited to that provision account until such provision is fully utilized, and secondly to proﬁt and loss. Parent Bank: Treasury shares Treasury shares is the term used to describe when an enter- prise 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 bal- ance 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 re-measurement of treas- ury shares in the trading portfolio to market value are includ- ed in the income statement. Treasury shares included in Financial investments are carried at the lower of cost or mar- ket value. Foreign currency translation Transactions and translation of assets and liabilities denomi- nated in foreign currencies into the Parent Bank’s or a branch’s reporting currency are accounted for as described in Note 1i). 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, ﬁx- tures and ﬁttings is recognized on a straight-line basis over the estimated useful lives of the related assets. The useful lives of Property and equipment are summarized in Note 1, Summa- ry of 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 oper- ating income or expenses and appear within the appropriate income or expense category. These items are separately iden- tiﬁed on page 198. 197 UBS AG (Parent Bank) Notes to the Financial Statements Additional Income Statement Information Net Trading Income CHF million Equities Fixed income 1 Foreign exchange and other Total 1 Includes commodities trading income. Extraordinary Income and Expenses For the year ended % change from 31.12.04 31.12.03 31.12.03 2,262 (266) 1,473 3,469 1,708 (1,307 ) 120 521 32 80 566 Extraordinary income contains CHF 609 million ﬁrst-time adop- tion impact as at 1 January 2004 from changing the valuation method for treasury shares from lower of cost or market to the mark to market method. It further includes CHF 72 million (2003: CHF 33 million) from the sale of investments in associ- ates and CHF 334 million from release of provisions (2003: CHF 59 million). Extraordinary expenses contain CHF 48 million loss from the liquidation of investments in associates in 2004. 198 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 Total provisions as per balance sheet Balance at 31.12.03 4,218 2,723 392 1,871 1,118 10,322 6,428 3,894 Provisions applied in accordance with their speciﬁed purpose Recoveries, doubtful interest, currency translation differences (814 ) (312 ) (580 ) (819 ) (2,525) (292 ) 413 15 164 24 324 Provisions released to income (962 ) (77 ) (137 ) (1,176) New provisions charged to income 627 201 215 190 1,535 2,768 Balance at 31.12.04 2,777 3,337 233 1,508 1,858 9,713 5,784 3,929 Statement of Shareholders’ Equity CHF million Share capital General statutory reserves: Share premium General statutory reserves: Retained earnings As at 31.12.02 and 1.1.03 Cancellation of own shares Capital increase Increase in reserves Prior year dividend Proﬁt for the period Changes in reserves for own shares As at 31.12.03 and 1.1.04 Cancellation of own shares Capital increase Increase in reserves Prior year dividend Proﬁt for the period Changes in reserves for own shares 1,005 (61 ) 2 11,550 (5,468 ) 59 842 229 946 (47 ) 2 6,141 1,071 72 288 As at 31.12.04 901 6,213 1,359 Reserves for own shares 6,623 1,401 8,024 1,032 9,056 Total Shareholders’ equity (before Other reserves distribution of proﬁt) 24,119 (229 ) (2,298 ) 4,197 (1,401 ) 24,388 (4,469 ) (288 ) (2,806 ) 5,946 (1,032 ) 21,739 44,139 (5,529) 61 (2,298) 4,197 40,570 (4,516) 74 (2,806) 5,946 39,268 Share Capital As at 31.12.04 Issued and paid up Conditional share capital As at 31.12.03 Issued and paid up Conditional share capital Par value Ranking for dividends No. of shares Capital in CHF No. of shares Capital in CHF 1,126,858,177 901,486,542 1,086,923,083 869,538,466 3,533,012 2,826,410 1,183,046,764 946,437,411 1,126,339,764 901,071,811 6,871,752 5,497,402 199 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 31.12.04 31.12.03 Change in % Book value Effective liability Book value Effective liability Book value Effective liability 16,022 175 102,726 118,923 5,063 60 55,126 60,249 6,225 428 96,065 102,718 210 66,395 66,605 157 (59 ) 7 16 (71 ) (17 ) (10 ) 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. Commitments and Contingent Liabilities CHF million Contingent liabilities Irrevocable commitments Liabilities for calls on shares and other equities Conﬁrmed credits 31.12.04 123,429 50,552 104 1,820 31.12.03 122,555 42,708 97 1,592 % change from 31.12.03 1 18 7 14 Derivative Instruments CHF million Interest rate contracts Credit derivative contracts Foreign exchange contracts Precious metal contracts Equity / index contracts Commodity contracts 31.12.2004 NRV 2 183,210 9,353 79,046 1,590 44,107 1,616 Notional amount CHF bn 15,398 671 3,729 61 721 41 PRV 1 174,995 7,895 81,377 1,919 20,487 1,739 Total derivative instruments 288,412 318,922 20,621 1 PRV: Positive replacement values prior to netting. 2 NRV: Negative replacement values prior to netting. 31.12.2003 NRV 149,972 7,679 70,658 2,176 37,613 895 268,993 Notional amount CHF bn 10,321 315 3,131 55 346 11 14,179 PRV 141,654 7,085 75,229 2,382 25,362 1,025 252,737 200 Fiduciary Transactions CHF million Deposits: with other banks with Group banks Loans and other ﬁnancial transactions Total 31.12.04 31.12.03 % change from 31.12.03 30,581 740 6 31,327 29,549 672 6 30,227 3 10 0 4 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 31.12.04 31.12.03 % change from 31.12.03 1,329 3,778 16 1,096 2,930 25 21 29 (36 ) 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. Headcount Parent Bank headcount was 35,542 on 31 December 2004 and 33,949 on 31 December 2003. 