UBS AG Annual Report 2005

Plain-text annual report

ab Financial Report 2005 ab UBS AG P.O. Box, CH-8098 Zurich P.O. Box, CH-4002 Basel www.ubs.com 5 0 0 2 t r o p e R l a i c n a n i F S B U On the cover “Hand in hand we are worldclass.” What “You & Us” means to Christian Mutzner, who works for us in Zurich. 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 development 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, governmental and regulatory trends, (2) movements in local and international securities markets, currency exchange rates and interest rates, (3) competitive pressures, (4) technological developments, (5) changes in the ﬁnancial position or 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 2005. 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-0601 Introduction Our Financial Report comprises the audited ﬁnancial state- ments of UBS for 2005, 2004 and 2003, prepared according to International Financial Reporting Standards (IFRS) and rec- onciled to the United States Generally Accepted Accounting Principles (US GAAP). It includes the audited ﬁnancial state- ments of UBS AG (the “Parent Bank”) for 2005 and 2004, prepared according to Swiss banking law. Our Financial Report also discusses the ﬁnancial and business performance of UBS and its Business Groups, and provides additional disclosure re- quired by Swiss and US regulations. The Financial Report should be read together with the other publications described on page 4. We sincerely hope that you will ﬁnd our publications useful and informative. We believe that UBS is one of the leaders in corporate disclosure, and we would be keen to hear your views on how we might improve the content, information or presentation of our products. Tom Hill 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 2006 UBS Results UBS Performance Indicators Financial Businesses Results Global Wealth Management & Business Banking Global Asset Management Investment Bank 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 10 12 13 15 19 20 28 42 47 52 55 59 60 63 65 66 68 71 191 205 1 Introduction UBS ﬁnancial highlights UBS income statement CHF million, except where indicated Net proﬁt attributable to UBS shareholders Basic earnings per share (CHF) 1 Diluted earnings per share (CHF) 1 Return on equity attributable to UBS shareholders (%) 2 Performance indicators from continuing operations 3 Basic earnings per share (CHF) 1 Return on equity attributable to UBS shareholders (%) 4 Financial businesses 5 Operating income Operating expenses Net proﬁt attributable to UBS shareholders Cost / income ratio (%) 6 Net new money, wealth management businesses (CHF billion) 7 Personnel (full-time equivalents) Pre-goodwill earnings from continuing operations 3 Operating income Operating expenses Net proﬁt attributable to UBS shareholders Cost / income ratio (%) 6 UBS balance sheet & capital management CHF million, except where indicated Balance sheet key ﬁgures Total assets Equity attributable to UBS shareholders Market capitalization BIS capital ratios Tier 1 (%) 8 Total BIS (%) Risk-weighted assets Invested assets (CHF billion) Long-term ratings Fitch, London Moody’s, New York Standard & Poor’s, New York 31.12.05 14,029 13.93 13.36 39.4 9.78 27.6 39,896 27,704 13,517 70.1 95.1 69,569 39,896 27,704 9,442 70.1 For the year ended 31.12.04 8,016 31.12.03 5,904 7.78 7.40 25.5 8.02 26.3 35,971 26,149 7,656 73.2 60.4 67,407 35,971 25,503 8,003 71.4 5.44 5.19 17.8 5.72 18.8 32,957 25,397 5,959 76.8 44.0 65,879 32,957 24,720 6,468 74.8 % change from 31.12.04 75 79 81 22 11 6 77 3 11 9 18 31.12.05 As at 31.12.04 % change from 31.12.03 31.12.04 2,060,250 1,737,118 1,553,979 44,324 131,949 12.9 14.1 310,409 2,652 AA+ Aa2 AA+ 33,941 103,638 11.9 13.8 264,832 2,217 AA+ Aa2 AA+ 33,659 95,401 12.0 13.5 252,398 2,098 AA+ Aa2 AA+ 19 31 27 17 20 1 For the EPS calculation, see note 8 to the ﬁnancial statements. the amortization of goodwill in 2004 and 2003. Due to changes in accounting standards, there is no amortization of goodwill from 2005 onwards. continuing operations / average equity attributable to UBS shareholders less proposed distributions. 5 Excludes results from industrial holdings. loss expense or recovery. to the BIS capital and ratios table in the capital management section and note 28 to the ﬁnancial statements. 7 Includes Wealth Management International & Switzerland and Wealth Management US. Excludes interest and dividend income. 3 Excludes 4 Net proﬁt attributable to UBS shareholders from 6 Operating expenses / operating income less credit 8 Includes hybrid Tier1 capital, please refer 2 Net proﬁt attributable to UBS shareholders / average equity attributable to UBS shareholders less proposed distributions. From 2005 on, all tables, charts, comments and analysis reﬂect the integration of Wealth Management US into the new Global Wealth Management & Business Banking Business Group, the change in treatment of the Wealth Management US cash man- agement business and the shift of the municipal securities business to the Investment Bank. Prior years have been restated to reﬂect those changes. In 2005, the entire private equity portfolio started being reported as part of the Industrial Holdings segment. Throughout this report, 2004 and 2003 results have been restated to reﬂect accounting changes (IAS1, IFRS 2, IFRS 4, IAS 27, and IAS 28) effective 1 January 2005 as well as the presentation of discontinued operations. 2 UBS at a glance UBS is one of the world’s leading ﬁnancial ﬁrms, serving a dis- cerning global client base. As an organization, it combines ﬁnancial strength with a culture that embraces change. As an integrated ﬁrm, UBS creates added value for clients by draw- ing on the combined resources and expertise of all its busi- nesses. UBS is present in all major ﬁnancial centers worldwide, with ofﬁces in 50 countries. UBS employs more than 69,500 people, 39% in the Americas, 37% in Switzerland, 16% in the rest of Europe and 8% 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 12.9%, invested assets of CHF 2.65 trillion, shareholders’ equity of CHF 44.3 billion and mar- ket capitalization of CHF 131.9 billion on 31 December 2005. Businesses Wealth management With more than 140 years of experience, an extensive global network that includes one of the largest private client busi- nesses in the US, and more than CHF 1,700 billion in invested assets, UBS is the world’s leading wealth management busi- ness, providing a comprehensive range of services customized for wealthy individuals, ranging from asset management to estate planning and from corporate ﬁnance to art banking. Investment banking and securities UBS is a global investment banking and securities ﬁrm with a strong institutional and corporate client franchise. Consis- tently placed in the top tiers of major industry rankings, it is a leading player in the global primary and secondary mar- kets 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 premium 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 over CHF 750 billion, provides a broad base of innovative capa- bilities stretching from traditional to alternative investment solutions for, among other clients, ﬁnancial intermediaries and institutional investors across the world. Swiss corporate and individual clients UBS is the leading bank for Swiss corporate and individual clients. It serves around 2.6 million individual clients through more than 3 million accounts, mortgages and other ﬁnancial relationships. It also offers comprehensive banking and securi- ties services for 136,500 corporations, institutional investors, public entities and foundations as well as 3,000 ﬁnancial insti- tutions worldwide. With a total loan book of over CHF 140 bil- lion, UBS leads the Swiss lending and retail mortgage markets. Corporate Center The Corporate Center partners with the businesses, ensur- ing that the ﬁrm operates as a coherent and integrated whole with a common vision and set of values. It helps UBS’s busi- nesses grow sustainably through its ﬁnancial control, risk, treasury, communication, legal, human resources and tech- nology functions. 3 Introduction Sources of information This Financial Report contains UBS’s audited ﬁnancial statements for the year 2005 and 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. 80531-0601). Annual Review 2005 Our Annual Review contains a description of UBS and our Business Groups, as well as a summary review of our perfor- mance in 2005. It is available in English, German, French, Italian, Spanish and Japanese. (SAP no. 80530-0601). Handbook 2005 / 2006 The Handbook 2005 / 2006 contains a detailed description of UBS, our strategy, organization, employees 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. 80532-0601). 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. Compensation Report 2005 The Compensation Report 2005 provides detailed information on the compensation paid to the members of UBS’s Board of Directors (BoD) and the Group Executive Board (GEB). The re- port is available in English and German. (SAP no.82307-0601). The same information can also be read in the Corporate Governance chapter of the Handbook 2005 / 2006. The making of UBS Our “The making of UBS” brochure outlines the series of transformational mergers and acquisitions that created today’s UBS. It also includes brief proﬁles of the ﬁrm’s an- tecedent 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 in a PDF format on the in- ternet at www.ubs.com/investors in the reporting section. Prtinted copies can be ordered from the same website by accessing the order / subscribe panel on the right-hand side of the screen. Alternatively, they can be ordered by quoting the SAP number 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. Messaging service On the Analysts and Investors website, you can register to re- ceive news alerts about UBS via Short Messaging System (SMS) or e-mail. Messages are sent in either English or Ger- man and users are able to state their preferences for the top- ics 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 web- casts 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 our Annual Report on Form 20-F, ﬁled pursuant to the US Securities Exchange Act of1934. Our Form 20-F ﬁling is structured as a “wrap-around” doc- ument. Most sections of the ﬁling are satisﬁed by referring to parts of the Handbook 2005 / 2006 or to parts of this Financial Report 2005. 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 en- couraged 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 100 F Street, N.E., Room 1580, 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 in- spect 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-8001 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 ofﬁces in Zurich and New York. 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 Hotline Matthew Miller Caroline Ryton Reginald Cash Nina Hoppe 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 2281 +1-212-882 5734 +41-44-234 4307 +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 866-541 9689 +1-201-680 6578 +1-201-680 4675 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 480 Washington Boulevard Jersey City, NJ 07310, USA sh-relations@melloninvestor.com Presentation of Financial Information Presentation of Financial Information UBS reporting structure UBS reporting structure Changes in 2005 Changes to accounting In 2005, we implemented several accounting and reporting structure changes. To reﬂect these changes, we have restated our consolidated ﬁnancial statements and the segment report- ing of business units affected for all prior periods, except for the amortization of goodwill, which ceased at the beginning of 2005 for ﬁnancial years after 2004. The ﬁgures and results presented in this report are based on restated numbers. Changes to reporting structure and presentation In 2005, we implemented several changes in our reporting structure. At the year’s outset, we decided to start reporting our private equity investments, until then a part of the Investment Bank, in the Industrial Holdings segment. Effective 1 July, we brought our US, Swiss and international wealth management units along with our Swiss corporate and retail banking unit into one Business Group titled Global Wealth Management & Business Banking. We continue to disclose the Wealth Management International & Switzer- land, Wealth Management US and Business Banking Swit- zerland units separately. We also transferred our municipal securities unit, until then a part of the Wealth Management US unit, to the Investment Bank’s ﬁxed income area. In December 2005, we sold our independently branded Private Banks and specialist asset manager GAM to Julius Baer. The performance of Private Banks & GAM is shown as discontinued operations in a separate line in Corporate Center for all periods presented. At the start of 2005, we implemented the following changes in accounting: – IFRS 2 Share-based Payment. IFRS 2 requires entities to rec- ognize 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. – IAS 27 Consolidated and Separate Financial Statements and IAS 28 Investments in Associates. In the past, we treated all our private equity investments as “Financial investments available-for-sale”. The revised IAS 27 and IAS 28 required us to change the accounting treatment for some of our pri- vate equity investments, consolidating those that we con- trol, and using the equity method of accounting where we exercise signiﬁcant inﬂuence. – IFRS 3 Business Combinations. With the introduction of IFRS 3, we stopped amortizing goodwill at the beginning of 2005. Instead, from now on, we will test goodwill an- nually for impairment. – IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. This new standard requires that major lines of business and subsidiaries acquired exclusively with the intent of future sale be presented as “discontinued operations” from the time a sale is highly likely to occur. Private Banks & GAM and certain of our previously held private equity investments (now reported in Industrial Holdings) met these criteria and were reclassified ac- cordingly. 8 UBS Reporting Structure Global Asset Management Investment Bank Corporate Center Industrial Holdings Motor-Columbus & Private Equity Financial Businesses Global Wealth Management & Business Banking Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland – IAS 1 Presentation of Financial Statements. The adoption of revised IAS 1 requires the inclusion of minority interests in both net proﬁt and equity. The newly deﬁned net proﬁt is then allocated into “Net proﬁt attributable to UBS share- holders” and “Net proﬁt attributable to minority inter- ests”. When analyzing our performance, our focus will, as before, be on “Net proﬁt attributable to UBS sharehold- ers” (attributable proﬁt) and “Equity attributable to UBS shareholders” (shareholders’ equity). – IFRS 4 Insurance Contracts. The majority of insurance prod- ucts issued by UBS are considered investment contracts and are accounted for as ﬁnancial liabilities and not as insurance contracts under IFRS 4. The related assets in the balance sheet were reclassiﬁed from other assets to trading assets in 2004. – A redeﬁnition of recurring income for the Wealth Management US unit to include interest income, bringing it in line with the deﬁnition of recurring income for the other wealth management units. The overall impact of all the changes above was a decrease in net proﬁt attributable to UBS shareholders by CHF 73 mil- lion and CHF 335 million for 2004 and 2003, respectively. 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 during 2005. We have split personnel expenses into cash and share- based components. This helps to distinguish between cash expenses paid or accrued during the quarter, and deferred payments which are driven by option and share grants made in previous periods. In our Information Technology Infrastructure (ITI) unit, we show the cost of IT infrastructure per average number of ﬁ- nancial business employees, helping us to track the success of the unit. We also provided a new capital ratio to measure capital consumption by our business units. Called the return on adjusted regulatory capital, it is shown as a key perform- ance indicator for the Investment Bank and Business Banking Switzerland. 9 Presentation of Financial Information Measurement and analysis of performance Measurement and analysis of performance UBS’s performance is reported in accordance with Interna- tional Financial Reporting Standards (IFRS). Additionally, our results discussion and analysis comments on the underlying operational performance of our business, focusing on con- tinuing operations insulated from the impact of discontinued activities and individual gain or loss items that are not rele- vant to our internal approach to managing the company. This includes items that we would not consider as indicative of our future potential performance and are therefore not included in our business planning decisions, and which are event- and UBS-speciﬁc, rather than industry-wide. It also helps to bet- ter assess our performance against peers and to estimate fu- ture growth potential. In the last three years, two such items had a signiﬁcant im- pact on our consolidated ﬁnancial statements: – In fourth quarter 2005, we sold our Private Banks & GAM unit to Julius Baer for a gain of CHF 3.7 billion after tax (pre-tax CHF 4.1 billion). The unit comprised the Banco di Lugano, Ehinger & Armand von Ernst and Ferrier Lullin pri- vate banks as well as specialist asset manager GAM. After the sale, we retained a stake of 20.7% in the new Julius Baer. – A net gain of CHF 2 million (pre-tax CHF 161 million) in second quarter 2003 from the sale of the Wealth Manage- ment US Business Unit’s Correspondent Services Corpo- ration (CSC) clearing business. A substantial portion of CSC’s net assets comprised goodwill stemming from the PaineWebber acquisition. After deducting taxes of CHF 159 million (based on the purchase price) and the write- down of the goodwill associated with CSC, the net gain from the transaction was CHF 2 million. Up to and including 2004, we had provided comments and analysis on an adjusted basis that also excluded the amor- tization of goodwill and other acquired intangible assets. With the introduction of IFRS 3, Business Combinations, at the beginning of 2005, we ceased amortizing goodwill, which was by far the largest impact on our results. In our 2005 re- porting, our result and analysis commentary compares current results to the prior year on a pre-goodwill basis. Accordingly, 2004 results in this report are analyzed on a pre-goodwill basis. Seasonal characteristics Our main businesses do not generally show signiﬁcant seasonal patterns, except for the Investment Bank, where revenues are impacted by the seasonal characteristics of general ﬁnancial market activity and deal ﬂows in investment banking. When discussing quarterly performance, we therefore compare the Investment Bank’s ﬁnancial results of the re- ported quarter 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. Because of the volatile nature of market movements and the resulting business and trading opportunities, the market risk and balance sheet items in our Investment Bank are compared on a present quarter to pre- vious quarter basis. For all other Business Groups and Units, recent quarterly results are compared to the previous quar- ter’s, as they are only slightly impacted by seasonal compo- nents such as asset withdrawals in fourth quarter and lower client activity levels related to the end of year holiday season. Performance measures UBS performance indicators For the last six years, we have focused on a consistent set of four long-term performance indicators that are valid through periods of varying market conditions and designed to ensure that we deliver continuously improving returns to our share- holders. We have reported our performance against these in- dicators each quarter: – We seek to increase the value of UBS by achieving a sus- tainable, after-tax return on equity of 15–20% – We aim to increase shareholder value through double-digit average annual percentage growth in basic earnings per share (EPS) – By cost reduction and earnings enhancement initiatives, we aim to manage UBS’s cost / income ratio at 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. As we have been steadily exceeding our performance in- dicators for some time now, we have decided to modify them for 2006 (for further details, see page 12). Business Group Key Performance Indicators At the Business Group or Business Unit level, our performance is measured by carefully chosen Key Performance Indicators (KPIs). They indicate the Business Group’s or Business Unit’s success in creating value for shareholders but do not dis- close explicit targets. The KPIs show the key drivers of each unit’s core business activities and include ﬁnancial metrics, such as cost / income ratios and invested assets, along with non-ﬁnancial metrics, such as the number of client advisors. 10 Business Group Key Performance Indicators Business Key performance indicators Deﬁnition Business Groups and Business Units within Financial Businesses Cost / income ratio (%) Total operating expenses / total operating income before adjusted expected credit loss. Cost / income ratio before goodwill (%) Total operating expenses excluding amortization of goodwill / total operating income before adjusted expected credit loss. Wealth & Asset Management Businesses and Business Banking Switzerland Invested assets (CHF billion) Client assets managed by or deposited with UBS for investment purposes only (for further details please refer to page 12). Net new money (CHF billion) Inﬂow of invested assets from new clients – outﬂows due to client defection +/– inﬂows / outﬂows from existing clients (for further details please refer to page 17). Wealth & Asset Management Businesses Gross margin on invested assets (bps) Operating income before adjusted expected credit loss / average invested assets. Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Client advisors Expressed in full-time equivalents. Recurring income (CHF million) Interest, asset-based fees for portfolio management and fund distribution and account-based and advisory fees (as opposed to transactional fees). Revenues per advisor (CHF thousand) Non-performing loans / gross loans ratio (%) Private client revenues / average number of ﬁnancial advisors. Non-performing loans / gross loans. Impaired loans / gross loans ratio (%) Impaired loans / gross loans. Return on adjusted regulatory capital (%) Business Unit performance before tax / average adjusted regulatory capital. Return on adjusted regulatory capital before goodwill (%) Business Unit performance before tax and goodwill amortization / average adjusted regulatory capital. Investment Bank Compensation ratio (%) Personnel expenses / operating income before adjusted expected credit loss. Corporate Center Industrial Holdings Non-performing loans / gross loans ratio (%) Non-performing loans / gross loans. Impaired loans / gross loans ratio (%) Impaired loans / gross loans. Return on adjusted regulatory capital (%) Return on adjusted regulatory capital before goodwill (%) Average VaR (10-day 99%) Information technology infrastructure (ITI) cost per Financial Business full-time employee Investment (private equity, only comprising ﬁnancial investments available-for-sale) Portfolio fair value (private equity, only comprising ﬁnancial investments available-for-sale) Business Group performance before tax / average adjusted regulatory capital. Business Group performance before tax and goodwill amortization / average adjusted regulatory capital. 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. ITI costs / average Financial Business personnel. Historical cost of investment made, less divestments and impairments. 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 trans- action after an orderly sale process where the parties each act knowledgeably, prudently and without compulsion. 11 Presentation of Financial Information Measurement and analysis of performance These Business Group KPIs are used for internal perfor- mance measurement and planning as well as external report- ing. This ensures management accountability for perform- ance by the business leaders and consistency in external and internal performance measurement. 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 includes, for ex- ample, discretionary and advisory wealth management port- folios, managed institutional assets, managed fund assets and wealth management securities or brokerage accounts. It excludes all assets held for purely transactional and custody- only purposes as UBS only administers the assets and does not offer advice on how these assets should be invested. Since 1 January 2004, corporate client assets (other than pension funds) deposited with the Business Banking Switzerland unit have been excluded from invested assets, as we have a min- imal advisory role for such clients and as asset ﬂows are driven more by liquidity requirements than investment reasons. The same holds true for the corporate cash management business of the Wealth Management US unit, which we excluded from invested assets towards the end of 2005. Non-bankable as- sets (for example art collections) 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. Net new money is calculated using the direct method, which is based on transactional level ﬂows. Interest and dividend income, the effects of market or currency movements, fees and commissions 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. Reclassiﬁcations be- tween invested assets and client assets as a result of a change in the service level delivered are treated as net new money ﬂows. 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 and sold by Global Wealth Management & Business Banking. Both businesses involved count these funds as invested assets. This approach is in line with industry prac- tice and our open architecture strategy and allows us to ac- curately reﬂect the performance of each individual business. Overall, CHF 332 billion of invested assets were double counted in 2005 (CHF 294 billion in 2004). Changes in accounting and presentation in 2006 Fair value option for ﬁnancial instruments (IAS 39) Effective 2006, we will adopt the revised fair value option for ﬁnancial instruments in IAS 39 and plan to apply it as follows. Until this year, we had mainly applied the fair value option to hybrid debt in- struments issued by UBS. Starting in second quarter 2006, we will also apply the fair value option to certain new loans and loan commitments made by the Investment Bank. These are hedged with credit derivatives and designated, when made, as ﬁnancial instruments carried at fair value. Fluctuations in their fair value are therefore taken to the in- come statement. This will offset move- ments in the value of the accompany- ing credit derivatives, which are also fair-value accounted. By adopting this option, we reduce temporary proﬁts and losses caused by the different accounting treatments of the loan and the hedge. Revised performance indicators for UBS In the six years since we introduced our performance measures, our ﬁrm has evolved, and our business and client base have grown. Our performance has steadily exceeded our targets. That is why, starting this year, we have decided to modify our performance measures. From 2006, on average and through periods of varying market conditions, we will: – seek to increase the value of UBS by achieving a sustainable, after-tax return on equity of a minimum of 20% (we previously targeted a range of 15–20%) – aim to achieve a clear growth trend in net new money for all our ﬁnan- cial businesses, including Global Asset Management and Business Banking Switzerland. (This measure was previously only applied to our wealth management units.) In future, we will use diluted earnings per share (EPS) instead of basic EPS as a reference for our EPS growth target which remains, as before, annual double-digit percentage growth. Our cost / income objective will not change, and we will continue to manage it at levels that compare well with our best competitors. 12 Presentation of Financial Information UBS Results UBS Results 2005 In 2005, attributable proﬁt was CHF 14,029 million, includ- ing a net gain of CHF 3,705 million from the sale of Private Banks & GAM. Our ﬁnancial businesses contributed CHF 13,517 million to attributable proﬁt, of which CHF 9,442 million was from continuing operations. This was an improvement of 18% (pre-goodwill) from CHF 8,003 million in 2004. Discontinued operations contributed CHF 4,075 million. Industrial Holdings added CHF 512 million, with CHF 402 million stemming from continuing operations. Dividend The Board of Directors will recommend a total payout of CHF 3.80 per share for the 2005 ﬁnancial year at the Annual General Meeting (AGM) on 19 April 2006 in Basel. The pay- out comprises a regular dividend of CHF 3.20 and a one-time par value repayment of CHF 0.60 per share. The repayment will allow our shareholders to beneﬁt from the gain realized from the sale of Private Banks & GAM. Our dividend for the 2004 ﬁnancial year (paid in 2005) was CHF 3.00 a share, up from the CHF 2.60 paid for the 2003 ﬁnancial year. 2004 In 2004, attributable proﬁt was CHF 8,016 million, up 36% from CHF 5,904 million a year earlier. Continuing operations contributed CHF 7,609 million to the result, while discontin- ued operations made up CHF 407 million. Financial businesses contributed CHF 7,656 million to at- tributable proﬁt, up 28% from CHF 5,959 million a year ear- lier. Continuing operations contributed CHF 7,357 million to 2004 attributable proﬁt. Industrial holdings added CHF 252 million to the 2004 result from continuing operations and CHF 108 million from discontinued operations. Risk factors As a global ﬁnancial services ﬁrm, we are affected by the factors driving the mar- kets in which we operate. Different risk factors can impact our ability to effec- tively 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 revenues and operating proﬁt have and are likely to continue to vary from period to period. Revenues and operat- ing proﬁt for any particular period may not, therefore, be indicative of sustain- able results. Interest rates, equity prices, foreign exchange levels and other market ﬂuctuations may affect earnings A substantial part of our business consists in taking trading positions in the interest rate, debt, currency, equity, precious metal and energy cash and derivative markets. The value of these assets and liabilities can be adversely affected by market price ﬂuctuations. Our market risks are subject to a control framework and to portfolio and concentration limits. We avoid undue concentrations of risk and, where appropriate, hedge exposure to stress events. Nevertheless, in the event of sudden, severe or unexpected market movements, we might suffer signiﬁcant losses. A description of our controls and limits, including those applicable to our exposure to market stress events, is provided from page 53 onwards of our Handbook 2005 / 2006. Because we prepare our accounts in Swiss francs while assets, liabilities, re- venues and expenses from certain busi- nesses are denominated in other curren- cies, changes in foreign exchange rates, particularly between the Swiss franc and the US dollar (US dollar income repre- senting the major part of our non-Swiss franc income), may have an effect on our reported earnings. Our approach to currency management is explained on page 78 of our Handbook 2005 / 2006. Regulatory or political changes impact- ing ﬁnancial market structures can affect our earnings. An example was the intro- duction of the euro in 1999, which af- fected European foreign exchange mar- kets by reducing the volume of foreign exchange business, and prompted greater harmonization between ﬁnancial products. Movements 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 portfo- lios and our asset management busi- nesses may also be impacted by credit events, including defaults, related to the issuers of bonds and equities. Our pri- vate equity and commercial real estate investments can be adversely affected by economic, business and general mar- ket conditions. We consider our market risk control framework, which is described on pages 70 to 79 of our Handbook 2005 / 2006, 13 Presentation of Financial Information UBS Results Risk factors (continued) to be robust, but severe market disloca- tions or an extended period of market disruptions could have a material impact on our earnings. Furthermore, income in businesses such as investment banking, and wealth and asset management is often directly related to client activity levels. As a re- sult, our income is susceptible to adverse effects from sustained market down- turns as well as any signiﬁcant deteriora- tion of investor sentiment. Asset-based revenues generated in our wealth and asset management businesses depend on the levels of invested 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 geo- political or regional issues or events beyond our control, such as the possibil- ity of war or terrorism, or by economic developments such as low growth, inﬂa- tion, recession or depression. Counter- party 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, contingent liabilities such as letters of credit, and derivative products such as swaps and options) would be adversely affected 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 sus- tained might have a material adverse 14 effect on both our income and the value of our assets. A discussion of our approach to manag- ing credit risk can be found on page 57 of our Handbook 2005 / 2006. 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 currencies 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 physi- cal protection, are appropriately con- trolled. However, if our system of inter- nal controls is ineffective in identifying and remedying such risks, we will be exposed to operational failures that might result in losses. A discussion of our approach to the management and con- trol of operational risks is provided on page 83 of our Handbook 2005 / 2006. 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 outside Switzerland, including the United States, arising in the ordinary course of busi- ness. 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 commercial banks, and private banking, investment banking, brokerage and other invest- ment services ﬁrms. We face intense competition not only from ﬁrms compet- ing locally in particular lines of business, but also from global ﬁnancial institutions that are comparable to UBS in size and breadth. The trend towards consolidation in the global ﬁnancial services industry is creat- ing competitors with broad ranges of product and service offerings, increased access to capital, and greater efﬁciency and pricing power. We expect these trends to continue and competition to increase in the future. Our competitive strength will depend on the ability of our businesses to adapt quickly to signiﬁcant market and industry trends. Our global presence exposes us to other risks We operate in 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 disruptions, currency crises, the break- down of monetary controls or terrorism, may adversely affect the ability of clients or counterparties located in that country or region to obtain foreign exchange or credit and, therefore, 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, and a discussion of our country risk controls is provided on page 65 of our Handbook 2005 / 2006. However, if our controls failed to fully identify and respond to country risk, we might suffer a negative impact on our results and ﬁnancial condition. UBS Performance Indicators 15 UBS Performance Indicators Performance against targets RoE (%) 1 as reported from continuing operations, before goodwill Basic EPS (CHF) 2 as reported from continuing operations, before goodwill Cost / income ratio of the ﬁnancial businesses (%) 3, 4 as reported before goodwill Net new money, wealth management businesses (CHF billion) 5 Wealth Management International & Switzerland Wealth Management US Total For the year ended 31.12.05 31.12.04 31.12.03 39.4 27.6 13.93 9.78 70.1 70.1 68.2 26.9 95.1 25.5 26.3 7.78 8.02 73.2 71.4 42.3 18.1 60.4 17.8 18.8 5.44 5.72 76.8 74.8 29.7 14.3 44.0 RoE 1 in % 40 30 20 10 0 2003 2004 2005 2003 2004 2005 Cost / income ratio of the financial businesses 3, 4 in % 39.4 27.6 26.3 25.5 18.8 17.8 80 70 60 50 40 76.8 74.8 73.2 71.4 70.1 As reported From continuing operations before goodwill As reported Before goodwill Basic EPS 2 CHF 16.00 12.00 8.00 4.00 0.00 Net new money, wealth management businesses 5 CHF billion 2003 2004 2005 2003 2004 13.93 9.78 8.02 7.78 5.72 5.44 100 75 50 25 0 60.4 44.0 2005 95.1 As reported From continuing operations before goodwill 1 Net proﬁt attributable to UBS shareholders / average equity attributable to UBS shareholders less proposed distributions. statements. 4 Operating expenses / operating income less credit loss expense or recovery. 3 Excludes results from industrial holdings. 2 Details of the EPS calculation can be found in note 8 to the ﬁnancial 5 Excludes interest and dividend income. 16 2005 For the last six years, we have consistently focused on four performance indicators designed to ensure we deliver contin- ually improving returns to our shareholders. These measures are calculated before the effect of goodwill amortization in 2004 and 2003. We will modify some of them starting in 2006 to reﬂect the evolution of our business (see sidebar on page 12). They will continue to focus solely on continuing op- erations. Our cost / income ratio target will still be limited to our ﬁnancial businesses.This avoids the distortion from indus- trial holdings, which operated at a 92.3% cost / income ratio in 2005. Before the amortization of goodwill, our continuing opera- tions showed: – Return on equity in full-year 2005 at 27.6%, up from 26.3% in 2004. The increase was driven by higher attrib- utable proﬁt, but was partially offset by an increase in av- erage equity levels, reﬂecting the growth in retained earn- ings. From 2006 onwards, we aim to exceed 20% over pe- riods of ﬂuctuating market conditions. – Basic earnings per share in 2005 at CHF 9.78, up 22% from CHF 8.02 a year ago, reﬂecting increased earnings and a slight reduction in the average number of shares outstand- ing (–2%) following share repurchases. Diluted earnings per share, our performance indicator from 2006 on, were at CHF 9.39 in 2005, up 23% from CHF 7.64 in 2004. – A cost / income ratio for our ﬁnancial businesses of 70.1% in 2005, down 1.3 percentage points from 71.4% a year ago. This reﬂects the increase in net fee and commission income and net income from trading activities, partly off- set by higher costs related to personnel – all related to the expansion of our business volumes. Our wealth management businesses continue to gather assets rapidly in all regions. In 2005, net new money totaled CHF 95.1 billion, up 57% from CHF 60.4 billion in 2004, corresponding to an annual growth rate of 6.9% of the asset base at the end of 2004. Wealth Management Inter- Net new money 1 CHF billion Global Wealth Management & Business Banking Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Asset Management Institutional Wholesale Intermediary Investment Bank UBS excluding Private Banks & GAM Corporate Center Private Banks & GAM 2 UBS 1 Excludes interest and dividend income. 2 Private Banks & GAM was sold on 2 December 2005. Invested assets CHF billion Global Wealth Management & Business Banking Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Asset Management Institutional Wholesale Intermediary Investment Bank UBS excluding Private Banks & GAM Corporate Center Private Banks & GAM 1 UBS 1 Private Banks & GAM was sold on 2 December 2005. For the year ended 31.12.05 31.12.04 31.12.03 68.2 26.9 3.4 21.3 28.2 0.0 148.0 0.5 148.5 42.3 18.1 2.6 23.7 (4.5 ) 0.0 82.2 7.7 89.9 29.7 14.3 2.5 12.7 (5.0 ) 0.9 55.1 7.2 62.3 31.12.05 As at 31.12.04 % change from 31.12.03 31.12.04 982 752 153 441 324 0 2,652 0 2,652 778 606 140 344 257 0 2,125 92 2,217 701 599 136 313 261 4 2,014 84 2,098 26 24 9 28 26 25 (100 ) 20 17 UBS Performance Indicators national & Switzerland recorded inﬂows of CHF 68.2 billion, driven by further growth in our ﬁve key European markets and Asia. Our US business contributed CHF 26.9 billion in net new money, CHF 8.8 billion above 2004 levels. Starting in 2006, we will be reporting net new money for all ﬁnancial businesses. For the whole of 2005, net new money was CHF 148.0 billion, an all-time high, and up 80% from CHF 82.2 billion a year earlier. This amounts to an an- nual growth rate of 7% of the asset base at the end of 2004. All the ﬁgures above exclude Private Banks & GAM. 2004 From our continuing operations and before goodwill amorti- zation: – Our return on equity was 26.3%, up from 18.8% in 2003, well above our target range of 15% to 20%. The increase reﬂects the combined effects of our strong earnings, con- tinued buyback programs and the dividend outpacing in- creased retained earnings. – Basic earnings per share (EPS) were CHF 8.02, up 40% or CHF 2.30 from CHF 5.72 in 2003. The high level reﬂected the increase in net proﬁt as well as the 5% reduction in av- erage number of shares outstanding due to our continu- ing buyback programs. – The cost / income ratio of our ﬁnancial businesses was 71.4% in 2004, an improvement from 74.8% in 2003. Strong asset-based revenues drove fee and commission in- come higher, demonstrating the inherent operating lever- age of our wealth and asset management businesses. For full-year 2004, net new money inﬂows into our wealth management businesses totalled CHF 60.4 billion, up 37% from CHF 44.0 billion in 2003, corresponding to an annual growth rate of 4.6% of the asset base at the end of 2003. We saw gains in all geographical areas, especially from Asian clients, and a particularly strong CHF 13.7 billion inﬂow into our European wealth management business. 18 Financial Businesses Financial Businesses Results Results Income statement 1 CHF million, except where indicated Continuing operations 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 Cash components Share-based components 2 Total personnel expenses General and administrative expenses Services to / from other business units Depreciation of property and equipment Amortization of goodwill Amortization of other intangible assets Total operating expenses Operating proﬁt from continuing operations before tax Tax expense Net proﬁt from continuing operations Discontinued operations Proﬁt from discontinued operations before tax Tax expense Net proﬁt from discontinued operations Net proﬁt Net proﬁt attributable to minority interests from continuing operations from discontinued operations Net proﬁt attributable to UBS shareholders from continuing operations from discontinued operations Additional information Personnel (full-time equivalents) For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 59,286 (49,758) 9,528 375 9,903 21,436 7,996 561 39,896 18,275 1,628 19,903 6,448 (14) 1,240 0 127 27,704 12,192 2,296 9,896 4,564 489 4,075 13,971 454 454 0 13,517 9,442 4,075 39,228 (27,484 ) 11,744 241 11,985 18,506 4,902 578 35,971 16,310 1,396 17,706 6,387 (20 ) 1,262 646 168 26,149 9,822 2,104 7,718 396 3 97 299 8,017 361 361 0 7,656 7,357 299 40,045 (27,784 ) 12,261 (102 ) 12,159 16,673 3,670 455 32,957 15,892 1,464 17,356 5,882 (23 ) 1,320 677 185 25,397 7,560 1,409 6,151 220 3 52 168 6,319 360 360 0 5,959 5,791 168 51 81 (19 ) 56 (17 ) 16 63 (3 ) 11 12 17 12 1 30 (2 ) (100 ) (24 ) 6 24 9 28 404 74 26 26 77 28 31.12.05 69,569 As at 31.12.04 67,407 31.12.03 65,879 % change from 31.12.04 3 1 Excludes results from industrial holdings. CHF 68 million and CHF 79 million for the years ended 31 December 2004 and 31 December 2003 respectively. 2 Additionally includes related social security contributions and expenses related to alternative investment awards. 3 Includes goodwill amortization of 20 2005 Results Our 2005 result was the best ever, with all our ﬁnancial busi- nesses reporting a stronger performance than a year earlier. Attributable proﬁt in 2005 was CHF 13,517 million, of which discontinued operations contributed CHF 4,075 million, re- ﬂecting the impact of the sale of Private Banks & GAM. Net proﬁt from continuing operations was CHF 9,442 million, and there was no goodwill charge. This was up 28% from CHF 7,357 million after goodwill in 2004, or 18% from CHF 8,003 million before goodwill. Higher revenues in practically all busi- nesses drove the increase, clearly outpacing growth in costs. Asset-based revenues showed particular strength, reﬂecting rising market levels as well as strong inﬂows into our wealth and asset management businesses. We also saw a strong in- crease in brokerage, corporate ﬁnance and underwriting fees. Overall, net fee and commission income now contributes 54% to total operating income. Income from trading activi- ties reached a record high as well, fueled by improved mar- ket opportunities, particularly in second half 2005. Revenues from interest margin products increased, reﬂecting the suc- cess and growth of lending activities to wealthy private clients worldwide. We also reported record credit loss recoveries. Per- sonnel expenses were up 12% from a year earlier; perform- ance-related payments rose with revenues and there was a general increase in staff numbers (the number of employees across the ﬁnancial businesses rose 3% in 2005, with the in- crease spread across all businesses). For 2005, 50% of per- sonnel expenses took the form of bonus or other variable com- pensation, up from 49% a year earlier. Average variable compensation per head in 2005 was 10% higher than in 2004. Despite continued investments in expanding our busi- ness while improving services to clients and streamlining in- ternal processes, we kept costs under control. General and ad- ministrative expenses were up just 1% in 2005 from a year Net interest and trading income CHF million Net interest income Net trading income Total net interest and trading income Breakdown by business activity Equities Fixed income Foreign exchange Other Net income from trading activities Net income from interest margin products Net income from treasury and other activities Total net interest and trading income earlier. Because of the strength of revenue growth, our cost / income ratio was 70.1% in 2005. Operating income Total operating income was CHF 39,896 million in 2005, up 11% from CHF 35,971 million in 2004. This was the highest level ever. Net interest income was CHF 9,528 million in 2005, down from CHF 11,744 million in the same period a year earlier. Net trading income was CHF 7,996 million, up from CHF 4,902 million in 2004. 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 peri- od to period, depending on the composition of the trading portfolio. 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. Net income from trading activities increased by 4% or CHF 387 million from CHF 11,032 million in 2004 to CHF 11,419 million in 2005. At CHF 3,928 million, equities trading income in 2005 was up 27% or CHF 830 million from CHF 3,098 mil- lion in 2004. Last year saw a large increase in derivatives and prime brokerage revenues around the globe, with the deriv- atives business seeing signiﬁcant growth in both Asia Pacif- ic and Europe as we continued to develop in these regions. Americas showed the strongest growth in prime brokerage, reﬂecting the growth of our client base. These gains were par- tially offset by lower revenues in our equity cash business. Fixed income trading revenues, at CHF 5,741 million in 2005, were down 8% or CHF 523 million from CHF 6,264 million in 2004. The drop was driven by declines in credit ﬁxed in- come and ﬁxed income, partially offset by increased revenues in our rates, principal ﬁnance and commercial real estate busi- For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 9,528 7,996 17,524 3,928 5,741 1,458 292 11,419 5,355 750 17,524 11,744 4,902 16,646 3,098 6,264 1,467 203 11,032 5,070 544 16,646 12,261 3,670 15,931 2,445 6,474 1,436 258 10,613 5,000 318 15,931 (19 ) 63 5 27 (8 ) (1 ) 44 4 6 38 5 21 Financial Businesses Results ness. Credit ﬁxed income saw large revenue decreases in structured credit, notably in the US and credit trading in the emerging markets business and the high yield sector. Rev- enues in our rates business were up, driven mainly by struc- tured LIBOR derivatives, European interest rates and US en- ergy trading. We recorded revenues of CHF 103 million relating to Credit Default Swaps (CDSs) hedging existing credit exposure in the loan book, against losses of CHF 62 million a year earlier. At CHF 1,458 million, revenues from our foreign exchange business were stable in 2005 compared to CHF 1,467 million recorded a year earlier. While derivatives trading was negatively impacted by historically low volatility levels, foreign exchange trading revenues rose due to high- er volumes. Net income from interest margin products increased by 6% to CHF 5,355 million in 2005 from CHF 5,070 million in 2004. 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 collateralized lending business also grew during the year. In addition, revenues rose due to a rise of interest rates for client liabilities (with variable rates denominated in US dol- lars and Swiss francs). It also rose because of the appreciation of the US dollar against the Swiss franc, which helped revenues from US dollar cash accounts. This increase was partially off- set by lower income from our shrinking Swiss recovery port- folio, which dropped by CHF 1.1 billion compared to year-end 2004. At CHF 750 million, net income from treasury and other activities in 2005 was CHF 206 million or 38% higher than CHF 544 million in 2004. The increase reﬂects the beneﬁts of the diversiﬁcation of our capital base into currencies oth- er than the Swiss franc in a way that matches the currency mix of our risk weighted assets. The higher equity base had a positive impact on treasury income as well, as did a posi- tive timing effect related to cash ﬂow hedging. In 2005, we experienced a net credit loss recovery of CHF 375 million, compared to a net credit loss recovery of CHF 241 million in 2004. Releases in country allowances and pro- visions of CHF 118 million reﬂected the generally positive macro-economic environment in key emerging markets. This favorable result was achieved in a period which saw a benign 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. The net credit loss recovery at Global Wealth Management & Business Banking was CHF 223 million in 2005 compared to a net credit loss recovery of CHF 94 million in 2004. The benign credit environment in Switzerland, where the corpo- rate bankruptcy rate has receded in 2005 coupled with the measures taken in recent years to improve the quality of our credit portfolio has resulted in a continued low level of new defaults. The success we have had in managing our impaired portfolio has also resulted in a higher than anticipated level of recoveries. The Investment Bank experienced a net credit loss recov- ery of CHF 152 million in 2005, compared to a net credit loss recovery of CHF 147 million in 2004. This continued strong performance was the result of minimal exposure to new de- faults and strong recoveries of previously established al- lowances and provisions as we actively sold impaired assets at better than anticipated terms. 