201 UBS AG (Parent Bank) Report of the Statutory Auditors 202 UBS AG (Parent Bank) Report of the Capital Increase Auditors 203 204 Additional Disclosure Required under SEC Regulations Additional Disclosure Required under SEC Regulations Table of Contents Additional Disclosure Required under SEC Regulations Table of Contents 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 Contractual maturities of the Investments in Debt Instruments Due from Banks and Loans (gross) Due from Banks and Loan Maturities (gross) Impaired, Non-performing and Restructured Loans Cross-Border Outstandings Summary of Movements in Allowances and Provisions for Credit Losses Allocation of the Allowances and Provisions for Credit Losses Due from Banks and Loans by Industry Sector (gross) Loss History Statistics 207 207 209 210 211 211 211 211 212 212 212 214 216 217 218 219 220 221 222 223 225 226 227 A B C D 206 A – Introduction The following pages contain additional disclosure about the UBS Group which is required under SEC regulations. Unless otherwise stated, UBS’s Financial Statements have been prepared in accordance with International Financial Re- porting Standards (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 Unit- ed States Generally Accepted Accounting Principles (US GAAP). Comparative ﬁgures for 2001 and 2000 have not been re- stated. B – Selected Financial Data The tables below set forth, for the periods and dates indicat- ed, information concerning the noon buying 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 2005 the noon buying rate was 0.8632 USD per 1 CHF. Year ended 31 December 2000 2001 2002 2003 2004 Month September 2004 October 2004 November 2004 December 2004 January 2005 February 2005 1 The average of the noon buying rates on the last business day of each full month during the relevant period. Average rate 1 (USD per 1 CHF) At period end 0.5912 0.5910 0.6453 0.7493 0.8059 0.6172 0.5857 0.7229 0.8069 0.8712 High 0.6441 0.6331 0.7229 0.8189 0.8843 High 0.8026 0.8371 0.8781 0.8843 0.8712 0.8632 Low 0.5479 0.5495 0.5817 0.7048 0.7601 Low 0.7865 0.7908 0.8315 0.8616 0.8381 0.8182 207 Additional Disclosure Required under SEC Regulations B – Selected Financial Data (continued) CHF million, except where indicated 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 Income from Industrial Holdings Operating income Operating expenses Operating proﬁt before tax Tax expense / (beneﬁt) Minority interests Net proﬁt Cost / income ratio (%) 1 Per share data (CHF) Basic earnings per share 2 Diluted earnings per share 2 Operating proﬁt before tax per share Cash dividends declared per share (CHF) 3 Cash dividend equivalent in USD 3 Dividend payout ratio (%) 3 Rates of return (%) Return on Shareholders’ equity 4 Return on average equity Return on average assets 31.12.04 31.12.03 31.12.02 31.12.01 31.12.00 For the year ended 39,398 (27,538) 11,860 276 12,136 19,416 4,972 897 3,648 41,069 30,395 10,674 2,135 (450) 8,089 72.6 7.68 7.47 10.14 3.00 39.1 24.7 22.9 0.44 40,159 (27,860 ) 12,299 (72 ) 12,227 17,345 3,756 462 33,790 25,613 8,177 1,593 (345 ) 6,239 75.6 5.59 5.48 7.32 2.60 2.00 46.5 17.8 16.8 0.40 39,963 (29,417 ) 10,546 (115 ) 10,431 18,221 5,451 4 34,107 29,570 4,537 676 (331 ) 3,530 86.4 2.92 2.87 3.75 2.00 1.46 68.5 8.9 8.3 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 3.93 3.78 5.31 0.00 0.00 11.7 11.3 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 6.44 6.35 8.44 1.50 0.86 23.3 21.5 22.0 0.70 1 Operating expenses / operating income before credit loss expense for Financial Businesses. 3 Dividends are normally declared and paid in the year subsequent 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. 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 was paid on 23 April 2003 and CHF 2.60 on 20 April 2004. A dividend of CHF 3.00 per share will be paid on 26 April 2005 subject to approval by shareholders at the Annual General Meeting. The USD amount per share will be determined on 22 April 2005. 4 Net proﬁt / average Shareholders’ equity excluding dividends. 2 For EPS calculation, see Note 8 to the Financial Statements. 208 B – Selected Financial Data (continued) CHF million, except where indicated 31.12.04 31.12.03 As at 31.12.02 31.12.01 31.12.00 Balance sheet data Total assets Shareholders’ equity Average equity to average assets (%) Market capitalization 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) Headcount Financial Businesses (full-time equivalents) Switzerland Europe (excluding Switzerland) Americas Asia Paciﬁc Total Long-term ratings 1 Fitch, London Moody’s, New York Standard & Poor’s, New York 1,734,784 1,550,056 1,346,678 1,253,297 1,087,552 34,978 1.93 103,638 35,310 2.38 95,401 38,952 2.87 79,448 43,530 3.49 105,475 44,833 3,17 112,666 1,126,858,177 1,183,046,764 1,256,297,678 1,281,717,499 1,333,139,187 0 0 0 0 103,524,971 111,360,692 97,181,094 41,254,951 28,444,788 55,265,349 11.8 13.6 264,125 2,250 25,990 10,764 26,232 4,438 67,424 AA+ Aa2 AA+ 11.8 13.3 251,901 2,133 26,662 9,906 25,511 3,850 65,929 AA+ Aa2 AA+ 11.3 13.8 238,790 1,959 27,972 10,009 27,350 3,730 69,061 AAA Aa2 AA+ 11.6 14.8 253,735 2,448 29,163 9,650 27,463 3,709 69,985 AAA Aa2 AA+ 11.7 15.7 273,290 2,445 30,215 9,286 28,114 3,461 71,076 AAA Aa1 AA+ 1 See the Handbook 2004/2005, page 48 for information about the nature of these ratings. Balance Sheet Data CHF million Assets Total assets Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Trading portfolio assets pledged as collateral Positive replacement values Loans Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Financial liabilities designated at fair value Due to customers Debt issued Shareholders’ equity 31.12.04 31.12.03 As at 31.12.02 31.12.01 31.12.00 1,734,784 1,550,056 1,346,678 1,253,297 1,087,552 35,264 220,242 357,164 370,259 159,115 284,577 232,387 118,901 61,545 422,587 171,033 303,712 65,756 376,083 117,828 34,978 31,740 213,932 320,499 341,013 120,759 248,206 212,679 127,012 53,278 415,863 143,957 254,768 35,286 346,633 88,843 35,310 32,516 139,049 294,067 261,071 110,365 247,421 211,740 83,178 36,870 366,858 106,453 247,206 14,516 306,876 114,446 38,952 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 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 44,833 209 Additional Disclosure Required under SEC Regulations B – Selected Financial Data (continued) US GAAP Income Statement Data CHF million Operating income 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 Income from Industrial Holdings Total operating income Operating expenses Personnel expenses General and administrative expenses Depreciation of property and equipment Amortization of goodwill Amortization of other intangible assets Goods and materials purchased 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 1 Cumulative adjustment of accounting for certain equity based compensation plans as cash settled, net of tax Net proﬁt / (loss) 31.12.04 31.12.03 31.12.02 31.12.01 31.12.00 For the year ended 39,124 (27,306) 11,818 276 12,094 19,416 4,879 1,188 3,648 41,225 18,729 6,705 1,385 0 186 2,861 0 29,866 11,359 2,112 9,247 (435) 6 8,818 39,940 (27,700 ) 12,240 (72 ) 12,168 17,345 4,021 380 39,679 (29,334 ) 10,345 (115 ) 10,230 18,221 5,940 96 51,907 (44,096 ) 7,811 (498 ) 7,313 20,211 8,959 534 51,565 (43,584 ) 7,981 130 8,111 16,703 8,597 1,514 33,914 34,487 37,017 34,925 17,615 6,086 1,396 0 112 0 25,209 8,705 1,842 6,863 (350 ) 18,610 7,072 1,613 0 1,443 0 28,738 5,749 511 5,238 (331 ) 639 19,713 7,631 1,815 2,484 298 112 32,053 4,964 1,386 3,578 (344 ) 17,262 6,813 1,800 2,018 134 191 28,218 6,707 2,183 4,524 (87 ) 6,513 5,546 3,234 4,437 1 Please refer to Note 41.1 (e) to the Consolidated Financial Statements, under the heading “Financial investments and private equity”, for further information about this item. Certain prior year US GAAP amounts in 2003 and 2002 have been adjusted to conform to the current year’s presentation. 210 B - Selected Financial Data (continued) US GAAP Balance Sheet Data CHF million Assets Total assets Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Trading portfolio assets pledged as collateral 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 31.12.04 31.12.03 As at 31.12.02 31.12.01 31.12.00 1,903,186 1,699,007 1,296,938 1,361,920 1,124,554 35,286 218,414 357,164 449,389 159,115 284,468 228,968 26,977 1,722 101,068 119,021 57,792 423,513 190,907 12,950 360,345 386,913 14,830 164,744 52,668 31,758 211,058 320,499 423,733 120,759 248,924 212,729 26,775 1,174 64,381 127,385 51,157 415,863 149,380 13,071 326,136 347,358 13,673 123,259 53,174 32,481 139,073 294,086 331,480 110,365 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 1 Positive and negative replacement values represent the fair value of derivative instruments. From 2003 onwards, they are presented on a gross basis under US GAAP. 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. IFRS 1 US GAAP 1 For the year ended 31.12.04 31.12.03 31.12.02 31.12.01 31.12.00 1.36 1.39 1.27 1.29 1.14 1.18 1.14 1.10 1.23 1.15 1 The ratio is provided using both IFRS and US GAAP values, since the ratio is materially different under the two accounting standards. C – Information on the Company Property, Plant and Equipment At 31 December 2004, UBS Financial Businesses operated about 1,044 business and banking locations worldwide, of which about 42% were in Switzerland, 11% in the rest of Eu- rope, Middle East and Africa, 45% in the Americas and 2% in Asia Paciﬁc. 39% of the business and banking locations in Switzerland were owned directly by UBS with the remainder, along with most of UBS’s ofﬁces outside Switzerland, being held under commercial leases. At 31 December 2004, the Industrial Holdings segment op- erated about 212 business locations in Europe, of which 33% were in Switzerland and 67% in the rest of Europe. 81% of all business locations in Switzerland and the rest of Europe were held under commercial leases. These premises are subject to continuous maintenance and upgrading and are considered suitable and adequate for our current and anticipated operations. 211 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 Selected Statistical Information The tables below set forth selected statistical information re- garding the Group’s banking operations extracted from the Financial Statements. Unless otherwise indicated, average balances for the years ended 31 December 2004, 31 Decem- ber 2003 and 31 December 2002 are calculated from month- ly data. The distinction between domestic and foreign is gen- erally based on the booking location. For loans, this method is not signiﬁcantly different from an analysis based on the domicile of the borrower. 