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 2005/2006. In 2005, net fee and commission income was CHF 21,436 million, up 16% from CHF 18,506 million a year earlier. The increase was driven by a strong contribution from recurring asset-based fees, higher investment fund fees and net bro- kerage fees, rising corporate ﬁnance fees as well as an in- crease in underwriting fees. Underwriting fees, at their high- est level ever, were CHF 2,857 million in 2005, up 13% from CHF 2,531 million in 2004. Fixed income underwriting fees increased due to signiﬁcantly improved market conditions and our enhanced competitive position, but were slightly off- set by lower equity underwriting fees. Fixed income under- writing was CHF 1,516 million in 2005, up 36% from CHF 1,114 million in 2004. Equity underwriting slightly decreased by 5% to CHF 1,341 million in the same period. At CHF 1,460 million, corporate ﬁnance fees in 2005 were up 35% from CHF 1,078 million a year earlier. Advisory gross revenues in- creased notably during 2005, signalling the continued strength of merger and acquisition markets, and our grow- ing franchise in this area. Net brokerage fees were CHF 5,087 million in 2005, up 15% or CHF 680 million from CHF 4,407 million in 2004, reﬂecting the improved markets and the re- sulting higher confidence of institutional and individual clients – especially in the second half of 2005. Investment Credit loss (expense) / recovery CHF million Global Wealth Management & Business Banking Investment Bank UBS 22 For the year ended 31.12.05 31.12.04 31.12.03 223 152 375 94 147 241 (70 ) (32 ) (102 ) 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 31.12.05 31.12.04 31.12.03 31.12.04 1,341 1,516 2,857 1,460 6,718 4,750 212 1,176 5,310 372 22,855 306 1,027 24,188 1,631 1,121 2,752 21,436 1,417 1,114 2,531 1,078 5,794 3,948 197 1,143 4,488 343 19,522 264 977 20,763 1,387 870 2,257 18,506 1,267 1,084 2,351 761 5,477 3,500 216 1,097 3,718 356 17,476 244 1,082 18,802 1,473 656 2,129 16,673 (5 ) 36 13 35 16 20 8 3 18 8 17 16 5 16 18 29 22 16 fund fees, at their highest level ever, were CHF 4,750 million in 2005, up 20% from CHF 3,948 million in 2004, mainly re- ﬂecting higher asset-based fees for our wealth and asset management businesses, driven by strong client money in- flows and strong market conditions. Fiduciary fees were slightly higher in 2005 increasing from CHF 197 million in 2004 to CHF 212 million, reﬂecting an increased number of mandates. At CHF 1,176 million, custodian fees in 2005 were up 3% from CHF 1,143 million in 2004. This increase was en- tirely due to an enlarged asset base. Portfolio and other management and advisory fees increased by 18% to CHF 5,310 million in 2005 from CHF 4,488 million in 2004. The increase is again the result of rising invested asset levels driv- en by market valuations and strong net new money inﬂows. Insurance-related and other fees, at CHF 372 million in 2005, increased by 8% from a year earlier, due to higher commis- sions from insurance related products. Credit-related fees and commissions increased by 16% to CHF 306 million in 2005 from CHF 264 million in 2004, reﬂecting improved market conditions which brought higher volumes. Commission income from other services increased by 5% from CHF 977 million in 2004 to CHF 1,027 million in 2005, mainly driven by equity derivative products distributed in Switzerland. Other income decreased by 3% to CHF 561 million in 2005 from CHF 578 million in 2004, mainly due to both low- er net gains from disposal of associates and subsidiaries and from investments in property. This was partially offset by high- er net gains from disposal of investment in ﬁnancial assets available-for-sale. Operating expenses We continue to tightly manage our cost base with a clear fo- cus on improving the efﬁciency of our businesses. Total op- erating expenses increased by 6% to CHF 27,704 million in 2005 from CHF 26,149 million in 2004. Personnel expenses increased by CHF 2,197 million or 12% to CHF 19,903 million in 2005 from CHF 17,706 mil- lion in 2004. The rise was driven by higher performance-re- lated compensation reﬂecting the better performance in all our businesses. Personnel expenses are managed on a full- year basis with ﬁnal ﬁxing of annual performance-related pay- ments in fourth quarter. Salary expenses rose due to the 6% increase in personnel over the year (excluding the staff of Pri- vate Banks & GAM), showing the continuous expansion of our business as well as annual pay rises. Share-based com- ponents increased by 17% or CHF 232 million to CHF 1,628 million from CHF 1,396 million. This was due to an increase in the UBS share price and the higher proportion of stock in bonuses granted in 2005, partially offset by lower option ex- penses. Contractors’ expenses increased to CHF 823 million in 2005, up 45% from CHF 567 million in 2004, mainly re- lated to the integration of former Perot employees into our central ITI function. It also reﬂects higher usage, mainly in our Investment Bank in support of increased business ﬂows. In- surance and social security contributions rose by 23% to CHF 1,256 million in 2005 compared with CHF 1,024 million in 2004, reﬂecting higher salary and bonus payments. Contri- butions to retirement beneﬁt plans were up 9% or CHF 61 million from CHF 651 million in 2004 to CHF 712 million in 2005 because of the higher salaries paid. At CHF 1,390 mil- 23 Financial Businesses Results Indicative pre-goodwill tax rates for ﬁnancial businesses in % Global Wealth Management & Business Banking Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Asset Management Investment Bank For the year ended 31.12.05 31.12.04 31.12.03 19 18 40 17 24 29 18 18 37 19 21 30 18 16 38 20 20 32 lion in 2005, other personnel expenses increased CHF 25 mil- lion from CHF 1,365 million in 2004, mainly driven by in- creased headcount, partially offset by the end of retention payments in the Wealth Management US business and lower severance payments. 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 doing business during 2005 on a stand-alone basis, without the beneﬁt of tax losses brought forward from earlier years. At CHF 6,448 million in 2005, general and administrative expenses increased CHF 61 million from CHF 6,387 million a year ago. The increase was driven by travel and entertainment expenses, and additional administration costs, reflecting higher employee levels and further increases in business ac- tivity. Marketing costs increased due to continued investment in our brand. This was partially offset by lower provisions (2004 included the civil penalty levied by the Federal Reserve Board relating to our banknote trading business) and reduced expenses for IT outsourcing and professional fees, as well as lower rent and maintenance of machines and equipment. Depreciation was CHF 1,240 million in 2005, down 2% from CHF 1,262 million in 2004. This was the lowest level ever, reﬂecting falling IT-related charges, partially offset by higher depreciation on real estate. There was no amortization of goodwill in 2005 as we were required to stop doing so at the start of the year. In 2004, amortization of goodwill was CHF 646 million. At CHF 127 million, amortization of other intangible as- sets was down 24% from CHF 168 million a year earlier, due to the reclassiﬁcation of the Wealth Management US work- force to goodwill. Tax Tax expense for 2005 was CHF 2,296 million, resulting in an effective tax rate of 18.8%, down from the full-year 2004 tax rate of 21.4% (20.1% pre-goodwill). The tax rate for full-year 2005 was positively inﬂuenced by the absence of goodwill amortization and the successful conclusion of tax audits in the third and fourth quarters. We believe that a tax rate of about 21% is a reasonable initial estimate for 2006. 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- The indicative tax rates for 2004 and 2003 are presented pre-goodwill. They give an indication of what the tax rate would have been if goodwill had not been charged for ac- counting purposes. It is the sum of the tax expense payable on net proﬁt before tax and goodwill in each location, cal- culated on the above basis, divided by the total net proﬁt be- fore 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. Fair value disclosure of shares and options The fair value of shares granted in 2005 rose to CHF 1,376 million, 24% higher than CHF 1,113 million a year earlier. The increase compared to 2004 is primarily driven by an increased proportion of bonuses being delivered in restricted shares. The fair value of options granted as of 31 December 2005 was CHF 362 million, down 29% from CHF 508 million in 2004. The decrease reﬂects a lower fair value per option, pri- marily due to a change in the valuation model, and a drop in the number of options granted. Most share-based compensation is granted in the ﬁrst quarter of the year, with any further grants mainly under the Equity Plus program, a continuing employee participation program under which voluntary investments in UBS shares each quarter are matched with option awards. These amounts, net of forfeited awards, will be recog- nized as compensation expense over the service period, which is generally equal to the vesting period. Most UBS share and option awards vest incrementally over a three-year period. Outlook At this time last year, we said that it would be challenging to beat our then record 2004 result. Helped by continued favor- 24 able market conditions, especially in the second half of 2005, we did exceed last year’s record performance; but this makes the task for 2006 even greater. Early indications for 2006 show that business has started on a positive note. Deal pipelines are promising, investors are upbeat and macroeconomic indica- tors are encouraging. The fundamentals driving the growth of the ﬁnancial industry remain intact for the time being. We are therefore optimistic about the outlook for UBS – for 2006 and beyond. We now have a strong competitive po- sition in the areas we have chosen to invest in – among them European wealth management, alternative investments, in- vestment banking, prime brokerage and in Asia Paciﬁc across business lines. These areas are becoming major revenue con- tributors, allowing us to invest in other opportunities that ﬁt our strategy. This will help us sustain growth as well as our attractiveness to clients, employees and shareholders well in- to the future. 2004 Results Net proﬁt attributable to UBS shareholders in 2004 was CHF 7,656 million, with CHF 7,357 million coming from continu- ing operations and CHF 299 million from discontinued oper- ations – the latter solely related to Private Banks & GAM. Over- all, performance improved 28% compared to 2003, when attributable net proﬁt was CHF 5,959 million. Before good- will and excluding the sale of our Correspondent Services Cor- poration (CSC) clearing subsidiary, which was completed in second quarter 2003, net proﬁt rose by 25%. 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. We also saw a strong increase in bro- kerage, corporate ﬁnance, underwriting fees and trading in- come. We reported record credit loss recoveries as well. Per- formance-related compensation rose in line with revenues, with higher general and administrative expenses driven by higher legal provisions and operational risk costs. Operating income Total operating income was CHF 35,971 million in 2004, up 9% from CHF 32,957 million in 2003. The increase was driv- en by our ability to capture opportunities in increasingly ac- tive ﬁnancial markets. The increase in market levels positive- ly 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 im- proved market environment that boosted institutional and private client transaction activity. We also recorded credit loss recoveries in 2004 compared to expenses in 2003. The over- all 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 11,744 million in 2004, down from CHF 12,261 million in the same period a year ear- lier. Net trading income was CHF 4,902 million, up from CHF 3,670 million in 2003. At CHF 5,070 million, net income from interest margin products in 2004 was 1% higher than CHF 5,000 million a year earlier. The increase was driven by the growth in lend- ing to wealthy US clients through our US bank, UBS Bank USA. Our domestic Swiss mortgage and wealth management margin lending business also grew over the year. This increase was nearly offset by lower income from our shrinking Swiss recovery portfolio, which dropped by CHF 2.0 billion com- pared to year-end 2003, reduced interest margins on client cash and savings accounts, as well as declining revenues from US dollar-denominated accounts. Net income from trading activities was CHF 11,032 million in 2004, up by 4% or CHF 419 million from CHF 10,613 mil- lion a year earlier. 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, the market environment in 2004 saw rising interest rates and lower volatility, which drove activity from the market. We recorded losses of CHF 62 million relating to Credit Default Swaps (CDSs) hedging existing credit exposure in the loan book, against losses of CHF 678 million a year earlier. Foreign exchange trading revenues increased by 2% to CHF 1,467 mil- lion 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 544 million, net income from treasury and other activities in 2004 was CHF 226 million or 71% higher than CHF 318 million in 2003. The impact of falling interest rates was partially offset by the diversiﬁcation of our invested eq- uity into currencies other than the Swiss franc. Other activi- ties improved due to lower goodwill funding costs. In 2004, we experienced a net credit loss recovery of CHF 241 million, compared to net credit loss expense of CHF 102 million in 2003. This favorable result was achieved in a period which saw a very sanguine environment for credit markets globally. Economic expansion in the US provided a strong stim- ulus for growth worldwide. Almost without exception, cred- it spreads contracted in all the major developed and emerg- 25 Financial Businesses Results ing capital markets, as healthy expansion of cash ﬂows allowed the corporate sector to de-leverage and build liquidity. Net credit loss recovery at Global Wealth Management & Business Banking amounted to CHF 94 million in 2004 com- pared to net credit loss expenses of CHF 70 million in 2003. Our domestic credit portfolio demonstrated strong resilience in a Swiss economic environment which saw a 9.2% increase in corporate bankruptcies compared to 2003. The measures taken in past years to improve the quality of our credit port- folio have resulted in lower levels of new defaults and our success in managing the impaired portfolio resulted in a higher than anticipated level of recoveries. The Investment Bank experienced a net credit loss recov- ery of CHF 147 million in 2004, compared to a net credit loss expense of CHF 32 million in 2003. This strong performance was the result of minimal exposure to new defaults and strong recoveries of previously established allowances and provisions. Releases in country allowances and provisions were due partly to exposure reductions in the affected coun- tries and partly to a more favorable outlook for emerging market economies. There was also a partial release of a size- able allowance for a corporate counterparty which managed a turnaround during 2004. In 2004, net fee and commission income was CHF 18,506 million, up 11% from CHF 16,673 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. Un- derwriting fees were CHF 2,531 million in 2004, up 8% from CHF 2,351 million in 2003. Both equity and ﬁxed income un- derwriting fees increased. Fixed income underwriting was CHF 1,114 million in 2004, up 3% from CHF 1,084 million in 2003. Equity underwriting increased 12% to CHF 1,417 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 acquisition activity, and our strengthened advi- sory business, particularly in the US. Net brokerage fees were CHF 4,407 million in 2004, up 10% or CHF 403 million from CHF 4,004 million in 2003, reﬂecting the improved markets and the resulting higher institutional and individual client ac- tivity – especially in the ﬁrst and fourth quarters of 2004. In- vestment fund fees were CHF 3,948 million in 2004, up 13% from CHF 3,500 million in 2003, mainly reﬂecting high- er asset-based fees for our wealth and asset management businesses. At CHF 1,143 million, custodian fees in 2004 were up 4% from CHF 1,097 million in 2003. This increase was entirely due to an enlarged asset base. Insurance-relat- ed and other fees, at CHF 343 million in 2004, decreased by 4% from a year earlier. Excluding the effect of the weaken- ing US dollar, insurance-related and other fees were actual- ly slightly higher compared to 2003. Credit-related fees and commissions increased by 8% to CHF 264 million in 2004 from CHF 244 million in 2003, reﬂecting improved market conditions which brought higher volumes. Portfolio and oth- er management and advisory fees increased by 21% to CHF 4,488 million in 2004 from CHF 3,718 million in 2003. The increase was again the result of rising invested asset levels driven by market valuations and strong net new money in- ﬂows, as well as an increase in performance fees. Other income increased by 27% to CHF 578 million in 2004 from CHF 455 million in 2003. The increase was driven by higher disposal gains from ﬁnancial investments available- for-sale (up CHF 42 million) and lower impairment charges (down CHF 150 million). This was partially offset by lower gains from the divestment of associates and subsidiaries, which dropped by 51% to CHF 84 million in 2004 (the major disposal being the Noga Hilton hotel in Geneva) from CHF 170 million in 2003 (the major disposal being Correspondent Ser- vices Corporation (CSC)). Operating expenses We continued to tightly manage our cost base with a clear focus on improving the efﬁciency of our businesses. Total op- erating expenses increased by 3% to CHF 26,149 million in 2004 from CHF 25,397 million in 2003. Personnel expenses increased by CHF 350 million or 2% to CHF 17,706 million in 2004 from CHF 17,356 million in 2003. The rise was driven by higher performance-related compensation reﬂecting the better performance in most of our businesses. Cash components rose by CHF 418 million due to the 2% increase in headcount over the year, whereas share-based components decreased by 5%. Contractors’ ex- penses increased to CHF 567 million in 2004, up 6% from CHF 536 million in 2003, reﬂecting higher usage, mainly in our In- vestment Bank in support of increased business ﬂows. At CHF 1,365 million, other personnel expenses dropped CHF 263 million from CHF 1,628 million in 2003 due to the end of re- tention payments in the Wealth Management US business and lower severance payments. For 2004, 49% of personnel ex- penses took the form of bonus or variable compensation, up from 46% in 2003. Average variable compensation per head in 2004 was 9% higher than in 2003. At CHF 6,387 million in 2004, general and administrative expenses increased CHF 505 million from CHF 5,882 million in the same period a year ago. The increase was driven by higher provisions (up CHF 257 million) which rose due to spe- ciﬁc operational and legal provisions (including the civil penal- ty levied by the Federal Reserve Board relating to our ban- knote trading business), higher IT and other outsourcing expenses as well as professional fees, the latter due to high- er legal and project costs. This was partially offset by savings in telecommunication, rent and maintenance expenses. Depreciation was CHF 1,262 million in 2004, down 4% from CHF 1,320 million in 2003, reﬂecting falling IT-related charges as well as lower writedowns of equipment. At CHF 646 million, amortization of goodwill was down 5% from CHF 677 million. Amortization of other intangible 26 assets was down 9% from CHF 185 million in 2003, reﬂect- ing lower amortization charges and the weakening of the US dollar against the Swiss franc. Tax In 2004, we incurred a tax expense of CHF 2,104 million, re- ﬂecting an effective tax rate of 21.4% for full-year 2004, com- pared to the full-year rate of 16.9% in 2003 (excluding the gain on sale of CSC). The 2003 tax rate was positively inﬂu- enced 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. Fair value disclosure of options The fair value of options granted in 2004 was CHF 508 mil- lion (pre-tax: CHF 543 million) compared to CHF 439 million (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. 27 Financial Businesses Global Wealth Management & Business Banking Global Wealth Management&Business Banking Pre-tax proﬁt for our international and Swiss wealth management businesses was CHF 4,161 million, up 20% from the pre-goodwill result achieved in 2004. In the US, pre-tax proﬁt rose to CHF 312 million from CHF 29 mil- lion a year earlier. Business Banking Switzerland's pre-tax proﬁt was CHF 2,189 million, up 9% from 2004. Business Group reporting CHF million, except where indicated Income Adjusted expected credit loss 1 Total operating income Cash components Share-based components 2 Total personnel expenses General and administrative expenses Services to / from other business units Depreciation of property and equipment Amortization of goodwill Amortization of other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and amortization of goodwill KPIs Cost / income ratio (%) 3 Cost / income ratio before goodwill (%) 3 Capital return and BIS data Return on adjusted regulatory capital (%) 4 Return on adjusted regulatory capital before goodwill (%) 4 BIS risk-weighted assets Goodwill Adjusted regulatory capital 5 Additional Information Client assets (CHF billion) Personnel (full-time equivalents) 31.12.05 19,131 107 19,238 8,252 237 8,489 2,845 960 226 0 56 12,576 6,662 6,662 65.7 65.7 34.7 34.7 147,348 5,407 20,142 31.12.05 2,895 44,612 For the year ended 31.12.04 17,506 (38 ) 17,468 7,630 235 7,865 2,473 1,137 202 238 115 12,030 5,438 5,676 68.7 67.4 31.3 32.7 134,004 3,648 17,048 As at 31.12.04 2,306 42,570 31.12.03 16,792 (139 ) 16,653 7,711 288 7,999 2,383 1,285 236 246 137 12,286 4,367 4,613 73.2 71.7 25.8 27.3 132,106 3,713 16,924 31.12.03 2,196 42,386 % change from 31.12.04 9 10 8 1 8 15 (16 ) 12 (100 ) (51 ) 5 23 17 10 48 18 % change from 31.12.04 26 5 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). social security contributions and expenses related to alternative investment awards. 5 10% of BIS risk-weighted assets plus goodwill. 2 Additionally includes related 4 Business Group performance before tax / average adjusted regulatory capital. 3 Operating expenses / income. Marcel Rohner | Chairman & CEO Global Wealth Management & Business Banking 28 Wealth Management International & Switzerland Business Unit reporting CHF million, except where indicated 31.12.05 Income Adjusted expected credit loss 1 Total operating income Cash components Share-based components 2 Total personnel expenses General and administrative expenses Services to / from other business units Depreciation of property and equipment Amortization of goodwill Amortization of other intangible assets Total operating expenses Business Unit performance before tax Business Unit performance before tax and amortization of goodwill KPIs Invested assets (CHF billion) Net new money (CHF billion) 3 Gross margin on invested assets (bps) 4 Cost / income ratio (%) 5 Cost / income ratio before goodwill (%) 5 Cost / income ratio before goodwill and excluding the European wealth management business (%) 5 Client advisors (full-time equivalents) International clients Income Invested assets (CHF billion) Net new money (CHF billion) 3 Gross margin on invested assets (bps) 4 European wealth management (part of international clients) Income Invested assets (CHF billion) Net new money (CHF billion) 3 Client advisors (full-time equivalents) 9,024 (13) 9,011 2,491 88 2,579 804 1,371 89 0 7 4,850 4,161 4,161 982 68.2 102 53.7 53.7 47.7 4,154 6,476 729 64.2 100 722 114 21.8 803 For the year ended 31.12.04 7,701 (8 ) 31.12.03 6,797 (4 ) 7,693 2,047 72 2,119 642 1,395 66 67 8 4,297 3,396 3,463 778 42.3 103 55.8 54.9 47.2 3,744 5,429 562 40.4 102 437 82 13.7 838 6,793 1,921 75 1,996 604 1,479 82 54 21 4,236 2,557 2,611 701 29.7 101 62.3 61.5 53.2 3,300 4,734 491 29.7 101 267 46 10.8 672 % change from 31.12.04 17 (63 ) 17 22 22 22 25 (2 ) 35 (100 ) (13 ) 13 23 20 26 (1 ) 11 19 30 (2 ) 65 39 (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). 2 Additionally includes related social security contributions and expenses related to alternative investment awards. 3 Excludes interest and dividend income. 4 Income/average invested assets. 5 Operating expenses/income. 29 Financial Businesses Global Wealth Management & Business Banking Business Unit reporting (continued) CHF million, except where indicated For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 Swiss clients Income Invested assets (CHF billion) Net new money (CHF billion) 1 Gross margin on invested assets (bps) 2 Capital return and BIS data Return on adjusted regulatory capital (%) 3 Return on adjusted regulatory capital before goodwill (%) 3 BIS risk-weighted assets Goodwill Adjusted regulatory capital 4 Additional information Recurring income 5 Client assets (CHF billion) Personnel (full-time equivalents) 2,548 253 4.0 109 78.9 78.9 43,369 1,566 5,903 2,272 216 1.9 106 82.5 84.1 31,903 1,176 4,366 2,063 210 0.0 102 70.0 71.5 28,130 838 3,651 12 17 3 36 33 35 As at or for the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 6,635 1,235 11,555 5,679 972 10,093 4,787 884 9,176 17 27 14 1Excludes interest and dividend income. 5 Interest, asset-based fees for portfolio management and fund distribution, account-based and advisory fees. 2Income/average invested assets. 3Business Unit performance before tax/average adjusted regulatory capital. 410% of BIS risk-weighted assets plus goodwill. Components of operating income Wealth Management International & Switzerland derives its operating income principally from: – – – – net interest income. fees for ﬁnancial planning and wealth management services; fees for investment management services; transaction-related fees; and Wealth Management International & Switzerland’s fees are based on the market value of invested assets and the level of transaction- related activity. As a result, operating income is affected by factors such as ﬂuctuations in invested assets, changes in market conditions, investment performance and inﬂows and outﬂows of client funds. 2005 Key performance indicators In 2005, net new money inﬂows totaled CHF 68.2 billion, up 61% from CHF 42.3 billion in 2004, representing an annual growth rate of 8.8% of the underlying invested asset base at end-2004. This excellent performance was driven by gains in all geographical areas, especially from Asian clients, and a par- ticularly strong CHF 21.8 billion inﬂow into our European wealth management business. Invested assets, at CHF 982 billion on 31 December 2005, were up 26% from CHF 778 billion a year earlier, mainly re- ﬂecting the strong inﬂow of net new money and the positive market performance during the second half of the year, with CHF 11.1 billion coming from new assets gained from acqui- sitions we integrated in 2005. The 15% rise of the US dollar against the Swiss franc contributed to the increase. Approxi- Net new money CHF billion Invested assets CHF billion 2003 2004 2005 31.12.03 31.12.04 31.12.05 68.2 42.3 29.7 1,000 750 500 250 0 210 491 216 562 253 729 International Clients Swiss Clients 80 60 40 20 0 30 mately 36% of invested assets were denominated in US dol- lars at the end of 2005. Net new money European wealth management CHF billion The gross margin on invested assets was 102 basis points in 2005, down 1 basis point from 103 basis points a year ear- lier, as the asset base was boosted by the record inﬂows of net new money. Overall, recurring income made up 75 basis points of the margin in 2005, down from 76 basis points in 2004. Non-recurring income comprised 27 basis points of the margin in 2005, unchanged from 2004. Gross margin on invested assets bps 2003 2004 2005 101 103 102 110 100 90 80 70 The pre-goodwill cost / income ratio improved to 53.7% in 2005 from 54.9% a year earlier, reﬂecting the strong rise in income, which more than offset the increase in personnel ex- penses (mainly performance-related compensation) and high- er general and administrative costs. Excluding the European wealth management business, the 2005 cost / income ratio rose to 47.7% from 47.2% a year earlier. Cost / income ratio in % 2003 2004 2005 21.8 13.7 10.8 25 20 15 10 5 0 The level of invested assets was a record CHF 114 billion on 31 December 2005, a 39% increase compared to the CHF 82 billion a year earlier. As well as new inﬂows, this reﬂected ris- ing equity market levels and a 15% appreciation of the US dol- lar against the Swiss franc. Invested assets European wealth management CHF billion 31.12.03 31.12.04 31.12.05 120 90 60 30 0 114 82 46 2003 2004 2005 62.3 61.5 55.8 54.9 53.7 53.7 In 2005, income from our European wealth management business was CHF 722 million, up 65% from a year earlier, re- ﬂecting our growing asset and client base. In 2005, the number of client advisors decreased by 35. The decline was due to the reclassiﬁcation of some former Sauer- born Trust employees initially accorded client advisor status, and the departure of less productive client advisors. 70 60 50 40 30 As reported Adjusted for goodwill Results European wealth management Our European wealth management business continued to make signiﬁcant progress. With a particularly good perform- ance in the UK and Germany, the inﬂow of net new money in 2005 was CHF 21.8 billion, up 59% from the previous year’s intake of CHF 13.7 billion. The result reﬂects an annual net new money inﬂow rate of 27% of the underlying asset base at year- end 2004. In 2005, pre-tax proﬁt, at CHF 4,161 million, was up 20% from the pre-goodwill result in 2004. This increase reﬂects favorable equity markets, which drove a 17% increase in revenues through higher asset-based fees, and strengthening client ac- tivity. Rising interest income, a reﬂection of the expansion of our margin lending activities, also bolstered revenues. At the same time, our expenses, up 15% in 2005 from 2004 (pre-goodwill), reﬂect our ongoing growth strategy. Personnel expenses, up 22%, rose due to the hiring of an additional 1,462 employees. 31 Financial Businesses Global Wealth Management & Business Banking Performance before tax CHF million zation of intangible assets was CHF 7 million, practically un- changed from CHF 8 million in 2004. 2003 2004 2005 4,161 3,396 2,557 5,000 4,000 3,000 2,000 1,000 0 Operating income Total operating income in 2005 was CHF 9,011 million, up 17% from CHF 7,693 million a year earlier. This was the high- est level ever, reflecting a rise in recurring as well as in non- recurring revenues. Recurring income increased 17% on ris- ing 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 and commissions for sales of investment funds, reflecting an increase in client ac- tivity levels, which were particularly strong in the first quar- ter and in the second half of the year. These positive effects were supported by the appreciation of the US dollar against the Swiss franc. Operating expenses At CHF 4,850 million, operating expenses in 2005 were up 15% from CHF 4,230 million (pre-goodwill) a year earlier, re- flecting higher personnel expenses as well as the ongoing in- vestment in our growth initiatives. Personnel expenses rose 22% to CHF 2,579 million in 2005 compared to CHF 2,119 million a year earlier, reflecting the increase in salaries from the expansion of our business as well as higher performance- related compensation. Expenses for share-based awards in- creased with more shares and options being granted and the rise of the share price during the year. General and admin- istrative expenses, at CHF 804 million, were up 25% in 2005 from CHF 642 million a year earlier due to ongoing business expansion as well as investments in our physical and IT infrastructure. Expenses for services from other business units, at CHF 1,371 million in 2005, were down 2% from CHF 1,395 million the previous year, mainly due to lower charges for insurance. Depreciation was CHF 89 million in 2005, up 35% from CHF 66 million a year earlier because of higher charges for information technology equipment. Amortization of goodwill ceased in 2005, while the amorti- 32 2004 Key performance indicators In 2004, net new money inﬂows totaled CHF 42.3 billion, up 42% from CHF 29.7 billion in 2003. The excellent perform- ance 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 778 billion on 31 December 2004, were up 11% from CHF 701 billion a year earlier, mainly re- ﬂecting the strong inﬂow of net new money and CHF 22.4 bil- lion in new assets gained from acquisitions 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 dollar’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 earli- er, as revenues increased more than the average asset base. Overall, recurring income made up 76 basis points of the mar- gin 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. The pre-goodwill cost / income ratio declined to 54.9% in 2004 from 61.5% a year earlier, reﬂecting the strong rise in income, which more than offset the gain in performance-re- lated compensation. Excluding the European wealth manage- ment business, the cost / income ratio fell to 47.2% in 2004 from 53.2% a year earlier. European wealth management Our European wealth management business made 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 reﬂected an annual net new money inﬂow rate of 30% of the underlying asset base at year-end 2003. 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. In 2004, income from our European wealth management business was CHF 437 million, up 64% from a year earlier, re- ﬂecting our growing asset and client base. The number of client advisors increased by 166 in 2004, of which 144 were from businesses we acquired during the year. Results Wealth Management International and Switzerland’s 2004 pre-tax proﬁt, at CHF 3,396 million, increased 33% from 2003, mainly due to a recovery in major ﬁnancial markets that started in the middle of 2003, driving a 13% increase in rev- enues through higher asset-based fees. At the same time, our expenses only rose by 1% in 2004 from 2003, reﬂecting our tight cost management. Operating income Total operating income in 2004 was CHF 7,693 million, up 13% from CHF 6,793 million in 2003. Recurring income in- creased 19% on higher asset-based fees, the latter beneﬁt- ing from gains in asset levels. Rising interest income, reﬂect- ing the expansion of our margin lending activities, also had a positive impact on revenues. Non-recurring income rose due to higher brokerage fees, tracing the increase in client activi- ty levels, which were particularly strong in the ﬁrst and fourth quarters of the year. Operating expenses At CHF 4,297 million, operating expenses in 2004 were up 1% from CHF 4,236 million a year earlier, reﬂecting higher personnel expenses as well as the ongoing investment in growth initiatives. Personnel expenses in 2004 rose 6% to CHF 2,119 million from CHF 1,996 million a year earlier, reﬂecting higher performance-related compensation as well as an in- crease in salaries related to the expansion of our business. General and administrative expenses, at CHF 642 million, were up 6% in 2004 from CHF 604 million a year earlier, due to higher legal and operational provisions, an increase in trav- el 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 mil- lion in the previous year, mainly due to lower charges for in- surance 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 amortization was CHF 67 million in 2004, up 24% from a year earlier. 33 Financial Businesses Global Wealth Management & Business Banking Wealth Management US Business Unit reporting CHF million Private client revenues Net goodwill funding 2 Income Adjusted expected credit loss 3 Total operating income Cash components Share-based components 4 Total personnel expenses General and administrative expenses Services to / from other business units Depreciation of property and equipment Amortization of goodwill Amortization of other intangible assets Total operating expenses Business Unit performance before tax Business Unit reporting excluding acquisition costs CHF million Total operating income Add back: Net goodwill funding 2 Operating income excluding acquisition costs Total operating expenses Retention payments Amortization of goodwill Amortization of other intangible assets Operating expenses excluding acquisition costs Business Unit performance before tax and acquisition costs For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 5,347 (189) 5,158 (2) 5,156 3,353 107 3,460 1,047 223 65 0 49 4,844 312 4,906 (165 ) 4,741 (5 ) 4,736 3,206 114 3,320 767 275 67 171 107 4,707 29 4,959 1 (211 ) 4,748 (8 ) 4,740 3,394 161 3,555 689 415 66 192 116 5,033 (293 ) 9 (15 ) 9 60 9 5 (6 ) 4 37 (19 ) (3 ) (100 ) (54 ) 3 976 For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 5,156 189 5,345 4,844 0 0 (49) 4,795 550 4,736 165 4,901 4,707 (99 ) (171 ) (107 ) 4,330 571 4,740 211 4,951 5,033 (299 ) (192 ) (116 ) 4,426 525 9 15 9 3 100 100 54 11 (4 ) 1 Includes gain on disposal of Correspondent Services Corporation of CHF 161 million. 3 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). social security contributions and expenses related to alternative investment awards. 2 Goodwill and intangible asset-related funding, net of risk-free return on the corresponding capital allocated. 4 Additionally includes related 34 Business Unit reporting (continued) CHF million, except where indicated 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 (bps) 4 Cost / income ratio (%) 5 Cost / income ratio excluding acquisition costs (%) 6 Recurring income 7 Revenues per advisor (CHF thousand) 8 Capital return and BIS data Return on adjusted regulatory capital (%) 9 Return on adjusted regulatory capital before acquisition costs (%) 10 BIS risk-weighted assets Goodwill Adjusted regulatory capital 11 Adjusted regulatory capital excluding goodwill and intangible assets 12 Additional information Client assets (CHF billion) Personnel (full-time equivalents) Financial advisors (full-time equivalents) For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 752 26.9 18.3 75 78 93.9 89.7 2,834 715 5.8 31.1 18,928 3,841 5,734 1,818 31.12.05 826 17,034 7,520 606 18.1 15.3 77 80 99.3 88.3 2,343 655 0.6 35.5 17,664 2,472 4,238 1,610 As at 31.12.04 679 16,969 7,519 599 14.3 15.1 82 86 106.0 89.3 2,124 597 (6.5 ) 36.3 16,248 2,875 4,500 1,444 24 20 (3 ) (3 ) 21 9 7 55 35 13 % change from 31.12.03 31.12.04 690 17,029 7,766 22 0 0 1 Excludes interest and dividend income. 5 Operating expenses / income. 7 Interest, asset-based fees for portfolio management and fund distribution, account-based and advisory fees. performance before tax / average adjusted regulatory capital. assets. 4 Income, add back net goodwill funding / average invested assets. 6 Operating expenses less the amortization of goodwill (in 2004 and 2003), other intangible assets and retention payments / income, add back net goodwill funding. 9 Business Unit 10 Business Unit performance before tax and acquisition costs / average adjusted regulatory capital excluding goodwill and intangible 8 Private client revenues / average number of ﬁnancial advisors. 12 10% of BIS risk-weighted assets excluding intangible assets. 11 10% of BIS risk-weighted assets plus goodwill. 2 For purposes of comparison with US peers. 3 Income / average invested assets. Components of operating income Wealth Management US principally derives its operating income from: fees for ﬁnancial planning and wealth management services; – fees for investment 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 perform- ance, inﬂows and outﬂows of client funds, and investor activity levels. 35 Financial Businesses Global Wealth Management & Business Banking 2005 Gross margin on invested assets bps Key performance indicators 2003 2004 2005 The inﬂow of net new money in 2005 was a strong CHF 26.9 billion, up 49% from CHF 18.1 billion in 2004. Including in- terest and dividends, net new money in 2005 was CHF 45.2 billion, up from CHF 33.4 billion a year earlier. The increase in net new money was mainly due to the hiring of highly efﬁ- cient ﬁnancial advisors and inﬂows from ultra high net worth clients. 90 80 70 60 50 86 82 80 77 78 75 Net new money CHF billion 30 25 20 15 10 2003 2004 2005 26.9 18.1 14.3 Wealth Management US had CHF 752 billion in invested assets on 31 December 2005, up 24% from CHF 606 billion on 31 December 2004. The increase was due to the strong appreciation of the year-end US dollar spot rate against the Swiss franc, the inﬂows of net new money as well as positive market movements. In US dollar terms, invested assets were 8% higher on 31 December 2005 than they were on the same date in 2004. Invested assets CHF billion 31.12.03 31.12.04 31.12.05 752 As reported Excluding acquisition costs The cost / income ratio before acquisition costs was 89.7% for 2005, compared to 88.3% in 2004. The increase in the cost / income ratio reﬂects higher expenses associated with lit- igation provisions and personnel expenses, partially offset by a rise in revenues due to higher recurring income. Cost / income ratio in % 2003 2004 2005 106.0 89.3 99.3 88.3 93.9 89.7 120 100 80 60 40 As reported Excluding acquisition costs In 2005, recurring income was CHF 2,834 million, up 21% from CHF 2,343 million a year earlier. Excluding the impact of currency ﬂuctuations, recurring income was up 20% in 2005 from 2004, mainly due to higher levels of managed ac- count fees on a record level of invested assets in US dollar terms, and increased net interest income from the lending business. Flows into managed account products were USD 599 606 Recurring income CHF million 800 700 600 500 400 The gross margin on invested assets was 75 basis points in 2005, down from 77 basis points in 2004. The gross margin on invested assets before acquisition costs (net goodwill fund- ing costs) was 78 basis points, down from 80 basis points in 2004. The increase in average invested asset levels (up 11%) outpaced the gain in revenues (up 9%) following a decrease in transactional revenues over the year. 36 2003 2004 2005 2.834 2,343 2,124 3,000 2,500 2,000 1,500 1,000 16.7 billion in full-year 2005, comparing favorably to the USD 12.7 billion ﬂow for full-year 2004. Recurring income repre- sented about 55% of income in 2005 compared with 49% in 2004. Revenues per advisor increased in 2005 to CHF 715,000 from CHF 655,000 in 2004 as practically the same number of ﬁnancial advisors were able to produce higher recurring in- come than a year earlier. The number of ﬁnancial advisors was almost ﬂat compared to 2004, increasing by 1 advisor to 7,520 at the end of 2005. Increases in highly efﬁcient ﬁnancial ad- visors and trainees were offset by attrition among less produc- tive advisors. Revenues per advisor CHF thousand 2003 2004 2005 655 715 597 800 600 400 200 0 Financial advisors full-time equivalents 31.12.03 31.12.04 31.12.05 7,766 7,519 7,520 8,000 7,000 6,000 5,000 4,000 Results In 2005, we reported a pre-tax proﬁt of CHF 312 million compared to CHF 29 million in 2004. Excluding acquisition costs, proﬁt was CHF 550 million in 2005 and CHF 571 mil- lion in 2004. This decrease reﬂects mainly higher litigation provisions. In US dollar terms, operational performance (excluding acquisition costs) in 2005 was 4% lower than in 2004. Operating income In 2005, total operating income was CHF 5,156 million, up 9% compared to CHF 4,736 million in 2004. The same Performance before tax CHF million 2003 2004 2005 600 400 200 0 –200 –400 550 312 571 (5) 29 525 (293) As reported Excluding acquisition costs holds true for the operating income before acquisition costs. On the same basis and excluding currency effects, operat- ing income increased by 8% from 2004. The increase in op- erating income is primarily due to higher recurring income based on higher levels of assets, rising net interest income in UBS Bank USA, slightly offset by lower transactional rev- enues. Operating expenses Total operating expenses rose 3% to CHF 4,844 million in 2005 from CHF 4,707 million in 2004. Excluding acquisition costs, the increase was 11%. Excluding currency effects and acquisition costs, operating expenses were 10% higher. This reﬂects the impact of increased litigation provisions in second half 2005 which accounted for almost all the increase in non- personnel expenses. Personnel expenses increased by CHF 140 million due to higher variable compensation, reﬂecting the higher level of income partially offset by a credit related to a change in the estimated service period used for the amortization of certain long-term employee beneﬁts. Share based components de- creased, reﬂecting less share and options awards. Excluding the currency translation effect, the increase in personnel ex- penses amounted to 3%. General and administrative expens- es increased 37% to CHF 1,047 million in 2005 from CHF 767 million in 2004. In US dollar terms, they actually rose 35%, reﬂecting higher litigation provisions, partially offset by low- er professional fees. Services from other business units de- creased mainly due to lower charges in from ITI. Deprecia- tion was also lower due to a drop in infrastructure charges (down CHF 2 million). The amortization of other intangibles was CHF 49 million in 2005, down 54% from CHF 107 mil- lion due to the reclassiﬁcation of certain intangible assets. Un- der the new accounting rules, these assets are classiﬁed as goodwill, which is no longer amortized. 37 600 350 100 -150 -400 Financial Businesses Global Wealth Management & Business Banking 2004 Key performance indicators In 2004, inﬂows of net new money were CHF 18.1 billion, CHF 3.8 billion higher than the CHF 14.3 billion reported in 2003. Including interest and dividends, net new money in 2004 was CHF 33.4 billion, higher than the CHF 29.4 billion reported in 2003. Wealth Management US had CHF 606 billion in invested assets on 31 December 2004, up 1% from CHF 599 billion on 31 December 2003. The increase was due to inﬂows of net new money and the effects of market appreciation, partly off- set by the weakening of the US dollar against the Swiss franc. In US dollar terms, invested assets were 10% higher on 31 De- cember 2004 than they were on the same date in 2003. The gross margin on invested assets was 77 basis points in 2004, down from 82 basis points in 2003. The gross margin on invested assets before acquisition costs (net goodwill fund- ing costs) was 80 basis points, down from 86 basis points in 2003. The cost / income ratio before acquisition costs was 88.3% for 2004, compared to 89.3% in 2003. The improvement in the cost / income ratio reﬂects our continuous cost control. In 2004, recurring income was CHF 2,343 million, up 10% from CHF 2,124 million a year earlier. Excluding the impact of currency ﬂuctuations, recurring income was up 19% 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 12.7 billion in full-year 2004, comparing favorably to the USD 10.2 bil- lion ﬂow for full-year 2003. Revenues per advisor increased in 2004 to CHF 655,000 from CHF 597,000 in 2003 as a lower number of ﬁnancial ad- visors 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. Results In 2004, we reported a pre-tax gain of CHF 29 million com- pared to a loss of CHF 293 million in 2003. The 2003 results include a pre-tax gain of CHF 161 million from the sale of Cor- respondent Services Corporation (CSC) in second quarter. Af- ter the exclusion of the CSC gain and before acquisition costs, operational performance showed proﬁts of CHF 571 million in 2004 and CHF 364 million in 2003. In US dollar terms, op- erational performance (excluding the gain on sale of CSC) in 2004 was 69% higher than in 2003. This represents the best result since PaineWebber became part of UBS, reflecting record recurring income and increased net interest revenues beneﬁting from the ﬁrst full-year impact of UBS Bank USA. Operating income In 2004, total operating income was CHF 4,736 million, al- most unchanged compared to CHF 4,740 million in 2003. Be- fore acquisition costs and excluding the sale of our CSC busi- ness, total operating income rose from a year earlier. On the same basis and excluding currency effects, operating income increased by 11% from 2003. The increase in operating in- come is primarily due to higher recurring income, rising net interest income due to UBS Bank USA, and higher transaction- al revenues. Operating expenses Total operating expenses decreased 6% to CHF 4,707 million in 2004 from CHF 5,033 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 ef- fects and acquisition costs, operating expenses were up 6%, primarily due to an increase in general and administrative ex- penses. Personnel expenses dropped to CHF 3,320 million in 2004, down 7% from CHF 3,555 million a year earlier. Exclud- ing the effects of currency translation, personnel expenses were slightly higher than in 2003, reﬂecting higher bonus and broker compensation, which gained in line with performance, partially offset by lower retention payments, which ended in June. Non-personnel related expenses dropped 6% to CHF 1,387 million in 2004 from CHF 1,478 million in 2003. In US dollar terms, they actually rose 1%, reﬂecting higher legal fees and settlement charges and increased consulting fees related to key initiatives. This was partially offset by a declining good- will amortization (down CHF 21 million) due to the sale of CSC. 38 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 Cash components Share-based components 2 Total personnel expenses General and administrative expenses Services to / from other business units Depreciation of property and equipment Amortization of goodwill Amortization of other intangible assets Total operating expenses Business Unit performance before tax Business Unit performance before tax and amortization of goodwill KPIs Invested assets (CHF billion) Net new money (CHF billion) 3 Cost / income ratio (%) 4 Cost / income ratio before goodwill (%) 4 Non-performing loans / gross loans (%) Impaired loans / gross loans (%) Capital return and BIS data Return on adjusted regulatory capital (%) 5 Return on adjusted regulatory capital before goodwill (%) 5 BIS risk-weighted assets Goodwill Adjusted regulatory capital 6 Additional information Deferral (included in adjusted expected credit loss) Client assets (CHF billion) Personnel (full-time equivalents) For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 3,317 1,632 4,949 122 5,071 2,408 42 2,450 994 (634) 72 0 0 2,882 2,189 2,189 153 3.4 58.2 58.2 1.6 2.3 25.6 25.6 85,051 0 8,505 3,390 1,674 5,064 (25 ) 5,039 2,377 49 2,426 1,064 (533 ) 69 0 0 3,026 2,013 2,013 140 2.6 59.8 59.8 2.3 3.0 23.2 23.2 84,437 0 8,444 3,542 1,705 5,247 (127 ) 5,120 2,396 52 2,448 1,090 (609 ) 88 0 0 3,017 2,103 2,103 136 2.5 57.5 57.5 3.2 4.6 24.0 24.0 87,728 0 8,773 (2 ) (3 ) (2 ) 1 1 (14 ) 1 (7 ) (19 ) 4 (5 ) 9 9 9 1 1 As at or for the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 485 834 16,023 411 655 15,508 383 622 16,181 18 27 3 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). social security contributions and expenses related to alternative investment awards. tax / average adjusted regulatory capital. 6 10% of BIS risk-weighted assets plus goodwill. 3 Excludes interest and dividend income. 4 Operating expenses / income. 2 Additionally includes related 5 Business Unit performance before 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. 39 Financial Businesses Global Wealth Management & Business Banking 2005 Key performance indicators Net new money was CHF 3.4 billion in 2005, CHF 0.8 billion higher than the inﬂow of CHF 2.6 billion in 2004. Invested assets rose to CHF 153 billion in 2005 from CHF 140 billion a year earlier, driven by positive market develop- ments, net new money inﬂows as well as favorable currency translation effects. This was partially offset by the transfer of assets to Wealth Management International & Switzerland. During the course of 2005, we transferred CHF 8.6 billion of assets from the Business Banking Switzerland unit to Wealth Management International & Switzerland, reﬂecting the sys- tematic development of client relationships. The cost / income ratio was 58.2%, 1.6 percentage points below the ratio of 59.8% in 2004, mainly because of tight cost control. Cost / income ratio in % 2003 57.5 2004 59.8 2005 58.2 60 55 50 45 40 Business Banking Switzerland’s loan portfolio was CHF 141.3 billion on 31 December 2005, up CHF 4.2 billion from the previous year. An increase in volumes of private client mort- gages and higher credit demand from corporate clients was partially offset by a further reduction in the recovery portfolio, which fell to CHF 3.3 billion on 31 December 2005 from CHF 4.4 billion a year earlier. This positive development was also re- ﬂected in the key credit quality ratios: the non-performing loan ratio improved to 1.6% from 2.3%, while the ratio of impaired loans to gross loans was 2.3% compared to 3.0% in 2004. The return on adjusted regulatory capital was 25.6% for 2005, up 2.4 percentage points from 23.2% a year earlier. This reﬂects the increased proﬁtability of the business unit, outpac- ing the increase in risk-weighted assets. Return on adjusted regulatory capital in % 31.12.03 31.12.04 31.12.05 24.0 23.2 25.6 28 21 14 7 0 Results Pre-tax proﬁt in 2005, at a record level of CHF 2,189 million, was CHF 176 million or 9% higher than the result achieved in 2004. It was achieved despite a CHF 115 million fall in in- come, driven mainly by lower interest income. The result shows the continued tight management of our cost base, with a credit loss recovery of CHF 122 million reﬂecting the struc- tural improvement in our loan portfolio in recent years. While general and administrative costs were at their lowest levels, personnel expenses increased slightly, reﬂecting an increase in staff levels. Impaired loans / gross loans in % Performance before tax CHF million 31.12.03 31.12.04 31.12.05 2003 2004 2005 4.6 3.0 2.3 2,500 2,000 1,500 1,000 500 0 2,103 2,013 2,189 5 4 3 2 1 0 40 Operating income Total operating income in 2005 was CHF 5,071 million, up slightly from 2004’s level of CHF 5,039 million. Interest income declined by 2% to CHF 3,317 million in 2005 from CHF 3,390 million in 2004. The decline reﬂects lower revenues from our reduced recovery portfolio, as well as lower interest margins in our mortgage business. This was partially offset by higher private client mortgage volumes. Non-interest income dropped by CHF 42 million to CHF 1,632 million in 2005 from CHF 1,674 million in 2004, reﬂecting the gain from the sale of a participation in the Noga Hilton hotel in 2004, partially offset by higher asset based fees and higher client activity levels. Ad- justed expected credit loss recoveries, at CHF 122 million in 2005, increased from a credit loss expense of CHF 25 million in 2004. This positive result reﬂects the deferred beneﬁt of the structural improvement in our loan portfolio in recent years. Operating expenses Operating expenses in 2005 were CHF 2,882 million, down 5% from CHF 3,026 million in 2004. Personnel expenses, at CHF 2,450 million, were up 1% from CHF 2,426 million in 2004, as higher salary costs reﬂected the 3% increase in per- sonnel, partly offset by lower share based expenses as less share awards have been granted. General and administrative expenses, at CHF 994 million in 2005, continued to drop and were 7% lower than the CHF 1,064 million recorded in 2004, reﬂecting our continuing tight cost controls. Net charges to other business units rose to CHF 634 million in 2005 from CHF 533 million in 2004 because of lower charge-ins for IT serv- ices and insurance. Depreciation in 2005 slightly increased to CHF 72 million from CHF 69 million in 2004 due to higher ex- penses for information technology equipment. 2004 Key performance indicators from the previous year. An increase in private client mortgage volumes was offset by lower credit demand from corporate 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 2,013 million, only CHF 90 mil- lion or 4% lower than the record result achieved in 2003. It was achieved despite a CHF 183 million fall in income, driv- en mainly by lower interest income. The result showed 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 expens- es and depreciation reached their lowest levels since the UBS- SBC merger in 1998. Operating income Total operating income in 2004 was CHF 5,039 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 reﬂected lower revenues from our reduced recovery portfolio, as well as lower interest margins on savings and cash accounts. This was partially offset by high- er private client mortgage volumes. Non-interest income dropped by CHF 31 million to CHF 1,674 million in 2004 from CHF 1,705 million in 2003, reﬂecting lower client activity lev- els, partially offset by the gain from the sale of a participation in the Noga Hilton hotel. Adjusted expected credit loss expens- es, at CHF 25 million in 2004, decreased by 80% from CHF 127 million in 2003. This fall reﬂected the deferred beneﬁt of the structural improvement in our loan portfolio in recent years. 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 the international and Swiss wealth manage- ment businesses. During the course of 2004, we transferred CHF 7.4 billion in assets to the international and Swiss wealth management businesses, reﬂecting the increasingly sophisti- cated needs of a portion of our clients. The cost / income ratio was 59.8%, 2.3 percentage points above the ratio of 57.5% in 2003, reﬂecting falling interest income in the low interest rate environment. Business Banking Switzerland’s loan portfolio was CHF 137.1 billion on 31 December 2004, down CHF 1.4 billion Operating expenses Operating expenses in 2004 were CHF 3,026 million, up slightly from CHF 3,017 million in 2003. Personnel expens- es, at CHF 2,426 million, were down 1% from CHF 2,448 mil- lion in 2003, as falling salary costs reﬂected the 4% drop in personnel, partly offset by an increase in performance-relat- ed 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 mainly seen 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 equip- ment. 41 Financial Businesses Global Asset Management Global Asset Management Pre-tax proﬁt was CHF 1,057 million, an increase of 55% from the 2004 pre-goodwill proﬁt of CHF 681 million. The increase was driven by higher operating income, which rose 23%, reﬂecting strong net new money inﬂows, improved margins and consequently higher asset based revenues across all businesses. In addition, performance fees, particularly in alternative and quantitative investments, increased signiﬁcantly. Business Group reporting CHF million, except where indicated Institutional fees Wholesale intermediary fees Total operating income Cash components Share-based components 1 Total personnel expenses General and administrative expenses Services to / from other business units Depreciation of property and equipment Amortization of goodwill Amortization of other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and amortization of goodwill KPIs Cost / income ratio (%) 2 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 31.12.05 31.12.04 31.12.03 31.12.04 1,330 1,157 2,487 899 89 988 304 116 21 0 1 1,430 1,057 1,057 57.5 57.5 441 16 21.3 (3.0) 34 1,085 937 2,022 822 71 893 299 126 23 129 0 1,470 552 681 72.7 66.3 344 17 23.7 (1.2 ) 32 922 815 1,737 766 69 835 265 156 25 152 1 1,434 303 455 82.6 73.8 313 14 12.7 (5.0 ) 32 23 23 23 9 25 11 2 (8 ) (9 ) (100 ) (3 ) 91 55 28 (6 ) 6 1 Additionally includes related social security contributions and expenses related to alternative investment awards. 2 Operating expenses / operating income. 4 Operating income / average invested assets. 3 Excludes interest and dividend income. John A. Fraser | Chairman and CEO Global Asset Management 42 Business Group reporting (continued) CHF million, except where indicated 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 Capital return and BIS data Return on adjusted regulatory capital (%) 3 Return on adjusted regulatory capital before goodwill (%) 3 BIS risk-weighted assets Goodwill Adjusted regulatory capital 4 Additional information Invested assets (CHF billion) Personnel (full-time equivalents) 1 Excludes interest and dividend income. assets plus goodwill. For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 324 62 28.2 (9.7) 40 69.9 69.9 1,570 1,438 1,595 257 64 (4.5 ) (20.6 ) 36 36.4 44.8 1,702 1,189 1,359 261 87 (5.0 ) (23.0 ) 31 18.6 27.9 2,325 1,400 1,633 26 (3 ) 11 (8 ) 21 17 31.12.05 765 2,861 As at 31.12.04 601 2,665 % change from 31.12.03 31.12.04 574 2,627 27 7 2 Operating income / average invested assets. 3 Business Group performance before tax / average adjusted regulatory capital. 4 10% of BIS risk-weighted Components of operating income Global Asset Management generates its revenue from the asset man- agement 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. 43 82.6 73.8 72.7 66.3 The gross margin for full-year 2005 was 34 basis points, slightly above the 32 basis points of full-year 2004. Gross margin on invested assets, institutional bps 57.5 2003 2004 2005 Financial Businesses Global Asset Management 2005 Key performance indicators For 2005, the pre-goodwill cost/income ratio was 57.5%, a decrease of 8.8 percentage points from 2004. This was a re- sult of improving operating income across all businesses, mainly induced by higher asset based fees. This was partly off- set by increased operating expenses, mainly the result of higher personnel expenses reﬂecting the positive course of business in 2005. Cost / income ratio in % 2003 2004 2005 As reported Adjusted for goodwill Institutional Institutional invested assets were CHF 441 billion on 31 De- cember 2005 – up 28% from CHF 344 billion on 31 Decem- ber 2004, reﬂecting positive market performance, strong net new money and favorable currency translation effects. For full-year 2005, net new money inﬂows were CHF 21.3 billion, down slightly from the CHF 23.7 billion recorded in Invested assets, institutional CHF billion 31.12.03 31.12.04 31.12.05 16 425 14 299 17 327 90 80 70 60 50 40 500 400 300 200 100 0 44 2004. Although inﬂows in traditional investments continued to grow, alternative and quantitative investments did not reach the same level as a year earlier. Net new money, institutional CHF billion 2003 2004 2005 30 20 10 0 –10 24.9 24.3 17.7 (5.0) (1.2) (3.0) Non-money market funds Money market funds 32 32 34 35 30 25 20 15 Wholesale intermediary Invested assets were CHF 324 billion on 31 December 2005, up by CHF 67 billion from 31 December 2004. For full-year 2005, the net new money inﬂow was CHF 28.2 billion com- pared with a CHF 4.5 billion outﬂow in 2004. Invested assets, wholesale intermediary CHF billion 31.12.03 31.12.04 31.12.05 400 300 200 100 0 87 174 64 193 62 262 Non-money market funds Money market funds Non-money market funds Money market funds The money market outﬂow in 2005 was CHF 9.7 billion, compared with CHF 20.6 billion a year earlier. In 2005, this outﬂow was offset by positive inﬂows of CHF 37.9 billion, recorded across all traditional asset classes (equities, ﬁxed in- come, asset allocation). Net new money, wholesale intermediary CHF billion 2003 2004 2005 37.9 18.0 16.1 (23.0) (20.6) (9.7) 45 30 15 0 –15 –30 Non-money market funds Money market funds The 2005 gross margin was 40 basis points, up by 4 basis points from a year earlier, reﬂecting shifts into higher margin asset classes. Gross margin on invested assets, wholesale intermediary bps 2003 2004 2005 40 36 31 50 40 30 20 10 Results We had a very strong full-year result in 2005. Pre-tax proﬁt was CHF 1,057 million, an increase of 55% from the 2004 pre-tax proﬁt of CHF 681 million. The increase was driven by higher operating income, which rose 23%, reﬂecting strong net new money inﬂows and a positive market environment that resulted in higher asset valuations. In addition, perform- ance fees, particularly in alternative and quantitative invest- ments, increased. This was only partially offset by a slight rise in operating expenses (pre-goodwill), mainly due to higher personnel expenses, in line with business growth. Performance before tax CHF million 2003 2004 2005 1,200 900 600 300 0 1,057 552 303 Operating income In full-year 2005, operating income was CHF 2,487 million, up 23% from CHF 2,022 million a year earlier. The increase reﬂects strong net new money inﬂows and a positive market environment resulting in higher asset valuations and conse- quently higher asset-based income across all businesses. In ad- dition, performance fees, particularly in alternative and quan- titative investments, increased significantly. Institutional revenues increased by 23% to CHF 1,330 million in 2005 from CHF 1,085 million in 2004, reﬂecting higher management fees in all areas, and higher performance fees, mainly in alterna- tive and quantitative investments. Wholesale intermediary revenues rose by 23% to CHF 1,157 million in 2005 from CHF 937 million in 2004, reﬂecting higher management fees in all areas due to net new money inﬂows and higher market val- uations. Operating expenses In 2005, operating expenses decreased to CHF 1,430 million from CHF 1,470 million in 2004. Pre-goodwill, operating ex- penses increased by CHF 89 million, primarily due to higher personnel costs, which rose in line with business growth. Per- sonnel expenses were CHF 988 million in 2005, 11% above 2004. General and administrative expenses increased by 2% to CHF 304 million in 2005 from CHF 299 million in 2004. Net charges from other business units decreased by CHF 10 mil- lion to CHF 116 million in 2005 from CHF 126 million in 2004, partly due to higher charge-outs to the wealth management businesses reﬂecting the higher demand for specialized invest- ment research. Over the same period, depreciation remained virtually unchanged at CHF 21 million, down by only CHF 2 million. Amortization of goodwill ceased in 2005, and the amortization of intangible assets increased slightly to CHF 1 million due to the acquisition of Siemens' real estate business. 45 Financial Businesses Global Asset Management 2004 Key performance indicators For 2004, the pre-goodwill cost / income ratio was 66.3%, a decrease of 7.5 percentage points from 2003. This was a re- sult 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 contin- uing change in asset mix towards higher-margin products in- creased 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 2003. Alternative and quantitative investments, equity and ﬁxed income mandates experienced strong inﬂows, partially offset by outﬂows from asset allocation mandates and mon- ey market funds. The gross margin for full-year 2004 was 32 basis points, on par with full-year 2003. 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. 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. The 2004 gross margin was 36 basis points, up by 5 basis points from a year earlier, reﬂecting the signiﬁcant improvement of wholesale intermediary fees as a result of the continuing shift to higher-margin products. 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 de- 46 plete over time. Such funds are a low-fee component of in- vested assets. In 2004, total money market outﬂows in the US were CHF 13.6 billion, with CHF 11 billion related to UBS Bank USA. Results Pre-tax proﬁt was CHF 552 million in 2004, an increase of 82% from 2003. The signiﬁcant improvement was driven by higher operating income, which rose 16%, reﬂecting strong net new money inﬂows, a continuing change in asset mix towards high- er-margin products, and a rise in market valuations producing increased asset levels and revenues. This was only partially off- set by a slight rise in operating expenses, mainly due to higher incentive-based compensation as a result of the higher revenues. 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 al- ternative and quantitative investments, and equities and ﬁxed income mandates, resulting in higher invested asset levels and, consequently, higher asset-based revenues. Performance-relat- ed fees, especially in alternative and quantitative 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 environ- ment 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 most- ly offset by inﬂows into higher-margin products. Operating expenses In 2004, operating expenses increased to CHF 1,470 million from CHF 1,434 million in 2003, primarily due to higher incen- tive-based compensation as a result of increased proﬁtability. Personnel expenses were CHF 893 million in 2004, 7% above 2003. General and administrative expenses increased by 13% to CHF 299 million in 2004 from CHF 265 million in 2003. This increase was mainly due to a restructuring provision in our busi- ness in the Americas booked in third quarter 2004 and the dam- age caused by Hurricane Ivan in the Cayman 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 distribu- tion of alternative investment products. Over the same period, depreciation remained virtually unchanged at CHF 23 million, down by only CHF 2 million. Amortization of goodwill de- creased to CHF 129 million in 2004 from CHF 152 million a year earlier, due to the full amortization of the goodwill of some busi- nesses and the US dollar’s decline against the Swiss franc. Financial Businesses Investment Bank Investment Bank In 2005, the Investment Bank’s pre-tax proﬁt was CHF 5,181 million, up 6% from a year earlier (pre-goodwill). Results were driven by increased revenues, mainly in equities and investment banking. Business Group reporting CHF million Equities Fixed income, rates and currencies Investment banking Income Adjusted expected credit loss 1 Total operating income Cash components Share-based components 2 Total personnel expenses General and administrative expenses Services to / from other business units Depreciation of property and equipment Amortization of goodwill Amortization of other intangible assets Total operating expenses Business Group performance before tax Business Group performance before tax and amortization of goodwill For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 6,980 7,962 2,506 17,448 36 17,484 8,065 1,194 9,259 2,215 640 136 0 53 12,303 5,181 5,181 5,906 8,269 1,915 16,090 (7 ) 16,083 7,130 1,022 8,152 2,538 226 243 278 36 11,473 4,610 4,888 4,875 7,932 1,703 14,510 (55 ) 14,455 6,690 1,047 7,737 2,068 175 248 279 27 10,534 3,921 4,200 18 (4 ) 31 8 9 13 17 14 (13 ) 183 (44 ) (100 ) 47 7 12 6 Huw Jenkins | CEO Investment Bank (and Chairman from 1 January 2006) John P. Costas | Chairman Investment Bank (until 31 December 2005) 47 Financial Businesses Investment Bank Investment Bank (continued) CHF million, except where indicated KPIs Compensation ratio (%) 3 Cost / income ratio (%) 4 Cost / income ratio before goodwill (%) 4 Non-performing loans / gross loans (%) Impaired loans / gross loans (%) Average VaR (10-day 99%) 5 Capital return and BIS data Return on adjusted regulatory capital (%) 6 Return on adjusted regulatory capital before goodwill (%) 6 BIS risk-weighted assets Goodwill Adjusted regulatory capital 7 Additional information Deferral (included in adjusted expected credit loss) Client assets (CHF billion) Personnel (full-time equivalents) For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 53 70.5 70.5 0.2 0.2 346 28.6 28.6 51 71.3 69.6 0.4 0.6 358 30.5 32.4 53 72.6 70.7 0.6 1.1 295 27.9 29.9 151,313 4,309 19,440 116,512 3,579 15,230 102,517 3,812 14,064 (3 ) 30 20 28 As at or for the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 155 164 18,174 85 147 16,970 29 143 15,633 82 12 7 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). social security contributions and expenses related to alternative investment awards. municipal securities business of Wealth Management US from 1 January 2005. The business was transferred to the Investment Bank on 1 July 2005. adjusted regulatory capital. 7 10% of BIS risk-weighted assets plus goodwill. 4 Operating expenses / income. 3 Personnel expenses / income. 2 Additionally includes related 5 VaR for the Investment Bank includes the 6 Business Group performance before tax / average – 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 acquisition activity. These and other factors have had, and may in the future have, a signiﬁcant impact on results of operations from year to year. 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 transac- tions; – – mergers and acquisitions and other advisory fees; 48 2005 Average VaR (10-day 99%) CHF million Key performance indicators 2003 2004 2005 The pre-goodwill cost/income ratio rose to 70.5% in 2005 from 69.6% a year earlier. Revenue growth, driven by strong performances in investment banking and equities, was off- set by higher personnel expenses. Cost / income ratio in % 2003 2004 2005 72.6 70.7 71.3 69.6 70.5 80 70 60 50 40 As reported Adjusted for goodwill The full-year compensation ratio, at 53%, rose two per- centage points between 2004 and 2005. This reﬂects high- er performance-related compensation and increased staff lev- els. In particular, client-facing business areas, which are more service intensive but use less capital, saw faster growth this year. Share-based compensation was also higher, since awards made in 2005 for the 2004 ﬁnancial year contained an increased proportion of stock. 358 346 295 400 300 200 100 0 Impaired loans / gross loans in % 31.12.03 31.12.04 31.12.05 1.2 0.9 0.6 0.3 0.0 1.1 0.6 0.2 nesses as well as increased underwriting activity. The impaired loans to total loans ratio fell to 0.2% at the end of 2005 from 0.6% on 31 December 2004. The non-performing loans to total loans ratio fell to 0.2% from 0.4% in the same period. Compensation ratio in % Return on adjusted regulatory capital in % 2003 2004 2005 2003 2004 2005 55 50 45 40 35 53 53 51 50 40 30 20 10 29.9 27.9 32.4 30.5 28.6 As reported Adjusted for goodwill Market risk for the Investment Bank, as measured by the 10-day 99% Value at Risk (VaR), ended the year at CHF 355 million and averaged CHF 346 million for 2005, a slight increase on the 2004 year-end value of CHF 332 million but below the 2004 average of CHF 358 million. Total loans were CHF 87 billion on 31 December 2005 compared with CHF 68 billion on 31 December 2004, reﬂect- ing our expanding prime brokerage and equity ﬁnance busi- The return on adjusted regulatory capital in 2005 was 28.6%, down 3.8 percentage points from the pre-goodwill return of 32.4% a year earlier, despite the growth in pre-tax proﬁt. This reﬂects the 30% increase in risk-weighted assets which rose due to currency movements and in line with in- creased lending activity to the Investment Bank’s growing client base. 49 Financial Businesses Investment Bank Results 2005 was our most proﬁtable year since 2000. Pre-tax proﬁt was CHF 5,181 million, up 12% from 2004. Before goodwill, pre-tax proﬁt was up 6%. The result was driven by strong rev- enues in investment banking (up 31%) and in equities (up 18%), reflecting our successful expansion in significant growth areas such as M&A, in particular in Asia Paciﬁc, equi- ty derivatives and prime brokerage. Results in the ﬁxed in- come, rates and currencies business were slightly lower than last year’s all-time high. Lower revenues in structured credit – mainly driven by lower volumes and following the turmoil in the automotive sector in second quarter 2005 – were offset by an increase in the rates business. At the same time, costs increased as our business continued to expand. Performance before tax CHF million 2003 2004 2005 6,000 5,000 4,000 3,000 2,000 5,181 4,610 3,921 Operating income Total operating income in 2005 was CHF 17,484 million, up 9% from CHF 16,083 million a year earlier, as revenues rose strongly in the equities business and in investment banking. Equities revenues, at CHF 6,980 million in 2005, were up 18% from CHF 5,906 million in 2004. Signiﬁcant drivers of the increase were the derivatives business in the Asia Paciﬁc region and Eu- rope as well as prime brokerage where we saw an impressive rev- enue gain in the US, reﬂecting the growth of our client base in the last 12 months. Our proprietary and our equity-linked busi- nesses contributed slightly lower returns than the previous year. Fixed income, rates and currencies revenues were CHF 7,962 million, down 4% from CHF 8,269 million a year ear- lier. Revenues in the rates business were up against the prior year as a result of rising revenues in energy trading and de- rivatives. Credit ﬁxed income saw lower revenues in structured credit, notably in the US and in credit trading as well as in the high-yield sector. Credit default swaps hedging loan exposures recorded gains of CHF 103 million compared with losses of CHF 62 million a year earlier. The foreign exchange business decreased as derivatives trading was negatively impacted by historically low volatili- ty levels. This was partially offset by rising cash and collat- eral trading revenues due to higher market share and vol- umes. 50 Investment banking revenues, at CHF 2,506 million in 2005, increased 31% from CHF 1,915 million a year earlier. This reﬂected growth in each region. Advisory revenues grew signiﬁcantly, in line with the strong momentum in the M&A business and our increased presence in important transactions. During 2005, our Investment Bank advised on a total of 343 transactions with a deal volume of USD 496 billion, more than double from 2004. Its pace last year exceeded market growth and included some of the largest deals announced during the year – among them advising Gillette on its sale to Procter & Gamble. Revenues in the capital markets business rose as well, mainly in debt underwriting and in global syndicated ﬁnance, reﬂecting improved market conditions and our strengthened competitive position. Operating expenses Higher personnel costs and increased allocated costs prompt- ed total operating expenses in 2005 to rise to CHF 12,303 mil- lion, a 7% increase from CHF 11,473 million a year earlier. Personnel expenses, at CHF 9,259 million in 2005, in- creased 14% from a year earlier, reﬂecting an increase in the bonus accrual and additional increased salaries due to high- er staff levels. Share-based compensation rose 17% from pri- or year due to an increase in share-based awards and the high- er UBS share price in 2005 compared with 2004. General and administrative expenses were CHF 2,215 mil- lion in 2005, down 13% from 2004’s CHF 2,538 million. Pro- visions were lower than in 2004, when we recorded a civil penalty levied by the Federal Reserve Board relating to our banknote trading business. This was partially offset by an in- crease in IT and other outsourcing costs. Services from other business units increased to CHF 640 million in 2005 from CHF 226 million in 2004. Depreciation eased 44% to CHF 136 mil- lion in 2005 from CHF 243 million in 2004 due to the trans- fer of further IT infrastructure functions into our central ITI unit in Corporate Center. Amortization of goodwill ceased in 2005, while the amortization of other intangible assets, at CHF 53 million in 2005, was up 47% from CHF 36 million a year earlier due to the inclusion of the rest of Brunswick and the capital markets division of Charles Schwab, acquired in third quarter 2004, and the purchase of our remaining stake in Pre- diction, which became part of UBS in 2005. 2004 Key performance indicators The pre-goodwill cost / income ratio improved to 69.6% in 2004 from 70.7% a year earlier. It reﬂected a strong revenue performance in all businesses. Our compensation ratio in 2004 was 51%, down from 53% in 2003, reﬂecting the completion of the aggressive in- vestment banking hiring program. Payout levels were driven by the revenue mix across business areas and managed in line with market levels. Total loans were CHF 68 billion on 31 December 2004, up 24% from CHF 55 billion a year earlier, reﬂecting the strength- ened business franchise. Continued successful recovery efforts led the ratio of impaired loans to total loans to fall to 0.6% at the end of 2004 from 1.1% on 31 December 2003. The non-performing loans to total loans ratio fell to 0.4% from 0.6% in the same period. From the beginning of 2005, private equity investments were reported as part of the Industrial Holding segment. Fig- ures were restated for 2003 and 2004 to reﬂect the change. Results Pre-tax proﬁt was CHF 4,610 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 reﬂected revenue growth across all our businesses. In particular, our ﬁxed income, rates and cur- rencies business posted a record result, up 4% from 2003, while the equities business reported a 21% increase in rev- enues on the strong improvement in market conditions. Invest- ment banking also contributed to our result, recording rev- enues of CHF 1,915 million, a 12% improvement compared to 2003. At the same time, costs increased as our businesses continued to expand, with speciﬁc operational provisions also a factor. rivative activity. Losses of CHF 62 million relating to Credit Default Swaps (CDSs) hedging existing credit exposure in the loan book had a negative impact on the ﬁxed income, rates and currencies result. But they were signiﬁcantly lower than the losses of CHF 678 million in 2003. Investment banking revenues, at CHF 1,915 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 survey 1, 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. Income by business area CHF million 20,000 15,000 10,000 5,000 0 2003 2004 2005 1,703 4,875 7,932 1,915 5,906 8,269 2,506 6,980 7,962 Fixed income, rates and currencies (1,602) Equities Investment banking Operating income Total operating income in 2004 was CHF 16,083 million, up 11% from CHF 14,455 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 oc- curred 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 broker- age saw an impressive revenue gain following the acquisition of ABN Amro’s prime brokerage business in the US. Fixed income, rates and currencies revenues were CHF 8,269 million, up 4% from CHF 7,932 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 lower revenues in our municipal securities business due to lower transaction and underwriting volumes and reduced de- Operating expenses Higher personnel costs and general and administrative expens- es prompted total operating expenses in 2004 to rise to CHF 11,473 million, a 9% increase from CHF 10,534 million a year earlier. Personnel expenses, at CHF 8,152 million in 2004, in- creased 5% from a year earlier, reﬂecting higher performance- related compensation, which rose due to higher revenues, as well as an increase in salaries reﬂecting the 9% rise in employ- ees. General and administrative expenses were CHF 2,538 mil- lion in 2004, up 23% from 2003’s CHF 2,068 million. The in- crease reflected higher operational provisions, climbing professional fees and raised IT spending. This was partially off- set by a drop in administration and occupancy expenses. Ser- vices from other business units increased to CHF 226 million in 2004 from CHF 175 million in 2003. Depreciation fell 2% to CHF 243 million in 2004 from CHF 248 million in 2003 on declining writeoffs. Amortization of goodwill, at CHF 278 mil- lion, was slighty down from a year earlier. Amortization of oth- er intangible assets was CHF 36 million, up 33% from a year earlier, reﬂecting the ABN Amro acquisition. 1 Financial Times, 26 January 2005. Table: Global fee ranking 2004 51 Financial Businesses Corporate Center Corporate Center With the sale of Private Banks & GAM at the end of the year, Corporate Center recorded a pre-tax gain of CHF 3,856 million in 2005. The continuing operations of Corporate Center reported a pre-tax loss of CHF 708 million, compared with a loss before goodwill of CHF 777 million in 2004. Business Group reporting CHF million, except where indicated Income Credit loss (expense) / recovery 1 Total operating income Cash components Share-based components 2 Total personnel expenses General and administrative expenses Services to / from other business units Depreciation of property and equipment Amortization of goodwill Amortization of other intangible assets Total operating expenses 3 Business Group performance from continuing operations before tax Business Group performance from discontinued operations before tax Business Group performance before tax Business Group performance from continuing operations before tax and amortization of goodwill Additional information BIS risk-weighted assets (CHF million) Personnel (full-time equivalents) Personnel excluding IT Infrastructure (ITI) (full-time equivalents) Personnel for ITI (full-time equivalents) For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 455 232 687 1,059 108 1,167 1,084 (1,730) 857 0 17 1,395 (708) 4,564 3,856 (708) 31.12.05 8,143 3,922 1,370 2,552 112 286 398 728 68 796 1,077 (1,509 ) 794 1 17 1,176 (778 ) 396 (382 ) (777 ) As at 31.12.04 9,841 5,202 2,848 2,354 20 92 112 725 60 785 1,166 (1,639 ) 811 0 20 1,143 (1,031 ) 220 (811 ) (1,031 ) 306 (19 ) 73 45 59 47 1 (15 ) 8 (100 ) 0 19 9 9 31.12.03 13,406 5,233 2,878 2,355 % change from 31.12.04 (17 ) (25 ) (52 ) 8 1 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 expense recorded at Group level is reported in Corporate Functions (see note 2 to the ﬁnancial statements). 2 Additionally includes related social security contributions and expenses related to alternative investment awards. 3 Includes expenses for the Chairman’s Ofﬁce (comprising the Company Secretary, Board of Directors, and Group Internal Audit). Clive Standish | UBS Chief Financial Ofﬁcer and Head, Corporate Center 52 2005 Results Corporate Center’s result from continuing operations – for- merly reported as the separate Business Unit Corporate Func- tions – was a loss of CHF 708 million in full-year 2005, com- pared to a loss of CHF 777 million (pre-goodwill) a year earlier. The improvement was driven by a CHF 343 million increase in income. This was partly offset by lower credit loss recover- ies and a rise in performance-related personnel costs. Private Banks & GAM (discontinued operations) The sale of Private Banks & GAM to Julius Baer was success- fully completed on 2 December 2005. The disposal gain and the operating result realized during the year before the deal closed are reported as discontinued operations, resulting in a pre-tax gain of CHF 4,564 million. This consists of the dispos- al gain of CHF 4,094 million before tax (CHF 3,705 million af- ter tax) and CHF 470 million in operating pre-tax proﬁt. Operating income Total operating income increased to CHF 687 million in 2005 from CHF 398 million in 2004. The result was driven by high- er revenues, partially offset by lower credit loss recoveries. The credit loss expense or recovery booked in Corporate Center represents the difference between the adjusted expect- ed credit losses charged to the business units and the actual credit loss recognized in the UBS Financial Statements. In 2005, UBS recorded a credit loss recovery of CHF 375 million, compared to a recovery of CHF 241 million in 2004. In both years, credit loss expense was lower than the adjusted expect- ed credit loss charged to the business units, resulting in a cred- it loss recovery in Corporate Center of CHF 232 million in 2005 and CHF 286 million a year earlier. Income increased by CHF 343 million to CHF 455 million in 2005 mainly due to the diversiﬁcation of capital into US dol- lars. The higher average equity base produced a positive im- pact on treasury income, as did a timing effect related to cash ﬂow hedging. Operating expenses Total operating expenses were CHF 1,395 million in 2005, up CHF 219 million from CHF 1,176 million in 2004. At CHF 1,167 million in 2005, personnel expenses were up 47% from CHF 796 million in 2004, mainly reﬂecting the further integration of UBS's IT infrastructure into ITI. It was also due to addition- al hiring and accruals for performance-related compensation. In the same period, general and administrative expenses in- creased 1% to CHF 1,084 million from CHF 1,077 million. Low- er costs for rent and maintenance of IT equipment in ITI and a release of capital tax accruals were offset by costs incurred for the implementation of new accounting standards and regula- tory requirements. Additionally, we saw higher expenses for our brand initiative and corporate real estate. Other business- es were charged CHF 1,730 million compared to CHF 1,509 million, reﬂecting the further integration of UBS's IT infrastruc- ture into ITI. Amortization of other intangible assets was CHF 17 million in 2005, at the same level as in 2004. IT infrastructure In 2005 the information technology infrastructure cost per av- erage number of financial business employees was CHF 26,731, down CHF 1,600 from CHF 28,331 in 2004, show- ing the positive effects of managing our information technol- ogy infrastructure centrally. 2004 Results The pre-tax loss was CHF 382 million in 2004, down from a loss of CHF 811 million a year earlier. Private Banks & GAM, which is shown under discontinued operations, contributed proﬁt of CHF 396 million, whereas continuing operations – or our Corporate Functions – saw a loss of CHF 778 million. Operating income Total operating income increased to CHF 398 million in 2004 from CHF 112 million in 2003. The result was driven by high- er credit loss recoveries as well as higher revenues. Income in- creased by CHF 92 million to CHF 112 million in 2004, main- ly due to lower writedowns of ﬁnancial investments (in 2003 we recorded a writedown in our stake in Swiss International Airlines Ltd.). This was partially offset by lower interest income from invested equity as we continued to repurchase shares. In 2004, credit loss recovery recorded in Corporate Center was CHF 286 million compared to CHF 92 million in 2003. This represents the difference between the adjusted expected credit losses charged to the business units and the credit loss recognized in the UBS ﬁnancial statements (recovery of CHF 241 million in 2004 and a loss of CHF 102 million in 2003). In both years, credit loss expense for UBS was lower than the adjusted expected credit loss charged to the business units, resulting in the above mentioned credit loss recoveries in Cor- porate Center. Operating expenses Total operating expenses were CHF 1,176 million in 2004, up CHF 33 million from CHF 1,143 million in 2003. At CHF 796 million in 2004, personnel expenses were up 1% from CHF 785 million in 2003, reflecting higher performance-re- lated compensation. In the same period, general and admin- istrative expenses dropped 8% to CHF 1,077 million from CHF 1,166 million. This was mainly due to falling IT costs re- 53 Financial Businesses Corporate Center lated to infrastructure cost savings as well as lower legal pro- visions. Other business units were charged CHF 1,509 mil- lion for services provided by Corporate Functions in 2004, compared with CHF 1,639 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 811 million in 2003, reflecting lower IT-related charges, partially offset by higher costs for real estate. Amortization of other intan- gible assets was CHF 17 million in 2004, down CHF 3 mil- lion from 2003 due to the weakening of the US dollar against the Swiss franc. 54 Industrial Holdings Industrial Holdings Industrial Holdings Income statement 1 CHF million, except where indicated Continuing operations Revenues from industrial holdings Other income Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation of property and equipment Amortization of goodwill Amortization of other intangible assets Goods and materials purchased Total operating expenses Operating proﬁt / (loss) from continuing operations before tax Tax expense Net proﬁt / (loss) from continuing operations Discontinued operations Proﬁt from discontinued operations before tax Tax expense Net proﬁt from discontinued operations Net proﬁt / (loss) Net proﬁt / (loss) attributable to minority interests from continuing operations from discontinued operations Net proﬁt / (loss) attributable to UBS shareholders from continuing operations from discontinued operations Private equity 3 CHF billion Investment 4 Portfolio fair value Additional information Cost / income ratio (%) 5 BIS risk-weighted assets (CHF million) Personnel (full-time equivalents) For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 10,515 564 11,079 1,146 599 14 253 0 207 8,003 10,222 857 253 604 124 9 115 719 207 202 5 512 402 110 6,086 354 6,440 906 773 20 215 7 169 3,885 5,975 465 120 345 140 2 32 108 453 93 93 0 360 252 108 2,900 (230 ) 2,670 862 748 23 178 26 8 1,113 2,958 (288 ) 10 (298 ) 259 2 27 232 (66 ) (11 ) (17 ) 6 (55 ) (281 ) 226 73 59 72 26 (23 ) (30 ) 18 (100 ) 22 106 71 84 111 75 (11 ) (72 ) 6 59 123 117 42 60 2 31.12.05 0.7 1.0 As at 31.12.04 1.2 1.7 % change from 31.12.03 31.12.04 1.4 1.6 (42 ) (41 ) For the year ended or as at % change from 31.12.05 31.12.04 31.12.03 31.12.04 92.3 2,035 21,636 92.8 2,773 29,453 110.8 2,044 29,121 (27 ) (27 ) 1 Please refer to note 1 non-current assets held for sale and discontinued operations for further explanation. 31 December 2004 and the year ended 31 December 2003 respectively. impairments. 5 Operating expenses / operating income. 3 Only comprises ﬁnancial investments available-for-sale. 2 Includes goodwill amortization of CHF 1 million and CHF 2 million for the year ended 4 Historical cost of investments made, less divestments and 56 Major participations Our private equity investments were moved to our Indust- rial Holdings segment in ﬁrst quarter 2005, matching our strat- egy of de-emphasizing and reducing exposure to this asset class while capitalizing on orderly exit opportunities as they arise. The segment also includes UBS’s majority stake in Motor- Columbus, a ﬁnancial holding company whose most signif- icant asset is an interest in the Atel Group (Aare-Tessin Ltd. for Electricity). In late September 2005, UBS announced that it would sell its 55.6% stake in Motor-Columbus to a consortium of Atel’s Swiss minority shareholders, EOS Hold- ing and Atel, as well as to French utility Electricité de France (EDF), after corresponding agreements to that effect were signed. At the end of February the European Commission and the Swiss Competition Commission have cleared the acquisition of the participation held by UBS. At the date of the print or- der of this Annual Report (8 March 2006), the transaction is expected to be completed as soon as all contractual conditions have been met and the boards of the buyers have passed the appropriate revolutions. 2005 In 2005, the Industrial Holdings segment reported a net prof- it of CHF 719 million, of which CHF 512 million was attribut- able to UBS shareholders. In 2005, it completed the sale of four fully consolidated in- vestments. The operating proﬁt or loss and gains on disposal are presented as discontinued operations for the industrial holdings. Previous income statements have also been restat- ed to reﬂect these divestments. In 2005, unconsolidated private equity investments, includ- ing those accounted for under the equity method, recorded total divestment gains of CHF 684 million. The level of ﬁnan- cial investments available-for-sale fell to CHF 0.7 billion on 31 December 2005 from CHF 1.2 billion a year earlier due to a number of exits which were partially offset by the funding of existing commitments. The fair value of this part of the port- folio decreased to CHF 1.0 billion in 2005 from CHF 1.7 bil- lion in 2004. Unfunded commitments on 31 December 2005 were CHF 367 million, down from CHF 769 million at the end of December 2004, primarily due to the exit from one invest- ment. 2004 In 2004, industrial holdings reported a net proﬁt of CHF 453 million, of which CHF 360 million was attributable to UBS shareholders. Of the investments fully consolidated in the pe- riod, we sold ﬁve in 2004. In 2004, unconsolidated private equity investments, includ- ing those accounted for under the equity method, recorded total divestment gains of CHF 330 million and writedowns of CHF 57 million. The level of ﬁnancial investments available-for-sale fell to CHF 1.2 billion on 31 December 2004 from CHF 1.4 billion a year earlier. The fair value of this part of the private equity port- folio increased to CHF 1.7 billion at the end of 2004 from CHF 1.6 billion on 31 December 2003. Unfunded commitments on 31 December 2004 were CHF 769 million, down from CHF 1,493 million at the end of 2003. 57 58 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 2,060.3 billion on 31 Decem- ber 2005, up from CHF 1,737.1 billion on 31 December 2004. The increase in total assets was largely due to curren- cy movements against the Swiss franc (mainly the 15% ap- preciation of the US dollar). Other factors contributing to the rise were the growth in collateral trading (up CHF 127 bil- lion), the trading portfolio (up CHF 105 billion), positive re- placement values (up CHF 49 billion) and the loan book (up CHF 38 billion). Total liabilities rose due to higher borrow- ing (up CHF 174 billion), collateral trading liabilities (up CHF 72 billion) and negative replacement values (up CHF 34 bil- lion). Lending and borrowing Lending Cash was CHF 5.4 billion on 31 December 2005, down slightly (CHF 0.7 billion) from a year earlier, mainly from lower sight deposit balances held with central banks. At CHF 33.6 billion on 31 December 2005, the due from banks line decreased by CHF 1.8 billion largely due to the sale of Private Banks & GAM. The decline was partially offset by in- creased balances in Global Wealth Management & Business Banking related to higher current account balances. Our loans to customers stood at CHF 270 billion on 31 Decem- ber 2005, up by CHF 37.8 billion from a year earlier, reflect- ing higher mortgages in Switzerland and secured lending, mainly in our international wealth management businesses. This was further accentuated by an increase in the Invest- ment Bank’s secured lending to US mortgage originators, as well as its global syndicated finance, prime brokerage and equity traded derivatives lending businesses. Borrowing The due to banks line rose by CHF 4.3 billion because of in- creased deposits on current accounts. Major movements in the Investment Bank's cash and collateral trading activities were also behind the rise, although they were offset by a lower proportion of funding secured from European central banks. Total debt issued (including ﬁnancial liabilities designated at fair value) increased to CHF 278.1 billion on 31 December 2005, up CHF 94.5 billion from a year earlier. Money market paper issuance increased by CHF 23.3 billion, mainly due to higher volume and foreign exchange rate ﬂuctuations. The long-term debt issued (including ﬁnancial liabilities designat- ed at fair value) grew by CHF 71.2 billion to CHF 175.4 bil- lion. Equity Linked Notes, a class of hybrid instruments issued by UBS totalling approximately CHF 39 billion, had to be re- classiﬁed in the balance sheet from negative replacement val- ues to ﬁnancial liabilities designated at fair value. Currency and fair value movements and increased securitization activities al- so increased during the same period. We believe the maturi- ty proﬁle of our long-term debt portfolio adequately match- es 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 75.5 billion, main- ly reflecting growing deposits from private clients in our wealth management and retail banking businesses as well as growth in our prime brokerage business. Repo and securities borrowing/lending In 2005, cash collateral on securities borrowed and reverse re- purchase agreements increased by CHF 127 billion or 22% to CHF 705 billion, while the sum of securities lent and repos grew by CHF 72 billion or 15% to CHF 556 billion. The in- crease stems largely from the Investment Bank’s securities bor- rowing and equity ﬁnancing activities, while 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) decreased by realizing additional netting opportunities. Trading portfolio Trading assets increased by CHF 105 billion to CHF 654 bil- lion on 31 December 2005 from CHF 549 billion on 31 De- cember 2004. Money market paper inventories of our ﬁxed income, rates and currencies business increased by CHF 13 bil- lion. As spreads became more attractive, net assets within cash and collateral proprietary trading were increased and were pledged to central banks. A net increase was also registered in debt instruments (up CHF 33 billion), mainly in our princi- pal ﬁnance and credit arbitrage and credit ﬁxed income busi- nesses where growth was driven by the expanding local pres- ence of the emerging market business. Equity instruments were up by CHF 38 billion, largely driven by the derivatives business, and traded loans rose by CHF 20 billion, mainly in the securitization business. Over the same period, short trad- ing positions increased by CHF 18 billion to CHF 189 billion. Replacement values In 2005 positive replacement values increased by CHF 49 bil- lion to CHF 334 billion, while negative replacement values in- creased by CHF 34 billion up to CHF 338 billion over the same period. Three main factors contributed to this development: movements in interest rates (in particular in the ﬁrst half of 2005), foreign exchange rate movements in major currencies, and higher trading volumes. 60 Other assets / liabilities Investments in associates rose by 11%, to CHF 3.0 billion on 31 December 2005. The increase was related to private eq- uity and corporate real estate investments as well as invest- ments by Motor-Columbus. Property and equipment was down 1% to CHF 9.4 billion, mainly driven by disposals and write-offs. Goodwill and other intangible assets, at CHF 13.5 billion on 31 December 2005, rose 11% from a year earlier, mainly due to foreign exchange rate movements. Addition- ally, it reflects the acquisition of several businesses during 2005. Equity At CHF 44.3 billion on 31 December 2005, equity attributable to UBS shareholders increased by CHF 10.4 billion from 2004. The increase reﬂects the attributable proﬁt of CHF 14.0 billion, which includes the gain on sale of Private Banks & GAM and the strengthening of the US dollar against the Swiss franc, par- tially offset by dividend payments and share repurchases. Equity attributable to minority interests increased by 40% to CHF 7.6 billion on 31 December 2005 from CHF 5.4 billion on the same date a year ago, mainly reﬂecting the new is- suance of preferred securities. Contractual obligations The table below summarizes our contractual obligations as of 31 December 2005. All contracts, with the exception of purchase obligations (those where we are committed to pur- chase determined volumes of goods and services), are either recognized as liabilities on our balance sheet or, in the case of operating leases, disclosed in note 25 to the Financial Statements. The following liabilities recognized on the balance sheet are excluded from the table because we do not consider these obligations as contractual: provisions, current and de- ferred tax liabilities, liabilities to employees for equity par- ticipation 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, during which we are required to pay employees contractu- ally 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 a speciﬁc asset. 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 investment op- portunities through entities that are not controlled by UBS. The importance of such arrangements to us, with respect to liquid- ity, capital resources or market and credit risk support, is mini- mal. We do not rely on such arrangements as a major source of revenue. They have also not incurred signiﬁcant expenses and we do not expect them to result in any in the future. The fol- lowing paragraphs discuss three distinct areas of off-balance sheet arrangements as of 31 December 2005 and any poten- tial obligations that may arise from them. Guarantees In the normal course of business, we issue various forms of guar- antees to support our customers. These guarantees, with the exception of related premiums, are kept off-balance sheet un- less a provision is needed to cover probable losses. The contin- gent liabilities arising from these guarantees are disclosed in note 24 to the ﬁnancial statements. In 2005, our contingent li- abilities from guarantees are slightly above the level compared to a year earlier. Fee income earned from issuing guarantees is not material to our total revenues. Losses incurred under guar- antees and income from the release of related provisions 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 commer- cial mortgage loans and related securities. We also securitize customers’ debt obligations in transactions that involve SPEs Contractual obligations CHF million Long-term debt Capital lease obligations Operating leases Purchase obligations Other long-term liabilities Total Less than 1 year 1–3 years 3–5 years More than 5 years Payment due by period 53,720 135 963 20,082 222 75,122 25,071 317 1,752 11,183 1,039 39,362 29,512 275 1,455 2,545 59,469 3,973 8,251 33,787 71,693 61 Balance Sheet and Cash Flows Balance sheet and off-balance sheet which issue collateralized debt obligations. A typical securitiza- tion transaction of this kind would involve the transfer of as- sets into a trust or corporation in return for beneﬁcial interests in the form of securities. Generally, the beneﬁcial interests are sold to third parties shortly after securitization. We do not pro- vide 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 33 to the ﬁnancial statements. Derivative instruments recorded in equity attributable to UBS shareholders 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 ﬁnan- cial statements), derivative contracts linked to our shares are ac- counted for as derivative instruments and are carried at fair val- ue on the balance sheet under positive replacement values or negative replacement values. 62 Balance Sheet and Cash Flows Cash ﬂows Cash ﬂows 2005 At end-2005, the level of cash and cash equivalents rose to CHF 91.0 billion, up CHF 3.9 billion from CHF 87.1 billion at end-2004. Operating activities Net cash ﬂow used in operating activities was CHF 63.2 bil- lion in 2005 compared to CHF 24.1 billion in 2004. Operat- ing cash inﬂows (before changes in operating assets and lia- bilities and income taxes paid) totaled CHF 14.6 billion in 2005, an increase of CHF 3.4 billion from 2004. Our net prof- it rose by CHF 6.2 billion compared to 2004. Discontinued op- erations contributed CHF 3.8 billion which had to be reclas- siﬁed to cash ﬂow from investing activities. Cash of CHF 162.6 billion was used to fund the net increase in operating assets, while a net increase in operating liabili- ties generated cash inﬂows of CHF 87.2 billion. The increase in cash was used to fund operating assets – in line with the expansion of our business. The comparative amounts in 2004 and 2003 were smaller, primarily due to the continuing recov- ery seen in the ﬁnancial markets. Payments to tax authorities were CHF 2.4 billion in 2005, up CHF 1.1 billion from a year earlier, reﬂecting the increase in net proﬁt between 2004 and 2003. Investing activities Investing activities generated a cash outﬂow of CHF 2.4 bil- lion, due to our acquisition of new businesses totalling CHF 1.5 billion, increase of purchase of property and equipment of CHF 1.9 billion and net increase of ﬁnancial investments of CHF 2.5 billion. Disposals of subsidiaries and associates in 2005 generated a cash inﬂow of CHF 3.2 billion, mainly due to the sale of Private Banks & GAM of CHF 1.9 billion. By con- trast, in 2004 we saw a net cash outﬂow from investing ac- tivities of CHF 1.0 billion mainly due to the acquisitions of new businesses of CHF 2.5 billion at a net purchase of property and equipment of CHF 0.5 billion. This was only partially offset by disposals of subsidiaries and associates and net sales of ﬁnan- cial investments. Financing activities In 2005, ﬁnancing activities generated cash ﬂows of CHF 64.5 billion, which was used to ﬁnance the expansion of our busi- ness activities. This reﬂected the net issuance of money mar- ket paper of CHF 23.2 billion and the issuance of CHF 76.3 billion in long-term debt – the latter signiﬁcantly outpacing long-term debt repayments, which totaled CHF 30.5 billion. That inﬂow was partly offset by outﬂows attributable to net movements in treasury shares and own equity derivative ac- tivity (CHF 2.4 billion), and dividend payments (CHF 3.1 bil- lion). In contrast, in 2004, we had also a net cash inﬂow of CHF 39.8 billion from our ﬁnancing activities. The difference between the two years was mainly due to the fact that long- term debt issuance increased by CHF 25.1 billion in 2005. 2004 At end-2004, the level of cash and cash equivalents rose to CHF 87.1 billion, up CHF 13.7 billion from CHF 73.4 billion at end-2003. Operating activities Net cash ﬂow from operating activities was negative CHF 24.1 billion in 2004 compared to positive CHF 3.3 billion in 2003. Operating cash inﬂows (before changes in operating assets and liabilities and income taxes paid) totaled CHF 11.2 billion in 2004, an increase of CHF 2.3 billion from 2003. While our net proﬁt rose by CHF 2.2 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 70.9 billion was used to fund the net increase in operating assets, while a net increase in operating liabili- ties generated cash inﬂows of CHF 37.0 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 228 million from a year earlier, reﬂect- ing the increase in net proﬁt between 2003 and 2002. Investing activities Investing activities generated a cash outﬂow of CHF 1.0 bil- lion, mainly due to our acquisition of new businesses, which totaled CHF 1.2 billion net of disposals. By contrast, in 2003, we saw a cash inﬂow of CHF 1.9 billion, mainly from our di- vestments of ﬁnancial investments and the sale of the Corre- spondent Services Corporation, which was partially offset by the purchase of property and equipment of CHF 1.4 billion. Financing activities The overall increase in cash inﬂows seen in 2004 is attribut- able to our financing activities, which generated positive 63 Balance Sheet and Cash Flows Cash ﬂows 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 outpacing long-term debt repayments, which totaled CHF 24.7 billion. That inﬂow was partly offset by out- ﬂows attributable to net movements in treasury shares and own equity derivative activity (CHF 5.0 billion), and dividend payments (CHF 2.8 billion). In contrast, in 2003, we had experienced a negative cash ﬂow of CHF 13.7 billion from our ﬁnancing activities. The difference between the two years was mainly due to the fact that long-term debt issuance more than doubled from 2003, and because we issued CHF 21.4 billion in money market paper in 2004 after repay- ing CHF 14.7 billion a year earlier. 