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 2004, 2003 and 2002. Average balance 31.12.04 Interest Average rate (%) Average balance 31.12.03 Interest Average rate (%) Average balance 31.12.02 Interest Average rate (%) 12,463 23,648 183 389 17,969 457 710,065 10,549 10,122 337 494,692 18,914 2,309 27 497,001 18,941 196 0 0 0 168,456 60,382 5,401 1,813 1,132 4,122 0 4,122 27 66 0 66 38,163 1,235 1.5 1.6 2.5 1.5 3.3 3.8 1.2 3.8 3.2 3.0 2.4 1.6 0.0 1.6 2.5 11,417 21,118 200 1,035 6,576 200 582,066 10,948 7,990 222 407,867 18,151 1,668 21 409,535 18,172 0 0 0 0 165,397 51,457 6,437 1,805 1,988 4,798 0 4,798 1,262,342 40 35 0 35 39,094 1,065 1.8 4.9 3.0 1.9 2.8 4.5 1.3 4.4 3.9 3.5 2.0 0.7 0.0 0.7 3.1 12,534 17,668 388 634 5,471 235 573,526 10,949 7,812 269 373,810 16,714 1,720 31 375,530 16,745 0 0 0 0 170,641 55,199 6,987 1,789 3,794 8,781 0 8,781 1,230,956 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 3.1 1,505,556 39,398 2.6 1,262,342 40,159 3.2 1,230,956 39,963 3.2 246,952 7,840 68,925 1,829,273 249,155 11,710 40,104 1,563,311 188,462 12,625 53,293 1,485,336 CHF million, except where indicated 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 Financial assets designated at fair value Domestic Foreign Loans Domestic Foreign Financial investments Domestic Foreign – taxable Foreign – non-taxable Foreign – total Net interest on swaps Interest income and average interest-earning assets Non-interest-earning assets Positive replacement values Fixed assets Other Total average assets 212 Total interest-earning assets 1,505,556 D – Information Required by Industry Guide 3 (continued) Average balance 31.12.04 Interest Average rate (%) Average balance 31.12.03 Interest Average rate (%) Average balance 31.12.02 Interest Average rate (%) 452 1,362 355 9,726 146 8,080 0 341 435 625 447 1,507 3,062 0.5 2.4 1.3 1.8 4.8 7.7 28,625 60,621 18,382 523,375 3,239 109,013 0 3.3 10,905 42,484 71,465 27,646 141,595 172,650 0.2 0.6 1.9 0.6 1.3 0.0 1.4 2.9 4.2 2.3 69 0 91,616 1,915 10,082 35,958 433 2,038 1,206,130 29,417 191,183 45,337 1,442,650 42,686 1,485,336 1.6 2.2 1.9 1.9 4.5 7.4 3.1 1.0 0.9 1.6 1.1 1.8 0.0 2.1 4.3 5.7 2.4 0.9 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 Financial liabilities designated at fair value 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 31,129 94,747 416 1,575 33,846 614,295 3,717 161,286 489 9,525 180 7,813 85 1 49,234 1,167 67,005 84,112 19,052 170,169 192,992 167 414 280 861 2,677 1.3 1.7 1.4 1.6 4.8 4.8 1.2 2.4 0.2 0.5 1.5 0.5 1.4 28,719 72,712 23,287 515,665 3,252 127,104 0 22,445 55,496 81,963 21,125 158,584 161,723 150 1,751 295 9,328 156 9,769 0 751 100 527 395 1,022 2,149 246 0 64 0 79,902 1,338 1.7 73,193 1,015 Total interest-bearing liabilities 1,470,209 27,538 7,639 30,922 168 1,328 Non-interest-bearing liabilities Negative replacement values Other Total liabilities Shareholders’ equity 260,629 63,065 1,793,903 35,370 Total average liabilities and shareholders’ equity 1,829,273 Net interest income Net yield on interest-earning assets 1 Due to customers in foreign ofﬁces consists mainly of time deposits. 2.2 4.3 1.9 6,413 30,775 188 1,286 1,223,936 27,860 254,819 47,391 1,526,146 37,165 1,563,311 11,860 12,299 10,546 0.8 1.0 The percentage of total average interest-earning assets attrib- utable to foreign activities was 86% for 2004 (85% for 2003 and 84% for 2002). The percentage of total average interest- bearing liabilities attributable to foreign activities was 84% for 2004 (82% for 2003 and 83% for 2002). All assets and lia- bilities are translated into CHF at uniform month-end rates. Interest income and expense are translated at monthly aver- age rates. Average rates earned and paid on assets and liabilities can change from period to period based on the changes in inter- est rates in general, but are also affected by changes in the cur- rency mix included in the assets and liabilities. This is especial- ly 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 therefore the impact from such income is negligible. 213 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 2004 compared to the year ended 31 December 2003, and for the year ended 31 December 2003 compared to the year ended 31 December 2002. 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 221 of Industry Guide 3 for a discussion of the treatment of impaired, non-performing and restructured loans. 2004 compared to 2003 2003 compared to 2002 Increase / (decrease) due to changes in Increase / (decrease) due to changes in Average volume Average rate Net change Average volume Average rate Net change 19 124 342 2,432 60 3,907 8 (36) (770) (85) (2,831) 55 (3,144) (2) 3,915 (3,146) 0 0 119 312 (17) (5) 0 (5) 0 0 (4) 36 0 36 523 6,778 7,301 (1,217) (7,015) (8,232) (17) (646) 257 (399) 115 763 6 769 0 0 (13) 31 0 31 (694) (237) (931) 170 (761) (35 ) 124 48 162 6 1,533 (1 ) 1,532 0 0 (215 ) (120 ) (29 ) (48 ) 0 (48 ) (225 ) 1,650 1,425 (153 ) 277 (83 ) (163 ) (53 ) (96 ) (9 ) (105 ) 0 0 (335 ) 136 9 (22 ) 0 (22 ) (615 ) 123 (492 ) (188 ) 401 (35 ) (1 ) (47 ) 1,437 (10 ) 1,427 0 0 (550 ) 16 (20 ) (70 ) 0 (70 ) (840 ) 1,773 933 (737 ) 196 (1,155) (304) (1,036) 8 CHF million Interest income from interest-earning 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 Financial assets designated at fair value Domestic Foreign 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 214 D – Information Required by Industry Guide 3 (continued) Analysis of Changes in Interest Income and Expense (continued) CHF million Interest expense on interest-bearing liabilities Due to banks Domestic Foreign Cash collateral on securities lent and repurchase agreements Domestic Foreign Trading portfolio