64 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 consol- idated basis under IFRS. Pages 191 to 203 contain the ﬁnancial statements for the UBS AG Parent Bank – the Swiss company, including branch- es worldwide, which owns all the UBS companies, directly or indirectly. The Parent Bank’s ﬁnancial statements are prepared in order to meet Swiss regulatory requirements and in com- pliance with Swiss Banking Law. Except in those pages, or where otherwise explicitly stated, all references to “UBS” re- fer to the UBS Group and not to the Parent Bank. All references to 2005, 2004 and 2003 refer to the UBS Group and the Parent Bank’s ﬁscal years ended 31 December 2005 and 2004. 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 determine the revenues and expenses directly attributable to each busi- ness unit. The presentation of the business segments reﬂects UBS's organization structure and management responsibili- ties. Internal charges and transfer pricing adjustments are re- ﬂected in the performance of each business unit. Inter-business unit revenues and expenses. Revenue-shar- ing agreements are used to allocate external customer rev- enues to business units on a reasonable basis. Transactions be- tween business units are conducted at internally agreed transfer prices or at arm’s length. Inter-business unit charges are reported in the line “Services to / from other Business Units” for both Business Units concerned (see page 11). The corporate functions within Corporate Center expenses are al- located to the operating business units to the extent that it is appropriate. Net interest income is allocated to the business units 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 allocation, the ﬁnancial businesses are credited with a risk-free return on the regulatory capital adjusted for goodwill (see below). 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 re- sults discussion, we measure credit loss using an expected loss concept. Expected credit loss reﬂects the average annual costs that are expected to arise over time from positions in the cur- rent 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 ‘deferral’ in the table). The difference between the sum of these adjusted expected credit loss ﬁg- ures, which are charged to the Business Groups or Units, and the credit loss expense recorded at Group level for ﬁnancial reporting purposes is reported in Corporate Functions. The table on the next page shows the adjusted expected credit loss charged to the Business Groups. Regulatory capital requirements for the Business Units are deﬁned as 10% of BIS risk-weighted assets. To measure cap- ital consumption of the business units, we adjust regulatory capital for the goodwill allocated. Return on adjusted regula- tory capital is a key performance indicator for the Investment Bank and the Business Banking Switzerland unit. The levels of personnel are expressed in terms of full-time equivalents (FTE) and measured as a percentage of the standard hours normally worked by permanent full-time staff. The FTE level cannot exceed 1.0 for any particular in- dividual. Personnel includes all staff and trainees other than contractors. 66 Credit loss expense charged to the Business Groups CHF million Global Wealth Management & Business Banking Investment Bank UBS Total Wealth Management International & Switzerland Wealth Management US Business Banking CH For the year ended 31.12.05 Actuarial expected loss Deferrals Adjusted expected credit loss Credit loss (expense) / recovery Balancing item credited as credit loss recovery in Corporate Functions (54 ) 41 (13) (8) (8 ) 6 (2) 0 (363 ) 485 122 231 (119 ) 155 36 152 (544) 687 143 375 232 67 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 generally accepted account- ing principles in the United States (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 re- ported results. A broader and more detailed description of the accounting policies we employ is shown in Note 1 to the Fi- nancial 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 therefore 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 be- lieve 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. Liq- uidity is discussed in more detail on pages 80 to 82 of the Handbook 2005/2006. 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 va- riety of valuation techniques. These include present value methods, models based on observable input parameters, and models where some of the input parameters are unob- servable. Valuation models are used primarily to value derivatives transacted in the over-the-counter market, including credit de- rivatives and unlisted securities with embedded derivatives. All valuation models are validated before they are used as a ba- sis for ﬁnancial reporting, and periodically reviewed thereafter, 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 instru- ments, and with actual values when realized, in order to fur- ther validate and calibrate our models. A variety of factors are incorporated into our models, in- cluding 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 es- timating fair value inherently involves a signiﬁcant degree of judgment. Management therefore establishes valuation ad- justments to cover the risks associated with the estimation of unobservable input parameters and the assumptions within the models themselves. Valuation adjustments are also made to reﬂect such elements as aged positions, deteriorating cred- itworthiness (including country speciﬁc risks), concentrations in speciﬁc types of instruments and market risk factors (inter- est rates, currencies etc), and market depth and liquidity. Al- though a signiﬁcant degree of judgment is, in some cases, re- quired in establishing fair values, management believes the fair values recorded in the balance sheet and the changes in fair values recorded in the income statement are prudent and re- ﬂective of the underlying economics, based on the controls and procedural safeguards we employ. Nevertheless, for val- uations derived from models we have estimated the effect that a change in assumptions to reasonably possible alternatives could have on fair values where inputs are not market observ- able. To estimate that effect on the Financial Statements, we recalculated the model valuation adjustments at higher and lower conﬁdence levels than originally applied. A similar ap- proach was used for valuations other than those based on models. For the comparative prior year this assessment was based on estimates. For all ﬁnancial instruments carried at fair value which rely on assumptions for their valuation, we esti- mate that fair value could lie in a range from CHF 1,094 mil- lion lower to CHF 1,176 million higher than the fair values rec- ognized in the Financial Statements. In 2004 the estimate of that range was CHF 579 million lower to CHF 927 million high- er than the amounts recognized on the balance sheet. 68 Recognition of deferred Day 1 proﬁt and loss A closely related issue to determining fair value of ﬁnancial instruments is the recognition of deferred Day 1 proﬁt and loss. We have entered into transactions, some of which will mature after more than ten years, where we determine fair value using valuation models for which not all inputs are mar- ket observable prices or rates. We initially recognize a ﬁnan- cial instrument at the transaction price, which is the best in- dicator of fair value, although the value obtained from the relevant valuation model may differ. Such a difference be- tween the transaction price and the model value is common- ly referred to as "Day 1 proﬁt and loss". In accordance with applicable accounting literature, we do not recognize that ini- tial difference, usually a gain, immediately in proﬁt and loss. While applicable accounting literature prohibits immediate recognition of Day 1 proﬁt and loss, it does not address the recognition of Day 1 proﬁt and loss in the income statement prior to the time when fair value can be determined using mar- ket observable inputs or by reference to prices for similar in- struments in active markets. It also does not address subse- quent measurement of these instruments and recognition of subsequent fair value changes indicated by the model. Our decisions regarding recognizing deferred Day 1 prof- it and loss are made after careful consideration of facts and circumstances to ensure we do not prematurely release a por- tion of the deferred proﬁt to income. For each transaction, we determine individually the appropriate method of recogniz- ing the Day 1 proﬁt and loss amount in the income statement. Deferred Day 1 proﬁt and loss is either amortized over the life of the transaction, deferred until fair value can be deter- mined using market observable inputs, or realized through set- tlement. In all instances, any unrecognized Day 1 proﬁt and loss is immediately released to income if fair value of the ﬁ- nancial instrument in question can be determined either by using market observable 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. Special Purpose Entities and Securitizations UBS sponsors the formation of Special Purpose Entities (SPEs) primarily to allow clients to hold investments in separate le- gal entities, to allow clients to jointly invest in alternative as- sets, for asset securitization transactions, and for buying or selling credit protection. In accordance with IFRS we do not consolidate SPEs that we do not control. As it can sometimes be difﬁcult to determine whether we exercise control over an SPE, we have to make judgments about risks and rewards as well as our ability to make operational decisions for the SPE. In many instances, elements are present that, considered in isolation, indicate control or lack of control over an SPE, but when considered together make it difﬁcult to reach a clear conclusion. 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 be- ing conducted on our behalf according to our speciﬁc busi- ness needs so that we obtain the beneﬁts from the SPE’s op- erations. We consolidate an SPE if our assessment of the relevant factors indicate that we obtain the majority of the beneﬁts or risks 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 re- wards of the assets held by the SPE reside with the clients. Typ- ically, UBS will receive service and commission fees for creation of the SPE, or because it acts as investment manager, custo- dian or in some other function. Many of these SPEs are single-investor or family trusts while others allow a broad number of investors to invest in a diversified asset base through a single share or certiﬁcate. These latter SPEs range from mutual funds to trusts investing in real estate. As an ex- ample, UBS Alternative Portfolio AG provides a vehicle for in- vestors to invest in a diversiﬁed range of alternative investments through a single share. The majority of our SPEs are created for client investment purposes and are not consolidated. SPEs used to allow clients to jointly invest in alternative as- sets, e.g. feeder funds, for which generally no active markets exist, are often in the form of limited partnerships. Investors are the limited partners and contribute all or the majority of the capital, whereas UBS serves as the general partner. In that capacity, UBS is the investment manager and has sole discre- tion about investment and other administrative decisions, but has no or only a nominal amount of capital invested. UBS typ- ically receives service and commission fees for its services as general partner, but does not, or only to a minor extent, par- ticipate in the risks and rewards of the vehicle, which reside with the limited partners. In most instances, limited partner- ships are not consolidated because UBS neither controls them nor receives the majority of the beneﬁts. In some in- stances however, limited partnerships are consolidated be- cause UBS may have invested more than just a nominal amount and the limited partners have no right to liquidate the partnership or replace UBS as investment manager. Un- der US GAAP we consolidate some of the limited partnerships not consolidated under IFRS, because we are deemed to con- trol the entity as general partner through majority of votes, although the majority of risks and beneﬁts are with the lim- ited partners. 69 Accounting Standards and Policies Critical accounting policies SPEs used for securitization. SPEs for securitization are cre- ated when UBS has assets (for example a portfolio of loans) which it sells to an SPE, and the SPE in turn sells interests in the assets as securities to investors. Consolidation of these SPEs depends mainly on whether UBS retains the majority of the beneﬁts or risks of the assets in the SPE. We do not consolidate SPEs for securitization if UBS has no control over the assets and no longer retains any signiﬁcant exposure (for gain or loss) to the income or investment returns on the assets sold to the SPE or the proceeds of their liquida- tion. This type of SPE is a bankruptcy remote entity – if UBS were to go bankrupt the holders of the securities would clear- ly be owners of the asset, while if the SPE were to go bank- rupt the securities holders would have no recourse to UBS. 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. Allowances and provisions for credit losses Assets accounted for at amortized cost are assessed for ob- jective evidence of impairment and required allowances and provisions are estimated in accordance with IAS 39. Impair- ment exists if the book value of a claim or a portfolio of claims exceeds the present value of the cash ﬂows actually expect- ed in future periods. These cash ﬂows include scheduled in- terest payments, principal repayments, or other payments due (for example on guarantees), including liquidation of collat- eral where available. The total allowance and provision for credit losses consists of two components: speciﬁc counterparty allowances and pro- visions, 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, man- agement makes judgments about a counterparty’s ﬁnancial situation and the net realizable value of any underlying col- lateral or guarantees in our favor. Each impaired asset is as- sessed on its merits, and the workout strategy and estimate of cash ﬂows considered recoverable are independently ap- proved by the Credit Risk Control function. Collectively as- sessed credit loss allowances and provisions cover credit loss- es 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. In assessing the need for col- lective loan loss allowances and provisions, management con- siders factors such as credit quality, portfolio size, concentra- tions, and economic factors. In order to estimate the required allowance or provision, we make assumptions both to deﬁne the way we model inherent losses and to determine the re- quired input parameters, based on historical experience and current economic conditions. The accuracy of the allowances and provisions we make de- pends on how well we estimate future cash ﬂows for speciﬁc counterparty allowances and provisions and the model assump- tions and parameters used in determining collective allowances and provisions. While this necessarily involves judgment, we be- lieve that our allowances and provisions are reasonable and supportable. Further details on this subject are given in Note 1q) to the Financial Statements and in the Credit Risk section of the Handbook 2005/2006, on pages 57 to 69. Equity compensation IFRS 2, Share-based Payment, addresses the accounting for share-based employee compensation and was adopted by UBS on 1 January 2005 on a fully retrospective basis. The ef- fect of applying IFRS 2 is disclosed in Note 1 aa) to the ﬁnan- cial statements, and further information on UBS equity com- pensation plans, including inputs used to determine fair value of options, is disclosed in Note 31. IFRS 2 requires that share options awarded to employees are recognized as compensation expense based on their fair val- ue at grant date. The share options we issue to our employ- ees have features that make them incomparable to options on our shares traded in active markets. Accordingly, we cannot de- termine fair value by reference to a quoted market price, but we rather estimate it using an option valuation model. The model, a Monte Carlo simulation, requires inputs such as in- terest rates, expected dividends, volatility measures and spe- ciﬁc employee exercise behavior patterns based on statistical data. Some of the inputs we use are not market-observable and have to be estimated or derived from available data. Use of dif- ferent estimates would produce different option values, which in turn would result in higher or lower compensation expense recognized. We have not run the model with alternative inputs to quantify their effects on the fair value of the options. To value options, several recognized valuation models ex- ist. None of these models can be singled out as being the best or most correct one. The model we apply is able to handle some of the speciﬁc features included in the options granted to our employees, which is the reason for its use. If we were to use a different model, the option values would differ despite using the same inputs. Accordingly, using different assumptions cou- pled with using a different valuation model could have a sig- niﬁcant impact on the fair value of employee stock options. Fair value could be either higher or lower than the ones produced by the model we apply and the inputs we used. 70 Financial Statements Financial Statements Table of Contents Financial Statements Table of Contents 73 74 74 75 76 78 80 80 93 100 101 101 102 103 103 103 104 105 105 106 106 106 107 108 109 111 111 112 114 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 72 Balance Sheet: Liabilities 17 18 Due to Banks and Customers Financial Liabilities Designated at Fair Value and Debt Issued Other Liabilities Provisions Income Taxes Derivative Instruments 19 20 21 22 Off-Balance Sheet Information 23 24 25 Fiduciary Transactions Commitments and Contingent Liabilities Operating Lease Commitments Additional Information 26 115 115 115 117 117 117 119 124 124 124 126 127 Pledged Assets and Pledgeable 127 Off-Balance Sheet Securities 127 Litigation 128 Financial Instruments Risk Position 138 Fair Value of Financial Instruments Pension and Other Post-Retirement Beneﬁt Plans 143 Equity Participation and Other Compensation Plans 149 153 Related Parties 156 Securitizations 156 Post-Balance Sheet Events 157 Signiﬁcant Subsidiaries and Associates 161 Invested Assets and Net New Money 162 Business Combinations 167 Discontinued Operations 169 Currency Translation Rates 170 Swiss Banking Law Requirements 171 Reconciliation to US GAAP Additional Disclosures Required under US GAAP and SEC Rules 182 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 Financial Statements Report of the Group Auditors 73 Financial Statements Financial Statements Income Statement CHF million, except per share data Note 31.12.05 31.12.04 31.12.03 31.12.04 For the year ended % change from Continuing operations 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 Revenues from industrial holdings Total operating income 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 from continuing operations before tax Tax expense Net proﬁt from continuing operations Discontinued operations Proﬁt from discontinued operations before tax Tax expense Net proﬁt from discontinued operations Net proﬁt Net proﬁt attributable to minority interests from continuing operations from discontinued operations Net proﬁt attributable to UBS shareholders from continuing operations from discontinued operations Earnings per share Basic earnings per share (CHF) from continuing operations from discontinued operations Diluted earnings per share (CHF) from continuing operations from discontinued operations 74 3 3 3 4 3 5 6 7 14 15 15 21 38 21 8 8 59,286 (49,758) 9,528 375 9,903 21,436 7,996 1,125 10,515 50,975 21,049 7,047 1,493 0 334 8,003 37,926 13,049 2,549 10,500 4,688 498 4,190 14,690 661 656 5 14,029 9,844 4,185 13.93 9.78 4.15 13.36 9.39 3.97 39,228 (27,484 ) 11,744 241 11,985 18,506 4,902 932 6,086 42,411 18,612 7,160 1,477 653 337 3,885 32,124 10,287 2,224 8,063 536 129 407 8,470 454 454 0 8,016 7,609 407 7.78 7.39 0.39 7.40 7.04 0.36 40,045 (27,784 ) 12,261 (102 ) 12,159 16,673 3,670 225 2,900 35,627 18,218 6,630 1,498 703 193 1,113 28,355 7,272 1,419 5,853 479 79 400 6,253 349 343 6 5,904 5,510 394 5.44 5.07 0.37 5.19 4.84 0.35 51 81 (19 ) 56 (17 ) 16 63 21 73 20 13 (2 ) 1 (100 ) (1 ) 106 18 27 15 30 775 286 929 73 46 44 75 29 928 79 32 964 81 33 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 Equity Share capital Share premium Net gains / (losses) not recognized in the income statement, net of tax Revaluation reserve from step acquisitions, net of tax Retained earnings Equity classiﬁed as obligation to purchase own shares Treasury shares Equity attributable to UBS shareholders Equity attributable to minority interests Total equity Total liabilities and equity Note 31.12.05 31.12.04 31.12.04 % change from 9 10 10 11 11 22 9 12 13 14 15 16, 21 17 10 10 11 22 18 17 18 19, 20, 21 5,359 33,644 300,331 404,432 499,297 154,759 333,782 1,153 269,969 6,551 8,918 2,956 9,423 13,486 16,190 6,036 35,419 220,242 357,164 389,487 159,115 284,577 653 232,167 4,188 6,309 2,675 9,510 12,201 17,375 2,060,250 1,737,118 124,328 77,267 478,508 188,631 337,663 117,401 451,533 18,392 160,710 53,874 120,026 61,545 422,587 171,033 303,712 65,756 376,076 15,040 117,856 44,120 2,008,307 1,697,751 871 9,992 (182) 101 44,414 (133) (10,739) 44,324 7,619 51,943 901 9,231 (2,081 ) 90 37,001 (96 ) (11,105 ) 33,941 5,426 39,367 2,060,250 1,737,118 (11 ) (5 ) 36 13 28 (3 ) 17 77 16 56 41 11 (1 ) 11 (7 ) 19 4 26 13 10 11 79 20 22 36 22 18 (3 ) 8 91 12 20 (39 ) 3 31 40 32 19 75 Financial Statements Statement of Changes in Equity CHF million Share capital Balance at the beginning of the year Issue of share capital Cancellation of second trading line treasury shares (2002 program) Cancellation of second trading line treasury shares (2003 program) Cancellation of second trading line treasury shares (2004 program) Balance at the end of the year Share premium Balance at the beginning of the year Change in accounting policy Premium on shares issued and warrants exercised Net premium / (discount) on treasury share and own equity derivative activity Employee share and share option plans Cancellation of second trading line treasury shares (2002 program) 1 Balance at the end of the year Net gains / (losses) not recognized in the income statement, net of tax Foreign currency translation Balance at the beginning of the year Change in accounting policy Movements during the year Subtotal – balance at the end of the year 2 Net unrealized gains / (losses) on available-for-sale investments, net of tax Balance at the beginning of the year Change in accounting policy Net unrealized gains / (losses) on available-for-sale investments Impairment charges reclassiﬁed to the income statement 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 tax 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 Balance at the beginning of the year Movements during the year Balance at the end of the year Retained earnings Balance at the beginning of the year Change in accounting policy Net proﬁt attributable to UBS shareholders for the year Dividends paid 3 Cancellation of second trading line treasury shares (2003 program) 1 Cancellation of second trading line treasury shares (2004 program) 1 Balance at the end of the year For the year ended 31.12.05 31.12.04 31.12.03 901 2 (32) 871 946 2 (47 ) 901 1,005 2 (61 ) 946 9,231 7,595 12,641 660 103 (130 ) (211 ) (5,468 ) 7,595 (849 ) (50 ) (795 ) (1,694 ) 946 (406 ) (108 ) 285 (340 ) 22 399 (256 ) 116 (4 ) (144 ) (1,439 ) 32,700 (46 ) 5,904 (2,298 ) 295 (302) 768 325 (20 ) 1,331 9,992 9,231 (2,520) (1,694 ) 2,088 (432) (826 ) (2,520 ) 761 463 96 (396) 7 931 (322) (474) 115 (681) (182) 90 11 101 399 501 192 (353 ) 22 761 (144 ) (223 ) 45 (322 ) (2,081 ) 90 90 37,001 36,260 8,016 (2,806 ) (4,469 ) 14,029 (3,105) (3,511) 44,414 1 In 2004 and 2005 the cancellation of second trading line treasury shares is made against retained earnings. In 2003 it was made against the share premium account. 236 million and CHF 121 million of related taxes for the years ended 2005, 2004 and 2003, respectively. 2003, 20 April 2004 and 26 April 2005, respectively. 2 Net of CHF (292) million, CHF 3 Dividends of CHF 2.00 per share, CHF 2.60 per share and CHF 3.00 were paid on 23 April 76 37,001 36,260 Statement of Changes in Equity (continued) CHF million Equity classiﬁed as obligation to purchase own shares Balance at the beginning of the year Movements during the year Balance at the end of the year Treasury shares Balance at the beginning of the year Change in accounting policy Acquisitions Disposals Cancellation of second trading line treasury shares (2002 program) Cancellation of second trading line treasury shares (2003 program) Cancellation of second trading line treasury shares (2004 program) Balance at the end of the year Equity attributable to UBS shareholders Equity attributable to minority interests Balance at the beginning of the year Change in accounting policy Issuance of preferred securities Other increases Decreases and dividend payments Foreign currency translation Minority interest in net proﬁt Balance at the end of the year Total equity Shares issued Number of shares Balance at the beginning of the year Issue of share capital For the year ended 31.12.05 31.12.04 31.12.03 (96) (37) (133) (49 ) (47 ) (96 ) (11,105) (9,654 ) (8,375) 5,198 3,543 (10,739) 44,324 (9,368 ) 3,401 4,516 (11,105 ) 33,941 (104 ) 55 (49 ) (7,131 ) (1,474 ) (8,424 ) 1,846 5,529 (9,654 ) 33,659 5,426 3,879 3,529 1,539 44 (595) 544 661 7,619 51,943 1,922 (523 ) (306 ) 454 5,426 39,367 143 372 247 (357 ) (404 ) 349 3,879 37,538 For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 1,126,858,177 1,183,046,764 1,256,297,678 1,709,439 3,293,413 2,719,166 (5 ) (48 ) Cancellation of second trading line treasury shares (2002 program) Cancellation of second trading line treasury shares (2003 program) (75,970,080 ) (59,482,000 ) Cancellation of second trading line treasury shares (2004 program) (39,935,094) Balance at the end of the year 1,088,632,522 1,126,858,177 1,183,046,764 (3 ) Treasury shares Number of shares Balance at the beginning of the year Change accounting policy Acquisitions Disposals Cancellation of second trading line treasury shares (2002 program) Cancellation of second trading line treasury shares (2003 program) For the year ended 31.12.05 31.12.04 124,663,310 136,741,227 31.12.03 97,181,094 25,380,535 78,218,035 96,139,004 116,080,976 (58,686,377) (48,734,921 ) (25,931,298 ) (75,970,080 ) (59,482,000 ) % change from 31.12.04 (9 ) (19 ) (20 ) Cancellation of second trading line treasury shares (2004 program) (39,935,094) Balance at the end of the year 104,259,874 124,663,310 136,741,227 (16 ) During the year a total of 39,935,094 shares acquired under the second trading line buyback program 2004 were cancelled. On 31December2005, a maximum of1,823,501shares can be issued against the future exercise of options from former PaineWebber employee option plans. These shares are shown as conditional share capital in the UBS AG (Parent Bank) disclosure. Out of the total number of 104,259,874 treasury shares, 33,885,000 shares (CHF 3,597 million) have been repurchased for cancella- tion. The Board of Directors will propose to the Annual General Meeting on 19 April 2006 to reduce the outstanding number of shares and the share capital by the number of shares pur- chased for cancellation. All issued shares are fully paid. 77 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 31.12.05 31.12.04 31.12.03 14,690 8,470 6,253 1,556 340 (374) (152) (382) (5,062) 4,025 (1,690) (127,357) (74,799) 42,440 (1,227) 71,643 15,536 (2,394) (63,207) (1,540) 3,240 (1,892) 270 (2,487) (2,409) 1,576 1,066 (241 ) (67 ) 171 (1,008 ) 1,203 (7,471 ) (42,975 ) (19,733 ) 10,093 (10,809 ) 14,991 22,019 (1,345 ) (24,060 ) (2,511 ) 1,277 (1,149 ) 704 703 (976 ) 1,570 980 102 (138 ) 360 (301 ) 115 42,916 (101,381 ) (52,193 ) 38,636 (20,296 ) 65,413 22,420 (1,117 ) 3,339 (428 ) 1,234 (1,376 ) 123 2,317 1,870 78 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 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 and 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 with original maturity of less than three months Total Signiﬁcant non-cash investing and ﬁnancing activities 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 Private Banks and GAM, deconsolidation Financial investments Property and equipment Goodwill and other intangible assets Debt issued Private equity investments, deconsolidation Property and equipment Goodwill and other intangible assets Minority interests Acquisitions of businesses Financial investments Property and equipment Goodwill and other intangible assets Minority interests For the year ended 31.12.05 31.12.04 31.12.03 (14,737 ) (6,810 ) 2 (2,298 ) 23,644 (13,615 ) 419 (278 ) (13,673 ) (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 ) 85 (332 ) 39,823 (1,052 ) 13,735 73,356 87,091 6,036 45,523 35,532 87,091 644 261 2,083 1,194 727 1,742 336 23,221 (2,416) 2 (3,105) 76,307 (30,457) 1,572 (575) 64,549 5,018 3,951 87,091 91,042 5,359 57,826 27,857 91,042 60 180 362 5 248 3 27 35 112 377 6 2 Money market paper is included 1 Includes issuance of preferred securities of CHF 1,539 million for the year ended 31 December 2005 and CHF 372 million for the year ended 31 December 2003. in the balance sheet under Trading portfolio assets and Financial investments. CHF 4,744 million, CHF 5,289 million and CHF 6,430 million were pledged at 31 December 2005, 31 December 2004 and 31 December 2003, respectively. Cash paid for interest was CHF 44,392 million and CHF 24,192 million for 2005 and 2004 respectively. 79 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 and brokerage on a global level, and retail banking in Switzerland. The Group was formed on 29 June 1998 when Swiss Bank Corporation and Union Bank of Switzerland merged. The merger was accounted for using the uniting of interests method of accounting. The consolidated ﬁnancial statements of UBS (the “Finan- cial Statements”) are prepared in accordance with Internatio- nal Financial Reporting Standards (IFRS), issued by the International Accounting Standards Board (IASB), and stated in Swiss francs (CHF), the currency of the country in which UBS AG is incorporated. On 2 March 2006, the Board of Directors 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 re- ported income, expenses, assets, liabilities and disclosure of contingent assets and liabilities. Use of available information and application of judgment are inherent in the formation of estimates. Actual results in the future could differ from such estimates, and the differences may be material to the Financial Statements. c) Consolidation The Financial Statements comprise those of the parent com- pany (UBS AG), its subsidiaries and certain special purpose en- tities, presented as a single economic entity. The effects of intra-group transactions are eliminated in preparing the Financial Statements. Subsidiaries and special purpose entities that are directly or indirectly controlled by the Group are con- solidated. Subsidiaries acquired are consolidated from the date control is transferred to the Group. Subsidiaries to be di- vested are consolidated up to the date of disposal. Assets held in an agency or ﬁduciary capacity are not as- sets 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. 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 80 UBS owns 20% or more of a company’s voting rights. Investments in associates are initially recorded at cost, and the carrying amount is increased or decreased to recognize the Group’s share of the investee’s proﬁts or losses after the date of acquisition. Assets and liabilities of subsidiaries and investments in as- sociates are classiﬁed as “held for sale” if UBS has entered into an agreement for their disposal within a period of 12 months. Major lines of business and subsidiaries that were acquired ex- clusively with the intent for resale are presented as discontin- ued operations in the income statement in the period where the sale occurred or it becomes clear that a sale will occur within 12 months. Discontinued operations are presented in the income statement as a single amount comprising the total of proﬁt after tax from operations and net gain or loss on sale. 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 de- ﬁned objectives. These companies may acquire assets directly or indirectly from UBS or its afﬁliates. Some of these compa- nies 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 re- lationship 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 transac- tions 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 re- wards of the transferred assets or a portion of them. If all or substantially all risks and rewards are retained, the trans- ferred 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 re- purchase transactions described under paragraphs f) and g) below. They further include transactions where assets are sold to a third party with a concurrent total rate of return swap on the transferred assets to retain all their risks and rewards. These types of transactions are accounted for as secured ﬁnancing transactions similar to repurchase agreements. In transactions where substantially all the risks and re- wards of ownership of a ﬁnancial asset are neither retained nor transferred, UBS derecognizes the asset if control over the asset is lost. The rights and obligations retained in the trans- fer are recognized separately as assets and liabilities as appro- priate. In transfers where control over the asset is retained, the Group continues to recognize the asset to the extent of its con- tinuing 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 in- vestors. Interests in the securitized ﬁnancial assets may be re- tained in the form of senior or subordinated tranches, inter- est-only strips or other residual interests (‘retained interests’). Retained interests are primarily recorded in Trading portfolio assets and carried at fair value. Gains or losses on securitiza- tion depend in part on the carrying amount of the transferred ﬁnancial assets, allocated between the ﬁnancial assets dere- cognized and the retained interests based on their relative fair values at the date of the transfer. Gains or losses on securiti- zation 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, predominantly with securities delivered or received as collateral. Transfer of the securities themselves, whether in a borrowing / lending transaction or as collateral, is not reﬂected on the balance sheet unless the risks and rewards of ownership are also transferred. In such transactions where UBS transfers owned securities and where the borrower is granted the right to sell or re-pledge them, the securities are reclassiﬁed on the bal- ance sheet to Trading portfolio assets pledged as collateral. Cash collateral received is recognized with a corresponding obligation to return it (Cash collateral on securities lent). Cash collateral delivered is derecognized with a corresponding re- ceivable reﬂecting UBS’s right to receive it back (Cash collat- eral on securities borrowed). Securities received in a lending or borrowing transaction are disclosed as off-balance sheet items if UBS has the right to resell or re-pledge them, with securities that UBS has actu- ally resold or re-pledged also disclosed separately. UBS monitors the market value of securities borrowed and lent on a daily basis and provides or requests additional col- lateral or recalls or returns surplus collateral in accordance with the underlying agreements. Fees and interest received or paid are recognized on an ac- crual basis and recorded as Interest income or Interest ex- pense. 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 delivered is derecognized and a corre- sponding receivable, including accrued interest, is recorded, recognizing UBS’s right to receive it back (Reverse repurchase agreements). In repurchase agreements, the cash received, in- cluding accrued interest, is recognized on the balance sheet with a corresponding obligation to return it (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 the risks and rewards of ownership are obtained or relin- quished. UBS monitors the market value of the securities received or delivered on a daily basis and provides or requests addi- tional collateral or recalls or returns surplus collateral in accor- dance with the underlying agreements. In repurchase agreements where UBS transfers owned se- curities and where the recipient is granted the right to resell or re-pledge them, the securities are reclassiﬁed in the balance sheet to Trading portfolio assets pledged as collateral. Securities received in a reverse repurchase agreement are dis- closed as off-balance sheet items if UBS has the right to resell or re-pledge them, with securities that UBS has actually resold or re-pledged also disclosed separately. Interest earned on reverse repurchase agreements and inter- est incurred on repurchase agreements is recognized as inter- est income or interest expense over the life of each agreement. The Group offsets reverse repurchase agreements and re- purchase 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. Global Wealth Management & Business Banking is segregated into three segments, Wealth Management International & Swit- zerland, Wealth Management US and Business Banking Swit- zerland. The Corporate Center also consists of two segments, Private Banks & GAM and Corporate Functions. Private Banks & GAM was sold on 2 December 2005 and are presented as a discontinued operation in these Financial Statements. The Industrial Holdings segment holds all industrial operations controlled by the Group. In total, UBS reports eight business segments. 81 Financial Statements Notes to the Financial Statements Segment income, segment expenses and segment per- formance include transfers between business segments and between geographical segments. Such transfers are con- ducted either at internally agreed transfer prices or, where possible, at arm’s length. i) Foreign currency translation Foreign currency transactions are recorded at the rate of ex- change on the date of the transaction. At the balance sheet date, monetary assets and liabilities denominated in foreign currencies are reported using the closing exchange rate. Exchange differences arising on the settlement of trans- actions at rates different from those at the date of the trans- action, as well as unrealized foreign exchange differences on unsettled foreign currency monetary assets and liabilities, are recognized in the income statement. Unrealized exchange differences on non-monetary ﬁnan- cial assets (investments in equity instruments) are a compo- nent of the change in their entire fair value. For a non-mon- etary ﬁnancial asset classiﬁed as held for trading, unrealized exchange differences are recognized in the income state- ment. For non-monetary ﬁnancial investments, which are classiﬁed as available-for-sale, unrealized exchange differ- ences are recorded directly in Equity until the asset is sold or becomes impaired. 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 the closing rate are recognized directly in Foreign currency translation within Equity. j) Cash and cash equivalents Cash and cash equivalents consist of Cash and balances with central banks, balances included in Due from banks with original maturity of less than three months and Money mar- ket paper included in Trading portfolio assets and Financial investments. k) Fee income UBS earns fee income from a diverse range of services it pro- vides to its customers. Fee income can be divided into two broad categories: income earned from services that are pro- vided over a certain period of time, for which customers are generally billed on an annual or semi-annual basis, and in- come earned from providing 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 recog- nized when the service has been completed. Performance linked fees or fee components are recognized when the per- formance 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 predomi- nantly earned from providing transaction-type services in- clude underwriting fees, corporate ﬁnance fees and broker- age 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 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 or in- terest rate and currency swaps. For these ﬁnancial instru- ments, inputs into models are market-observable. For more complex instruments, UBS uses internally devel- oped models, which are usually based on valuation methods and techniques generally recognized as standard within the industry. Some of the inputs to these models may not be mar- ket-observable and are therefore estimated based on assump- tions. When entering into a transaction where any model input is unobservable, the ﬁnancial instrument is initially rec- ognized at the transaction price, which is the best indicator of fair value. This may differ from the value obtained from the valuation model. The timing of the recognition in income of this initial difference in fair value depends on the individual facts and circumstances of each transaction but is never later than when the market data become observable. The output of a model is always an estimate or approxi- mation of a value that cannot be determined with certainty, and valuation techniques employed may not fully reﬂect all factors relevant to the positions UBS holds. Valuations are therefore adjusted, where appropriate, to allow for additional factors including model risks, liquidity risk and counterparty credit risk. Management believes that these valuation adjust- ments are necessary and appropriate to fairly state the values of ﬁnancial instruments 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 instruments, precious metals and commodities owned by the Group (‘long’ positions). Trading portfolio liabilities consist 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). 82 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. Interest and dividend income and expense on trading portfolio assets or liabilities are included in Interest and dividend income or Interest and dividend expense. 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 proﬁts and losses arising from revaluing that contract to fair value in the income statement. When the transaction is con- summated (settlement date), a resulting ﬁnancial asset or li- ability is recognized on the balance 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 designated almost all of its issued compound debt instruments as ﬁnancial liabilities held at fair value through proﬁt and loss. These liabilities are presented in a separate line on the face of the balance sheet. In addition, a small amount of ﬁnancial assets has been designated as ﬁnancial assets held at fair value through proﬁt and loss, and they are likewise pre- sented in a separate line. A ﬁnancial instrument may only be designated at inception as held at fair value through proﬁt and loss and cannot subsequently be changed. When adopt- ing revised IAS 39 on 1 January 2004, the Group designated approximately CHF 35.3 billion of existing issued compound debt instruments as held at fair value through proﬁt and loss in accordance with the revised standard’s transition guidance. All fair value changes related to ﬁnancial instruments held at fair value through proﬁt and loss are recognized in Net trad- ing income. o) Derivative instruments and hedging All derivative instruments are carried at fair value on the bal- ance sheet and are reported as Positive replacement values or Negative replacement values. Where the Group enters into derivatives for trading purposes, realized and unrealized gains and losses are recognized in Net trading income. The Group also uses derivative instruments as part of its asset and liability management activities to manage expo- sures to interest rate, foreign currency and credit risks, includ- ing exposures arising from forecast transactions. The Group applies either fair value or cash ﬂow hedge accounting when transactions meet the speciﬁed criteria to obtain hedge ac- counting 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), including the risk management objectives and strategy in undertaking the hedge transaction, together with the methods that will be used to assess the effectiveness of the hedging relationship. Accordingly, the Group assesses, both at the inception of the hedge and on an ongoing basis, whether the hedging deriv- atives 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 indicate, 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 that ac- tual results are within a range of 80% to 125%. In the case of hedging a forecast transaction, the transaction must have a high probability of occurring and must present an exposure to variations in cash ﬂows that could ultimately affect the re- ported Net proﬁt or loss. The Group discontinues hedge ac- counting when it determines that a derivative 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 transac- tion 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 cur- rent period earnings in Net trading income, as are gains and losses on components of a hedging derivative that are ex- cluded 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 that are attrib- utable 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. The fair value change of the hedged item in a portfolio hedge of in- terest rate risks is reported separately from the hedged port- folio in Other assets or Other liabilities as appropriate. 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 and loss over the remaining term of the original hedge, while for non-interest bearing instruments that amount is immediately recognized in earnings. If the hedged item is derecognized, e.g. due to sale or repayment, the unamortized fair value ad- justment 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- 83 Financial Statements Notes to the Financial Statements nized initially in Equity attributable to UBS shareholders. When the cash ﬂows that the derivative is hedging material- ize, resulting in income or expense, then the associated gain or loss on the hedging derivative is simultaneously transferred from Equity attributable to UBS shareholders to the corre- sponding income or expense line item. If a cash ﬂow hedge for a forecast transaction is deemed to be no longer effective, or if the hedge relationship is ter- minated, the cumulative gain or loss on the hedging deriva- tive previously reported in Equity attributable to UBS share- holders remains there until the committed or forecast trans- action occurs or is no longer probable of occurring, at which point it is transferred 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 cannot apply hedge account- ing. In the event that the Group recognizes an impairment 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 22 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 in- struments. If the host contract is not carried at fair value with changes in fair value reported in Net proﬁt and loss, the em- bedded derivative is separated from the host contract and ac- counted for as a stand-alone derivative instrument at fair value if the economic characteristics and risks of the embedded de- rivative are not closely related to the economic characteristics and risks of the host contract and the embedded derivative ac- tually 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 that are intended to be sold in the short term are recorded as Trading portfolio assets. 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, plus 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 di- rect costs relating to loan origination, reﬁnancing 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 that 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 or provision for credit losses is established if there is objective evidence that the Group will be unable to collect all amounts due on a claim according to the original contractual terms or the equivalent value. A ‘claim’ means a loan carried at amortized cost, a commitment such as a let- ter of credit, a guarantee, a commitment 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 on 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 fu- ture cash ﬂows, that may result from restructuring or liquida- tion. 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 in- crease of the present value of impaired claims due to the pas- sage 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 with the prior es- timates result in a change in the allowance for credit losses and are charged or credited to Credit loss expense. An allowance for impairment is reversed only when the credit quality has improved to such an extent that there is rea- sonable assurance of timely collection of principal and inter- est in accordance with the original contractual terms of the claim agreement. 84 A write-off is made when all or part of a claim is deemed uncollectible or forgiven. Write-offs are charged against pre- viously 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 writ- ten 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 portfolios with similar credit risk characteristics to collectively assess whether impairment exists within a portfolio. Allowances from collective assessment of impairment are recognized as Credit loss expense and result in an offset to the loan posi- tion. 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 or obligors in a country are affected by a systemic cri- sis, transfer restrictions or non-enforceability, country al- lowances and provisions for probable losses are established. They are based on country-speciﬁc scenarios, taking into con- sideration the nature of the individual exposures but exclud- ing those amounts covered by counterparty-speciﬁc al- lowances and provisions. Such country allowances and pro- visions are part of the collectively assessed loan loss al- lowances and provisions. r) Financial investments Financial investments are classiﬁed as available-for-sale and recorded on a settlement date basis. Available-for-sale ﬁnan- cial investments are instruments that, in management’s opin- ion, may be sold in response to or in anticipation of needs for liquidity or changes in interest rates, foreign exchange rates or equity prices. Financial investments consist of money mar- ket paper, other debt instruments and equity instruments, in- cluding certain 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 Equity attributable to UBS sharehold- ers, net of applicable income taxes, until such investments are sold, collected or otherwise disposed of, or until such invest- ment is determined to be impaired. On disposal of an avail- able-for-sale investment, the accumulated unrealized gain or loss included in Equity attributable to UBS shareholders is transferred to Net proﬁt and loss for the period and reported in Other income. Gains and losses on disposal are determined using the average cost method. Interest and dividend income on available-for-sale ﬁnancial investments is included in Interest and dividend income from ﬁnancial investments. If an available-for-sale investment is determined to be im- paired, the cumulative unrealized loss previously recognized in Equity attributable to UBS shareholders is included in Net proﬁt and loss for the period and reported in Other income. A ﬁnan- cial investment is considered impaired if its cost exceeds the recoverable amount. For non-quoted equity investments, the recoverable amount is determined by applying recognized val- uation techniques. The standard method applied is based on the multiple of earnings observed in the market for compa- rable companies. Management may adjust valuations deter- mined in this way based on its judgment. For quoted ﬁnancial investments, the recoverable amount is determined by refer- ence to the market price. They are considered impaired if ob- jective evidence indicates that the decline in market price has reached such a level that recovery of the cost value, adjusted for impairments recognized in prior periods as applicable, can- not be reasonably expected within the foreseeable future. s) Property and equipment Property and equipment includes own-used properties, in- vestment 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 rental income 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 rental income or for capital appreciation, the classiﬁcation is based on whether or not these portions can be sold separately. 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 classiﬁed 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 required, is capitalized as part of the total leasehold improvements costs. At the same time, a corresponding li- ability is recognized to reﬂect the obligation incurred. Rein- statement costs are recognized in proﬁt and loss through de- preciation of the capitalized 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 cost can be measured reliably. Internally developed soft- ware meeting these criteria and purchased software is classi- ﬁed within IT, software and communication. 