liabilities Domestic Foreign Financial liabilities designated at fair value 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 Total interest expense 2004 compared to 2003 2003 compared to 2002 Increase / (decrease) due to changes in Increase / (decrease) due to changes in Average volume Average rate Net change Average volume Average rate Net change 12 529 137 1,775 22 2,632 0 884 23 13 (39) (3) 406 0 94 36 6 254 (705) 57 (1,578) 2 266 (176) 194 197 24 (4,588) (1,956) 1 (468) 44 (126) (76) (158) 122 0 229 (56) 36 1 416 67 (113) (115) (161) 528 0 323 (20) 42 304 (626) (322) 204 6,326 6,530 100 (6,952) (6,852) 2 266 93 (146 ) 1 1,339 0 358 130 94 (104 ) 120 (197 ) 0 (387 ) (158 ) (295 ) 58 938 996 (304 ) 123 (153 ) (252 ) 9 350 0 52 (465 ) (192 ) 52 (605 ) (716 ) 0 (513 ) (87 ) (457 ) (302 ) 389 (60 ) (398 ) 10 1,689 0 410 (335 ) (98 ) (52 ) (485 ) (913 ) 0 (900 ) (245 ) (752 ) (1,140 ) (1,413 ) (2,553 ) (1,082 ) (475 ) (1,557 ) 215 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 2004, 2003 and 2002. 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 49,699 million, CHF 49,857 million and CHF 43,914 million at 31 December 2004, 31 December 2003 and 31 December 2002, respectively. CHF million, except where indicated 31.12.04 31.12.03 31.12.02 Average deposit Average rate (%) Average deposit Average rate (%) Average deposit Average rate (%) 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. 7,770 4,693 12,463 23,648 36,111 67,005 84,112 19,052 170,169 192,992 363,161 0.1 1.7 0.7 1.7 1.3 0.2 0.5 1.5 0.5 1.4 1.0 3,836 7,581 11,417 21,118 32,535 55,496 81,963 21,125 158,584 161,723 320,307 0.0 0.6 0.4 2.4 1.7 0.2 0.6 1.9 0.6 1.3 1.0 3,524 9,010 12,534 17,668 30,202 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 At 31 December 2004, the maturity of time deposits exceeding CHF 150,000, or an equivalent amount in other currencies, was as follows: Domestic 30,107 1,392 882 932 215 Foreign 128,027 3,470 662 2,627 2,843 33,528 137,629 CHF million Within 3 months 3 to 6 months 6 to 12 months 1 to 5 years Over 5 years Total time deposits 216 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 2004, 2003 and 2002. Money market paper issued Due to banks Repurchase agreements 1 CHF million, except where indicated 31.12.04 31.12.03 31.12.02 31.12.04 31.12.03 31.12.02 31.12.04 31.12.03 31.12.02 Period-end balance Average balance Maximum month-end balance Average interest rate during the period (%) Average interest rate at period-end (%) 79,442 80,148 94,366 1.7 2.1 58,115 73,257 92,605 1.4 1.3 72,800 91,685 83,381 89,765 108,463 115,880 2.1 1.5 1.6 2.0 89,089 68,896 96,694 2.8 1.5 48,732 557,892 500,592 464,020 59,044 587,988 498,679 509,572 77,312 637,594 593,738 593,786 3.1 2.0 1.5 2.0 1.8 1.3 1.8 1.7 1 For the purpose of this disclosure, balances are presented on a gross basis. 217 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 (continued) Contractual Maturities of the Investments in Debt Instruments CHF million, except percentages 31 December 20041 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 1 Money market papers have contractual maturities of less than one year. CHF million, except percentages 31 December 20031 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 1 Money market papers have contractual maturities of less than one year. CHF million, except percentages 31 December 20021 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 1 Money market papers have contractual maturities of less than one year. Within 1 year 1–5 years 5–10 years Over 10 years Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) 1 10 36 57 3 0 107 5.50 3.97 2.13 2.74 2.50 0.00 4.29 4.14 1.25 2.92 0.00 0.00 2 10 4 50 0 0 66 3.80 0.00 0.00 0.00 3.21 0.00 6 0 0 0 5 0 11 4.00 0.00 0.00 0.00 4.36 0.00 1 0 0 33 64 0 98 Within 1 year 1–5 years 5–10 years Over 10 years Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) 3 5 45 81 0 4 138 6.61 3.90 1.89 1.09 0.00 0.00 4 20 9 68 0 8 109 2.92 2.01 1.49 3.53 0.00 0.00 3.80 0.00 0.00 7.38 0.00 0.00 6 0 0 7 0 0 13 4.00 0.00 0.00 0.00 0.00 0.00 1 0 0 0 0 0 1 Within 1 year 1–5 years 5–10 years Over 10 years Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) 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 3.86 3.59 6.12 3.41 4.03 0.00 8 4 1 19 4 0 36 4.00 0.00 0.00 8.02 0.00 0.00 1 0 0 21 0 0 22 218 D – Information Required by Industry Guide 3 (continued) Due from Banks and Loans (gross) 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 Handbook 2004 / 2005. The following table illustrates the diversiﬁcation of the loan portfolio among industry sectors at 31 December 2004, 2003, 2002, 2001 and 2000. The industry categories presented are consistent with the classiﬁcation of loans for re- porting to the Swiss Federal Banking Commission and Swiss National Bank. CHF million Domestic Banks 1 Construction Financial institutions Hotels and restaurants Manufacturing 2 Private households Public authorities Real estate and rentals Retail and wholesale Services 3 Other 4, 5 Total domestic Foreign Banks 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 5, 7 Total foreign Total gross 31.12.04 31.12.03 31.12.02 31.12.01 31.12.00 1,406 1,943 4,332 2,269 5,485 105,160 5,460 11,466 4,908 9,110 894 619 2,175 4,009 2,440 6,478 102,181 5,251 12,449 6,062 9,493 1,201 1,029 2,838 4,301 2,655 7,237 95,295 5,529 13,573 7,172 10,237 1,722 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 2,651 152,433 152,358 151,588 158,996 164,645 34,114 31,405 366 122 745 35,459 2,758 1,695 30,237 1,228 940 1,102 8,002 762 319 245 84 249 23,493 2,421 1,114 21,194 1,224 473 1,880 7,983 3,658 214 31,882 519 153 1,105 18,378 2,300 868 33,063 2,628 616 1,367 1,654 676 2,304 26,728 1,080 266 977 14,458 4,258 1,313 25,619 6,454 10,227 1,732 4,786 2,117 2,973 117,849 270,282 95,637 247,995 97,513 249,101 102,988 261,984 27,168 1,423 773 1,584 20,348 4,596 2,070 29,470 11,754 5,077 1,862 1,585 993 11,168 119,871 284,516 3 Includes transportation, communication, health and social 1 Includes Due from banks from Industrial Holdings of CHF 764 million at 31 December 2004. work, education and other social and personal service activities. 