85 Financial Statements Notes to the Financial Statements Plant and manufacturing equipment include primarily thermal and hydroelectric power plants and power transmis- sion grids and equipment. The useful life is estimated based on the economic 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 under an operating lease and equipment the Group has decided to sell are classiﬁed as assets held for sale and recorded in Other assets. Upon classiﬁcation as held for sale, they are no longer depreciated and are carried at the lower of book value or fair value less costs to sell. Foreclosed property is deﬁned as Properties held for resale and recorded in Other assets. They are carried at the lower of cost and 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. Goodwill is not amortized but tested annually for impairment. Until 31 December 2004, goodwill acquired in business combina- tions entered into prior to 31 March 2004 was amortized over its estimated useful economic life, not exceeding 20 years, using the straight-line method. The impairment test is con- ducted at the segment level as reported in Note 2a. The segment has been determined as the cash generating unit for impair- ment testing purposes as this is the level at which the perform- ance of investments is reviewed and assessed by management. Other intangible assets comprise separately identiﬁable in- tangible items arising from acquisitions and certain purchased trademarks and similar items. Other intangible assets are rec- ognized on the balance sheet at cost determined at the date of acquisition and are amortized using the straight-line method over their estimated useful economic life, generally not exceeding 20 years. At each balance sheet date, other in- tangible assets are reviewed for indications of impairment or changes in estimated future beneﬁts. If such indications exist, the intangible assets are analyzed to assess whether their car- rying amount is fully recoverable. A write-down is made if the carrying amount exceeds the recoverable amount. Intangible assets are classiﬁed into two categories: Infrastructure, and Customer relationships, contractual rights and other. Infrastructure includes one intangible asset recog- nized in connection with the acquisition of PaineWebber Group, Inc. Customer relationships, contractual rights and other include customer relationship intangibles from the ac- quisition of ﬁnancial services businesses as well as from the ac- quisition of Motor-Columbus, where other contractual rights from delivery and supply contracts were identiﬁed. These con- tractual rights are amortized over the remaining contract terms, which are up to 24 years at 31 December 2005. The most signiﬁcant contract, however, is amortized over its re- maining contract life of six years at 31 December 2005, which is the shortest useful 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 pe- riod 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 pur- poses, which will result in taxable amounts in future periods. Deferred tax assets are recognized for temporary differences that will result in deductible amounts in future periods, but only to the extent it is probable that sufﬁcient taxable proﬁts will be available against which these 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, relate to the same tax authority, the legal right to offset exists, and they are intended to be settled net or realized simultaneously. 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 des- ignated as cash ﬂow hedges, which are recorded net of taxes in Net gains or losses not recognized in the income statement within Equity attributable to UBS shareholders. 86 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 re- demption value over the life of the debt. Compound debt instruments that are related to non- UBS AG equity instruments, foreign exchange, credit instru- ments or indices are considered structured instruments. If such instruments 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 stand-alone de- rivative if the criteria for separation are met. The host contract is subsequently measured at amortized cost. UBS has desig- nated most of its structured debt instruments as held at fair value through proﬁt and loss, see section n). Debt instruments with embedded derivatives that are related to UBS AG shares or to a derivative instrument that has UBS AG shares as its underlying are separated into a lia- bility 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 component based on its fair value. The determi- nation of fair value is generally based on quoted market prices for UBS debt instruments with comparable terms. The liability component is subsequently measured at amortized cost. The remaining amount is allocated to the equity com- ponent and reported in Share premium. Subsequent changes in fair value of the separated equity component are not rec- ognized. However, if the compound instrument or the em- bedded derivative related to UBS AG shares is cash settled or if it contains a settlement alternative, then the separated derivative is accounted for as a trading instrument, with changes in fair value recorded in income or the entire com- pound 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 29), and to apply fair value hedge accounting. When hedge accounting is applied to ﬁxed-rate debt instruments, the carrying values of debt is- sues 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 dis- cussion. Own bonds held as a result of market making activities or deliberate purchases in the market are treated as a re- demption of debt. A gain or loss on redemption is recorded depending on whether the repurchase price of the bond was lower or higher than its carrying value. A subsequent sale of own bonds in the market is treated as a reissuance of debt. Interest expense on debt instruments is included in Interest on debt issued. w) Treasury shares and contracts on UBS shares UBS AG shares held by the Group are classiﬁed in Equity attributable to UBS shareholders 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 Equity attributable to UBS share- holders and reported as Share premium. 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 are physically settled written put options and forward share purchase contracts, including contracts where physical settlement is a settle- ment alternative. In both cases, the present value of the obligation to purchase own shares in exchange for cash is transferred out of Equity attributable to UBS shareholders 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 equity originally transferred to liability is re- classiﬁed within Equity attributable to UBS shareholders 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 serv- ice cost. The principal actuarial assumptions used by the actuary are set out in Note 30. 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 re- porting period are outside the corridor deﬁned as 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. 87 Financial Statements Notes to the Financial Statements The unrecognized actuarial gains and losses exceeding the greater of these two values are recognized in the income statement 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 present value of the deﬁned beneﬁt obligation cannot be re- covered fully through refunds or reductions in future contri- butions, no gain is recognized solely as a result of deferral of an actuarial loss or past service cost in the current period, and no loss is recognized solely as a result of deferral of an actu- arial 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 recognizes the fair value of stock and stock option awards determined at the date of grant as compensation expense over the required service period, which generally is equal to the vesting period. The fair value of stock awards is equal to the market price at the date of grant. For stock options, fair value is determined using a proprietary option valuation model that reﬂects em- ployees’ exercise behavior and the speciﬁc terms and condi- tions under which the options are granted. Equity-settled awards are classiﬁed as equity instruments and are not re- measured subsequent to the grant date, unless an award is modiﬁed such that its fair value immediately after modiﬁca- tion exceeds its fair value immediately prior to modiﬁcation. Any increase in fair value resulting from a modiﬁcation is rec- ognized as compensation expense, either over the remaining service period or immediately for vested awards. Cash settled awards are classiﬁed as liabilities and re-measured to fair value at each balance sheet date as long as they are out- standing. Decreases in fair value reduce compensation expense, and no compensation expense, on a cumulative basis, is recog- nized for awards that expire worthless or remain unexercised. Plans where participants have the option to roll stock-based awards into alternative investments are treated as cash settled. z) Earnings per share (EPS) Basic earnings per share are calculated by dividing the Net proﬁt and loss for the period attributable to ordinary share- holders by the weighted average number of ordinary shares outstanding during the period. Diluted earnings per share are calculated 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 Private equity investments On 1 January 2005, UBS adopted revised IAS 27 Consolidated and Separate Financial Statements and revised IAS 28 Investments in Associates. IAS 27 was amended to eliminate the exemption from consolidating a subsidiary where control is exercised tem- porarily. UBS has several private equity investments where it owns a controlling interest that used to be classiﬁed and ac- counted for as Financial investments available-for-sale. UBS adopted IAS 27 on1 January 2005 retrospectively and restated comparative prior years 2004 and 2003. The effect of the adoption and consolidating these investments was as follows: at 1 January 2003, equity including minority interests was re- duced by CHF 723 million, representing the difference be- tween the carrying value as Financial investments available- for-sale and the book value on a consolidated basis. Consoli- dation led to recognition of total assets in the amount of CHF 1.7 billion and CHF 2.9 billion at 31 December 2004 and 2003 respectively. Signiﬁcant balance sheets line items affected in- clude Property and equipment, Intangible assets, Goodwill and Other assets. These investments generated additional op- erating income of CHF 2.5 billion and CHF 2.7 billion in 2004 and 2003 respectively and additional Net proﬁt attributable to UBS shareholders of CHF 142 million and CHF 74 million in 2004 and 2003 respectively. IAS 28 was likewise amended to eliminate the exemption from equity method accounting for investments that are held exclusively for disposal. Private equity investments where UBS has signiﬁcant inﬂuence are now accounted for using the eq- uity method whereas they were previously classiﬁed as Financial investments available-for-sale. The adoption was made retrospectively from 1 January 2003 and prior periods were restated. Application of the equity method of account- ing for these investments had the following effects: on 1 January 2003, opening equity was debited by CHF 266 mil- lion, representing the difference between the carrying value as Financial investments available-for-sale and the book value on an equity method basis. The carrying value of these equity method investments was CHF 248 million and CHF 393 mil- lion at 31 December 2004 and 2003 respectively, which in- cludes 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 were CHF 1 million and zero respectively. When accounted for as Financial investments available-for-sale, gains on sale recog- nized were CHF 70 million in 2004 and CHF 34 million in 2003. These entities, along with all other investments made by the private equity business unit, were reclassiﬁed from the Investment Bank segment to the Industrial Holdings segment effective 1 January 2005. In addition, nine of the newly con- solidated investments held at 1 January 2003 were sold after that date and are 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 were reported in 2004 and 2003 in connection with private equity investments sold after 1 January 2003. On a restated basis, the Net proﬁt from 88 discontinued operations related to these entities was CHF 145 million and CHF 186 million in 2004 and 2003 respectively. IFRS 2 Share-based Payment In February 2004, the IASB issued IFRS 2 Share-based Pay- ment, which requires share-based payments made to em- ployees and non-employees to be recognized in the ﬁnan- cial statements based on the fair value of these awards meas- ured at the date of grant. UBS adopted the new standard on 1 January 2005 and fully restated the two comparative prior years. In accordance with IFRS 2, UBS applied the new require- ments of the standard to all prior period awards that affect income statements commencing 1 January 2003. This in- cludes all unvested equity settled awards and all outstanding cash settled awards on 1 January 2003. The effects of restate- ment were as follows: the opening balance of retained earn- ings at 1 January 2003 was credited by CHF 559 million. Additional compensation expense of zero and CHF 558 mil- lion was recognized in 2004 and 2003 respectively. The change in compensation expense is attributable to the ﬁrst- time recognition of compensation expense for the fair value of share options, as well as the recognition of expense for share awards over the vesting period. Previously, share awards were recognized as compensation expense in the perform- ance year, which is generally the year prior to grant. The rea- son for the zero impact in 2004 was that a signiﬁcantly higher amount of bonus payments were made in the form of share awards rather than cash. The reversal of compensation ex- pense attributable to these share payments offsets the effect from recognizing options at fair value and share awards made prior to 2004 over the vesting period. UBS introduced 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 were not affected by this change in valuation model. As part of the implementation of IFRS 2, UBS thoroughly reviewed the option valuation model employed in the past by comparing it with alternative mod- els. As a result 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. Concurrent with the introduction of the new model, UBS is using implied and historical volatility as inputs. UBS also has employee beneﬁt trusts that are used in connection with share-based payment arrangements and deferred compensation schemes. In connection with the is- suance of IFRS 2, the IFRIC amended SIC 12 Consolidation – Special Purpose Entities, an interpretation of IAS 27, to elim- inate the scope exclusion for equity compensation plans. Therefore, pursuant to the criteria set out in SIC 12, an entity that controls an employee beneﬁt trust (or similar entity) set up for the purpose of a share-based payment arrangement is required to consolidate that trust. Consolidating these trusts had the following effects: on 1 January 2003, no adjustment to opening retained earnings was made as assets and liabili- ties of the trusts were equal. Consolidation led 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 increased by CHF 2,029 million and CHF 1,474 million at 31 December 2004 and 2003 respectively. 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 denominator used to calculate basic earnings per share. The reduction in weighted average shares out- standing increased basic earnings per share, but had no im- pact on diluted earnings per share as the additional treasury shares will be fully added back for calculating diluted earn- ings per share. Goodwill and Intangible Assets On 31 March 2004, the IASB issued IFRS 3 Business Combi- nations, revised IAS 36 Impairment of Assets and revised IAS 38 Intangible Assets. UBS prospectively adopted the stan- dards for goodwill and intangible assets existing at 31 March 2004 on 1 January 2005, whereas goodwill and intangible as- sets recognized from business combinations entered into after 31 March 2004 were accounted for immediately in ac- cordance with IFRS 3. Goodwill is no longer amortized, but instead reviewed annually for impairment. UBS recorded goodwill amortization expense of CHF 722 million in 2004 and CHF 784 million in 2003. Intangible assets acquired in a business combination must be recognized separately from goodwill if they meet deﬁned recognition criteria. Existing intangible assets that do not meet the recognition criteria under the new standards have to be reclassiﬁed to goodwill. On 1 January 2005, UBS reclas- siﬁed the trained workforce intangible asset recognized in connection with the acquisition of PaineWebber with a book value of CHF 1.0 billion to goodwill. Insurance Contracts On 31 March 2004, the IASB issued IFRS 4 Insurance Con- tracts. The standard applies to all insurance contracts written and to reinsurance contracts held. The majority of insurance products issued by UBS is considered to be investment con- tracts and is accounted for as ﬁnancial liabilities and not as insurance contracts under IFRS 4. The related assets of CHF 19 billion were reclassiﬁed from Other assets to Trading port- folio assets in 2004. UBS adopted the new standard as of 1 January 2005 and applies it to its insurance contracts. The new standard did not have a material effect on the Financial Statements. 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 89 Financial Statements Notes to the Financial Statements as held for sale if their carrying amount is recovered princi- pally through a sale transaction rather than through contin- uing use. Such assets are measured at the lower of carrying amount and fair value less costs to sell and are classiﬁed sep- arately from other assets in the balance sheet. Netting of as- sets and liabilities is not permitted. Discontinued operations are presented on the face of the income statement as a sin- gle amount comprising the total of the Net proﬁt and loss from discontinued operations and the gain or loss after tax recognized on the sale or the measurement to fair value less costs to sell of the net assets constituting the discontinued op- erations. In the period where an operation is presented for the ﬁrst time as discontinued, the income statements for all com- parative prior periods presented are restated to present that operation as discontinued. IFRS 5 provides certain criteria to be met for a component of an entity to be deﬁned as a discontinued operation. Certain private equity investments meet this deﬁnition and will be re- classiﬁed to Discontinued operations. UBS adopted the new standard on 1 January 2005 and restated comparative prior years 2004 and 2003. The income statement is now divided into two sections: Net proﬁt from continuing operations and Net proﬁt from discontinued operations. Presentation of minority interests and earnings per share With the adoption of revised IAS 1 Presentation of Financial Statements on 1 January 2005, Net proﬁt and Equity are pre- sented including minority interests. Net proﬁt is split into Net proﬁt attributable to UBS shareholders and Net proﬁt attrib- utable to minority interests. Earnings per share continue to be calculated based on Net proﬁt attributable to UBS sharehold- ers, but they are split into Earnings per share from continuing operations and from discontinued operations. Minority inter- ests and Earnings per share are presented on the face of the income statement. Financial Instruments On 1 January 2004, UBS adopted revised IAS 32 Financial Instruments: Disclosure and Presentation and revised IAS 39 Financial Instruments: Recognition and Measurement, which were applied retrospectively to all ﬁnancial instruments af- fected by the two standards, except the guidance relating to derecognition of ﬁnancial assets and liabilities and, in part, recognition of Day 1 proﬁt and loss, which were applied prospectively. As a result of adopting the revised standards, UBS restated prior period comparative information. Revised IAS 32 amended the accounting for certain deriv- ative contracts linked to an entity’s own shares. Physically set- tled written put options and forward purchase contracts with UBS shares as their underlying are recorded as liabilities, see section w). UBS currently has physically settled written put op- tions linked to own shares. The present value of the contrac- tual amount of these options is recorded as a liability, while the premium received is credited to Equity. Liabilities of CHF 96 million at 31 December 2004 and CHF 49 million at 31 December 2003 were debited to Equity attributable to UBS shareholders due to written options. The impact on the in- come statement of all periods presented is insigniﬁcant. All other existing derivative contracts linked to own shares are ac- counted for as derivative instruments and are carried at fair value on the balance sheet under Positive replacement values or Negative replacement values. Revised IAS 39 permits any ﬁnancial instrument to be des- ignated at inception, or at adoption of revised IAS 39, as car- ried at fair value through proﬁt and loss. Upon adoption of revised IAS 39, UBS made that designation for the majority of its compound instruments issued. Previously, UBS separated the embedded derivative from the host contract and ac- counted for the separated derivative as a trading instrument. The amounts are now included on the balance sheet within the line item Financial liabilities designated at fair value, with amounts of CHF 117,401 million and CHF 65,756 million at 31 December 2005 and 2004 being reported in that line. Also, at 31 December 2005 and 2004 assets in the amount of CHF 1,153 million and CHF 653 million are reported in the line Financial assets designated 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 from 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. Investment properties Effective 1 January 2004, UBS changed its accounting policy for investment property from historical cost less accumulated depreciation to the fair value model. All changes in the fair value of investment property are now recognized in the in- come statement, and depreciation expense is no longer recorded. Investment property is deﬁned as property held ex- clusively to earn rental income and / or beneﬁt from appreci- ation in value. Fair value of investment property is deter- mined by appropriate valuation techniques employed in the real estate industry, taking into account the speciﬁc circum- stances for each item. Comparative prior periods were re- stated and resulted in a reduction of Net proﬁt by CHF 64 mil- lion in 2003. Credit losses incurred on OTC derivatives Effective 1 January 2004, the method of accounting for credit losses incurred on over-the-counter (OTC) derivatives was 90 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. It did, however, affect segment reporting, since losses reported 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 income are not subject to such a deferral. In the seg- ment report, therefore, losses on OTC derivatives are now re- ported as they are incurred. The changed method of account- ing had the following impact on the performance before tax of the Business Groups: in 2003, it reduced Business Banking’s pre-tax performance by CHF 8 million, it raised the Investment Bank’s by CHF 37 million and it caused Corporate Functions’ result to fall by CHF 29 million. Segment reporting On July 1 2005, UBS integrated its two wealth management businesses into one Business Group, Global Wealth Manage- ment & Business Banking. As part of the integration, the mu- nicipal securities unit within the former Wealth Management US was transferred into the Investment Bank. The integration had no effect on the presentation of segments in Note 2a, and Wealth Management US continues to be reported as a sepa- rate segment. The comparative prior period information for the Wealth Management US and Investment Bank segments has been restated to reﬂect the transfer of the municipal se- curities unit. In the past two years, the municipal securities unit contributed between 7% and 9% to Wealth Management US revenues and a substantial portion to performance before tax. On 1 July 2004, UBS purchased an additional 20% inter- est in Motor-Columbus AG, increasing its overall ownership stake to 55.6%. Motor-Columbus has been consolidated since 1 July 2004, when UBS gained control over the com- pany. Due to its size and the nature of its business (produc- tion, distribution and trading of electricity) a new business segment, Industrial Holdings, was added in which Motor- Columbus is reported. Also included in that segment are also all private equity investments, which comprise businesses of a predominantly industrial nature. 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 the Corporate Center. At the same time, GAM was transferred out of Global Asset Management into the Corporate Center. The two businesses formed the Private Banks & GAM segment, whereas the remainder of the Cor- porate Center is reported as the Corporate Functions segment. On 2 December 2005, PB & GAM was sold to Julius Baer. Note 2 to these Group Financial Statements reﬂects the new segment reporting structure. In all applicable instances, prior period 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 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 31 March 2004. Intangible assets may be assigned an indeﬁnite useful life if supportable based on facts and circumstances. These intan- gibles are not amortized but tested periodically for impair- ment. In a step acquisition, where control over a subsidiary is achieved in stages, all assets and liabilities of that entity, ex- cluding goodwill, are re-measured to fair value as of the ac- quisition date of the latest share transaction. The revaluation difference on the existing ownership interest from the carry- ing value to the newly established fair value is recorded di- rectly in Equity attributable to UBS shareholders. As a conse- quence of re-measuring all assets and liabilities to fair value, minority interests are also carried at fair value of net assets ex- cluding goodwill. Previously, only the percentage of assets and liabilities was increased to fair value by which the own- ership interest was increased. Existing ownership interests were kept at their carryover basis. Other relevant changes in accounting for business combinations are that liabilities in- curred for restructuring and integration of newly acquired businesses must be expensed as incurred, unless they were a pre-acquisition contingency of the acquired business. Previously, liabilities incurred for restructuring and integration could be recognized in purchase accounting if they met cer- tain criteria, increasing goodwill recognized. Contingent lia- bilities of an acquired business have to be recognized on the balance sheet at their fair value in purchase accounting if fair value is determinable. Previously, contingent liabilities were not recognized. ab) International Financial Reporting Standards to be adopted in 2006 and later IAS 39 Amendment to the fair value option In June 2005, The IASB issued amendments to IAS 39 Finan- cial Instruments: Recognition and Measurement in relation to the fair value option. UBS will adopt the revised fair value option for ﬁnancial instruments on a prospective basis at 1 January 2006. In the past, UBS applied the fair value option predominantly to hybrid debt instruments issued, and will continue to make use of the fair value option for this class of ﬁnancial instruments. It is planned to apply the fair value op- tion also to certain new loans and loan commitments within the Investment Bank’s Credit Exposure Management business 91 starting in second quarter 2006. These loans and loan com- mitments will be hedged with credit derivatives and desig- nated, at inception, as at fair value through proﬁt and loss to achieve offset of the accounting mismatch with the credit de- rivatives that currently exist. UBS will not apply the fair value option to positions in the existing loan portfolio. IFRS 7 Financial Instruments: Disclosures In August 2005, the IASB issued IFRS 7. The new standard is a pure disclosure standard and does not change the recogni- tion and measurement of ﬁnancial instruments. Accordingly, it will have no effect on Net proﬁt and Equity attributable to UBS shareholders. The new standard requires entities to make enhanced quantitative and qualitative risk disclosures for all major categories of ﬁnancial instruments in their ﬁnancial statements. UBS will adopt the new standard on 1 January 2007. Amendments to existing standards Minor amendments have been made to three existing International Accounting Standards, which will be effective and adopted by UBS at 1 January 2006. IAS 19 Employee Beneﬁts has been amended to allow a choice of whether to recognize actuarial gains and losses in a deﬁned post-retirement beneﬁt plan immediately in equity or to apply the corridor approach. UBS decided to continue to apply the corridor approach as described in section x) above. Other amendments made to IAS 19 have no impact on UBS. IAS 39 Financial Instruments: Measurement and Recogni- tion and IFRS 4 Insurance Contracts have been amended in re- lation to ﬁnancial guarantee contracts to clarify when a ﬁnan- cial guarantee is within the scope of IAS 39 and when it is considered an insurance contract within the scope of IFRS 4. This amendment will not have a signiﬁcant impact on UBS’s Financial Statements. IAS 21 The Effects of Changes in Foreign Exchange Rates has been amended to require that exchange differences aris- ing in consolidation on loan ﬁnancings that form part of a net investment in a foreign operation and are denominated in an- other currency than the functional currencies of both the re- porting entity and the foreign operation, are reclassiﬁed to equity in the consolidated ﬁnancial statements of the report- ing entity. This amendment has no signiﬁcant impact on UBS’s Financial Statements. IFRIC 4 Leases: Determining Whether an Arrangement Contains a Lease IFRIC 4 was issued in December 2004 and provides guidance on (a) how to determine whether an arrangement is, or con- tains, a lease as deﬁned in IAS 17; (b) when the assessment or a reassessment of whether an arrangement is, or contains, a lease should be made; and (c) if an arrangement is, or con- tains, a lease, how the payments for the lease should be sep- arated from payments for any other elements in the arrange- ment. If an arrangement contains a lease element, the inter- pretation requires that the payments for the lease element are accounted for in accordance with IAS 17 Leases. UBS will adopt the interpretation at 1 January 2006, its effective date. The interpretation will not have a signiﬁcant effect on UBS’s Financial Statements . IFRIC 5 Provisions: Rights to Interests Arising from Decommissioning, Restoration and Environmental Rehabilitation Funds IFRIC 5 was issued in December 2004 and provides guid- ance on the accounting for contributions into a decommis- sioning fund and rights to receive reimbursements from the fund. The interpretation is effective from 1 January 2006 and will be adopted by UBS’s subsidiary Motor-Columbus. It is not expected to have a signiﬁcant impact on UBS’s Financial Statements. 92 Note 2a Segment Reporting by Business Group UBS’s ﬁnancial businesses are organized on a worldwide basis into three Business Groups and the Corporate Center. Global Wealth Management & Business Banking consists of three segments, Wealth Management International & Switzerland, Wealth Management US and Business Banking Switzerland. The Corporate Center consists of two segments, Corporate Functions and Private Banks & GAM, which was sold on 2 December 2005. The Industrial Holdings segment holds all industrial operations controlled by the Group. In total, UBS re- ports eight business segments. Global Wealth Management & Business Banking Global Wealth Management & Business Banking comprises three segments. Wealth Management International & Swit- zerland offers a comprehensive range of products and serv- ices individually tailored to afﬂuent international and Swiss clients, operating from ofﬁces around the world. Wealth Management US is a US ﬁnancial services ﬁrm providing so- phisticated wealth management services to afﬂuent US clients through a highly trained ﬁnancial advisor network. Business Banking Switzerland provides individual and corporate clients in Switzerland with a complete portfolio of banking and se- curities services, focused on customer service excellence, prof- itability and growth, by using a multi-channel distribution. The segments share technological and physical infrastruc- ture, and have joint departments supporting major functions such as e-commerce, ﬁnancial planning and wealth manage- ment, investment policy and strategy. Global Asset Management Global Asset Management provides investment products and services to institutional investors and wholesale interme- diaries around the globe. Clients include corporate and pub- lic pension plans, ﬁnancial institutions and advisors, central banks as well as charities, foundations and individual in- vestors. Investment Bank The Investment Bank operates globally as a client-driven in- vestment banking and securities ﬁrm providing innovative products, research, advice and complete access to the world’s capital markets for intermediaries, governments, corporate and institutional clients and other parts of UBS. Corporate Center Corporate Center comprises two segments. Corporate Functions ensures that the Business Groups operate as a co- herent and effective whole with a common set of values and principles in such areas as risk management and control, ﬁ- nancial reporting, marketing and communications, funding, capital and balance sheet management, management of for- eign exchange earnings and information technology infra- structure. Private Banks & GAM, the second segment, was sold on 2 December 2005. Industrial Holdings The Industrial Holdings segment includes the non-ﬁnancial businesses of UBS. The most signiﬁcant business in this seg- ment is Motor-Columbus, a ﬁnancial holding company whose only signiﬁcant asset is a 59.3% interest in the Atel Group. Atel is a European energy provider focused on domestic and international power generation, electricity transmission, en- ergy services as well as electricity trading and marketing. The private equity business investing UBS and third-party funds, primarily in unlisted companies, is reported in Industrial Holdings. 93 Financial Statements Notes to the Financial Statements Note 2a Reporting by Business Group (continued) For the year ended 31 December 2005 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 internally agreed transfer prices or 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 expected credit loss on its portfolio plus the difference between credit loss expense and ex- pected 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. 94 CHF million Income 1 Credit loss (expense) / recovery Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation of property and equipment Amortization of other intangible assets 2 Goods and materials purchased Total operating expenses Business Group performance from continuing operations before tax Business Group performance from discontinued operations before tax Business Group performance before tax Tax expense on continuing operations Tax expense on discontinued operations Net proﬁt Additional information 3 Total assets Total liabilities Capital expenditure Income 1 Adjusted expected credit loss Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation of property and equipment Amortization of other intangible assets 2 Goods and materials purchased Total operating expenses Business Group performance from continuing operations before tax Business Group performance from discontinued operations before tax Business Group performance before tax Tax expense on continuing operations Tax expense on discontinued operations Net proﬁt Global Wealth Management & Business Banking Global Asset Management Investment Bank Financial Businesses Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Corporate Center Private Banks & GAM Corporate Functions Industrial Holdings UBS 9,024 (8 ) 9,016 2,579 804 1,371 89 7 4,850 4,166 5,158 0 5,158 3,460 1,047 223 65 49 4,844 314 4,949 231 5,180 2,450 994 (634 ) 72 0 2,882 2,298 2,487 0 2,487 988 304 116 21 1 1,430 1,057 17,448 152 17,600 9,259 2,215 640 136 53 12,303 5,297 4,166 314 2,298 1,057 5,297 4,556 4,556 455 0 455 1,167 1,084 (1,730 ) 857 17 1,395 (940) 8 (932) 223,719 219,069 81 64,896 59,567 84 176,713 170,544 58 40,782 39,191 16 1,768,391 1,750,762 138 (225,800 ) (242,640 ) 1,264 25 9,024 (13 ) 9,011 2,579 804 1,371 89 7 4,850 4,161 5,158 (2 ) 5,156 3,460 1,047 223 65 49 4,844 312 4,949 122 5,071 2,450 994 (634 ) 72 0 2,882 2,189 2,487 0 2,487 988 304 116 21 1 1,430 1,057 17,448 36 17,484 9,259 2,215 640 136 53 12,303 5,181 4,161 312 2,189 1,057 5,181 4,508 4,508 455 232 687 1,167 1,084 (1,730 ) 857 17 1,395 (708) 56 (652) 11,079 0 11,079 1,146 599 14 253 207 8,003 10,222 857 124 981 11,549 11,814 299 11,079 0 11,079 1,146 599 14 253 207 8,003 10,222 857 124 981 50,600 375 50,975 21,049 7,047 0 1,493 334 8,003 37,926 13,049 4,688 17,737 2,549 498 14,690 2,060,250 2,008,307 1,965 50,600 375 50,975 21,049 7,047 0 1,493 334 8,003 37,926 13,049 4,688 17,737 2,549 498 14,690 1 Impairments of ﬁnancial investments for the year ended 31 December 2005 were as follows: Global Wealth Management & Business Banking CHF10 million; Global Asset Management CHF 0 million; Investment Bank CHF 0 million; Corporate Center CHF 16 million and Industrial Holdings CHF 81 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. 95 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 internally agreed transfer prices or 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 expected credit loss on its portfolio plus the difference between credit loss expense and ex- pected 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. 96 CHF million Income 2 Credit loss (expense) / recovery Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation of property and equipment Amortization of goodwill 3 Amortization of other intangible assets 3 Goods and materials purchased Total operating expenses Business Group performance from continuing operations before tax Business Group performance from discontinued operations before tax Business Group performance before tax Tax expense on continuing operations Tax expense on discontinued operations Net proﬁt Additional information 4 Total assets Total liabilities Capital expenditure Income 2 Adjusted expected credit loss Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation of property and equipment Amortization of goodwill 3 Amortization of other intangible assets 3 Goods and materials purchased Total operating expenses Business Group performance from continuing operations before tax Business Group performance from discontinued operations before tax Business Group performance before tax Tax expense on continuing operations Tax expense on discontinued operations Net proﬁt Global Wealth Management & Business Banking Global Asset Management Investment Bank Financial Businesses Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Corporate Center Private Banks & GAM Corporate Functions Industrial 1 Holdings UBS 7,701 (1 ) 7,700 2,119 642 1,395 66 67 8 4,297 3,403 3,403 4,741 3 4,744 3,320 767 275 67 171 107 4,707 37 37 5,064 92 5,156 2,426 1,064 (533 ) 69 0 0 3,026 2,130 2,022 0 2,022 893 299 126 23 129 0 1,470 552 16,090 147 16,237 8,152 2,538 226 243 278 36 11,473 4,764 2,130 552 4,764 386 386 112 0 112 796 1,077 (1,509 ) 794 1 17 1,176 (1,064) 10 (1,054) 164,716 161,042 304 48,026 43,847 48 210,133 204,479 212 29,698 28,311 8 1,477,275 1,463,469 415 8,043 7,480 19 (210,167 ) (220,843 ) 599 7,701 (8 ) 7,693 2,119 642 1,395 66 67 8 4,297 3,396 3,396 4,741 (5 ) 4,736 3,320 767 275 67 171 107 4,707 29 29 5,064 (25 ) 5,039 2,426 1,064 (533 ) 69 0 0 3,026 2,013 2,022 0 2,022 893 299 126 23 129 0 1,470 552 16,090 (7 ) 16,083 8,152 2,538 226 243 278 36 11,473 4,610 2,013 552 4,610 438 438 112 286 398 796 1,077 (1,509 ) 794 1 17 1,176 (778) (42 ) (820) 6,440 0 6,440 906 773 20 215 7 169 3,885 5,975 465 140 605 9,394 9,966 1,484 6,440 0 6,440 906 773 20 215 7 169 3,885 5,975 465 140 605 42,170 241 42,411 18,612 7,160 0 1,477 653 337 3,885 32,124 10,287 536 10,823 2,224 129 8,470 1,737,118 1,697,751 3,089 42,170 241 42,411 18,612 7,160 0 1,477 653 337 3,885 32,124 10,287 536 10,823 2,224 129 8,470 1 Results for Motor-Columbus include the six month period beginning on 1 July 2004. 2 Impairments of ﬁnancial investments for the year ended 31 December 2004 were as follows: Global Wealth Management & Business Banking CHF 47 million; Global Asset Management CHF 4 million; Investment Bank CHF (17) million; Corporate Center CHF 0 million and Industrial Holdings CHF 57 million. 3 For further information regarding goodwill and other intangible assets by Business Group, please see Note 15: Goodwill and Other Intangible Assets. 4 The funding surplus or requirement is reﬂected in each Business Group and adjusted in Corporate Center. 97 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 internally agreed transfer prices or 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 expected credit loss on its portfolio plus the difference between credit loss expense and ex- pected 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. 98 CHF million Income 1 Credit loss (expense) / recovery Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation of property and equipment Amortization of goodwill 2 Amortization of other intangible assets 2 Goods and materials purchased Total operating expenses Business Group performance from continuing operations before tax Business Group performance from discontinued operations before tax Business Group performance before tax Tax expense on continuing operations Tax expense on discontinued operations Net proﬁt Additional information 3 Total assets Total liabilities Capital expenditure Income 1 Adjusted expected credit loss Total operating income Personnel expenses General and administrative expenses Services to / from other business units Depreciation of property and equipment Amortization of goodwill 2 Amortization of other intangible assets 2 Goods and materials purchased Total operating expenses Business Group performance from continuing operations before tax Business Group performance from discontinued operations before tax Business Group performance before tax Tax expense on continuing operations Tax expense on discontinued operations Net proﬁt Global Wealth Management & Business Banking Global Asset Management Investment Bank Financial Businesses Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Corporate Center Private Banks & GAM Corporate Functions Industrial Holdings UBS 6,797 4 6,801 1,996 604 1,479 82 54 21 4,236 2,565 4,748 (3 ) 4,745 3,555 689 415 66 192 116 5,033 (288) 5,247 (71 ) 5,176 2,448 1,090 (609 ) 88 0 0 3,017 2,159 1,737 0 1,737 835 265 156 25 152 1 1,434 303 14,510 (32 ) 14,478 7,737 2,068 175 248 279 27 10,534 3,944 2,565 (288) 2,159 303 3,944 20 0 20 785 1,166 (1,639 ) 811 0 20 1,143 2,670 0 2,670 862 748 23 178 26 8 1,113 2,958 (1,123) (288) 209 209 11 (1,112) 259 (29) 150,282 147,476 173 44,972 40,346 68 192,517 186,185 261 22,584 20,912 18 1,318,752 1,305,025 500 9,084 8,406 17 (186,867 ) (197,442 ) 420 6,797 (4 ) 6,793 1,996 604 1,479 82 54 21 4,236 2,557 4,748 (8 ) 4,740 3,555 689 415 66 192 116 5,033 (293) 5,247 (127 ) 5,120 2,448 1,090 (609 ) 88 0 0 3,017 2,103 1,737 0 1,737 835 265 156 25 152 1 1,434 303 14,510 (55 ) 14,455 7,737 2,068 175 248 279 27 10,534 3,921 2,557 (293) 2,103 303 3,921 2,655 5,533 371 2,670 0 2,670 862 748 23 178 26 8 1,113 2,958 20 92 112 785 1,166 (1,639 ) 811 0 20 1,143 (1,031) (288) 205 205 15 (1,016) 259 (29) 1 Impairments of ﬁnancial investments for the year ended 31 December 2003 were as follows: Global Wealth Management & Business Banking CHF 19 million; Global Asset Management CHF 2 million; Investment Bank CHF14 million; Corporate Center CHF 149 million and Industrial Holdings CHF178 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. 99 35,729 (102 ) 35,627 18,218 6,630 0 1,498 703 193 1,113 28,355 7,272 479 7,751 1,419 79 6,253 1,553,979 1,516,441 1,828 35,729 (102 ) 35,627 18,218 6,630 0 1,498 703 193 1,113 28,355 7,272 479 7,751 1,419 79 6,253 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 are based on the location of the ofﬁce in which the transac- tions and assets are recorded. Because of the global nature of ﬁnancial markets, the Group’s business is managed on an integrated basis worldwide, with a view to proﬁtability by product line. The geographical analysis of operating income, total assets and capital expenditure is provided in order to comply with IFRS and does not reﬂect the way the Group is managed. Management believes that analysis by Business Group, as shown in Note 2a to these Financial Statements, is a more meaningful representation of the way in which the Group is managed. For the year ended 31 December 2005 Switzerland Rest of Europe / Middle East / Africa Americas Asia Paciﬁc Total For the year ended 31 December 2004 Switzerland Rest of Europe / Middle East / Africa Americas Asia Paciﬁc Total For the year ended 31 December 2003 Switzerland Rest of Europe / Middle East / Africa Americas Asia Paciﬁc Total Total operating income Total assets Capital expenditure CHF million Share % CHF million Share % CHF million Share % 15,042 17,680 15,293 2,960 50,975 29 35 30 6 203,854 687,963 1,006,185 162,248 10 33 49 8 973 467 386 139 49 24 20 7 100 2,060,250 100 1,965 100 Total operating income Total assets Capital expenditure CHF million Share % CHF million Share % CHF million Share % 13,863 12,240 14,048 2,260 42,411 33 29 33 5 193,411 561,390 830,350 151,967 11 32 48 9 1,993 556 376 164 65 18 12 5 100 1,737,118 100 3,089 100 Total operating income Total assets Capital expenditure CHF million Share % CHF million Share % CHF million Share % 12,294 8,373 13,160 1,800 35,627 35 23 37 5 182,225 538,305 739,021 94,428 12 35 47 6 683 562 530 53 37 31 29 3 100 1,553,979 100 1,828 100 100 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 exam- ple, generates both trading proﬁts and coupon income. UBS management therefore analyzes net interest and trading in- come according to the business activity generating it. The table below (labeled Breakdown by business activity) provides information that corresponds to this management view. For example, net income from trading activities is further broken down into the four sub-components of Equities, Fixed in- come, Foreign 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 table on the next page (Net trading income). 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 Equities Fixed income Foreign exchange Other Net income from trading activities Net income from interest margin products Net income from treasury and other activities Total net interest and trading income Net interest income CHF million Interest income For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 9,528 7,996 17,524 11,744 4,902 16,646 12,261 3,670 15,931 (19 ) 63 5 For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 3,928 5,741 1,458 292 11,419 5,355 750 17,524 3,098 6,264 1,467 203 11,032 5,070 544 16,646 2,445 6,474 1,436 258 10,613 5,000 318 15,931 27 (8 ) (1 ) 44 4 6 38 5 For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 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 11,414 23,641 86 24,145 59,286 11,080 20,626 10,736 2,390 4,926 49,758 9,528 8,907 11,006 38 19,277 39,228 5,475 10,014 7,993 1,168 2,834 27,484 11,744 10,449 11,148 57 18,391 40,045 4,996 9,623 9,925 751 2,489 27,784 12,261 28 115 126 25 51 102 106 34 105 74 81 (19 ) 101 Financial Statements Notes to the Financial Statements Note 3 Net Interest and Trading Income (continued) Interest includes forward points on foreign exchange swaps used to manage short-term interest rate risk on foreign currency loans and deposits. Net trading income 1 CHF million Equities Fixed income 2 Foreign exchange and other Net trading income For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 3,900 1,256 2,840 7,996 2,254 131 2,517 4,902 1,660 369 1,614 3,670 73 859 13 63 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 (4,024) million for the year ended 31 Decem- ber 2005, CHF (1,203) million for the year ended 31 December 2004, and CHF (115) million for the year ended 31 December 2003 related to ﬁnancial liabilities designated as held at fair value through proﬁt and loss. For 2005, CHF (4,277) million of the total fair value change was attributable to changes in fair value of embedded derivatives, while CHF 253 million was attributable to changes in LIBOR. For 2004, CHF (801) million of the total fair value change was attributable to changes in fair value of embedded derivatives, while CHF (402) million was attributable to changes in LIBOR. The exposure from em- bedded derivatives is economically hedged with derivatives whose change in fair value is also reported in Net trading income, offsetting the fair value changes related to ﬁnancial liabilities designated as held at fair value. For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 1,341 1,516 2,857 1,460 6,718 4,750 212 1,176 5,310 372 22,855 306 1,027 24,188 1,631 1,121 2,752 21,436 1,417 1,114 2,531 1,078 5,794 3,948 197 1,143 4,488 343 19,522 264 977 20,763 1,387 870 2,257 18,506 1,267 1,084 2,351 761 5,477 3,500 216 1,097 3,718 356 17,476 244 1,082 18,802 1,473 656 2,129 16,673 (5 ) 36 13 35 16 20 8 3 18 8 17 16 5 16 18 29 22 16 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 102 Note 5 Other Income CHF million Associates and subsidiaries Net gains from disposals of consolidated subsidiaries Net gains from disposals of investments in associates Total Financial investments available-for-sale Net gains from disposals Impairment charges Total Net income from investments in property 1 Equity in income of associates Net gains / (losses) from investment properties 2 Other Total other income from Financial Businesses Other income from Industrial Holdings Total other income For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 1 26 27 231 (26) 205 42 57 12 218 561 564 1,125 83 1 84 132 (34 ) 98 65 43 11 277 578 354 932 168 2 170 90 (184 ) (94 ) 75 123 (42 ) 223 455 (230 ) 225 (99 ) (68 ) 75 24 109 (35 ) 33 9 (21 ) (3 ) 59 21 1 Includes net rent received from third parties and net operating expenses. 2 Includes unrealized and realized gains/(losses) from investment properties at fair value. Note 6 Personnel Expenses CHF million Salaries and bonuses Contractors Insurance and social security contributions Contribution to retirement plans Other personnel expenses Total personnel expenses Note 7 General and Administrative Expenses CHF million Occupancy Rent and maintenance of IT and other equipment Telecommunications and postage Administration Marketing and public relations Travel and entertainment Professional fees Outsourcing of IT and other services Other 31.12.05 16,646 834 1,351 736 1,482 21,049 31.12.05 1,276 675 853 998 609 777 689 872 298 For the year ended 31.12.04 14,807 580 1,069 670 1,486 18,612 31.12.03 14,206 539 960 685 1,828 18,218 % change from 31.12.04 12 44 26 10 0 13 For the year ended % change from 31.12.04 31.12.03 31.12.04 1,259 722 822 1,036 527 639 718 924 513 1,300 748 847 1,048 459 522 599 826 281 Total general and administrative expenses 7,047 7,160 6,630 1 (7 ) 4 (4 ) 16 22 (4 ) (6 ) (42 ) (2 ) 103 Financial Statements Notes to the Financial Statements Note 8 Earnings per Share (EPS) and Shares Outstanding For the year ended % change from 31.12.05 31.12.04 31.12.03 31.12.04 Basic earnings (CHF million) Net proﬁt attributable to UBS shareholders from continuing operations from discontinued operations Diluted earnings (CHF million) Net proﬁt attributable to UBS shareholders Less: (Proﬁt) / loss on equity derivative contracts Net proﬁt attributable to UBS shareholders for diluted EPS from continuing operations from discontinued operations Weighted average shares outstanding Weighted average shares outstanding 14,029 9,844 4,185 14,029 (22) 14,007 9,845 4,162 8,016 7,609 407 8,016 (5 ) 8,011 7,612 399 5,904 5,510 394 5,904 1 5,905 5,511 394 1,006,993,877 1,029,918,463 1,086,161,476 Potentially dilutive ordinary shares resulting from options and warrants outstanding 1 41,601,893 52,042,897 52,639,149 Weighted average shares outstanding for diluted EPS 1,048,595,770 1,081,961,360 1,138,800,625 Earnings per share (CHF) Basic from continuing operations from discontinued operations Diluted from continuing operations from discontinued operations 13.93 9.78 4.15 13.36 9.39 3.97 7.78 7.39 0.39 7.40 7.04 0.36 5.44 5.07 0.37 5.19 4.84 0.35 75 29 928 75 (340 ) 75 29 943 (2 ) (20 ) (3 ) 79 32 964 81 33 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 14,558,875, 18,978,199 and 37,234,538 for the years ended 31 December 2005, 31 December 2004 and 31 December 2003, respectively. 31.12.05 As at 31.12.04 % change from 31.12.03 31.12.04 1,088,632,522 1,126,858,177 1,183,046,764 (3 ) 56,707,000 39,935,094 84,728,216 80,034,227 33,885,000 70,374,874 104,259,874 124,663,310 136,741,227 984,372,648 1,002,194,867 1,046,305,537 (17 ) (16 ) (2 ) Shares outstanding Total ordinary shares issued Second trading line treasury shares 2003 program 2004 program 2005 program Other treasury shares Total treasury shares Shares outstanding 104 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 1 Residential mortgages Commercial mortgages Other loans Subtotal Allowance for credit losses Net loans Net due from banks and loans 1 Includes Due from banks and loans from Industrial Holdings in the amount of CHF 728 million and 909 million for 2005 and 2004, respectively. By geographical region (based on the location of the borrower) CHF million Switzerland Rest of Europe / Middle East /Africa 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 31.12.05 33,689 (45) 33,644 127,990 18,509 125,081 271,580 (1,611) 269,969 303,613 31.12.05 158,465 50,669 83,514 12,621 305,269 (1,656) 303,613 31.12.05 148,412 45,393 24,338 87,126 305,269 (1,656) 303,613 31.12.04 35,675 (256 ) 35,419 117,731 18,950 97,777 234,458 (2,291 ) 232,167 267,586 31.12.04 152,130 45,840 61,751 10,412 270,133 (2,547 ) 267,586 31.12.04 138,692 38,872 18,973 73,596 270,133 (2,547 ) 267,586 105 Financial Statements Notes to the Financial Statements Note 9b Allowances and Provisions for Credit Losses CHF million Balance at the beginning of the year Write-offs Recoveries Increase / (decrease) in credit loss allowance and provision Disposal of subsidiaries Foreign currency translation and other adjustments Balance at the end of the year 1 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 provisions for contingent claims Total allowances and provisions for credit losses Speciﬁc allowances and provisions Collective loan loss provision Total 31.12.05 Total 31.12.04 2,641 (647) 63 (298) (61) (8) 1,690 161 (4) 0 (76) 0 5 86 2,802 (651) 63 (374)2 (61) (3) 1,776 3,775 (856 ) 59 (241 ) 0 65 2,802 31.12.05 31.12.04 45 1,611 11 1,667 109 1,776 256 2,291 41 2,588 214 2,802 1 Includes country provisions of CHF 65 million and CHF183 million at 31 December 2005 and 31 December 2004, respectively. 