5 31 December 2003 and 31 December 2002 amounts include a change in accounting treatment of credit risk losses on OTC derivatives as at 1 January 2004, which are now recorded under Net trading income. As a consequence, the underlying gross exposure is no longer reported as “Due from Banks and Loans (gross)”. Years prior to 2002 have not been restated. 4 Includes mining and electricity, gas and water supply. 2 Includes chemicals, food and beverages. 7 Includes hotels and restaurants. 6 Includes food and beverages. 219 Additional Disclosure Required under SEC Regulations D - Information Required by Industry Guide 3 (continued) Due from Banks and Loans (gross) (continued) The following table analyzes the Group’s mortgage portfolio by geographic origin of the client and type of mortgage at 31 December 2004, 2003, 2002, 2001 and 2000. Mortgages are included in the industry categories mentioned above. CHF million Mortgages Domestic Foreign Total gross mortgages Mortgages Residential Commercial Total gross mortgages 31.12.04 31.12.03 31.12.02 31.12.01 31.12.00 124,496 12,185 136,681 117,731 18,950 136,681 122,069 7,073 129,142 109,980 19,162 129,142 116,359 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 96,181 24,373 120,554 Due from Banks and Loan Maturities (gross) The following table discloses loans by maturity at 31 December 2004. The determination of maturities is based on contract terms. Information on interest rate sensitivities can be found in Note 29 to the Financial Statements. CHF million Domestic Banks Mortgages Other loans Total domestic Foreign Banks Mortgages Other loans Total foreign Total gross 1 Within 1 year 1 to 5 years Over 5 years Total 812 48,428 18,818 68,058 32,285 10,691 59,198 102,174 170,232 594 67,205 5,960 73,759 1,442 1,314 6,581 9,337 83,096 0 8,863 1,753 10,616 387 180 5,771 6,338 16,954 1,406 124,496 26,531 152,433 34,114 12,185 71,550 117,849 270,282 At 31 December 2004, the total amounts of Due from banks and loans due after one year granted at ﬁxed and ﬂoating rates are as follows: CHF million Fixed rate loans Adjustable or ﬂoating rate loans Total 1 Includes Due from banks from Industrial Holdings of CHF 764 million at 31 December 2004. 1 to 5 years Over 5 years 78,623 4,473 83,096 14,828 2,126 16,954 Total 93,451 6,599 100,050 220 D – Information Required by Industry Guide 3 (continued) Impaired, Non-performing and Restructured Loans A loan (included in Due from banks or loans) is classiﬁed as non-performing, 1) when the payment of interest, principal or fees is overdue by more than 90 days and there is no ﬁrm evidence that they will be made good by later payments or the liquidation of collateral; 2) when insolvency proceedings have commenced; or 3) when obligations have been restructured on concessionary terms. The gross interest income that would have been recorded on non-performing loans was CHF 107 million for domestic loans and CHF 17 million for foreign loans for the year ended 31 December 2004, CHF 171 million for domestic loans and CHF 23 million for foreign loans for the year ended 31 December 2003, CHF 148 million for domestic loans and CHF 53 mil- lion for foreign loans for the year ended 31 December 2002, CHF 336 million for all non-performing loans for the year end- ed 31 December 2001 and CHF 182 million for all non-performing loans for the year ended 31 December 2000. The amount of interest income that was included in net income for those loans was CHF 106 million for domestic loans and CHF 8 mil- lion for foreign loans for the year ended 31 December 2004, CHF 163 million for domestic loans and CHF 8 million for for- eign loans for the year ended 31 December 2003, CHF 152 million for domestic loans and CHF 22 million for foreign loans for the year ended 31 December 2002 and CHF 201 million for all non-performing loans 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-performing loans, for further information see the Handbook 2004 / 2005. CHF million Non-performing loans: Domestic Foreign Total non-performing loans Foreign restructured loans 1 31.12.04 31.12.03 31.12.02 31.12.01 31.12.00 2,772 924 3,696 4,012 889 4,901 4,609 1,391 6,000 6,531 2,108 8,639 7,588 2,864 10,452 179 1 Include only performing foreign restructured loans. UBS does not, as a matter of policy, typically restructure loans to accrue interest at rates different 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 1,165 million, CHF 2,308 million, CHF 3,933 mil- lion, CHF 5,990 million and CHF 8,042 million in “other impaired loans” for the years ended 31 December 2004, 2003, 2002, 2001 and 2000, respectively. For the years ended 31 December 2002, 2001 and 2000, these are loans that are current, or less than 90 days in arrears, with respect to payment of principal or interest; and for the years ended 31 December 2004 and 2003, these are loans not considered “non-performing” in accordance with Swiss regulatory guidelines, but where the Group’s credit ofﬁcers have expressed doubts as to the ability of the borrowers to repay the loans. As at 31 December 2004 and 31 December 2003 speciﬁc allowances of CHF 241 million and CHF 694 million respectively had been established against these loans. 