2 Credit loss expense of CHF1 million relates to discontinued operations. 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 31.12.05 31.12.04 3,434 32 1,561 1,593 4,089 4,699 239 2,185 2,424 5,858 1 All impaired due from banks and loans have a speciﬁc allowance for credit losses. and CHF 279 million for 2003. 3 Average balances were calculated from quarterly data. 2 Interest income on impaired due from banks and loans was CHF 123 million for 2005, CHF 172 million for 2004 CHF million Total gross impaired due from banks and loans Estimated liquidation proceeds of collateral Net impaired due from banks and loans Total allowances for credit losses related to impaired due from banks and loans 31.12.05 31.12.04 3,434 (1,366) 2,068 1,593 4,699 (1,758 ) 2,941 2,424 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 the liquidation of collateral; 2) when insolvency proceedings have commenced; or 3) when obligations have been restruc- tured on concessionary terms. 106 Note 9d Non-Performing Due from Banks and Loans (continued) 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 geographical region (based on the location of borrower) CHF million Switzerland Rest of Europe/Middle East/Africa Americas Asia Paciﬁc Total non-performing due from banks and loans 31.12.05 31.12.04 2,363 1,393 3,082 3,555 2,183 4,197 31.12.05 31.12.04 3,555 (515) (677) 2,363 4,758 (496 ) (707 ) 3,555 31.12.05 27 31.12.04 242 621 1,715 2,336 2,363 31.12.05 2,106 155 94 8 2,363 1,011 2,302 3,313 3,555 31.12.04 2,772 466 220 97 3,555 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 credit 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 31.12.05 Reverse repurchase agreements 31.12.05 Cash collateral on securities borrowed 31.12.04 Reverse repurchase agreements 31.12.04 236,286 64,045 300,331 259,608 144,824 404,432 167,567 52,675 220,242 Cash collateral on securities lent 31.12.05 Repurchase agreements 31.12.05 Cash collateral on securities lent 31.12.04 46,766 30,501 77,267 278,287 200,221 478,508 40,580 20,965 61,545 243,890 113,274 357,164 Repurchase agreements 31.12.04 252,151 170,436 422,587 107 Financial Statements Notes to the Financial Statements 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 22 pro- vides a description of the various classes of derivatives to- gether with the related notional amounts. 31.12.05 31.12.04 57,685 11,717 16,307 11,563 589 77,569 64,823 169,841 74,253 387,075 146,035 110,857 139,101 20,958 160,059 33,559 32,339 36,212 13,025 654,056 407 74,758 52,833 19,885 1,224 149,107 39,524 188,631 44,956 4,706 17,869 12,580 776 92,330 80,539 144,684 35,650 353,979 147,525 120,317 103,924 18,516 122,440 27,140 26,218 16,077 11,150 548,602 511 54,848 49,512 27,413 2,600 134,884 36,149 171,033 CHF million Trading portfolio assets Money market paper thereof pledged as collateral with central banks thereof pledged as collateral (excluding 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 predominantly consist of energy. 108 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 31.12.05 31.12.04 141 587 91 678 2,548 1,738 4,286 1,446 6,551 40 567 261 28 289 504 689 1,193 2,139 4,188 86 The following tables show the unrealized gains and losses not recognized in the income statement for the years ended 2005 and 2004: CHF million 31 December 2005 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 investments Private equity investments Total 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 investments 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 141 3 0 64 47 421 143 0 4,286 1,446 6,551 0 0 0 0 0 7 0 0 738 405 1,150 0 0 0 (1 ) 0 (11 ) (3 ) 0 (16 ) (15 ) (46) 0 0 0 (1 ) 0 (4 ) (3 ) 0 0 0 0 0 0 0 0 0 722 390 1,104 (133 ) (31 ) (164) 0 0 0 (1 ) 0 (4 ) (3 ) 0 589 359 940 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 40 147 72 0 1,193 2,139 4,188 0 1 1 0 0 7 0 0 455 577 1,041 0 0 0 0 0 (4 ) 0 0 (5 ) (22 ) (31) 0 1 1 0 0 3 0 0 0 0 0 0 0 0 0 0 450 555 1,010 (83 ) (88 ) (171) 0 1 1 0 0 3 0 0 367 467 839 109 Financial Statements Notes to the Financial Statements 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 invest- ments, valuations and research undertaken by UBS, the cur- rent 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 2005: Fair value Unrealized losses CHF million 31 December 2005 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 investments Private equity investments Total Investments Investments with unrealized with unrealized loss more than 12 months loss less than 12 months 0 0 0 55 0 272 0 0 2,032 117 2,476 0 0 0 0 0 0 143 0 16 34 193 Investments Investments with unrealized with unrealized loss more than 12 months loss less than 12 months 0 0 0 (1 ) 0 (11 ) 0 0 (13 ) (10 ) (35) 0 0 0 0 0 0 (3 ) 0 (3 ) (5 ) (11) Total 0 0 0 55 0 272 143 0 2,048 151 2,669 Total 0 0 0 (1 ) 0 (11 ) (3 ) 0 (16 ) (15 ) (46) Contractual maturities of the investments in debt instruments1 CHF million, except percentages Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) Within 1 year 1–5 years 5–10 years Over 10 years 31 December 2005 Swiss national government and agencies Swiss local governments US Treasury and agencies Foreign governments and ofﬁcial institutions Corporate debt securities Mortgage-backed securities Other debt securities Total fair value 0 0 0 38 13 0 0 51 0.00 0.00 0.00 1.91 3.20 0.00 0.00 2 0 42 2 239 0 0 285 4.36 0.00 5.51 1.90 4.25 0.00 0.00 0 0 10 5 66 14 0 95 0.00 0.00 5.77 5.64 5.38 3.92 0.00 1 0 12 2 103 129 0 247 4.00 0.00 6.03 6.17 5.66 4.80 0.00 1 Money market paper has a contractual maturity 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 110 31.12.05 31.12.04 298 60 1 277 58 45 Note 13 Investments in Associates CHF million Carrying amount at the beginning of the year Additions Disposals Transfers Income 2 Dividend paid Foreign currency translation Carrying amount at the end of the year 31.12.05 2,675 938 (935) (13) 152 (59) 198 2,956 31.12.04 2,009 1,919 1 (823 ) (378 ) 67 (42 ) (77 ) 2,675 1 Additions of CHF 1,022 million due to the consolidation of Motor-Columbus. 2 Income of CHF 95 million and CHF 24 million is related to Industrial Holdings for 2005 and 2004, respectively. Note 14 Property and Equipment At historical cost less accumulated depreciation CHF million Historical cost Own-used properties Leasehold IT, software and com- improve- ments munication Other machines and equipment Plant and manu- facturing equipment Projects in progress 31.12.05 31.12.04 Balance at the beginning of the year 9,752 2,592 3,979 1,835 3,031 Additions Additions from acquired companies Disposals / write-offs1 Reclassiﬁcations Foreign currency translation Balance at the end of the year Accumulated depreciation 178 3 (490 ) (26 ) 29 132 1 (98 ) 232 191 841 2 (880 ) 108 211 194 0 (393 ) (118 ) 78 127 110 (494 ) 71 59 9,446 3,050 4,261 1,596 2,904 Balance at the beginning of the year 4,701 1,659 3,375 1,503 Depreciation2 Disposals / write-offs1 Reclassiﬁcations Foreign currency translation Balance at the end of the year Net book value at the end of the year3 276 (158 ) (42 ) 4 4,781 4,665 216 (61 ) 71 114 1,999 1,051 716 (811 ) 0 194 3,474 787 115 (318 ) 3 46 1,349 247 760 233 (354 ) 0 33 672 2,232 239 393 0 (8 ) (217 ) 6 413 0 0 0 0 0 0 413 21,428 20,346 1,865 116 1,462 2,093 (2,363) (2,020 ) 50 574 (186 ) (267 ) 21,670 21,428 11,998 1,556 11,867 1,576 (1,702) (1,182 ) 32 391 12,275 9,395 (43 ) (220 ) 11,998 9,430 1 Includes write-offs of fully depreciated assets. value of property and equipment is CHF 16,050 million (2004: CHF 16,031 million). 2 Depreciation expense of CHF 63 million and CHF 99 millon is related to Discontinued operations for 2005 and 2004 respectively. 3 Fire insurance At fair value CHF million Balance at the beginning of the year Additions Additions from acquired companies Sales Reclassiﬁcations Foreign currency translation Balance at the end of the year Investment properties Projects in progress 31.12.05 31.12.04 41 26 0 (25 ) (16 ) 2 28 39 0 0 0 (39 ) 0 0 80 26 0 (25) (55) 2 28 236 91 1 (241 ) 0 (7 ) 80 111 Financial Statements Notes to the Financial Statements Note 15 Goodwill and Other Intangible Assets Six out of eight segments carry goodwill, of which Industrial Holdings and Private Banks & GAM (at 31 December 2004 only) each have less than 5% of the total balance. Business Banking Switzerland and Corporate Functions carry no good- will. For the purpose of testing goodwill for impairment, UBS determines the recoverable amount of its segments on the basis of value in use. The recoverable amount is determined using a proprietary model based on the discounted cash ﬂow method, which has been adapted to give effect to the special features of the banking business and its regulatory environment. The recoverable amount is determined by es- timating streams of earnings available to shareholders in the next four quarters based on a rolling forecast process, dis- counted to their presented values. The terminal value reﬂect- ing the second and subsequent years is calculated using the ﬁrst-year proﬁt multiplied by the individual price-earnings multiple per segment, and discounted to present value. The recoverable amount of the segments is the sum of earnings available to shareholders in the ﬁrst year and the terminal value. The model is most sensitive to changes in the estimated earnings available to shareholders in year one and to the price-earnings multiple. Earnings available to shareholders are estimated based on forecast results, business initiatives and planned capital investments and returns to shareholders. Price-earnings multiples are determined internally, taking into account the forecast return on equity, the cost of equity and the long-term growth rate. Applied values are also validated against UBS's most recent share price development to ensure that the applied values are reasonably in line with market de- velopment. Discount rates applied range from 8.5% for Wealth Management International & Switzerland and Wealth Management US to 10.5% for Investment Bank. Management believes that reasonable changes in key as- sumptions used to determine the recoverable amounts of segments will not result in an impairment situation. CHF million Historical cost Balance at the beginning of the year Additions and reallocations Disposals Write-offs 1 Foreign currency translation Balance at the end of the year Accumulated amortization 2 Balance at the beginning of the year Amortization 3 Reallocations Disposals Write-offs 1 Foreign currency translation Balance at the end of the year Goodwill Other intangible assets Total Infrastructure Customer relationships, contractual rights and other Total 31.12.05 31.12.04 8,865 1,518 (354 ) 0 1,284 11,313 880 0 0 0 136 1,016 184 49 0 0 0 30 263 753 3,351 (1,426 ) (41 ) (112 ) 284 2,056 711 291 (307 ) (30 ) (112 ) 83 636 4,231 (1,426 ) (41 ) (112 ) 420 3,072 895 340 (307 ) (30 ) (112 ) 113 899 13,096 92 (395) (112) 1,704 14,385 895 340 (307) (30) (112) 113 899 1,420 2,173 13,486 15,741 2,503 (407 ) (524 ) (1,203 ) 16,110 3,872 1,066 0 (188 ) (524 ) (317 ) 3,909 12,201 Net book value at the end of the year 11,313 1 Represents write-offs of fully amortized other intangible assets. requires that accumulated goodwill amortization be netted against the historical cost. in 2004, amortization expense of CHF 69 million for goodwill and CHF 7 million for other intangible assets is related to discontinued operations. 2 Goodwill amortization ceased to be recorded on 1 January 2005 due to the adoption of IFRS 3, Business Combinations. The standard 3 In 2005, amortization expense of CHF 6 million for other intangible assets relates to discontinued operations, 112 Note 15 Goodwill and Other Intangible Assets (continued) The following table presents the disclosure of goodwill and other intangible assets by business segment for the year ended 31 December 2005. CHF million Goodwill Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Asset Management Investment Bank Private Banks & GAM Corporate Functions Industrial Holdings UBS Other intangible assets Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Asset Management Investment Bank Private Banks & GAM Corporate Functions Industrial Holdings UBS Balance at the beginning of the year Additions and reallocations Disposals Amortization Foreign currency translation Balance at the end of the year 1,176 2,472 0 1,189 3,579 311 0 138 8,865 159 1,560 0 0 418 14 24 1,161 3,336 263 996 0 57 184 0 0 18 1,518 (15 ) (996 ) 0 10 (132 ) 0 0 14 (1,119) 0 0 0 0 0 (353 ) 0 (1 ) (354) 0 0 0 0 0 (9 ) 0 (2 ) (11) 0 0 0 0 0 0 0 0 0 (7 ) (49 ) 0 (1 ) (53 ) (5 ) (18 ) (207 ) (340) 127 373 0 192 546 42 0 4 1,284 4 238 0 (1 ) 63 0 3 0 307 1,566 3,841 0 1,438 4,309 0 0 159 11,313 141 753 0 8 296 0 9 966 2,173 For further information about disclosure by Business Group, including the amortization of goodwill and other intangible assets of previous years, please see Note 2a: Segment Reporting by Business Group. The estimated, aggregated amortization expenses for other intangible assets are as follows: CHF million Estimated, aggregated amortization expenses for: 2006 2007 2008 2009 2010 2011 and thereafter Total Other intangible assets 297 283 269 238 219 867 2,173 Due to the issuance of IFRS 3 Business Combinations, goodwill amortization ceased from 1January 2005. In addition, cer- tain intangible assets were 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 Note 1aa) for further details. 113 Financial Statements Notes to the Financial Statements 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 Accounts receivable trade Inventory – Industrial Holdings Other receivables Total other assets Note 21 31.12.05 31.12.04 2,758 3,528 312 832 578 364 2,007 5,811 16,190 2,554 4,747 358 804 535 387 2,045 5,945 17,375 114 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 31.12.05 124,328 113,889 337,644 451,533 575,861 31.12.04 120,026 101,081 274,995 376,076 496,102 Note 18 Financial Liabilities Designated at Fair Value and Debt Issued The Group issues both CHF and non-CHF denominated ﬁxed- rate and ﬂoating-rate debt. Floating-rate debt generally pays interest based on the three-month or six-month London Interbank Offered Rate (LIBOR). Subordinated debt securities are unsecured obligations of the Group and are subordinated in right of payment to all present and future senior indebtedness and certain other obligations of the Group. At 31 December 2005 and 31 December 2004, the Group had CHF 10,001 million and CHF 8,605 million, respectively, in subordinated debt. Sub- ordinated debt usually pays interest annually and provides for single principal payments upon maturity. At 31 December 2005 and 31 December 2004, the Group had CHF 157,771 million and CHF 91,455 million, respectively, in unsubordinated debt (excluding money market paper). Equity Linked Notes, a class of compound instruments issued by UBS totalling approximately CHF 39 billion, had to be re- classiﬁed in the balance sheet from negative replacement val- ues to ﬁnancial liabilities designated at fair value during 2005. The Group issues debt with returns linked to equity, inter- est rates, foreign exchange and credit instruments or indices. As described in Note 1n), most of these debt instruments have been designated as held at fair value through profit and loss and are presented in a separate line in the balance sheet. At 31 December 2005 and 31 December 2004, the Group had CHF 0 million and CHF 148 million, respectively, 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 (held at amortized cost). In the case of interest rate risk management, the Group applies hedge accounting as dis- cussed in Note 1o) and Note 22 – Derivative Instruments. As a result of applying hedge accounting, at 31 December 2005 and 31December 2004, the carrying value of debt issued was CHF 294 million higher and CHF 349 million higher, respec- tively, 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 carry- ing value at 31 December 2005 and 31 December 2004. 115 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 Bonds and compound debt instruments issued Compound debt instruments – OTC 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 31.12.05 109,724 7,677 117,401 31.12.05 102,662 46,545 10,001 38 1,464 58,048 160,710 31.12.04 61,646 4,110 65,756 31.12.04 79,442 28,063 8,605 60 1,686 38,414 117,856 The following table shows the split between ﬁxed-rate and ﬂoating-rate debt issues based on the contractual terms. However, it should be noted that the Group uses interest rate swaps to hedge many of the ﬁxed-rate debt issues, which changes their re-pricing characteristics into those of ﬂoating- rate debt. Contractual maturity dates CHF million, except where indicated 2006 2007 2008 2009 2010 2011–2015 Thereafter Total 31.12.05 Total 31.12.04 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 90,714 0–16.5 9,296 1,637 4.25–7.25 0 8,597 0–12.25 560 1,385 5.75–8 0 5,982 0–20 32 0 0 0 101,647 10,542 6,014 53,878 0–10 263 0 0 960 0–10 678 0 0 5,955 0–10 1,499 0 0 7,988 0–13.5 226 518 5.875 0 8,732 7,688 0–18.5 1,367 0 0 6,754 0–19.4 386 7,687 0–12 1,176 128,504 69,413 782 0–10 13,624 25,300 22,585 0 3,112 1,006 7,658 8,247 0 2.375–7.375 7.247–8.75 0 7,140 1,931 13,906 395 2,326 342 15,807 163,788 100,587 3,420 0–10 1,182 0 0 4,180 0–35 3,804 0 0 17,251 93,332 71,018 0–35 4,504 17 9 0 13,297 7,881 17 0 16 0 Subtotal Total 54,141 155,788 1,638 12,180 7,454 13,468 9,055 17,787 4,602 11,742 7,984 21,890 21,772 37,579 106,646 270,434 78,915 179,502 The table above indicates ﬁxed interest rate coupons ranging from 0 up to 35% 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 in- terest rate on such debt issues generally does not reﬂect 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. 116 Note 19 Other Liabilities CHF million Provisions Provisions for contingent claims Current tax liabilities Deferred tax liabilities VAT and other tax payables Settlement and clearing accounts Amounts due under unit-linked investment contracts 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 Disposal of subsidaries Foreign currency translation Balance at the end of the year Note 31.12.05 31.12.04 20 9b 21 Other 1 1,236 1 86 3 5 (217 ) 0 32 1,146 2,072 109 3,592 2,633 712 2,707 30,224 1,425 10,400 53,874 2,020 214 2,318 3,146 520 2,185 22,057 1,597 10,063 44,120 Total 31.12.05 2,020 Total 31.12.04 1,490 1 520 3 25 (588) (11) 102 2,072 700 587 66 34 (772 ) (11 ) (74 ) 2,020 Operational Litigation 299 0 117 0 3 (102 ) (4 ) 21 334 485 0 317 0 17 (269 ) (7 ) 49 592 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. Note 21 Income Taxes CHF million Tax expense from continuing operations Domestic Current Deferred Foreign Current Deferred Total income tax expense from continuing operations Tax expense from discontinued operations Domestic Foreign Total income tax expense from discontinued operations Total income tax expense For the year ended 31.12.05 31.12.04 31.12.03 1,490 64 1,441 (446) 2,549 489 9 498 3,047 1,225 13 828 158 2,224 108 21 129 2,353 795 99 264 261 1,419 66 13 79 1,498 The Group made net tax payments, including domestic and foreign taxes, of CHF 2,394 million, CHF 1,345 million and CHF 1,117 million for the full years of 2005, 2004 and 2003 respectively. 117 Financial Statements Notes to the Financial Statements Note 21 Income Taxes (continued) The components of operating proﬁt before tax, as well as 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 from continuing operations before tax Domestic Foreign Income taxes at Swiss statutory rate of 22% for 2005 and 24% for 2004 and 2003 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 and other intangible asset amortization Other non-deductible expenses Adjustments related to prior years and other Change in deferred tax valuation allowance 31.12.05 13,049 6,241 6,808 2,871 For the year ended 31.12.04 10,287 5,882 4,405 2,469 31.12.03 7,272 4,996 2,276 1,745 436 75 (100) (603) 22 223 (219) (156) 137 103 (249 ) (660 ) 262 219 (296 ) 239 (233 ) 85 (291 ) (366 ) 386 186 (191 ) 98 Income tax expense from continuing operations 2,549 2,224 1,419 Signiﬁcant components of the Group’s gross deferred income tax assets and liabilities are as follows: CHF million Deferred tax assets Compensation and beneﬁts Net operating loss carry-forwards Trading assets Other Total Valuation allowance Net deferred tax assets Deferred tax liabilities Compensation and beneﬁts Property and equipment Investments Provisions Trading assets Intangible assets Other Total deferred tax liabilities 31.12.05 31.12.04 1,851 2,235 586 804 5,476 (2,718) 2,758 55 515 468 0 448 264 883 2,633 1,582 2,251 483 906 5,222 (2,668 ) 2,554 119 542 343 313 408 272 1,149 3,146 The change in the balance of net deferred tax assets and deferred tax liabilities does not equal the deferred tax expense in those years. This is mainly due to the impact of the effects of foreign currency rate changes on tax assets and liabilities de- nominated in currencies other than CHF, as well as the booking of some of the tax beneﬁts related to deferred compensa- tion through Equity. In 2004, the acquisition of Motor-Columbus also had a signiﬁcant impact. 118 Note 21 Income Taxes (continued) Certain foreign branches and subsidiaries of the Group have deferred tax assets related to net operating loss carry-forwards and other items. Because realization of these assets is uncer- tain, the Group has established valuation allowances of CHF 2,718 million (CHF 2,668 million at 31 December 2004). For companies that suffered tax losses in either the current or pre- ceding year, an amount of CHF 442 million (CHF 436 million at 31 December 2004) has been recognized as deferred tax assets based on expectations that sufﬁcient taxable income will be generated in future years to utilize the tax loss carry-forwards. The Group provides deferred income taxes on undistributed earnings of non-Swiss subsidiaries except to the extent that such earnings are indeﬁnitely invested. In the event these earn- ings were distributed, additional taxes of approximately CHF 20 million would be due. At 31 December 2005 net operating loss carry-forwards to- taling CHF 5,553 million (not recognized as a deferred tax asset) are available to reduce taxable income of certain branches and subsidiaries. The carry forwards expire as follows: Within 1 year From 2 to 4 years After 4 years Total 31.12.05 8 211 5,334 5,553 Note 22 Derivative Instruments A derivative is a ﬁnancial instrument, the value of which is de- rived from the value of another (“underlying”) ﬁnancial in- strument, an index or some other variable. Typically, the un- derlying 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 (over-the-counter or OTC contracts). The rest are standardized in terms of their amounts and settlement dates and are bought and sold on organized markets (exchange-traded contracts). 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 value 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 repre- sent 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 re- placement values on different transactions are only netted if the transactions are with the same counterparty and the cash ﬂows will be settled on a net basis. Changes in replacement values of derivative instruments are recognized in trading in- come unless they qualify as hedges for accounting purposes, as explained 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 on the 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 predeter- mined 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-rate and ﬂoating-rate interest pay- ments 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 ex- change 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 protec- tion makes one or more payments to the party selling pro- 119 Financial Statements Notes to the Financial Statements Note 22 Derivative Instruments (continued) tection in exchange for an undertaking by the seller to make a payment to the buyer following a credit event (as deﬁned in the contract) with respect to a third-party credit entity (as deﬁned in the contract). 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 and is made regardless of whether the protec- tion buyer has actually suffered a loss. After 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 asset, in exchange for a series of payments, often based on a reference interest rate, e.g. LIBOR. The total return payer has an equal and opposite position. Options are contractual agreements under which, typically, 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 instrument 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 activities. 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. Arbitrage 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 purposes 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 account- ing 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 be- low. The Group’s accounting policies for derivatives desig- nated and accounted for as hedging instruments are ex- 120 plained in Note 1o), Derivative instruments and hedging, where terms used in the following sections are explained. The Group also enters into CDSs that provide economic hedges for credit risk exposures in the loan and traded prod- uct portfolios but do not meet the requirements for hedge ac- counting treatment. Starting in fourth quarter 2005, the Group also entered into interest rate swaps for day-to-day economic interest rate risk management purposes, but without applying hedge ac- counting. The fair value changes of such swaps are booked to Net trading income. The Group is limiting the resultant in- come volatility by selecting short-term to medium term swaps only. Longer term swaps continue to be supported by the cash ﬂow hedging model explained below. Fair value hedges The Group’s fair value hedges principally consist of interest rate swaps that are used to protect against changes in the fair value of ﬁxed-rate instruments due to movements in market interest rates. For the year ended 31 December 2005, the Group recognized a net loss of CHF 22 million and in 2004 a net gain of CHF 22 million, representing the ineffective portions, as deﬁned in Note 1o), of fair value hedges. The fair values of outstanding derivatives designated as fair value hedges were a CHF 380 million net positive replacement value at 31 December 2005 and a CHF 438 million net posi- tive replacement value at 31 December 2004. Fair value hedge of portfolio of interest rate risk The Group has decided to apply the new hedge method introduced by IFRS to a speciﬁc portfolio of mortgage loans from the end of September 2005. In the months of November and December, the hedge relations were ineffec- tive, and the hedges have therefore been de-designated. The Group recognized a net loss of CHF 1 million as hedge inef- fectiveness on the hedges in fourth quarter 2005. The change in fair value of the hedged items up to the point of de-designation of the hedges is recorded separately from the hedged item on the balance sheet and is amortized to Interest income or expense as applicable over the remaining life of the de-designated hedge contracts. A CHF 0.4 million gain was recorded in Interest income as a result of such amortization in fourth quarter 2005. There were no deriva- tive contracts designated as hedges under this hedge method at 31 December 2005. Cash ﬂow hedges of forecast transactions The Group is exposed to variability in future interest cash ﬂows on non-trading assets and liabilities that bear interest at variable rates or are expected to be refunded or reinvested in the future. The amounts and timing of future cash ﬂows, representing both principal and interest ﬂows, are projected Note 22 Derivative Instruments (continued) for each portfolio of ﬁnancial assets and liabilities, based on contractual terms and other relevant factors including esti- mates 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 22 years. The schedule of forecast principal balances on which the expected interest cash ﬂows arise as at 31 December 2005 is shown below. 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 212 93 119 391 117 274 270 28 242 263 182 81 8 60 (52) Gains and losses on the effective portions of derivatives designated as cash ﬂow hedges of forecast transactions are initially recorded in Shareholders’ equity as gains / losses not recognized in the income statement and 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. A CHF 35 million gain and a CHF 13 million gain were recognized in 2005 and 2004, respectively, due to hedge ineffectiveness. As at 31 December 2005 and 2004, the fair values of out- standing derivatives designated as cash ﬂow hedges of fore- cast transactions were a CHF 1,124 million net negative re- placement value and a CHF 818 million net negative replace- ment value, respectively. Swiss franc hedging interest rate swaps terminated during 2005 had a positive replacement value of CHF 80 million, but no interest rate swaps designated as cash ﬂow hedges were terminated during 2004. At the end of 2005, unrecognized income of CHF 346 million associated with these swaps has remained deferred in Equity. It will be removed from equity when the hedged cash ﬂows have an impact on 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 243 million net gain in 2005 and a CHF 304 million net gain in 2004. These amounts were recorded in Net interest 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 28, Financial Instruments Risk Position, part a) Market risk. Derivative instruments are transacted with many different counterparties, most of whom are also counterparties for other types of business. The credit risk of derivatives is man- aged and controlled in the context of the Group’s overall credit exposure to each counterparty. The Group’s approach to credit risk is described in Note 28, Financial Instruments Risk Position, part b) Credit risk. It should be noted that, al- though the positive replacement values shown on the balance sheet can be an important component of the Group’s credit exposure, the positive replacement values for any one coun- terparty are rarely an adequate reﬂection of the Group’s credit exposure on its derivatives business with that counterparty. This is because, on the one hand, replacement values can in- crease over time (“potential future exposure”), while on the other hand, exposure may be mitigated by entering into mas- ter netting 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 28, part b) Credit risk, the Derivatives positive replace- ment values shown under Traded products, and in Note 28 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 re- quirements shown in Note 28 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. 121 Financial Statements Notes to the Financial Statements Note 22 Derivative Instruments (continued) As at 31 December 2005 Term to maturity CHF million Interest rate contracts Over-the-counter (OTC) contracts Forward contracts Swaps Options Exchange-traded contracts 3 Futures Options Total Credit derivative contracts Over-the-counter (OTC) contracts Credit default swaps Total rate of return swaps Total Foreign exchange contracts Over-the-counter (OTC) contracts Forward contracts Interest and currency swaps Options Exchange-traded contracts 3 Futures Options Total Precious metals contracts Over-the-counter (OTC) contracts Forward contracts Options Exchange-traded contracts 3 Futures Options Total Equity / index contracts Over-the-counter (OTC) contracts Forward contracts Options Exchange-traded contracts 3 Futures Options Total Commodity contracts Over-the-counter (OTC) contracts Forward contracts Options Exchange-traded contracts 3 Futures Options Total 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 652 5,953 832 607 154 96 97 32 86 179 989 914 1,345.7 4,701 12,630 13,156 77,445 75,523 105,029 101,256 201,057 194,636 15,680.4 690 1,750 2,163 9,600 10,701 6,738 9,247 18,920 22,801 1,273.1 59 55 118 123 6 6 183 184 26.6 7,496 6,053 14,652 15,538 87,148 86,262 111,853 110,682 221,149 218,535 20,744.1 2,418.3 13 50 63 21 74 95 290 30 320 195 143 338 7,911 10,691 757 778 4,247 713 2,472 12,461 13,379 1,481.0 820 1,550 1,815 44.4 8,668 11,469 4,960 3,292 14,011 15,194 1,525.4 2,905 2,470 962 20,162 22,092 10,239 1,910 1,800 1,855 806 9,256 1,600 643 499 54 96 4,564 3,871 502.9 12,102 12,252 5,875 6,242 48,378 49,842 3,592.6 386 637 5 2 4,156 4,039 659.6 6 6 1 1 7 7 4.7 0.1 24,983 26,368 13,057 11,663 13,131 13,388 5,934 6,340 57,105 57,759 4,759.9 444 276 365 431 407 607 366 521 558 1,128 284 1,050 85 99 91 55 1,494 2,110 1,106 2,057 1,179 1,899 1,143 1,939 1,498 2,512 1,512 2,399 1,288 2,974 1,312 2,646 184 146 3,965 7,569 3,967 7,130 859 270 627 1,058 747 3,017 769 4,621 1,410 7,154 499 8,635 2 13 3,018 1,908 2,237 4,487 12,678 18,801 1,997 3,126 1,827 3,512 2,396 6,160 2,473 3,787 4,277 178 206 8,358 8,783 7,863 12,351 13,411 2,417 4,706 24,054 29,492 17.4 56.9 1.6 4.4 80.3 101.8 204.7 59.5 345.3 711.3 2,146 164 2,099 185 4,208 354 3,908 300 2,301 599 2,488 457 28 42 64 47 26 23 2,338 2,326 4,626 4,255 2,926 2,968 3 1 4 8,658 1,118 8,495 946 4 70.7 6.8 118 112 4 9,894 9,553 105.4 12.2 195.1 Total derivative instruments 39,905 40,293 41,327 42,056 127,198 130,144 125,352 125,170 333,782 337,663 1 PRV: positive replacement value. 2 NRV: negative replacement value. 3 Exchange-traded products include own account trades only. 122 Note 22 Derivative Instruments (continued) As at 31 December 2004 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 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 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 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 Exchange-traded contracts 3 Futures Options Total 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 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 74 2 414 343 67 6 416 519 85 604 491 77 2 570 420 118 379 57 1,277 1,213 277 201 2 8 538 436 0 0 1,556 1,422 41.2 103.6 223.6 8.1 401.6 736.9 35.4 3.6 1.0 1.2 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 own account trades only. 123 Financial Statements Notes to the Financial Statements Off-Balance Sheet Information Note 23 Fiduciary Transactions Fiduciary placement represents funds 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 31.12.05 40,603 0 40,603 31.12.04 39,588 57 39,645 The Group also acts in its own name as trustee or in ﬁduciary capacities for the account of third parties. The assets man- aged 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 activi- ties potentially expose UBS to liability risks in cases of gross negligence with regard to non-compliance with its ﬁduciary and contractual duties. UBS has policies and processes in place to control these risks. Note 24 Commitments and Contingent Liabilities The Group utilizes various lending-related ﬁnancial instru- ments in order to meet the ﬁnancial needs of its customers. 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 as- surances, 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 en- ters into commitments to extend credit in the form of credit lines that are available to secure the liquidity needs of cus- tomers but have not yet been drawn on by them, the major- ity of which range in maturity from one month to ﬁve 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 subject to the same risk management and control framework. For the years ended 31 December 2005, 2004 and 2003 the Group recognized credit loss recoveries of CHF 39 million, CHF 31 million and CHF 23 million respectively, 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 by another party to take a share of the loss in the event that the borrower fails to fulﬁll its ob- ligations and, where applicable, to fund a part of the credit facility. The Group retains the contractual relationship with the borrower, and the sub-participant has only an indirect re- lationship with the borrower. The Group will only enter into sub-participation agreements with banks whose rating is equal to or better than that of the borrower. 124 Note 24 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 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 31.12.05 31.12.04 11,526 (719) 10,807 2,805 (335) 2,470 2,235 (207) 2,028 16,566 (1,261) 15,305 72,905 (2) 72,903 20 72,925 (2) 72,923 89,491 (1,263) 88,228 317,973 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 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 re- placement value, which is signiﬁcantly lower than the under- lying 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 subject to UBS’s risk management and control framework. Accordingly, neither the underlying total contract volume nor the negative replacement value are indicative of the actual risk exposure arising from written put options. 125 Financial Statements Notes to the Financial Statements Note 24 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 31.12.05 Total 31.12.04 Mortgage collateral Other collateral Unsecured Total 355 3,333 3,688 3,599 9,558 33,722 43,280 30,045 6,653 35,850 20 42,523 34,437 16,566 72,905 20 89,491 68,081 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 2005 and 31 December 2004 was CHF 933 million and CHF 1,019 million respectively. Note 25 Operating Lease Commitments At 31 December 2005, 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 re- strictions on UBS’s ability to pay dividends, engage in debt ﬁ- nancing transactions or enter into further lease agreements. The minimum commitments for non-cancellable leases of premises and equipment are presented as follows: 31.12.05 963 908 844 783 672 3,973 8,143 821 7,322 31.12.05 31.12.04 31.12.03 1,232 1,157 75 51 1,181 1,106 75 1,309 1,236 73 43 1,266 1,193 73 1,354 1,263 91 43 1,311 1,220 91 CHF million Operating leases due 2006 2007 2008 2009 2010 2011 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 CHF million Gross operating lease expense from continuing operations from discontinued operations Sublease rental income from continuing operations Net operating lease expense from continuing operations from discontinued operations 126 Additional Information Note 26 Pledged Assets and Pledgeable Off-Balance Sheet Securities Assets are pledged from the Group’s balance sheet as collateral or for other purposes. Additionally, the Group receives pledge- able securities in various types of transactions. These securities are not recognized on the balance sheet. 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 as- sets pledged or assigned as security for liabilities and assets subject to reservation of title for the years ended 31 December 2005 and 31 December 2004. CHF million Mortgage loans Securities Property and equipment Other Total pledged assets Pledgeable Off-Balance Sheet Securities Carrying amount Related liability 31.12.05 31.12.05 Carrying amount 31.12.04 Related liability 31.12.04 64 115,580 520 474 38 88,596 683 0 116,638 89,317 175 92,440 320 0 92,935 60 87,113 0 0 87,173 The Group also obtains off-balance sheet securities with the right to sell or repledge them as shown in the table below. CHF million Fair value of securities received which can be sold or repledged as collateral under reverse repurchase, securities borrowing and lending arrangements, derivative transactions and other transactions in unsecured borrowings which can be sold or repledged thereof sold or repledged in connection with ﬁnancing activities to satisfy commitments under short sale transactions in connection with derivative transactions in connection with other transactions Note 27 Litigation 31.12.05 1,255,176 1,183,238 71,938 1,002,423 918,802 70,174 9,205 4,242 31.12.04 968,737 921,067 47,670 818,151 737,805 57,903 6,714 15,729 Due to the nature of their business, the bank and other com- panies within the UBS Group are involved in various claims, dis- putes and legal proceedings, arising in the ordinary course of business. The Group makes provisions for such matters when, in the opinion of management and its professional advisors, it is probable that a 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 management that such claims are either with- out merit, can be successfully defended or will not have a ma- terial adverse effect on the Group’s ﬁnancial condition, results of operations or liquidity. 127 Financial Statements Notes to the Financial Statements Note 28 Financial Instruments Risk Position This section presents information about UBS’s exposure to and its management and control of risks, in particular the pri- mary 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 risk (part c) is the risk that UBS is unable to meet its payment obligations when due. Part d) presents and explains the Group’s regulatory capi- tal position. Part e) covers the ﬁnancial instruments risk position of the industrial holding Motor-Columbus through its operating subsidiary Atel. Sections a) to d) generally refer only to UBS’s ﬁnancial busi- nesses, and the tables in this note which are based on risk in- formation include only the ﬁnancial businesses of the Group. Those which present an analysis of the whole balance sheet include the positions of the Industrial Holdings segment, in- cluding Motor-Columbus. Any representation of risk at a speciﬁc date offers only a snapshot of the risks taken, since both trading and non-trad- ing positions can vary signiﬁcantly on a daily basis, because they are actively managed. As such, it may not be represen- tative of the level of risk at other times. 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 indices, and others which may be only indirectly observable such as volatilities and cor- relations. The risk of price movements on securities and other 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, but also arises in some non-trading businesses. Trading activities are centered in the Investment Bank and include market making, facilitation of client business and proprietary position taking. UBS is active in the cash and de- rivative markets for equities, ﬁxed income and interest rate products, foreign exchange and, to a lesser extent, precious metals and energy. In 2005, trading in derivatives on commodi- ties (base metals and soft commodities) commenced, but the market risk from this business is not currently material. Non-trading market risk arises primarily in Treasury (part of the Corporate Center) as a result of its balance sheet and cap- ital management responsibilities. Interest rate risk arises from the funding of non-business items such as property and in- vestments, from the investment of equity, and from long-term interest rate risk transferred from other Business Groups. Other market risks from non-trading activities, predomi- nantly interest rate risk, arise in all Business Groups but they are not signiﬁcant. There is a Chief Risk Ofﬁcer (CRO) in each Business Group and a designated CRO for Treasury. The CROs report function- ally to the Group CRO and are responsible for the independ- ent control of market risk. The CROs and their teams ensure that all market risks are identiﬁed, establish the necessary controls and limits, monitor positions and exposures, and en- sure the complete capture of market risk in risk measurement and reporting systems. An important element of the CRO’s role is the assessment of market risk in new businesses and products and in structured transactions. Market risk authority is vested in the Chairman’s Ofﬁce and the GEB and is delegated ad personam to the Group CRO and market risk ofﬁcers in the Business Groups. Market risk measures and controls are applied at the port- folio level, and concentration limits and other controls are ap- plied where necessary to individual risk types, to particular books and to speciﬁc exposures. Portfolio risk measures are common to all market risks, but concentration limits and other controls are tailored to the nature of the activities and the risks they create. The principal portfolio risk measures and limits on market risk are Value at Risk (VaR) and stress loss. VaR is a statistically based estimate of the potential loss on the current portfolio from adverse market movements. It ex- presses maximum potential loss, but only to a certain level of conﬁdence (99%), and there is therefore a speciﬁed statistical probability (1%) that actual loss could be greater than the VaR estimate. UBS’s VaR model assumes a certain holding period until positions can be closed (10 days) and it assumes that mar- ket moves occurring over this holding period will follow a sim- ilar pattern to those that have occurred over 10-day periods in the past. The assessment of past movements is based on data for the past ﬁve years, and these are applied directly to current positions, a method known as historical simulation. The VaR measure captures both ‘general’ and ’residual’ mar- ket risk. General market risk includes movements in interest rates, changes in credit spreads by rating class, directional movements in equity market indices, exchange rates, and precious metal and energy prices and associated option volatilities. Residual risks are risks that cannot be explained by general market moves – broadly 128 Note 28 Financial Instruments Risk Position (contimued) a) Market Risk (continued) changes in the prices of individual debt and equity securities resulting from factors speciﬁc to individual issuers. Stress loss measures quantify exposure to more extreme market movements than are normally reﬂected in VaR, under a variety of scenarios, and are an essential complement to VaR. Controls are also applied to prevent any undue risk con- centrations in trading books, taking into account variations in price volatility and market depth and liquidity. They include controls on exposure to individual market risk variables, such as individual interest or exchange rates (’risk factors’), and on positions in the securities of individual issuers (’issuer risk’) – see (a)(v) below. (ii) Interest Rate Risk Interest rate risk is the risk of loss resulting from changes in interest rates, including changes in the shape of yield curves. It is controlled primarily through the limit structure described in (a)(i). Exposure to interest rate movements can be expressed for all interest rate sensitive positions, whether marked to market or subject to amortized cost accounting, as the impact on their fair values of a one basis point (0.01%) change in interest rates. This sensitivity, analyzed by time band, is set out below. Interest rate sensitivity is one of the inputs to the VaR model. The table sets out the extent to which UBS was exposed to interest rate risk at 31 December 2005 and 2004. 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. 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- Interest rate sensitivity position 1 Interest rate sensitivity by time bands at 31.12.05 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 167 (258 ) (306 ) 70 536 (2 ) 169 (1 ) 194 (0 ) 2 (3 ) (526 ) (57 ) (103 ) (159 ) (344 ) (33 ) (652 ) (8 ) 367 (0 ) (48 ) (1 ) 120 (883 ) 122 (546 ) (302 ) (18 ) 131 (78 ) (435 ) (3 ) 69 (0 ) 1 to 5 years 213 (6,514 ) (3,238 ) (7,847 ) (2,792 ) (271 ) (310 ) (437 ) 406 (4 ) (125 ) (1 ) Over 5 years (322 ) (287 ) 3,329 35 2,725 1,174 (9 ) 536 (704 ) 0 (371 ) (3 ) 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 1 Positions in Industrial Holdings are excluded. 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 ) Total (349) (7,998) (196) (8,447) (178) 850 (672) 12 (172) (7) (473) (8) Total 195 (6,745) (358) (4,731) (922) (409) (319) (62) (972) (6) 96 (2) 129 Financial Statements Notes to the Financial Statements Note 28 Financial Instruments Risk Position (continued) a) Market Risk (continued) trading’ includes all other interest rate sensitive assets and liabilities including derivatives designated as hedges for ac- counting purposes (as explained in Note 22) and off-balance sheet commitments on which an interest rate has been ﬁxed. This distinction differs somewhat from the accounting classi- ﬁcation of trading and non-trading assets and liabilities. Details of money market paper and debt instruments de- ﬁned as trading portfolio for accounting purposes are in- cluded in Note 11 and of debt instruments deﬁned as ﬁnan- cial investments for accounting purposes in Note 12. Details of derivatives are shown in Note 22. It should be noted that interest 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 primar- ily forward starting ﬁxed-term loans. Trading The major part of this risk arises in the Investment Bank busi- ness area Fixed Income, Rates and Currencies, which includes the Cash and Collateral Trading unit. 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 material non-trading interest rate risks, the largest items being those arising in the Global Wealth Management & Business Banking Business Group, are transferred from the originating business units to one of the two centralized interest rate risk management units, Treasury, which is part of Corporate Center, and the Investment Bank’s Cash and Collateral Trading unit. The risks are then managed within the market risk limits and controls described in (a)(i). The margin risks embedded in retail products remain with, and are subject to additional analysis and control by, the orig- inating business units. Many client products have no contractual maturity date or directly market-linked rate. Their interest rate risk is trans- ferred on a pooled basis through ’replication’ portfolios – portfolios of revolving transactions between the originating business unit and Treasury at market rates designed to ap- proximate their average cash ﬂow and re-pricing behavior. The structure and parameters of the replication portfolios are based on long-term market observations and client behavior, and are reviewed periodically. Interest rate risk also arises from non-business related balance sheet items such as the ﬁnancing of bank property and equity investments in associated companies. The risk on these items is also transferred to Treasury, through replicating port- folios designed to approximate the mandated funding proﬁle. 130 The Group’s equity is represented in the Treasury book in the form of equity replicating portfolios which reﬂect the strategic investment targets set by senior management. Based on these portfolios, 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. These in- vestments account for CHF 16.9 million of the non-trading in- terest rate sensitivity shown in the table on the previous page, with CHF 7.5 million arising in CHF, CHF 8.3 million in USD and the remainder in EUR and GBP. The interest rate sensitiv- ity of these investments is directly related to the chosen in- vestment duration, and although investing in signiﬁcantly shorter maturities would lead to a reduction in apparent in- terest rate sensitivity, it would lead to higher volatility in inter- est earnings. (iii) Currency Risk Currency risk is the risk of loss resulting from changes in ex- change rates. Trading UBS is an active participant in currency markets and carries currency risk from these trading activities, conducted primar- ily in the Investment Bank. These trading exposures are sub- ject to the VaR, stress and concentration limits described in (a)(i). Details of foreign exchange contracts, most of which arise from trading activities and contribute to currency risk, are shown in Note 22. 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 subsequent changes in exchange rates. Treasury also, from time to time, proactively hedges signiﬁcant expected foreign currency earn- ings / costs (mainly USD, EUR and GBP) within a time horizon up to one year, in accordance with the instructions of the GEB and subject to its VaR limit. Economic hedging strategies employed include a cost-efﬁcient options purchase program, which pro- vides a safety net against unfavorable currency ﬂuctuations while preserving some upside potential. Within clearly deﬁned tolerances, a certain volatility in ﬁnancial results due to currency ﬂuctuations is accepted. The hedge program has a time horizon of up to twelve months and is not restricted to the current ﬁ- nancial year. Although intended to economically hedge future earnings, these transactions are considered open currency po- sitions and are included in VaR for internal and regulatory cap- ital purposes. Note 28 Financial Instruments Risk Position (continued) a) Market Risk (continued) The Group’s equity is invested in a diversiﬁed portfolio broadly reﬂecting the currency distribution of its risk- weighted assets in CHF, USD, EUR and GBP. This creates struc- tural foreign currency exposures, the gains or losses on which are recorded through equity, leading to ﬂuctuations in UBS’s capital base in line with the ﬂuctuations in risk-weighted as- sets, thereby protecting the BIS Tier 1 capital ratio. At 31 December 2005, the largest combined trading and non-trading currency exposures against the Swiss franc were in USD (short USD 695 million), EUR (short EUR 36 million) and GBP (long GBP 6 million). At 31 December 2004, the largest exposures were in USD (short USD 224 million), EUR (short EUR 664 million) and GBP (long GBP 221 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 equity markets and carries equity risk from these activities. These ex- posures are subject to the VaR, stress and concentration lim- its described in (a)(i) and, in the case of individual stocks, to the issuer risk controls 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 22. related and other events and, ultimately, default and insol- vency of the issuer or obligor. As an active trader and market maker in equities, bonds and other securities, the Investment Bank holds positions in these instruments, which are included in VaR and are also subject to concentration limits on exposure to individual is- suers. This includes not only exposures arising from physical holdings, but also exposures from derivatives based on such assets. Exposures arising from security underwriting commit- ments are, additionally, subject to control processes and spe- ciﬁc approvals prior to commitment, generally including re- view by both origination and sales units within the business, and by risk control and other relevant functions. (vi) Financial Investments UBS holds ﬁnancial investments for a variety of purposes. Some are held for revenue generation, while others are held in support of other businesses (for example exchange seats and clearing house memberships). The majority of holdings are unlisted and fair values tend to be driven predominantly by factors speciﬁc to the individual companies rather than movements in equity markets, which have only a limited im- pact. For this reason and because they are not generally liq- uid, they are controlled outside the market risk measures and controls described in (a)(i) to (v). Private equity positions make up the largest portfolio, which is subject to a comprehensive control and reporting process, but is being run down. (v) Issuer Risk Issuer risk is the risk of loss on securities and other obligations in tradable form (including traded loans), arising from credit- Debt ﬁnancial investments, including money market paper, are included in the measures of interest rate risk described in (a)(ii). b) Credit Risk Credit risk is the risk of loss to UBS as a result of failure by a client or counterparty to meet its contractual obligations. It is inherent in traditional banking products – loans, commit- ments to lend and contingent liabilities, such as letters of credit – and in traded products – derivative contracts such as forwards, swaps and options, repurchase agreements (repos and reverse repos) and securities borrowing and lending transactions. Some of these products are accounted for on an amortized cost basis, while others are recorded in the ﬁnan- cial statements at fair value. Banking products are generally carried at amortized cost, but loans which have been origi- nated by the Group for subsequent syndication or distribution through the cash markets are carried at fair value. Within 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 governed by the same credit risk management and con- trol framework. Global Wealth Management & Business Banking and the Investment Bank, which take material credit risk, have inde- pendent credit risk control units, headed by Chief Credit Ofﬁcers (CCOs) reporting functionally to the Group CCO. They are responsible for counterparty ratings, credit risk as- sessment and the continuous monitoring of counterparty and portfolio credit exposures. Credit risk authority, including au- thority to establish allowances, provisions and credit valuation adjustments for impaired claims, is vested in the Chairman’s Ofﬁce and the GEB and is delegated ad personam to the Group CCO and to credit ofﬁcers within the Business Groups. 131 Note 28 Financial Instruments Risk Position b) Credit Risk (continued) 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 replacement value, taking account of master netting agreements with indi- vidual counterparties where they are considered enforceable 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 market 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 risk measurement, and credit limits are applied on this basis. Loans to private individuals are typically secured by portfolios of marketable securities, and property ﬁnancing to individuals or for income producing real estate is secured by a mortgage over the relevant property. In the table, the amounts shown as credit exposure differ somewhat from the internal credit view. For banking prod- ucts, they are based on the accounting view, which, for ex- ample, does not reﬂect risk reduction resulting from credit hedges and collateral received, but does include cash collat- eral posted by UBS against negative replacement values on derivatives. For traded products, positive and negative re- placement values are shown net where permitted for regula- tory capital purposes (consistent with the table in part d) Capital Adequacy), and potential future exposure is not in- cluded. This in turn differs from the accounting treatment of traded products in several respects. OTC derivatives are rep- resented on the balance sheet by positive and negative re- placement values, which are netted only if the cash ﬂows will actually be settled net, which is not generally the case – for Breakdown of credit exposure 1 details see Note 22. Securities borrowing and lending trans- actions are represented on the balance sheet by the gross val- ues of cash collateral placed with or received from counter- parties while repos / reverse repos are represented by the gross amounts of the forward commitments – for details see Note 10 – but the credit exposure is generally only a small percent- age of these balance sheet amounts. UBS manages, limits and controls concentrations of credit risk wherever they are identiﬁed, in particular to individual counterparties and groups, and to industries and countries where appropriate. Concentrations of credit risk exist if clients are engaged in similar activities, or are located in the same ge- ographic region or have comparable economic characteristics such that their ability to meet contractual obligations would be similarly affected by changes in economic, political or other conditions. UBS sets limits on its credit exposure to both individual counterparties and counterparty groups. Limits are also applied in a variety of forms to portfolios or sectors where UBS considers it appropriate to restrict credit risk con- centrations or areas of higher risk, or to control the rate of portfolio growth. Stress measures are applied to assess the impact of varia- tions in default rates and asset values, taking into account risk concentrations in each portfolio. Stress loss limits are applied where considered necessary, including limits on credit expo- sure to all but the best-rated countries. With the exceptions of Private households (CHF 149,829 million), Banks and ﬁnan- cial institutions (CHF 90,267 million) and Real estate and rentals in Switzerland (CHF 11,792 million), there are no ma- terial concentrations of loans at 31 December 2005, and the vast majority of those to Private households and to Real es- tate and rentals are secured. Derivatives exposure is predom- Amounts for each product type are shown gross before allowances and provisions. CHF million Banking products Due from banks and loans 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 31.12.05 31.12.04 304,541 16,566 72,905 86,950 40,765 (1,776) 519,951 269,224 14,894 53,168 78,317 24,768 (2,802 ) 437,569 1 Positions in Industrial Holdings are excluded. 3 See Note 24 – 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. 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. 5 Replacement values are shown net where netting is permitted for regulatory capital purposes. See also Note 28 d) – Capital Adequacy. 8 See Note 9b – Allowances and Provisons for Credit Losses for further informaion. 2 See Note 9a – Due from Banks and Loans for further information. 132 Note 28 Financial Instruments Risk Position (continued) b) Credit Risk (continued) inantly to investment grade banks and ﬁnancial institutions, and much of it is collateralized. Impaired claims UBS classiﬁes a claim as impaired if it considers it likely that it will suffer a loss on that claim as a result of the obligor’s inabil- ity to meet its commitments (including interest payments, prin- cipal repayments or other payments due, for example on a de- rivative product or under a guarantee) according to the con- tractual terms, and after realization of any available collateral. Loans carried at amortized cost are classiﬁed as non-perform- ing 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 collat- eral, or where insolvency proceedings have commenced or ob- ligations 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 principles of IAS 39. For products recorded at fair value, im- pairment 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 con- sidered impaired on a collective basis if there is objective evi- dence to suggest that it contains impaired obligations but the individual impaired items cannot yet be identiﬁed. c) Liquidity Risk 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 provisions for collective impairment are included in the total of allowances and provisions in the table on the previous page, and in Notes 9 a) and 9 b), but that portfolios against which collective loan loss provisions have been established are not included in the totals of impaired loans in Note 9 c). 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 portfolio, and to encourage risk-adjusted pricing for products carried at amortized cost, UBS uses the concept of ’expected credit loss’ for management purposes. Expected credit loss is a forward-looking, statistically based concept which is used to estimate the annual costs that will arise, on average over time, from positions in the current portfolio that become im- paired. It is derived from the probability of default (given by the counterparty rating), current and likely future exposure to the counterparty and the likely severity of the loss should default occur. Note 2 a) includes two tables: the ﬁrst shows Credit loss expense, as recorded in the Financial Statements, for each Business Group; the second reﬂects an ’Adjusted ex- pected credit loss’ for each Business Group, which is the ex- pected 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 the total of these Adjusted expected credit loss ﬁgures and the Credit loss ex- pense recorded at Group level for ﬁnancial reporting is re- ported in Corporate Center. 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, under both normal and stressed conditions without incurring unacceptable losses or risking sustained damage to business franchises. A centralized approach is adopted, based on an integrated framework incorporating an assessment of all material known and ex- pected cash ﬂows and the availability of high-grade collateral which could be used to secure additional funding if required. The framework entails careful monitoring and control of the daily liquidity position, and regular liquidity stress testing under a variety of scenarios. Scenarios encompass both nor- mal and stressed market conditions, including general mar- ket crises and the possibility that access to markets could be impacted by a stress event affecting some part of UBS’s busi- ness or, in the extreme case, if UBS suffered a severe rating downgrade. The breakdown by contractual maturity of assets and lia- bilities at 31 December 2005, which is the starting point for the liquidity analyses, is shown in the table on the next page. 133 Financial Statements Notes to the Financial Statements Note 28 Financial Instruments Risk Position (continued) c) Liquidity Risk (continued) 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 2 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 31.12.05 Total 31.12.04 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 31.12.05 Total 31.12.04 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 5.4 21.9 0.0 0.0 499.3 154.7 333.8 1.2 27.1 5.7 8.9 0.0 0.0 0.0 16.2 1,074.2 910.0 32.0 0.0 0.0 188.6 337.7 0.0 132.0 18.4 0.0 23.7 732.4 662.8 0.1 202.6 59.3 0.0 0.0 0.0 0.0 39.7 0.0 0.0 0.0 0.0 0.0 0.0 301.7 271.8 5.6 66.2 21.5 0.0 0.0 0.0 123.1 0.0 0.0 30.2 246.6 212.5 6.0 90.4 281.0 0.0 0.0 0.0 0.0 73.6 0.1 0.0 0.0 0.0 0.0 0.0 451.1 345.2 83.5 10.5 406.2 0.0 0.0 6.7 189.1 0.0 95.5 0.0 791.5 663.4 2.1 7.3 57.3 0.0 0.0 0.0 0.0 31.5 0.1 0.0 0.0 0.0 0.0 0.0 98.3 79.4 2.7 0.6 50.8 0.0 0.0 18.2 6.8 0.0 11.0 0.0 90.1 65.6 1.8 0.0 5.7 0.0 0.0 0.0 0.0 80.1 0.3 0.0 0.0 0.0 0.0 0.0 87.9 87.3 0.1 0.0 0.0 0.0 0.0 66.3 0.4 0.0 8.0 0.0 74.8 56.1 1.7 0.0 1.1 0.0 0.0 0.0 0.0 18.0 0.4 0.0 3.0 9.4 13.5 0.0 47.1 43.4 0.4 0.0 0.0 0.0 0.0 26.2 0.1 0.0 46.2 0.0 72.9 37.4 Total 5.4 33.6 300.3 404.4 499.3 154.7 333.8 1.2 270.0 6.6 8.9 3.0 9.4 13.5 16.2 2,060.3 1,737.1 124.3 77.3 478.5 188.6 337.7 117.4 451.5 18.4 160.7 53.9 2,008.3 1,697.8 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 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 of notice). the instruments may, however, extend over signiﬁcantly longer periods. 134 Note 28 Financial Instruments Risk Position (continued) d) Capital Adequacy The adequacy of UBS’s capital is monitored using, among other measures, the rules and ratios established by the Basel Committee on Banking Supervision (’BIS rules / ratios’). The BIS ratios compare the amount of 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 Swiss Federal Banking Commission (SFBC), which ultimately determine the regulatory capital required to underpin its busi- ness, and these rules, on balance, result in higher RWAs than the BIS rules. As a result, UBS’s ratios are lower when calcu- lated under the SFBC 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 in- cluding current-year proﬁt, foreign currency translation and minority interests less accrued dividends, net long posi- tions in own shares and goodwill. Certain adjustments are made to IFRS-based proﬁt and reserves, in line with BIS rec- ommendations, as prescribed by the SFBC. Tier 2 capital in- cludes subordinated 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, other assets and market risk, each of which is described below. The credit risk component consists of on- and off-balance sheet claims, measured according to regulatory formulas out- lined below, and weighted according to type of counterparty and collateral at 0%, 20%, 50% or 100%. The least risky claims, such as claims on OECD governments and claims col- lateralized by cash, are weighted at 0%, meaning that no capital support is required, while the claims deemed most risky, including unsecured claims on corporates and private customers, are weighted at 100%, meaning that 8% capital support 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 investments in Motor- Columbus and other consolidated industrial holdings are treated for regulatory capital purposes as a position in a se- curity 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 ac- cepted by the SFBC 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 val- ues. The add-ons component of the RWAs is shown in the table on the next page under Off-balance sheet exposures and other positions – Forward 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 credit risk, represent a risk to the Group in respect of their potential for write-down and impairment and which therefore require 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 eq- uities and traded debt obligations such as bonds. UBS com- putes this risk using a Value at Risk (VaR) model approved by the SFBC, from which the market risk capital requirement is derived for most of its market risk positions and under the standardized method for its base metals and soft commodi- ties derivative trading positions. Unlike the calculations for credit risk and other assets, this produces the capital require- ment itself rather than the RWA amount. In order to compute a total capital ratio, the market risk capital requirement is con- verted to an ‘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 requirement de- rived from VaR is multiplied by 12.5. 135 Financial Statements Notes to the Financial Statements Note 28 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 1 Net positions in securities 2, 3 Positive replacement values 4 Loans, net of allowances for credit losses and other collateralized lendings 1 Accrued income and prepaid expenses Property and equipment Other assets Off-balance sheet exposures Contingent liabilities Irrevocable commitments Forward and swap contracts 5 Purchased options 5 Market risk positions 6 Total risk-weighted assets Exposure 31.12.05 Risk-weighted amount 31.12.05 665,932 8,079 86,950 540,051 9,081 7,957 13,292 16,595 73,220 22,365,432 1,629,260 6,991 6,849 20,546 196,091 4,815 7,957 9,115 7,474 18,487 10,738 311 21,035 310,409 Exposure 31.12.04 556,947 8,227 78,317 429,186 5,790 8,772 33,432 14,894 53,187 14,419,106 2,306,605 Risk-weighted amount 31.12.04 7,820 6,914 17,121 164,620 3,573 8,772 9,656 7,569 11,764 8,486 386 18,151 264,832 1 Includes gross securities borrowing and reverse repo exposures, and those traded loans in trading portfolio assets originated by the Group for syndication or distribution. These ﬁnancial instruments are excluded from Market risk positions. 2 Security positions which are not in the trading book, including Motor-Colombus and other industrial holdings, which are not consolidated for capital adequacy. 4 Represents the mark to market values of Forward and swap contracts and Purchased options, where positive 3 Excluding positions in the trading book, which are included in Market risk positions. but after netting, where applicable. 6 Regulatory capital adequacy requirements for market risk, calculated using the approved Value at Risk model, or the standardized method, multiplied by 12.5. This results in the risk-weighted asset equivalent. 5 Represents the add-ons for these contracts. BIS capital ratios Tier1 of which hybrid Tier1 Tier 2 Total BIS Capital CHF million 31.12.05 39,943 4,975 3,974 43,917 Ratio % 31.12.05 12.9 1.6 1.3 14.1 Capital CHF million 31.12.04 31,629 2,963 4,815 36,444 Ratio % 31.12.04 11.9 1.1 1.8 13.8 The Tier 1 capital includes preferred securities of CHF 4,975 million (USD 2,600 million and EUR 1,000 million) at 31 Decem- ber 2005 and CHF 2,963 million (USD 2,600 million) at 31 December 2004. 136 Note 28 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 princi- ples 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 objective 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 re- ported in the income statement. Currency risks To minimize currency risk, Atel tries to offset operating in- come 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 for- eign subsidiaries is also subject to exchange 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 continuous 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. 137 Financial Statements Notes to the Financial Statements Note 29 Fair Value of Financial Instruments 29a 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 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 31.12.05 Fair value 31.12.05 Unrealized gain / (loss) 31.12.05 Carrying value 31.12.04 Fair value 31.12.04 Unrealized gain / (loss) 31.12.04 5.4 33.6 300.3 404.4 499.3 154.8 333.8 1.2 270.0 6.6 124.3 77.3 478.5 188.6 337.7 117.4 451.5 160.7 5.4 33.6 300.2 404.5 499.3 154.8 333.8 1.2 270.6 6.6 124.3 77.3 478.5 188.6 337.7 117.4 451.5 162.0 6.0 35.4 220.2 357.1 389.5 159.1 284.6 0.7 232.2 4.2 120.0 61.5 422.6 171.0 303.7 65.8 376.1 117.8 6.0 35.4 220.2 357.1 389.5 159.1 284.6 0.7 233.6 4.2 120.0 61.5 422.6 171.0 303.7 65.8 376.1 118.9 0.0 0.0 (0.1) 0.1 0.0 0.0 0.0 0.0 0.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (1.3) (0.7) 1.1 (0.9) (0.5) 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 1.0 (0.4 ) 0.9 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 and rates are not, however, available for cer- tain ﬁnancial assets and liabilities held and issued by UBS. In these cases, fair values are estimated using present value or other valuation techniques, 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 for both 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 undertaken for trading purposes are measured at fair value 138 Note 29 Fair Value of Financial Instruments (continued) 29a Fair Value of Financial Instruments (continued) 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 recog- nized 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 Equity until an asset is sold, collected or otherwise disposed of; (c) the fair value of demand deposits and savings accounts with no speciﬁc maturity is assumed to be the amount payable on demand at the balance sheet date; (d) the fair value of variable rate ﬁnancial 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 impairment is recog- nized separately by deducting the amount of the allowance for credit losses from both carrying and fair values; (e) the fair value of ﬁxed rate loans and mortgages carried at amortized cost is estimated by comparing market interest rates when the loans were granted with current market rates offered on similar loans. Changes in the credit qual- ity of loans within the portfolio are not taken into account in determining gross fair values, as the impact of impair- ment 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 disclo- sure on the previous page, the interest accrued to date on ﬁ- nancial instruments is included in the carrying value of the ﬁ- nancial 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 es- timating 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 medium-term notes and bonds issued are predominantly hedged by derivative instruments, mainly interest rate swaps, as explained in Note 22. The interest rate risk inherent in bal- ance sheet positions with no speciﬁc maturity is also hedged with derivative instruments based on management’s view on their average cash ﬂow and re-pricing behavior. 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 inter- est rate risk on a ﬁxed rate ﬁnancial instrument is hedged with a derivative in a fair value hedge, the ﬁxed rate ﬁnancial in- strument (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 explained in (e). Fair value changes are recorded in net proﬁt. The treatment of derivatives designated as cash ﬂow hedges is explained in Note 1 o). The amount shown in the table as ‘Derivative instruments designated as cash ﬂow hedges’ is the net change in fair values on such derivatives that is recorded in Equity and not yet transferred to income or expense. 139 Financial Statements Notes to the Financial Statements Note 29 Fair Value of Financial Instruments (continued) 29b 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 exchange traded derivatives, and for other ﬁnancial instru- ments for which quoted prices in an active market are avail- able, fair value is determined directly from those quoted mar- ket 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 ex- isting at the balance sheet date. This is the case for the ma- jority of OTC derivatives, and for many unlisted instruments and other 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 complex or structured ﬁnancial instruments. In these cases fair value is estimated indirectly using valuation tech- niques or models for which the inputs are reasonable assump- tions, based on market conditions. The following table presents the valuation methods used to determine fair values of ﬁnancial instruments carried at fair value: 31.12.05 Valuation technique – Valuation technique – market non-market observable inputs Quoted market observable inputs price 273.2 147.6 13.6 0.2 3.0 437.6 171.2 15.9 0.0 187.1 225.2 7.2 313.4 1.0 1.1 547.9 17.4 311.1 92.5 421.0 0.9 0.0 6.8 0.0 2.5 10.2 0.0 10.7 24.9 35.6 31.12.04 Valuation technique – market observable inputs Valuation technique – non-market observable inputs 160.1 3.1 265.2 0.0 0.4 428.8 9.7 270.1 65.8 345.6 1.0 0.0 13.2 0.0 2.7 16.9 0.0 23.8 0.0 23.8 Quoted market price 228.4 156.0 6.2 0.7 1.1 392.4 161.3 9.8 0.0 171.1 Total 499.3 154.8 333.8 1.2 6.6 995.7 188.6 337.7 117.4 643.7 Total 389.5 159.1 284.6 0.7 4.2 838.1 171.0 303.7 65.8 540.5 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 140 Note 29 Fair Value of Financial Instruments (continued) 29c 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 market observable prices or rates. Models used in these situations undergo an internal valida- tion process before they are certiﬁed for use. There may be uncertainty about a valuation, resulting from the choice of model used, the deep in the model parameters it employs, and the extent to which inputs are not market ob- servable, or as a result of other elements affecting the valua- tion, for example liquidity. Valuation adjustments are made to reﬂect such uncertainty and deducted from the fair values produced by the models or other valuation techniques. Based on the controls and procedural safeguards the Group employs, management believes the resulting 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 techniques from which the fair values of these ﬁnancial instruments are deter- mined has been quantiﬁed as a reduction of approximately CHF 1,094 million using less favorable assumptions and an in- crease of approximately CHF 1,176 million using more favor- able assumptions at 31 December 2005; and approximately CHF 579 million using less favorable assumptions and an in- crease of approximately CHF 927 million using more favorable assumptions at 31 December 2004. The determination of reasonably possible alternative as- sumptions is itself subject to considerable judgment. For valu- ations based on models, reasonably possible alternatives have been estimated using the same techniques as are used to de- termine model valuation adjustments, by increasing (for less favorable assumptions) and decreasing (for more favorable as- sumptions) the conﬁdence level applied. In changing the as- sumptions it was assumed that the impact of correlation be- tween different ﬁnancial instruments and models is minimal. A similar approach was used for valuation techniques other than those based on models at 31 December 2005, but the assess- ment applied at 31 December 2004 was based on estimates. 29d Changes in Fair Value Recognized in Proﬁt or Loss during the Period which were Estimated using Valuation Techniques Total Net trading income for the years ended 31 December 2005 and 31 December 2004 was CHF 7,996 million and CHF 4,902 million, respectively, 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 quoted prices in active markets when available, and is otherwise es- timated using valuation techniques. Included in the unrealized portion of Net trading income are net losses from changes in fair values of CHF 2,286 million for the year ended 31 December 2005 on ﬁnancial instruments for which fair values were estimated using valuation techniques. These valuation techniques included models such as those described in the previous section, which range from relatively simple models with market observable inputs, to those which are more complex and require the use of assumptions or esti- mates based on market conditions. Net losses from changes in fair values on financial ins- truments for which fair values were estimated using valua- tion techniques were CHF 7,123 million for the year ended 31 December 2004. This amount was determined using methods which have been subsequently reﬁned for the year ended 31 December 2005. The amount for the year ended 31 December 2004 has not been restated to conform to pre- sentation in the current year. Net trading income is often generated in transactions involv- ing several ﬁnancial instruments or subject to hedging or other risk management techniques, which may result in different por- tions of the transaction being priced using different 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. In many cases these amounts were offset by changes in fair value of other 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, including the effect of foreign currency transla- tion on unrealized transactions, was a gain of CHF 10,282 million for the year ended 31 December 2005 and CHF 12,025 million for the year ended 31 December 2004. Changes in fair value estimated using valuation techniques are also recognized in net proﬁt in situations of unrealized im- pairments on ﬁnancial investments available-for-sale. The total of such impairment amounts recognized in Net proﬁt was CHF 3 million for the year ended 31 December 2005 and CHF 218 million for the year ended 31 December 2004. 141 Financial Statements Notes to the Financial Statements Note 29 Fair Value of Financial Instruments (continued) 29e Continuing Involvement with Transferred Assets 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 Property and equipment Other collateralized securities trading Total 31.12. 05 Continued asset recognition in full Total assets Associated liability 50.5 100.0 0.5 60.6 211.6 10.0 78.6 0.7 3.0 92.3 31.12.04 Continued asset recognition in full Total assets 37.3 121.8 0.4 1 35.6 1 195.1 Associated liability 13.8 117.6 0.0 2.1 133.5 1 Comparatives have been restated to conform to presentation in the current year. The assets in the above table continue to be recognized to the extent shown, because the transactions by which they have been transferred do not meet the qualifying criteria for derecognition of the assets from the balance sheet. Derecognition criteria are discussed in more detail in Note 1d). 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. Nearly all repur- chase agreements relate to debt instruments, such as bonds, notes or money market paper; the majority of securities lend- ing agreements involve shares, and the remainder typically re- late to bonds and notes. Both types of transactions are con- ducted under standard agreements employed by ﬁnancial market participants and are undertaken with counterparties subject to UBS’s normal credit risk control processes. The re- sulting credit exposures are controlled by daily monitoring and collateralization of the positions. The amounts for repur- chase agreements and securities lending agreements are shown in the above table. A portion of retained assets relate to transactions in which UBS has transferred assets, but continues to have involvement in the transferred assets, for example through providing a guarantee, writing put options, acquiring call options, or en- tering into a total return swap or other type of swap linked to the performance of the asset. If control is retained through these types of associated transactions, UBS continues to rec- ognize 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 accom- panying swap derivative. The securities underlying these transactions are included in the above table within Other col- lateralized securities trading. 142 Note 30 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 Switzerland, the UK, the US and Germany. Independent ac- tuarial valuations are performed for the plans in these loca- tions. The measurement date of these plans is 31 December for each year presented. The pension funds of Atel Ltd. and some of its group com- panies in Switzerland and Germany are included in the dis- closure as at 31 December 2005 and 31 December 2004.The pension plans of the three private banks, Banco di Lugano, Ehinger & Armand von Ernst and Ferrier Lullin are no longer included in the disclosure as at 31 December 2005. The overall investment policy and strategy for the Group’s deﬁned beneﬁt pension plans is guided by the objective of achieving 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 determining the mix of asset types and target allocations which are reviewed by the plan trustees on an ongoing basis. Actual asset alloca- tion is determined by a variety of current economic and mar- ket conditions and in consideration of speciﬁc 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 esti- mates take into consideration historical asset class returns and are determined together with the plans’ investment and ac- tuarial advisors. Swiss pension plans The pension fund of UBS covers practically all UBS employees in Switzerland and exceeds the minimum beneﬁt require- ments 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 (including 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 retire- ment beneﬁts, disability, death and survivor pensions, and employment 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 contribu- tions as a percentage of salary and accrue at a minimum in- terest rate annually. The employer contributions expected to be made in 2006 to the Swiss pension plans are CHF 416 million. The accu- mulated beneﬁt obligation (which is the current value of ac- crued beneﬁts without allowance for future salary increases) for these pension plans was CHF 18,863 million as at 31 December 2005 (2004: CHF 18,566 million, 2003: CHF 16,817 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 2006 to these pension plans are CHF 75 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 4,992 million as at 31 December 2005 (2004: CHF 4,118 million, 2003: CHF 3,609 million). For pension plans with an accumulated beneﬁt obligation in excess of plan assets, the aggregate projected beneﬁt obligation and accumulated beneﬁt obligation was CHF 4,521 million and CHF 4,497 million as at 31 December 2005 (2004: CHF 3,755 million and CHF 3,735 million, 2003: CHF 944 million and CHF 930 million). The fair value of plan assets for these plans was CHF 3,789 million as at 31 December 2005 (2004: CHF 3,166 million, 2003: CHF 677 million). 143 Financial Statements Notes to the Financial Statements Note 30 Pension and Other Post-Retirement Beneﬁt Plans (continued) a) Deﬁned beneﬁt plans CHF million 31.12.05 31.12.04 31.12.03 31.12.05 31.12.04 31.12.03 Deﬁned beneﬁt obligation at the beginning of the year (20,225) (18,216 ) (19,204 ) (4,142) (3,663 ) (3,436 ) Swiss Foreign (353) (660) (219) (713) 866 (37) 369 (20,972) 18,575 925 1,284 468 219 (866) (376) 20,229 (743) 2,334 (345 ) (672 ) (203 ) (362 ) (703 ) (202 ) (1,392 ) 1,395 910 (35 ) (272 ) 930 (70 ) (82) (236) (416) (280) 144 (2) (6) (20,225 ) 17,619 (18,216 ) 16,566 (5,020) 3,580 263 247 253 89 878 102 411 203 (910 ) 272 818 593 370 202 (930 ) (83 ) (212 ) (296 ) 146 125 (159 ) (4,142 ) 3,402 248 122 (132 ) 65 (91 ) (197 ) (201 ) 138 124 (3,663 ) 2,382 178 251 (116 ) 831 (144) (125 ) (124 ) 18,575 (1,650 ) 3,006 17,619 (597 ) 1,716 4,288 (732) 1,222 1 3,580 (562 ) 1,046 1 (1,591) (1,356 ) (1,119 ) 0 0 0 491 485 (468) 468 (411 ) 411 0 0 0 0 33 (403 ) 370 0 0 485 (125) 89 (6) 48 491 832 (341) 491 710 (105 ) 65 (159 ) (26 ) 485 805 (320 ) 485 3,402 (261 ) 970 1 710 73 (168 ) 831 (26 ) 710 862 (152 ) 710 Service cost Interest cost Plan participant contributions Actuarial gain / (loss) Foreign currency translation Beneﬁts paid Special termination beneﬁts Acquisitions Settlements Deﬁned beneﬁt obligation at the end of the year Fair value of plan assets at the beginning of the year Expected return on plan assets Actuarial gain / (loss) Foreign currency translation Employer contributions Plan participant contributions Beneﬁts paid Acquisitions Settlements Fair value of plan assets at the end of the year 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 144 Note 30 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 Amortization of unrecognized past service cost Amortization of unrecognized net (gains) / losses Special termination beneﬁts Settlements Increase / (decrease) of unrecognized asset Net periodic pension cost Funded and unfunded plans CHF million Swiss Foreign 31.12.05 31.12.04 31.12.03 31.12.05 31.12.04 31.12.03 353 660 (925) (3) 101 37 10 235 468 345 672 (878 ) 35 237 411 362 703 (818 ) 188 70 (102 ) 403 Swiss 82 236 (263) 68 2 83 212 (248 ) 91 197 (178 ) 58 58 125 105 168 31.12.05 31.12.04 31.12.03 31.12.02 31.12.01 Deﬁned beneﬁt obligation from funded plans (20,972) (20,225 ) Plan assets Surplus / (deﬁcit) Experience gains / (losses) on plan liabilities Experience gains / (losses) on plan assets CHF million Deﬁned beneﬁt obligation from funded plans Deﬁned beneﬁt obligation from unfunded plans Plan assets Surplus / (deﬁcit) Experience gains / (losses) on plan liabilities Experience gains / (losses) on plan assets (18,216 ) 17,619 (597 ) (19,204 ) 16,566 (2,638 ) (17,879 ) 18,289 410 18,575 (1,650 ) 20,229 (743) (77) 1,284 31.12.05 31.12.04 31.12.03 31.12.02 31.12.01 Foreign (3,815 ) (327 ) 3,580 (562 ) (3,509 ) (154 ) 3,402 (261 ) (3,295 ) (141 ) 2,382 (1,054 ) (3,402 ) (151 ) 2,887 (666 ) (4,635) (385) 4,288 (732) 7 247 Swiss Foreign 31.12.05 31.12.04 31.12.03 31.12.05 31.12.04 31.12.03 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 Discount rate Expected rate of return on plan assets Expected rate of salary increase Rate of pension increase 3.0 2.5 0.8 3.3 5.0 2.5 1.0 3.3 2.5 1.0 3.8 5.0 2.5 1.0 3.8 2.5 1.0 3.8 5.0 2.5 1.5 5.0 4.4 1.9 5.5 7.0 4.4 1.9 5.5 4.4 1.9 5.7 7.2 4.6 1.9 5.7 4.6 1.9 5.8 7.1 4.4 1.5 145 Financial Statements Notes to the Financial Statements Note 30 Pension and Other Post-Retirement Beneﬁt Plans (continued) a) Deﬁned beneﬁt plans (continued) CHF million, except where indicated Expected future beneﬁt payments 2006 2007 2008 2009 2010 2011–2015 Plan assets (weighted average) Actual plan asset allocation (%) Equity instruments Debt instruments Real estate Other Total Long-term target plan asset allocation (%) Equity instruments Debt instruments Real estate Other Actual return on plan assets (%) 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 31.12.05 31.12.04 31.12.03 31.12.05 31.12.04 31.12.03 150 147 158 168 180 1,272 52 39 4 5 100 52–55 44–45 0–3 1–2 13.6 54 41 2 3 100 49–55 44–47 1–2 0–6 10.8 52 30 1 17 100 17.8 922 931 949 965 968 5,063 43 43 12 2 100 34–46 30–53 11–19 0 12.0 613 225 2,222 69 43 41 12 4 100 34–49 30–53 12–19 0 5.5 1,239 238 3,778 73 39 43 12 6 100 8.6 1,005 246 2,930 84 1 The number of UBS AG shares was 1,794,576, 2,493,173 and 2,908,699 as at 31 December 2005, 31 December 2004 and 31 December 2003, respectively. 146 Note 30 Pension and Other Post-Retirement Beneﬁt Plans (continued) 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 216 million as at 31 December 2005 (2004: CHF 166 million, 2003: CHF 179 mil- lion) and the total accrued post-retirement cost amounts to CHF 168 million as at 31 December 2005 (2004: CHF 136 mil- lion, 2003: CHF 137 million). The net periodic post-retirement costs for the years ended 31 December 2005, 31 December 2004 and 31 December 2003 were CHF 21 million, CHF 16 million and CHF 22 million, respectively. The employer contributions expected to be made in 2006 to the post-retirement medical and life plans are CHF 8 mil- lion. The expected future beneﬁt payments are CHF 8 million for the year 2006, CHF 9 million for each of the years 2007 and 2008, CHF 10 million for the year 2009, CHF 11 million for the year 2010 and CHF 63 million in total for the years 2011–2015. b) Post-retirement medical and life plans CHF million Post-retirement beneﬁt obligation at the beginning of the year Service cost Interest cost Actuarial gain / (loss) Foreign currency translation Beneﬁts paid Post-retirement beneﬁt obligation at the end of the year Fair value of plan assets at the beginning of the year Employer contributions Beneﬁts paid Fair value of plan assets at the end of the year 31.12.05 (166) 31.12.04 (179 ) 31.12.03 (166 ) (8) (11) (17) (22) 8 (216) 0 8 (8) 0 (6 ) (9 ) 8 12 8 (166 ) 0 8 (8 ) 0 (11 ) (10 ) (14 ) 16 6 (179 ) 2 4 (6 ) 0 Deﬁned beneﬁt obligation Plan asset Surplus / (deﬁcit) Experience gains / (losses) on plan liabilities (216) 0 (216) (3) (166 ) 0 (166 ) (179 ) 0 (179 ) (166 ) 2 (164 ) (145 ) 3 (142 ) 31.12.05 31.12.04 31.12.03 31.12.02 31.12.01 The assumed average health care cost trend rate used in determining post-retirement beneﬁt expense is assumed to be 11% for 2005 and to decrease to an ultimate trend rate of 5% in 2012. Assumed health care cost trend rates have a signiﬁcant effect on the amounts reported for the health care plan. A one percentage point change in the assumed health care cost trend rates would change the US post-retirement beneﬁt obligation and the service and interest cost components of the net periodic post-retirement beneﬁt costs as follows: CHF million Effect on total service and interest cost Effect on the post-retirement beneﬁt obligation 1% increase 1% decrease 4 28 (3) (23) 147 Financial Statements Notes to the Financial Statements Note 30 Pension and Other Post-Retirement Beneﬁt Plans (continued) c) Deﬁned contribution plans The Group also sponsors a number of deﬁned contribution plans primarily in the UK and the US. Certain plans permit employees to make contributions and earn matching or other contributions from the Group. The contributions to these plans recognized as expense for the years ended 31 December 2005, 31 December 2004 and 31 December 2003 were CHF 184 million, CHF 187 million and CHF 141 million, respectively. d) Related party disclosure UBS is the principal bank for the pension fund of UBS in Switzerland. In this function, UBS is engaged to execute most of the pension fund’s banking activities. These activities also include, but are not limited to, trading and securities lending and bor- rowing. All transactions have been executed at arm’s length conditions. The following fees and interest have been received or paid by UBS related to these banking activities: CHF million Received by UBS Fees Paid by UBS Interest Dividends and capital repayments For the year ended 31.12.05 31.12.04 31.12.03 48 4 7 42 4 7 33 3 7 The foreign UBS pension funds do not have a similar banking relationship with UBS, but they may hold and trade UBS shares and / or securities. The transaction volumes in UBS shares and other UBS securities are as follows (all pension funds): Financial instruments bought by pension funds UBS AG shares (in thousands of shares) UBS ﬁnancial instruments (nominal values in CHF million) Financial instruments sold by pension funds or matured UBS AG shares (in thousands of shares) UBS ﬁnancial instruments (nominal values in CHF million) For the year ended 31.12.05 31.12.04 31.12.03 1,387 0 2,263 45 2,822 47 3,713 18 4,987 34 5,760 36 UBS has also leased buildings from the Swiss pension fund. The rent paid by UBS under these leases amounted to CHF 4 million in 2005, CHF 5 million in 2004 and CHF 5 million in 2003. There were ﬁnancial instruments in the amount of CHF 163 million due from UBS pension plans outstanding as at 31 December 2005 (2004: CHF 0 million, 2003: CHF 0 million). The amounts due to UBS deﬁned beneﬁt pension plans are contained in the additional details to the fair value of plan assets. Furthermore, UBS deﬁned contribution plans hold 7,064,279 UBS shares with a market value of CHF 885 million as at 31 December 2005 (2004: 7,230,314 shares with a market value of CHF 691 million, 2003: 7,733,881 shares with a market value of CHF 652 million). 148 Note 31 Equity Participation and Other Compensation Plans a) 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 below describe the most signiﬁcant plans in general, but spe- ciﬁc 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 value on the purchase date and receive at no additional cost two UBS options for each share purchased, up to a maximum annual limit. The options have a strike price equal to the fair market value of the stock on the date the option is granted. Share purchases can be made annually from bonus compen- sation 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: Up to and including 2005, se- lected employees in Switzerland were entitled to purchase a speciﬁed number of UBS shares at a predetermined dis- counted price each year. The number of shares that could be purchased depended on rank. Any such shares purchased must be held for a speciﬁed period of time. The discount is recorded as compensation expense. No new awards will be made under this plan. 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 portion of their award in UBS shares (with a matching contribution in UBS options) or in Alternative Investment Vehicles (AIVs) (gen- erally money market funds, UBS and non-UBS mutual 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, options were not granted as part of EOP and awards were generally made in UBS shares. EOP awards vest in one-third increments over a three-year vesting period. Under certain conditions, these awards are fully forfeitable by the employee. Key employee option plans: Under these plans, key and high potential employees are granted UBS options with a strike price not less than the fair market value of the shares on the date the option is granted. Option grants generally vest in one-third increments over a three-year vesting period and generally expire from ten years to ten and one-half years after the grant date. One option gives the right to purchase one registered UBS share at the option’s strike price. Other plans: UBS sponsors a deferred compensation plan for selected eligible employees. Generally, contributions are made on a voluntary and tax deferred basis, and participants are allowed to notionally invest in AIVs. No additional com- pany match is granted, and the plan is generally not for- feitable. In addition, UBS also grants other compensation awards to new recruits and key employees, generally in the form of UBS shares or options. UBS satisﬁes share delivery obligations under its option based participation plans either by purchasing UBS shares in the market on grant date or shortly thereafter or through the issuance of new shares. At exercise, shares held in treasury are delivered, or alternatively newly issued, to the employee against receipt of the strike price. As at 31 December 2005, UBS was holding approximately 56 million shares in treasury which is expected to be sufﬁcient for anticipated employee exercises in the next year. 149 Financial Statements Notes to the Financial Statements Note 31 Equity Participation and Other Compensation Plans (continued) b) UBS share awards Movements in shares granted under various equity participation plans described in Note 31a) are as follows: UBS share awards Share compensation plans Unvested, at the beginning of the year Shares awarded during the year Vested during the year Forfeited during the year Unvested, at the end of the year Number of shares 31.12.05 24,636,819 13,626,050 (10,995,880) (404,396) 26,862,593 Weighted- average grant date fair value (CHF) 79 101 78 89 92 Number of shares 31.12.04 31,383,890 11,713,406 (17,996,498 ) (463,979 ) 24,636,819 Weighted- average grant date fair value (CHF) 75 95 79 77 79 Number of shares 31.12.03 48,136,561 11,023,553 (26,915,860 ) (860,364 ) 31,383,890 Weighted- average grant date fair value (CHF) 78 61 75 79 75 UBS estimates the grant date fair value of shares awarded during the year by using the average UBS share price on the grant date as quoted on the virtX. The market value of shares vested was CHF 1,083 million, CHF 1,922 million and CHF 1,677 million for the years ended 31 December 2005, 31 December 2004 and and 31 December 2003, respectively. c) UBS option awards Movements in options granted under various equity participation plans described in Note 31a) are as follows: UBS option awards Outstanding, at the beginning of the year 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 Number of options 31.12.05 100,907,354 22,601,427 (30,651,709) (1,905,053) (69,474) 90,882,545 37,394,419 Weighted- average exercise price 1 (CHF) Weighted- average exercise price 1 (CHF) Number of options 31.12.04 69 109 109,040,026 24,113,252 68 90 68 84 70 (29,396,959 ) (2,692,824 ) (156,141 ) 100,907,354 37,941,280 63 91 58 66 76 69 65 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 Weighted- average exercise price 1 (CHF) 67 59 54 64 76 63 59 1 Some of the options in this table have exercise prices denominated in USD which have been converted into CHF at the year-end spot exchange rates for the purposes of this table. The weighted average share price of options exercised during the year was CHF 106, CHF 93 and CHF 77 for the years ended 31 December 2005, 31 December 2004 and 31 December 2003, respectively. The following table provides additional information about option awards: Intrinsic value of options exercised during the year (CHF million) Weighted-average grant date fair value of options granted (CHF) 31.12.05 31.12.04 31.12.03 1,224 16 960 25 326 15 In addition, UBS received cash of CHF 2,018 million and an income tax beneﬁt of CHF 217 million from the exercise of share options for the year ended 31 December 2005. The intrinsic value of share-based liabilities (shares and options) paid for the years ended 31 December 2005, 31 December 2004 and 31 December 2003 was CHF 87 million, CHF 669 million and CHF 1,092 million, respectively. 150 Note 31 Equity Participation and Other Compensation Plans (continued) c) UBS option awards (continued) The following tables summarize additional information about options outstanding and options exercisable at 31 December 2005: as at 31.12.05 Range of exercise price per share CHF 53.37–70.00 70.01–85.00 85.01–100.00 100.01–126.45 53.37–126.45 USD 9.48–35.00 35.01–45.00 45.01–55.00 55.01–80.00 80.01–96.52 9.48–96.52 d) Valuation Number of options outstanding 11,419,873 9,663,720 12,146,701 14,458,375 47,688,669 1,610,614 7,739,569 12,192,501 10,127,640 11,523,552 43,193,876 Options outstanding Weighted- average exercise price (CHF / USD) Aggregate intrinsic value (CHF million) Weighted- average remaining contractual term (years) Number of options exercisable 5,374,311 9,110,432 4,179,263 9,459 738 456 362 304 6.8 6.3 7.2 9.1 1,860 7.5 18,673,465 113 402 577 244 91 1.0 7.1 5.0 7.8 9.1 1,610,614 3,967,147 10,336,354 2,745,506 61,333 1,427 7.0 18,720,954 60.44 77.90 95.31 104.08 86.09 25.23 43.15 47.81 71.02 87.38 62.13 Options exercisable Weighted- average exercise price (CHF / USD) Aggregate intrinsic value (CHF million) Weighted- average remaining contractual term (years) 59.77 77.82 96.83 102.93 76.89 25.23 42.92 47.75 66.61 83.58 47.67 351 431 118 0 900 113 207 490 78 1 889 6.4 6.3 5.6 9.3 6.2 1.0 7.1 4.6 6.3 9.0 5.1 Upon adoption of IFRS 2 and SFAS 123-R, both titled Share- based Payment, on 1 January 2005, UBS conducted a review of its option valuation inputs to ensure they were in line with the guidance included in the two standards. As a result of that review, UBS now uses a mix of implied and historic volatility instead of solely historic volatility and speciﬁc employee exer- cise behavior patterns based on statistical data instead of a single expected life input to determine the fair value of the options. A more sophisticated option valuation model was concurrently introduced to better model the UBS-speciﬁc em- ployee exercise behavior patterns. The overall change in fair value of the options in 2005 versus 2004 is primarily attribut- able to using implied instead of historic volatility. The use of market-implied volatility decreased the fair value of the option by approximately CHF 7 or 29% compared to using historic volatility. The remaining reduction in fair value of approxi- mately CHF 2 is attributable to the introduction of the new val- uation model which uses UBS-speciﬁc employee exercise be- havior patterns rather than an expected life input, as well as all other input changes based on observable market factors. The fair value of options granted during 2005 was deter- mined using the following assumptions: Expected volatility (%) Risk-free interest rate (%) Expected dividend (CHF/USD) Strike price (CHF/USD) Share price (CHF/USD) 31.12.05 CHF awards range low range high USD awards range low range high 23.20 2.00 4.59 104.16 102.65 12.39 0.62 3.00 96.45 96.45 27.03 2.34 7.78 126.45 126.45 23.36 4.11 3.77 88.21 86.79 15.21 1.91 2.43 78.49 78.49 27.21 4.63 8.24 96.52 96.52 151 Financial Statements Notes to the Financial Statements Note 31 Equity Participation and Other Compensation Plans (continued) d) Valuation (continued) The valuation technique takes into account the speciﬁc terms and conditions under which the share options are granted such as the vesting period, forced exercises during the lifetime, and gain- and time-dependent exercise behavior. The expected term of each op- tion is calculated, by means of Monte Carlo simulation, as the probability-weighted average of the time of exercise. The term structure of volatility is derived from the implied volatilities of traded UBS options in combination with the observed long- term historic share price volatility. Dividends are assumed to grow at a 10% yearly rate over the term of the option. The fair value of options granted during 2004 and 2003 was determined using a proprietary option pricing model, similar to an American-style binomial model, with the following assumptions: Expected volatility (%) Risk-free interest rate (%) Expected dividend rate (%) Strike price (CHF/USD) Share price (CHF/USD) Expected life (years) 31.12.04 31.12.03 CHF awards USD awards CHF awards USD awards 33.66 2.03 3.86 95.59 94.17 5.6 33.45 3.70 3.88 75.12 74.06 5.6 35.20 1.70 4.58 60.84 59.32 4.5 34.74 3.17 4.35 46.44 46.25 4.5 The expected life was estimated on the basis of observed employee option exercise patterns. Volatility was derived from the observed long-term historic share price volatility aligned to the expected life of the option. Dividends were assumed to grow at a 10% yearly rate over the expected life of the option. e) Compensation expense Generally, under IFRS, for all employee share and option awards for which the underlying is UBS shares, UBS recognizes compensation expense over the requisite service period which is generally equal to the vesting period. Share and option awards typically have a three-year tiered vesting structure which means awards vest in one-third increments over that pe- riod. The total share-based compensation expense recognized for the years ended 31 December 2005, 31 December 2004 and 31 December 2003 was CHF 1,662 million, CHF 1,406 million and CHF 1,474 million, respectively. The total income taxes recognized in the Income statement in relation to these expenses were a beneﬁt of CHF 431 million, CHF 64 million and CHF 197 million for the years ended 31 December 2005, 31 December 2004 and 31 December 2003, respectively. For the years ended 31 December 2005 and 31 December 2004, virtually all of the expense recorded for share-based payments was related to equity settled plans. For the year ended 31 December 2003, the expense recorded for equity- settled plans was CHF 1,247 million. At 31 December 2005 and 31 December 2004, the total liability related to vested and unvested cash-settled share-based plans was insigniﬁ- cant. At 31 December 2005, total compensation cost related to non-vested awards not yet recognized in the Income state- ment is CHF 1,252 million, which is expected to be recognized in Personnel expenses over a weighted average period of 1.87 years. 