221 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 unutilized commitments) and deposits with third parties, 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 exposures are rigorously limited. The following analysis excludes Due from banks from Industrial Holdings. Claims that are secured by third-party guarantees are recorded against the guarantor’s country of domicile. Outstandings that are secured by collateral are recorded against the country where the asset could be liquidated. This follows the “Guide- lines for the Management of Country Risk”, which are applicable to all banks that are supervised by the Swiss Federal Bank- ing Commission. The following tables list those countries for which cross-border outstandings exceeded 0.75% of total assets at 31 De- cember 2004, 2003 and 2002. At 31 December 2004, there were no outstandings that exceeded 0.75% of total assets in any country currently facing liquidity problems that the Group expects would materially affect the country’s ability to service its obligations. For more information on cross-border exposure, see the Handbook 2004 / 2005. Private Sector Public Sector Total % of total assets 31.12.04 114,202 5,977 2,699 10,409 11,929 6,835 132,085 31,994 24,090 21,247 20,578 15,170 9,150 7,351 16,803 9,472 328 2,776 31.12.03 7.6 1.8 1.4 1.2 1.2 0.9 Private Sector Public Sector Total % of total assets 108,461 2,233 5,884 11,344 5,604 7,845 126,724 25,269 24,654 20,234 14,716 13,477 8,138 18,289 1,270 550 4,271 4,001 31.12.02 8.2 1.6 1.6 1.3 0.9 0.9 Private Sector Public Sector Total % of total assets 105,375 6,038 1,955 11,963 7,640 4,114 3,044 7,958 5,857 17,071 345 8,138 2,285 5,851 124,444 29,528 23,515 22,310 20,996 11,834 11,081 9.2 2.2 1.7 1.7 1.6 0.9 0.8 Banks 8,733 18,666 4,588 1,366 8,321 5,559 Banks 10,125 4,747 17,499 8,340 4,841 1,630 Banks 11,111 17,633 4,490 10,001 5,218 5,435 2,186 CHF million United States Germany Italy Japan United Kingdom France CHF million United States Italy Germany United Kingdom France Japan CHF million United States Germany Italy United Kingdom France Australia Canada 222 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. The following analysis includes Due from banks from Industrial Holdings. UBS writes off loans against allowances only upon ﬁnal settlement of bankruptcy proceedings, the sale of the underlying assets and / or in case of debt forgiveness. Under Swiss law, a creditor can continue to collect from a debtor who has emerged from bankruptcy, unless the debt has been forgiven through a formal agreement. CHF million Balance at beginning of year 31.12.04 3,954 31.12.03 5,232 31.12.02 8,218 31.12.01 10,581 31.12.00 13,398 Domestic Write-offs 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 write-offs Foreign Write-offs Banks Chemicals Construction Electricity, gas and water supply Financial institutions Manufacturing 4 Mining Private households Public authorities Real estate and rentals Retail and wholesale Services Transport, storage and communication Other 5 Total foreign write-offs Total write-offs 1 Includes chemicals, food and beverages. electricity, gas and water supply. 4 Includes food and beverages. 0 (49) (24) (101) (77) (208) 0 (109) (68) (83) (9) (728) (21) (1) (3) 0 (34) (23) (8) (8) (2) 0 0 (7) 0 (22) (129) (857) 0 (73 ) (37 ) (57 ) (121 ) (262 ) (18 ) (206 ) (67 ) (111 ) (43 ) (995 ) (17 ) 0 0 0 (112 ) (77 ) (15 ) (11 ) 0 (1 ) (76 ) (25 ) (24 ) (83 ) (441 ) (1,436 ) 0 (148 ) (103 ) (48 ) (275 ) (536 ) 0 (357 ) (101 ) (155 ) (49 ) 0 (248 ) (51 ) (52 ) (109 ) (1,297 ) 0 (317 ) (115 ) (93 ) (46 ) 0 (261 ) (178 ) (193 ) (264 ) (640 ) 0 (729 ) (160 ) (227 ) (30 ) (1,772 ) (2,328 ) (2,682 ) (49 ) 0 0 (36 ) (228 ) (70 ) (1 ) (65 ) (1 ) (2 ) (10 ) (39 ) (74 ) (189 ) (764 ) (2,536 ) (24 ) (2 ) (10 ) (63 ) (74 ) (119 ) (304 ) (5 ) 0 (1 ) 0 (30 ) 0 (48 ) (680 ) (3,008 ) (15 ) 0 (13 ) (3 ) (33 ) (11 ) 0 0 (4 ) 0 (160 ) (8 ) (11 ) (55 ) (313 ) (2,995 ) 2 Includes transportation, communication, health and social work, education and other social and personal service activities. 3 Includes mining and 5 Includes hotels and restaurants. 223 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 (continued) Summary of Movements in Allowances and Provisions for Credit Losses (continued) CHF million Recoveries Domestic Foreign Total recoveries Net write-offs Increase / (decrease) in credit loss allowance and provision Collective loan loss provisions Other adjustments 1 Balance at end of year 1 See the table below for details. Doubtful interest Net foreign exchange Subsidiaries sold and other adjustments Total adjustments 31.12.04 31.12.03 31.12.02 31.12.01 31.12.00 54 5 59 (798) (251) (25) 3 2,883 0 2 1 3 49 38 87 (1,349 ) 72 (1 ) 3,954 0 (57 ) 56 (1 ) 43 27 70 (2,466 ) 115 (635 ) 5,232 0 (269 ) (366 ) (635 ) 58 23 81 (2,927 ) 498 66 8,218 0 44 22 66 124 39 163 (2,832 ) (130 ) 145 10,581 182 23 (60 ) 145 224 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 sector and geographic location at 31 December 2004, 2003, 2002, 2001 and 2000. For a description of procedures with respect to allowances and provisions for credit losses, see the Handbook 2004 / 2005. The following analysis includes Due from banks from Industrial Holdings. CHF million 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 Banks 4 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 Collective loan loss provisions 7 Total allowances and provisions for credit losses 8 31.12.04 31.12.03 31.12.02 31.12.01 31.12.00 10 112 82 98 224 333 9 250 363 222 188 10 158 137 214 327 511 9 383 201 549 150 10 265 89 286 458 750 39 577 315 470 225 1,891 2,649 3,484 230 4 1 15 140 112 14 48 66 5 95 32 1 22 785 207 2,883 256 5 0 0 168 359 19 48 69 7 51 32 195 (166 ) 1,043 262 3,954 24 5 6 96 153 314 148 58 0 6 13 262 144 (177 ) 1,052 696 5,232 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 8,218 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 10,581 1 Includes chemicals, food and beverages. electricity, gas and water supply. provisions for 2004. million, CHF 1,006 million and CHF 1,292 million respectively of country provisions. 305 million and CHF 54 million respectively of provisions for unused commitments and contingent liabilities. 3 Includes mining and 4 Counterparty allowances and provisions only. Country provisions with banking counterparties amounting to CHF 17 million are disclosed under collective loan loss 7 The 2004, 2003, 2002, 2001 and 2000 amounts include CHF 161 million, CHF 262 million, CHF 696 8 The 2004, 2003, 2002, 2001 and 2000 amounts include CHF 211 million, CHF 290 million, CHF 366 million, CHF 2 Includes transportation, communication, health and social work, education and other social and personal service activities. 6 Includes hotels and restaurants. 5 Includes food and beverages. 225 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 (continued) Due from Banks and Loans by Industry Sector (gross) 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 loss- es by industry sectors to evaluate the credit risks in each of the categories. in % Domestic Banks 1 Construction Financial institutions Hotels and restaurants Manufacturing 2 Private households Public authorities Real estate and rentals Retail and wholesale Services 3 Other 4 Total domestic Foreign 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 31.12.04 31.12.03 31.12.02 31.12.01 31.12.00 0.5 0.7 1.6 0.8 2.0 38.9 2.0 4.2 1.8 3.4 0.5 56.4 12.6 0.1 0.0 0.3 13.1 1.0 0.6 11.2 0.5 0.3 0.4 3.0 0.3 0.2 0.2 0.9 1.6 1.0 2.6 41.2 2.1 5.0 2.4 3.8 0.6 61.4 12.7 0.1 0.0 0.1 9.5 1.0 0.4 8.5 0.5 0.2 0.8 3.2 1.5 0.1 0.4 1.1 1.7 1.1 2.9 38.3 2.2 5.4 2.9 4.1 0.8 60.9 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 0.9 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 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 43.6 100.0 38.6 100.0 39.1 100.0 39.3 100.0 42.1 100.0 1 Includes Due from banks from Industrial Holdings in the amount of CHF 764 million. education and other social and personal service activities. 4 Includes mining and electricity, gas and water supply. 5 Includes food and beverages. 2 Includes chemicals, food and beverages. 3 Includes transportation, communication, health and social work, 6 Includes hotels and restaurants. 226 D - Information Required by Industry Guide 3 (continued) Loss History Statistics The following is a summary of the Group’s loan loss history (relating to Due from banks and loans). CHF million, except where indicated Gross loans Impaired loans Non-performing loans Allowances and provisions for credit losses 2 Net write-offs Credit loss (expense) / recovery 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 3 Allocated allowances as a percentage of non-performing loans 4 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 a multiple of net write-offs 31.12.04 270,282 1 4,861 3,696 2,883 798 276 1.8 1.4 1.1 59.3 78.0 51.5 61.3 0.3 0.3 27.7 3.61 31.12.03 247,995 7,209 4,901 3,954 1,349 (72 ) 2.9 2.0 1.6 54.8 80.7 48.0 56.4 0.5 0.5 34.1 2.93 31.12.02 249,101 9,933 6,000 5,232 2,466 (115 ) 31.12.01 261,984 14,629 8,639 8,218 2,927 (498 ) 4.0 2.4 2.1 52.7 87.2 45.7 57.6 1.0 1.0 47.1 2.12 5.6 3.3 3.1 56.2 95.1 49.9 62.2 1.1 1.2 35.6 2.81 31.12.00 284,516 18,494 10,452 10,581 2,832 130 6.5 3.7 3.7 57.2 101.2 52.4 60.6 1.0 1.1 26.8 3.74 1 Includes Due from banks from Industrial Holdings of CHF 764 million. performing loans only. 2 Includes collective loan loss provisions. 3 Allowances relating to impaired loans only. 4 Allowances relating to non- 227 228 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 European wealth management business, and other statements relating to our future business development and economic performance. While these forward-looking statements represent our judgments and future expectations concerning the develop- ment of our business, a number of risks, uncertainties and other important factors 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, govern- mental 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 creditworthiness of our customers, obligors and counterparties and developments in the markets in which they operate, (6) legislative developments, (7) management changes and changes to our Business Group structure 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 ﬁlings made by UBS with the SEC, including UBS’s Annual Report on Form 20-F for the year ended 31 December 2004. UBS is not under any obligation to (and expressly disclaims 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-No. 80531E-0501 ab UBS AG P.O. Box, CH-8098 Zurich P.O. Box, CH-4002 Basel www.ubs.com

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