152 Note 32 Related Parties The Group deﬁnes related parties as associated companies, post-employment beneﬁt plans for the beneﬁt of UBS employ- ees, key management personnel, close family members of key management personnel and enterprises which are, directly or in- directly, controlled by, jointly controlled by or signiﬁcantly inﬂu- enced by or in which signiﬁcant voting power resides with key management personnel or their close family members. Key management personnel is deﬁned as members of the Board of Directors (BoD) and Group Executive Board (GEB). This deﬁ- nition is based on the requirements of revised IAS 24 Related Party Disclosures adopted by UBS on 1 January 2005 and the “Directive on Information Relating to Corporate Governance” issued by the SWX Swiss Exchange and effective from 1 July 2002 for all listed companies in Switzerland. Where applicable, prior comparative periods have been re- stated. a) Remuneration of key management personnel The executive members of the BoD have top management employment contracts and receive pension beneﬁts upon retire- ment. Total remuneration of the executive members of the BoD and GEB is as follows: CHF million Base salaries and other cash payments Incentive awards - cash Employer’s contributions to retirement beneﬁt plans Beneﬁts in kind, fringe beneﬁts (at market value) Equity compensation beneﬁts 1 Total For the year ended 31.12.05 31.12.04 31.12.03 15 90 1 3 114 223 15 70 1 2 103 191 14 65 1 1 77 158 1 Expense for shares and options granted is measured at grant date and allocated over the vesting period, generally 3 years for options and 5 years for shares. Total compensation numbers exclude merger-related reten- tion payments for two ex-PaineWebber executives of CHF 21.1 million (USD 17.0 million) in 2003. These retention pay- ments were committed to at the time of the merger in 2000 and fully disclosed at the time. The external members of the BoD do not have employ- ment or service contracts with UBS, and thus are not entitled to beneﬁts upon termination of their service on the BoD. Payments to these individuals for their services as external board members amounted to CHF 6.1 million in 2005, CHF 5.7 million in 2004 and CHF 5.4 million in 2003. b) Equity holdings Number of stock options from equity participation plans held by executive members of the BoD and the GEB Number of shares held by members of the BoD, GEB and parties closely linked to them 31.12.05 5,431,125 4,356,992 As at 31.12.04 6,004,997 3,506,610 31.12.03 6,218,011 3,150,217 Of the share totals above, at 31 December 2005, 3,269 shares were held by close family members of key management per- sonnel and 1,243,030 shares were held by enterprises which are directly or indirectly controlled by, jointly controlled by or signiﬁcantly inﬂuenced by or in which signiﬁcant voting power resides with key management personnel or their close family members. In addition, at 31 December 2003, executive members of the BoD and GEB held 120,264 warrants (equal to 7,214 shares) from equity participation plans. Further informa- tion about UBS’s equity participation plans can be found in Note 31. No member of the BoD or GEB is the bene- ﬁcial owner of more than 1% of the Group’s shares at 31 December 2005. 153 Financial Statements Notes to the Financial Statements Note 32 Related Parties (continued) c) Loans, advances and mortgages to key management personnel Executive members of the BoD and GEB members have been granted loans, ﬁxed advances and mortgages on the same terms and conditions that are available to other employees, based on terms and conditions granted to third parties adjusted for re- duced credit risk. Non-executive BoD members are granted loans and mortgages at general market conditions. Movements in the loan, advances and mortgage balances are as follows: CHF million Balance at the beginning of the year Additions Reductions Balance at the end of the year 31.12.05 31.12.04 16 7 (2) 21 25 2 (11 ) 16 No unsecured loans were granted to key management personnel as at 31 December 2005 and 31 December 2004. d) Associated companies Movements in loans to associated companies are as follows: CHF million Balance at the beginning of the year Additions Reductions Credit loss (expense) / recovery Balance at the end of the year 31.12.05 31.12.04 83 267 (26) (3) 321 81 38 (36 ) 0 83 All loans to associated companies are transacted at arm’s length. Of the balances above, the amount of unsecured loans amounted to CHF 82 million and CHF 61 million at 31 December 2005 and 31 December 2004, respectively. Other transactions with associated companies transacted at arm's length are as follows: CHF million Payments to associates for goods and services received Fees received for services provided to associates Commitments and contingent liabilities to associates For the year ended or as at 31.12.05 31.12.04 31.12.03 397 258 39 248 180 83 120 122 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 35 provides a list of signiﬁcant associates. 154 Note 32 Related Parties (continued) e) Other related party transactions During 2005 and 2004, UBS entered into transactions at arm’s length with enterprises which are directly or indirectly con- trolled by, jointly controlled by or signiﬁcantly inﬂuenced by or in which signiﬁcant voting power resides with key manage- ment personnel or their close family members. In 2005 and 2004 these companies included Bertarelli Biotech SA (Switzerland, previously Bertarelli & Cie.), BMW Group (Germany), Kedge Capital Funds Ltd. (Jersey), Serono Group (Switzerland), Stadler Rail Group (Switzerland), Team Alinghi (Switzerland), and Unisys Corporation (USA). Related parties in 2005 also included Löwenfeld AG (Switzerland) and Royal Dutch Shell plc (UK). In 2004, related parties also included J. Sainsbury plc. (UK). Movements in loans to other related parties are as follows: CHF million Balance at the beginning of the year Additions Reductions Loans at the end of the year 1 31.12.05 31.12.04 294 628 3 919 79 275 60 294 1 In 2005 includes loans, guarantees and contingent liabilities of CHF 116 million and unused committed facilities of CHF 804 million but excludes unused uncommitted working capital facilities and unused guarantees of CHF 52 million. 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. No unsecured loans were entered into as at 31 December 2005 and 31 December 2004. Other transactions with these related parties include: CHF million Goods sold and services provided to UBS Fees received for services provided by UBS For the year ended 31.12.05 31.12.04 31.12.03 15 1 34 10 43 7 As part of its sponsorship of Team Alinghi, defender for the “America’s Cup 2007”, UBS paid CHF 8.4 million (EUR 5.4 mil- lion) as sponsoring fee for 2005. Team Alinghi’s controlling shareholder is UBS board member Ernesto Bertarelli. f) Additional information UBS also engages in trading and risk management activities (e.g. swaps, options, forwards) with various related parties men- tioned in previous sections. These transactions 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. 155 Note 33 Securitizations During the years ended 31 December 2005, 2004 and 2003, UBS securitized (i.e. transformed owned ﬁnancial assets into se- curities) residential mortgage loans and securities, commercial mortgage loans and other ﬁnancial assets, acting as lead or co-manager. UBS’s continuing involvement in these transactions was primarily limited to the temporary 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 31.12.05 31.12.04 31.12.03 66 5 9 91 3 9 131 4 2 Related pre-tax gains (losses) recognized, including unrealized gains (losses) on retained interests, at the time of securiti- zation were as follows: CHF million Residential mortgage securitizations Commercial mortgage securitizations Other ﬁnancial asset securitizations Pre-tax gains / (losses) recognized 31.12.05 31.12.04 31.12.03 107 125 17 197 141 21 338 214 2 At 31 December 2005 and 2004, UBS retained CHF 1.7 billion and CHF 2.4 billion, respectively, in agency residential mort- gage securities, backed by the Government National Mortgage Association (GNMA), the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (FHLMC). The fair value of retained interests in resi- dential mortgage securities is generally determined using observable market prices. Retained non-investment grade interests in other residential mortgage, commercial mortgage and other securities were not material at 31 December 2005 and 2004. Note 34 Post-Balance Sheet Events There have been no material post-balance sheet events which would require disclosure or adjustment to the 31 December 2005 Financial Statements. On 2 March 2006, the Board of Directors reviewed the Financial Statements and authorized them for issue. These Financial Statements will be submitted to the Annual General Meeting of Shareholders to be held on 19 April 2006 for approval. 156 Note 35 Signiﬁcant Subsidiaries and Associates The legal entity group structure of UBS is designed to support the Group’s businesses within an efﬁcient legal, tax, regulatory and funding framework. Neither the Business Groups of UBS (namely Investment Bank, Global Wealth Management & Business Banking and Global Asset Management) nor Corporate Center are replicated in their own individual legal entities, but rather they generally operate out of UBS AG (Parent Bank) 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 control 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 ac- quisition, it is either not possible or not efﬁcient to operate out of the parent bank, then local subsidiary companies host the businesses. The signiﬁcant operating subsidiary companies in the Group are listed below: Share capital in millions Equity interest accumulated in % Signiﬁcant subsidiaries Company Banco UBS SA Crédit Industriel SA Etra SIM SpA Factors AG Noriba Bank BSC PaineWebber Capital Inc PT UBS Securities Indonesia Jurisdiction of incorporation Rio de Janeiro, Brazil Zurich, Switzerland Milan, Italy Zurich, Switzerland Manama, Bahrain Delaware, USA Jakarta, Indonesia Thesaurus Continentale Effekten-Gesellschaft in Zürich Zurich, Switzerland UBS (Bahamas) Ltd UBS (France) SA Nassau, Bahamas Paris, France Business Group 1 IB Global WM&BB Global WM&BB Global WM&BB Global WM&BB IB IB Global WM&BB Global WM&BB Global WM&BB UBS (Grand Cayman) Limited George Town, Cayman Islands IB 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 UBS Capital (Jersey) Ltd UBS Capital AG UBS Capital Americas Investments II LLC UBS Capital Americas Investments III Ltd UBS Capital Asia Paciﬁc Limited UBS Capital BV UBS Capital II LLC 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 St. Helier, Jersey Zurich, Switzerland Delaware, USA George Town, Cayman Islands George Town, Cayman Islands Amsterdam, the Netherlands Delaware, USA UBS Capital Latin America LDC George Town, Cayman Islands Global WM&BB Global WM&BB Global WM&BB Global AM IB Global AM IB Global WM&BB IB Global WM&BB Global WM&BB Global WM&BB IB IB IB IB IB IB IB IB IB UBS Capital LLC UBS Card Center AG UBS Commodities Canada Ltd. UBS Corporate Finance Italia SpA UBS Derivatives Hong Kong Limited UBS Deutschland AG Delaware, USA Glattbrugg, Switzerland Global WM&BB Toronto, Canada Milan, Italy Hong Kong, China IB IB IB Frankfurt am Main, Germany Global WM&BB BRL CHF EUR CHF USD USD IDR CHF USD EUR USD EUR CHF EUR JPY AUD USD USD USD AUD CAD USD EUR GBP CHF USD USD USD EUR USD USD USD CHF USD EUR HKD EUR 52.9 0.1 7.6 5.0 10.0 25.8 100,000.0 0.1 4.0 10.7 25.0 60.0 150.0 9.2 11,150.0 580.8 2 0.0 4,550.8 0.0 50.0 8.5 1,700.0 17.0 226.0 5.0 130.0 2 61.1 2 5.0 118.8 2 2.6 2 113.0 2 378.5 2 0.1 11.3 1.9 60.0 176.0 1 Global WM&BB: Global Wealth Management & Business Banking, Global AM: Global Asset Management, IB: Investment Bank, CC: Corporate Center. 2 Share capital and share premium. 100.0 100.0 100.0 100.0 100.0 100.0 98.4 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 157 Financial Statements Notes to the Financial Statements Note 35 Signiﬁcant Subsidiaries and Associates (continued) Signiﬁcant subsidiaries (continued) Company UBS Employee Beneﬁts Trust Limited UBS Energy LLC 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 Jurisdiction of incorporation St. Helier, Jersey Delaware, USA 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 Delaware, USA Luxembourg, Luxembourg Basel, Switzerland Basel, Switzerland George Town, Cayman Islands Dublin, Ireland Luxembourg, Luxembourg UBS Global Asset Management (Americas) Inc UBS Global Asset Management (Australia) Ltd UBS Global Asset Management (Canada) Co Delaware, USA Sydney, Australia Toronto, Canada UBS Global Asset Management (Deutschland) GmbH Frankfurt am Main, Germany Business Group 1 CC IB Global WM&BB Global WM&BB Global WM&BB CC CC IB Global WM&BB Global WM&BB Global WM&BB Global AM Global AM Global AM Global AM Global AM Global AM Global AM Global AM Global AM Global AM UBS Global Asset Management (France) SA Paris, France Global WM&BB 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) Ltd Singapore, Singapore Global AM Global AM Global AM Global AM Global AM Global AM Global AM Global WM&BB Global WM&BB Taipei, Taiwan Delaware, USA London, Great Britain Vaduz, Liechtenstein St. John, Canada Amsterdam, the Netherlands CC New York, USA Dublin, Ireland Global WM&BB Global WM&BB 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 UBS Investment Bank Nederland BV Amsterdam, the Netherlands IB UBS Investment Management Canada Inc UBS Italia SIM SpA UBS Leasing AG UBS Life AG UBS Life Insurance Company (USA) UBS Limited UBS Loan Finance LLC UBS Mortgage Holdings LLC UBS New Zealand Limited UBS O’Connor LLC UBS Portfolio LLC UBS Preferred Funding Company LLC I UBS Preferred Funding Company LLC II Toronto, Canada Milan, Italy Zurich, Switzerland Zurich, Switzerland California, USA London, Great Britain Delaware, USA Delaware, USA Global WM&BB IB Global WM&BB Global WM&BB Global WM&BB IB IB Global WM&BB Auckland, New Zealand IB Delaware, USA Delaware, USA Delaware, USA Delaware, USA Global AM IB CC CC Share capital in millions Equity interest accumulated in % CHF USD EUR EUR USD USD USD USD USD USD USD CHF CHF CHF USD EUR CHF USD AUD CAD EUR EUR HKD EUR JPY SGD TWD USD GBP CHF CAD EUR USD EUR EUR CAD EUR CHF CHF USD GBP USD USD NZD USD USD USD USD 0.0 0.0 62.2 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 1.3 2.5 0.0 8.0 117.0 7.7 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 10.8 0.0 15.1 10.0 25.0 39.3 2 29.4 16.7 0.0 7.5 1.0 0.1 0.0 0.0 100.0 100.0 100.0 100.0 99.6 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 1 Global WM&BB: Global Wealth Management & Business Banking, Global AM: Global Asset Management, IB: Investment Bank, CC: Corporate Center. 2 Share capital and share premium. 158 Note 35 Signiﬁcant Subsidiaries and Associates (continued) Signiﬁcant subsidiaries (continued) Company 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 Kapitalanlagegesellschaft mbH 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 Malaysia Sdn Bdn UBS Securities Philippines Inc UBS Securities Pte. Ltd. UBS Services USA LLC Jurisdiction of incorporation Delaware, USA Delaware, USA Delaware, USA Business Group 1 CC CC IB Melbourne, Australia Global WM&BB Delaware, USA Munich, Germany Delaware, USA Massachusetts, 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 Kuala Lumpur, Malaysia Makati City, Philippines Singapore, Singapore Delaware, USA IB Global AM IB Global AM IB IB IB IB IB IB IB IB IB IB IB IB IB IB IB IB Global WM&BB UBS South Africa (Proprietary) Limited Sandton, South Africa IB UBS Swiss Financial Advisers AG UBS Trust Company National Association UBS Trustees (Bahamas) Ltd UBS Trustees (Cayman) Ltd UBS Trustees (Jersey) Ltd UBS Trustees (Singapore) Ltd UBS UK Holding Limited UBS UK Properties Limited UBS Wealth Management (UK) Ltd 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 Zurich, Switzerland New York, USA Nassau, Bahamas Global WM&BB Global WM&BB Global WM&BB George Town, Cayman Islands Global WM&BB St. Helier, Jersey Singapore, Singapore London, Great Britain London, Great Britain London, Great Britain Baden, Switzerland Olten, Switzerland Milan, Italy Olten, Switzerland Schaffhausen, Switzerland Heidelberg, Germany Locarno, Switzerland Global WM&BB Global WM&BB IB IB Global WM&BB CC CC CC CC CC CC CC Share capital in millions Equity interest accumulated in % USD USD USD AUD USD EUR USD USD THB HKD AUD CAD EUR EUR HKD INR GBP JPY GBP KRW USD MYR PHP SGD USD ZAR CHF USD USD USD GBP SGD GBP GBP GBP CHF CHF EUR CHF CHF EUR CHF 0.0 0.0 0.1 53.9 0.3 7.5 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 75.0 150.0 90.0 0.0 87.1 2 1.5 5.0 2 2.0 2.0 0.0 3.3 5.0 100.0 2.5 253.0 303.6 20.0 30.0 0.4 25.0 27.5 100.0 100.0 100.0 100.0 100.0 51.0 100.0 100.0 100.0 100.0 100.0 50.0 100.0 100.0 100.0 75.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 55.6 33.0 32.3 33.0 24.7 33.0 19.6 1 Global WM&BB: Global Wealth Management & Business Banking, Global AM: Global Asset Management, IB: Investment Bank, CC: Corporate Center. wholly owned subsidiary controlled by Motor-Columbus which itself is only 55.6% owned by UBS. 2 Share capital and share premium. 3 Not 159 Financial Statements Notes to the Financial Statements Note 35 Signiﬁcant Subsidiaries and Associates (continued) Consolidated companies: changes in 2005 Signiﬁcant new companies Etra SIM SpA – Milan, Italy UBS Real Estate Kapitalanlagegesellschaft mbH – Munich, Germany UBS Swiss Financial Advisers AG – Zurich, Switzerland Deconsolidated companies Signiﬁcant deconsolidated companies Ehinger & Armand von Ernst AG – Zurich, Switzerland Ferrier Lullin & Cie SA – Geneva, Switzerland BDL Banco di Lugano – Lugano, Switzerland GAM Holding AG – Zurich, Switzerland UBS Investment Bank AG – Frankfurt am Main, Germany UBS Capital SpA – Milan, Italy Cantrade Private Bank Switzerland (CI) Limited – St. Helier, Jersey GAM Limited – Hamilton, Bermuda BDL Banco di Lugano (Singapore) Ltd – Singapore, Singapore SBC Wealth Management AG – Zug, 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 UBS Alpha Select - George Town, Cayman Islands UBS Alpha Hedge Fund - George Town, Cayman Islands UBS Currency Portfolio Ltd - George Town, Cayman Islands UBS Global Equity Arbitrage Ltd - George Town, Cayman Islands Azienda Energetica Municipale S.p.A. - Milan, Italy Chou Mitsui Private Equity Partners Investment Limited Partnership V - Tokyo, Japan ATR Acquisition LLC - Texas, USA Waterside Plaza Holdings LLC - Delaware, USA Reason for deconsolidation Sold Sold Sold Sold Merged Sold Sold Sold Sold Merged Industry Electricity Electricity Electricity Electricity Financial Financial Private Investment Company Private Investment Company Private Investment Company Private Investment Company Electricity Private Investment Company Manufacturing Real Estate Equity interest in % Share capital in millions 16 7 13 9 33 33 32 23 25 21 2 47 28 50 CHF CHF CHF CHF CHF CHF USD USD USD USD EUR 140 140 350 1 450 26 45 295 2 345 2 957 2 613 2 930 JPY 10,490 USD USD 273 119 1 Thereof paid in CHF 290 million. 2 For hedge funds net asset value instead of share capital. None of the above investments carries voting rights that are signiﬁcantly different from the proportion of shares held. 160 Note 36 Invested Assets and Net New Money Invested assets include all client assets managed by or de- posited with UBS for investment purposes only. Assets in- cluded 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 ac- counts. All assets held for purely transactional purposes and custody-only including corporate client assets held for cash management and transactional purposes are excluded, as the bank only administers the assets and does not offer ad- vice on how the assets should be invested. Also excluded are non-bankable assets (e. g. art collections) and deposits from third-party banks for funding or trading purposes. 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 ex- isting UBS clients. Net new money is calculated with the di- rect method, which is based on transaction level in- and out- ﬂows to/from invested assets at client level. Interest and div- idend income from invested assets is not included in the net new money result. Market and currency movements as well as fees and commissions are also excluded, as are the effects resulting from any acquisition or divestment of a UBS sub- sidiary or business. Interest expense on loans to clients results in net new money outﬂows. Reclassiﬁcations between in- vested assets and client assets as a result of a change in the service level delivered are treated as net new money ﬂow. Private Banks & GAM was sold on 2 December 2005. CHF billion Fund assets managed by UBS Discretionary assets Other invested assets Total invested assets thereof double count Net new money 31.12.05 31.12.04 390 716 1,546 2,652 332 148.5 354 570 1,293 2,217 294 89.9 161 Note 37 Business Combinations During 2005, UBS completed several acquisitions that were ac- counted for as business combinations. None of the acquisi- tions was individually signiﬁcant to the ﬁnancial statements, and therefore they are presented in aggregate for each of Financial Businesses and Industrial Holdings. Financial Businesses In 2005, Wealth Management completed the acquisitions of Julius Baer North America, Etra SIM S.p.A. (Etra) and Dresdner Bank Lateinamerika (DBLA). Julius Baer North America On 1 April 2005, UBS acquired the assets of Julius Baer's wealth management operations in North America, which also include certain related assets in Switzerland, for an aggregate consideration of approximately CHF 76 million. The business manages over USD 4 billion of client assets, including custo- dial assets, and employs approximately 50 staff in four loca- tions. These operations have been integrated to further strengthen UBS’s wealth management operations. Etra Effective 31 May 2005, UBS acquired Etra, an independent Italian ﬁnancial intermediary ﬁrm, for an aggregate consider- ation of approximately CHF 26 million. Etra serves wealthy pri- vate and institutional clients in Italy and manages approxi- mately EUR 400 million of client assets with 20 staff. The op- erations have subsequently been integrated into UBS’s Italian wealth management unit. Dresdner Bank Lateinamerika On 29 April 2005, UBS acquired wealth management opera- tions from Dresdner Bank Lateinamerika (DBLA) located in Hamburg, New York, Miami, Zurich and the Bahamas. The Hamburg activities represent approximately two thirds of DBLA's acquired business, while the remainder is spread over the other four locations. The cost of the acquisition was ap- proximately CHF 136 million, and resulted in the recognition of goodwill of approximately CHF 133 million. The acquired business managed invested assets from private clients of ap- proximately EUR 3.7 billion. The acquired business covers all important Latin American markets and strengthens UBS's po- sition as a provider of wealth management services for clients in that region. Global Asset Management – Siemens Real Estate Funds Effective 1 April 2005, UBS expanded its asset management activities in Germany by acquiring a 51% stake in the real es- tate investment management business of Siemens Kapital- anlagegesellschaft mbH (SKAG), a subsidiary of Siemens AG, the German engineering conglomerate. The purchase price was CHF 67 million, allocated to identiﬁed net assets at fair value of approximately CHF 10 million and goodwill of approx- imately CHF 57 million. The business comprises three open- end real estate funds with a total fund volume of approxi- mately EUR 2 billion (as at 31 December 2004) and has been integrated into the global real estate business, giving it access to Global Asset Management's established distribution net- work. The business was renamed UBS Real Estate Kapital- anlagegesellschaft mbH. Investment Bank – Prediction On 11 November 2005, UBS acquired the remaining 68.3% of Prediction LLC (Prediction), a ﬁnancial engineering and trad- ing software company located in Santa Fe, New Mexico, USA. UBS has owned a 31.7% minority stake in the company since 2000. The purchase is in line with UBS’s focus on technology and allows continuous operation and development of Prediction’s automated trading systems. Furthermore, UBS se- cures the know-how available at Prediction and the opportu- nity to leverage it across UBS. The purchase price of approxi- mately CHF 84 million was primarily allocated to intangible as- sets valued at approximately CHF 26 million and goodwill of approximately CHF 51 million. Details of assets and liabilities recognized from the acquisi- tions above are as follows: 162 Note 37 Business Combinations (continued) 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 2 2 35 0 1,092 1,131 18 0 1,022 1,040 91 1,131 43 0 0 327 0 370 0 6 2 8 362 370 45 2 35 327 1,092 1,501 18 6 1,024 1,048 453 1,501 Industrial Holdings On 1 July 2005, Motor-Columbus acquired Elektroline a.s., a service company active in the electricity business in the Czech Republic. The operations are small and are an entry base in the energy service market in that country. On 20 December 2005, Motor-Columbus acquired Morav- ske Teplarny a.s., a power generator in the Czech Republic, for a consideration of approximately CHF 108 million. The purchase price was predominantly allocated to the power sta- tion and fair value of net assets acquired was equal to the pur- chase price. No goodwill was recognized in this acquisition. The acquisition is a further step in expanding Motor- Columbus’s operations in Eastern Europe. Details of assets and liabilities recognized from the two ac- quisitions above are as follows: CHF million Assets Property and equipment Deferred tax assets 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 97 0 0 15 112 1 6 6 13 99 112 14 2 4 0 20 0 5 (4 ) 1 19 20 111 2 4 15 132 1 11 2 14 118 132 163 Financial Statements Notes to the Financial Statements Note 37 Business Combinations (continued) Business combinations completed in 2004 During 2004, UBS completed several acquisitions that were accounted for as business combinations. Except Motor- Columbus, which is discussed separately, none of the acqui- sitions was individually signiﬁcant to the ﬁnancial statements, and therefore, they are presented in aggregate 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 have 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 management services to high net worth investors and chari- ties. 75 client advisors looked after invested assets of approx- imately CHF 11.4 billion, which doubled the size of UBS’s wealth management operations in the United Kingdom. Scott Goodman Harris, with 28 employees, provides advice on pen- sion and retirement beneﬁt products, serving primarily exec- utives and company directors. Subsequent to the acquisition both ﬁrms have been integrated into the UBS wealth man- agement operations 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 two years. The aggregate purchase price for the ﬁve acquisitions is approximately 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 from the purchase price has been rec- ognized as goodwill. Details of assets and liabilities recognized 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 existing customer relationships of the businesses and have been assigned useful lives of twenty years, over which they will be amortized. 164 Note 37 Business Combinations (continued) Investment Bank In fourth quarter 2004, UBS acquired Charles Schwab SoundView Capital Markets, the Capital Markets Division of Charles Schwab Corp. (Schwab), for an aggregate cash con- sideration of approximately CHF 304 million. The business comprises equities trading and sales, including a third-party execution business, along with Schwab’s NASDAQ trading system. This business handles over 200 million shares a day in trade volume and makes a market in over 11,000 stocks. As part of the acquisition, UBS and Schwab have entered into multi-year execution service agreements for the hand- ling of Schwab’s equities and listed options orders. The busi- ness was integrated in the Equities business of the Investment Bank. Also in fourth quarter 2004, UBS acquired from Brunswick Capital their 50% stake in the equal partnership joint venture Brunswick UBS, an equity brokerage and trading, investment banking and custody joint venture in Russia. The total pur- chase price has been estimated at approximately CHF 203 mil- lion, of which UBS paid at closing a cash consideration to the sellers of CHF 113 million (USD 99 million), while the balance, which includes 20% of Brunswick UBS’s net proﬁts for 2005, is payable in 2005 and 2006. Formed in 1997, Brunswick UBS has developed a signiﬁcant franchise in the Russian securities market, employing 120 people in Moscow. UBS already con- solidated 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. Accordingly, a revision of the current purchase price estimate will be made, if necessary, once ﬁnal payments have been de- termined. 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 from 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 Equity attributable to minority interests Equity attributable to shareholders Total liabilities and equity Book value Step-up to fair value Fair value 21 20 99 37 0 361 538 0 364 364 40 134 538 133 (13 ) (2 ) (37 ) 336 (1 ) 416 23 32 55 (39 ) 400 416 154 7 97 0 336 360 954 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. 165 Financial Statements Notes to the Financial Statements Note 37 Business Combinations (continued) Notz Stucki In ﬁrst quarter 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 opera- tions 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 from the purchase price was recognized as goodwill. On 2 December 2005, the business was sold as part of Private Banks & GAM to Julius Baer. 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 inci- dental 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 approximate 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 ac- quisition of the 20% ownership interest as a business combi- nation. The purchase price was allocated to acquired net as- sets of approximately CHF 260 million and the difference of CHF 119 million from 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 basis 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 valua- tion basis, so that assets acquired and liabilities assumed are carried at full fair value. Details of assets, liabilities and minor- ity interests, for which a step-up to fair value was recognized in purchase accounting, and all other assets and liabilities rec- ognized 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 Equity attributable to minority interests Equity attributable to shareholders Total liabilities and equity 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 0 1,347 75 27 308 0 410 382 555 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 The CHF 75 million step-up to fair value of provision 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 additional minority interests, bringing the total minority interest as of the acquisition date to CHF 1,742 million. Useful economic lives of between 4 and 25 years have been assigned to amortizable and depreciable assets based on contractual lives, where applicable, or estimates of the pe- riod during which the assets will beneﬁt the operations. 166 Note 37 Business Combinations (continued) Pro-forma information (unaudited) The following pro-forma information shows UBS’s total operating income, net proﬁt and basic earnings per share as if all of the acquisitions completed in 2005 had been made as at 1 January 2005 and 2004, and all acquisitions completed in 2004 had been made as at 1 January 2004 and 2003. Adjustments have been made to reﬂect additional amortiza- tion 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) 31.12.05 51,069 14,043 13.95 For the year ended 31.12.04 46,336 8,044 7.81 31.12.03 39,536 6,277 5.62 Acquisitions announced in 2006 UBS Bunting Limited On 19 January 2006, UBS announced the proposed acquisi- tion of the 50% minority interest in its Canadian institutional securities subsidiary, UBS Bunting Limited. The purchase price will consist of a combination of cash and UBS stock totaling CAD 144 million (approximately CHF 157 million) plus up to an additional CAD 29 million (approximately CHF 32 million) depending on the performance of the acquired business post- closing in 2006 and 2007. The transaction is expected to close during the ﬁrst quarter of 2006 and is subject to shareholder and regulatory approvals. UBS currently owns a controlling stake of 50% in UBS Bunting Limited, with the remaining shares held by employees of its wholly owned operating sub- sidiary. Note 38 Discontinued Operations Private Banks & GAM On 2 December 2005, UBS sold its Private Banks & GAM unit to Julius Baer for an aggregate consideration of CHF 5,683 mil- lion, of which CHF 3,375 million was received in cash, CHF 225 million in the form of hybrid Tier 1 instruments, and the re- maining CHF 2,083 million representing a 21.5% stake in the enlarged Julius Baer. As part of the sales agreement, CHF 200 million of cash was retained within UBS. The gain on sale after taxes from this transaction amounts to CHF 3,705 million. As part of the agreement, UBS agreed to a lock-up period of 18 months for 19.9% of the stake and of three months for the remaining 1.6%. The value of the Julius Baer stake is based on a price of CHF 86.20 per share at the date of clos- ing, which is a discount of 8.4% to the market price to take into account the 18-month lock-up period to which 19.9% of the stake is subject. Shortly after closing, UBS reduced its 21.5% stake to approximately 20.7% by settling call options that were outstanding on the shares of the former holding company of the Private Banks & GAM businesses. UBS has agreed not to take a seat on Julius Baer’s board of directors or exercise any control or inﬂuence on its strategy or on its operational business decisions, and has no right to reg- ister its shares with voting rights for a period of 3 years, un- less speciﬁcally deﬁned events occur that could materially di- lute or otherwise affect UBS’s position as an investor in Julius Baer. In such an event, UBS has the option to register its shares with voting rights and thus obtain the possibility to vote them at shareholders’ meetings. Given the fact that the shares are not entered into Julius Baer’s share register with voting rights, UBS classiﬁed the stake as a ﬁnancial investment available-for- sale. Private Banks & GAM is presented as a discontinued oper- ation in these ﬁnancial statements. Private Banks & GAM comprised the three private banks Banco di Lugano, Ehinger & Armand von Ernst and Ferrier Lullin as well as specialist asset manager GAM and was presented as a separate busi- ness segment. Industrial Holdings In 2005, UBS sold four of its consolidated private equity in- vestments for an aggregate cash consideration of CHF 179 million. In 2004, UBS sold ﬁve of its consolidated private eq- uity investments for an aggregate cash consideration of CHF 141 million, while in 2003 one consolidated private equity in- vestment was sold for an aggregate cash consideration of CHF 456 million. These private equity investments were all held within the Industrial Holdings segment and were sold in line with UBS’s strategy to exit the private equity business. These investments are presented as discontinued operations in these Financial Statements. 167 Note 38 Discontinued Operations (continued) CHF million Operating income Operating expenses Proﬁt from operations before tax Pre-tax gain on sale Proﬁt from discontinued operations before tax Tax expense on proﬁt from operations Tax expense on gain on sale Tax expense from discontinued operations Net proﬁt from discontinued operations Net cash ﬂows from operating activities investing activities ﬁnancing activities CHF million Operating income Operating expenses Proﬁt from operations before tax Pre-tax gain on sale Proﬁt from discontinued operations before tax Tax expense on proﬁt from operations Tax expense on gain on sale Tax expense from discontinued operations Net proﬁt from discontinued operations Net cash ﬂows from operating activities investing activities ﬁnancing activities CHF million Operating income Operating expenses Proﬁt from operations before tax Pre-tax gain on sale Proﬁt from discontinued operations before tax Tax expense on proﬁt from operations Tax expense on gain on sale Tax expense from discontinued operations Net proﬁt from discontinued operations Net cash ﬂows from operating activities investing activities ﬁnancing activities 168 For the year ended 31.12.05 Private Banks & GAM Industrial Holdings 1,102 633 469 4,095 4,564 99 390 489 4,075 (143 ) (22 ) 0 975 967 8 116 124 9 0 9 115 41 (14 ) 1 For the year ended 31.12.04 Private Banks & GAM Industrial Holdings 1,086 690 396 0 396 97 0 97 299 (725 ) 30 3 1,890 1,818 72 68 140 32 0 32 108 5 (34 ) 44 For the year ended 31.12.03 Private Banks & GAM Industrial Holdings 882 662 220 0 220 52 0 52 168 2,348 135 (1 ) 2,136 2,071 65 194 259 27 0 27 232 103 (118 ) (3 ) Note 38 Discontinued Operations (continued) Motor-Columbus On 30 September 2005, UBS announced that it had signed agreements to sell its 55.6% stake in Motor-Columbus to a consortium of Atel's Swiss minority shareholders, EOS Holding and Atel, as well as to the French utility Electricité de France (EDF). The sale price has been set at CHF 1.3 billion, resulting in an estimated pre-tax gain for UBS of around CHF 350 million. The transaction must be approved by various na- tional and international authorities. Motor-Columbus continues to be presented as a continuing operation until it is highly probable that the conditions prece- dent, to which the sale is subject, will be met. At that time, Motor-Columbus will be presented as a discontinued opera- tion in the Financial Statements. Note 39 Currency Translation Rates The following table shows the principal rates used to translate the ﬁnancial statements of foreign entities into Swiss francs: 1 USD 1 EUR 1 GBP 100 JPY Spot rate As at Average rate Year ended 31.12.05 31.12.04 31.12.05 31.12.04 31.12.03 1.31 1.56 2.26 1.11 1.14 1.55 2.19 1.11 1.25 1.55 2.27 1.13 1.24 1.54 2.27 1.15 1.34 1.54 2.20 1.16 169 Financial Statements Notes to the Financial Statements 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, all entities which are directly or indirectly con- trolled by the Group are consolidated. 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. 2. Financial investments Under IFRS, available-for-sale ﬁnancial investments are carried at fair value. Changes in fair value are recorded directly in Equity until an investment is sold, collected or otherwise dis- posed 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 recog- nized in Equity is included in net proﬁt or loss for the period. On disposal of a ﬁnancial investment, the difference between the net disposal proceeds and the carrying amount plus any attributable unrealized gain or loss balance recognized in 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 below 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. Under IFRS, when hedge accounting is applied for these in- struments, the unrealized gain or loss on the effective portion of the derivatives is recorded in Equity until the hedged cash ﬂows occur, at which time the accumulated gain or loss is re- alized 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, investment properties are carried at the lower of cost less accumulated depreciation or market value. Depreciation on investment properties is continued until a sale is executed. 5. Fair value option Under IFRS, the Group applies the fair value option to com- pound instruments issued. As a result the embedded deriva- tive as well as the host contract related to the compound instrument are marked to market. Under Swiss law, the fair value option is not available. Compound instruments are bifurcated: while the embedded derivative is marked to market, the host contract is accounted for on an accrued cost basis. 6. Goodwill and intangible assets 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 busi- ness 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. 7. Discontinued operations Under certain conditions, IFRS requires that non-current as- sets or disposal groups are classiﬁed as held for sale. Disposal groups that meet the criteria of discontinued operations are presented in the income statement in a single line as net in- come from discontinued operations. Under Swiss law, no such reclassiﬁcations take place. 170 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 Accounting Principles (“US GAAP”). The following is a sum- mary of the relevant signiﬁcant accounting and valuation dif- ferences between IFRS and US GAAP. a. Purchase accounting (merger of Union Bank of Switzerland and Swiss Bank Corporation) 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 value 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 Intangible Assets. SFAS 141 requires reclassiﬁcation of intangible 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. Identiﬁable intangible assets with ﬁnite lives will continue to be amortized. Upon adoption, the amortization charges related to the 1998 busi- ness combination of Union Bank of Switzerland and Swiss Bank Corporation ceased to be recorded under US GAAP. In 2005 and 2004, goodwill recorded under US GAAP was reduced by CHF 67 million and CHF 78 million respectively, due to recognition of deferred tax assets of Swiss Bank Corporation which had previously been subject to valuation reserves. Other purchase accounting adjustments The restatement of Swiss Bank Corporation’s net assets to fair value in 1998 resulted in decreasing net tangible assets by CHF 1,077 million for US GAAP. This amount is being amor- tized over periods ranging from two years to 20 years. b. Goodwill With the adoption of IFRS 3 Business Combinations on 31 March 2004, UBS ceased amortizing goodwill on 1 January 2005 for all goodwill existing before 31 March 2004. Goodwill is now subject to an annual impairment test as it is under US GAAP and is no longer amortized under both sets of stan- dards. Goodwill from business combinations entered into on or after 31 March 2004 was already accounted for under the provisions of IFRS 3, and no goodwill amortization was recorded for these transactions under IFRS or US GAAP. An IFRS to US GAAP difference remains on the balance sheet due to the fact that US GAAP goodwill amortization ceased on 1 January 2002 and IFRS goodwill amortization ceased on 31 December 2004. This difference was reduced during 2005 due to the sale of GAM on 2 December 2005. In addition on 31 March 2004, UBS adopted revised IAS 38 Intangible Assets. Under the revised standard, intan- gible assets acquired in a business combination must be rec- ognized separately from goodwill if they meet deﬁned recog- nition criteria. Existing intangible assets that do not meet the recognition criteria have to be reclassiﬁed to goodwill. On 1 January 2005, UBS reclassiﬁed the trained workforce in- tangible asset recognized in connection with the acquisi- tion of PaineWebber with a book value of CHF 1.0 billion to Goodwill. Under US GAAP, this asset was reclassiﬁed from Intangible assets to Goodwill on 1 January 2002 with the adoption of SFAS 142 Goodwill and Other Intangible Assets. 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 acquired at the acquisition date. In most cases, minority in- 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) (continued) Note 41.1 Valuation and Income Recognition Differences between IFRS and US GAAP (continued) terests 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 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 assets 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 derivative instruments are then used to hedge the estimated future cash ﬂows against repricing risk. SFAS 133 does not permit 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 in- come. In addition to the above, a new hedge methodology, fair value hedge of portfolio interest rate risk, has been imple- mented for a speciﬁc portfolio of mortgage loans. This new hedging method is not recognized under US GAAP and there- fore, the fair value change of hedged items recorded sepa- rately from the hedged items on the balance sheet under IFRS is reversed to Net trading income under US GAAP. 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 ac- counting for ﬁnancial investments available-for-sale: 1) Non- marketable equity ﬁnancial investments (excluding private equity investments discussed in the next section), which are classiﬁed as available-for-sale and carried at fair value under IFRS, continue to be carried at cost less “other than tempo- rary” impairments under US GAAP. The opening adjustment and subsequent changes in fair value recorded directly in 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 through proﬁt under IFRS if the value of the impaired assets increases. Such reversals of impairment writedowns are not allowed under US GAAP. Reversals under IFRS were not signiﬁcant in 2005, 2004 or 2003. 3) Private equity investments, as de- scribed in the next section. Private equity investments On 1 January 2005, UBS adopted revised IAS 27 Consolidated and Separate Financial Statements and revised IAS 28 Invest- ments in Associates. The comparative periods for 2004 and 2003 were restated. The adoption of these standards had an impact on the accounting for private equity investments. Previously under IFRS, such investments were classiﬁed as Financial investments available-for-sale with changes in fair value recorded directly in Equity. The effect of adopting these standards is that private equity investments in which UBS owns a controlling interest are now consolidated and those where UBS has signiﬁcant inﬂuence are accounted for as as- sociated companies using the equity method of accounting. The remaining private equity investments continue to be ac- counted for as Financial investments available-for-sale. Under US GAAP, private equity investments held within separate investment subsidiaries are accounted for in accor- dance with the AICPA Audit and Accounting Guide, Audits of Investment Companies. They are recorded on a separate line on the US GAAP Balance sheet and are accounted for at fair value with changes in fair value recorded in Net proﬁt. The re- maining private equity investments held by UBS are ac- counted for at cost less “other than temporary” impairment. The effects on the IFRS to US GAAP reconciliation are as follows: 1) Private equity investments consolidated under IFRS are de-consolidated under US GAAP and are either recorded at fair value or at cost less “other than temporary” impair- ment as described in the previous paragraph. 2) The equity method accounting adjustment for those private equity in- vestments accounted for as associated companies under IFRS is reversed for US GAAP. The asset on the US GAAP Balance sheet is reclassiﬁed from Investments in associates accounted for under the equity method to Private equity investments ac- counted for at fair value through net proﬁt or at cost less “other than temporary“ impairment as described in the pre- vious paragraph. 3) Those remaining private equity invest- 172 Note 41 Reconciliation of International Financial Reporting Standards (IFRS) to United States Generally Accepted Accounting Principles (US GAAP) (continued) Note 41.1 Valuation and Income Recognition Differences between IFRS and US GAAP (continued) ments still accounted for as Financial investments available- for-sale with changes in fair value recorded directly in Equity are reclassiﬁed to the line Private equity investments on the US GAAP balance sheet and are recorded either at fair value through net proﬁt or cost less “other than temporary” impair- ment as described in the previous paragraph. See Note 2 for information regarding impairment charges Under US GAAP, expenses and liabilities for post-retire- ment medical and life insurance beneﬁts are determined under the same methodology as under IFRS. Differences in the levels of expenses and liabilities have occurred due to dif- ferent transition date rules and the treatment of the merger of Union Bank of Switzerland and Swiss Bank Corporation under the purchase method. recorded for ﬁnancial investments. 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 current value of accrued beneﬁts without allowance for fu- ture salary increases), an additional minimum liability must be shown in the balance sheet. If an additional minimum liabil- ity 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 comprehensive income. The addi- tional minimum liability required under US GAAP amounts to CHF 1,252 million, CHF 1,125 million and CHF 306 million as at 31 December 2005, 2004 and 2003, respectively. The amount recognized in Other comprehensive income before tax was CHF 1,252 million, CHF 1,125 million and CHF 306 million as at 31 December 2005, 2004 and 2003, 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. h. Equity participation plans On 1 January 2005, UBS adopted IFRS 2 Share-based payment which requires that the fair value of all share-based payments made to employees be recognized as compensation expense from the date of grant over the service period, which is gen- erally equal to the vesting period. UBS applied IFRS 2 on a ret- rospective application basis and restated its 2003 and 2004 comparative prior periods for all awards that impact income statements commencing 2003. UBS recorded an opening re- tained earnings adjustment on 1 January 2003 to reﬂect the cumulative income statement effects of prior periods. See Note 1aa) for details. Previously under IFRS, option awards were expensed at their intrinsic value which is generally zero as options are normally granted at or out of the money. Shares were recognized as compensation expense in full in the per- formance year, which is generally the year prior to grant. On 1 January 2005, UBS also adopted SFAS 123 (revised 2004), Share-Based Payment, (SFAS 123-R). SFAS 123-R, like IFRS 2, also requires that share-based payments to em- ployees be recognized in the income statement over the requisite service period based on their fair values at the date of grant. The requisite service period is deﬁned as the period that the employee is required to provide active employment in order to earn their award. This may be different from the service period under IFRS, which is generally equal to the vesting period. UBS adopted SFAS 123-R using the modiﬁed prospective method. Prior periods were not restated. Under this method, compensation cost for the portion of awards for which the service period has not been rendered and that are outstand- ing (unvested) as of the effective date shall be recognized as the service is rendered on or after the effective date. As such, to the extent that the grant date fair value of shares or options has been previously recognized in the income statement or disclosed in the notes to the ﬁnancial statements, it should not be re-recognized upon adoption of SFAS 123-R. Prior to the adoption of SFAS 123-R, UBS recognized the fair value of share awards granted as part of annual bonuses in the year of corresponding performance, in alignment with the revenue produced. For disclosure purposes, UBS recognized the fair value of option awards on the date of grant. Thus, for recog- 173 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) (continued) Note 41.1 Valuation and Income Recognition Differences between IFRS and US GAAP (continued) nition 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. Prior to 1 January 2005, UBS applied the intrinsic value method under APB 25 which was similar to the previous IFRS treatment except that certain share and option plans were deemed variable under US GAAP. Changes in intrinsic value for these variable plans were recorded in US GAAP Net proﬁt. Due to the fact that IFRS 2 was applied on a retrospective basis and SFAS 123-R was applied on a modiﬁed prospective basis, for the IFRS to US GAAP reconciliation, the opening IFRS re- tained earnings adjustment on 1 January 2003 and subse- quent IFRS 2 restatement adjustments were reversed and only the awards required to be expensed were recorded in the 2005 US GAAP Financial Statements. Future awards will be recognized over the requisite service periods, which are de- termined by the terms of the award. In addition, under the transition provisions of SFAS 123-R, a cumulative adjustment of CHF 38 million expense reversal, net of tax, was recorded in US GAAP Net proﬁt on 1 January 2005. The adjustment mainly relates to the required recognition of es- timated forfeitures of share-based compensation awards under SFAS 123-R. The standard requires that expense be recognized only for those instruments where the requisite service is per- formed. During the service period, compensation cost recog- nized is based on the estimated number of instruments for which the requisite service is expected to be rendered. That es- timate is revised if subsequent information indicates that the actual number is likely to differ from previous estimates. Under SFAS 123-R, entities are required to continue to pro- vide pro-forma disclosures for the periods in which the fair value method of accounting for share-based compensation was not applied. See Note 42.5 for further information. Certain UBS awards contain provisions that permit the employee to leave the bank and continue to vest in the award provided they do not perform certain harmful acts against the bank. These are generally referred to as non-compete provi- sions. Under SFAS 123R, awards with non-compete provisions generally do not impose a requisite service period, and there- fore expense should be recognized upon grant. UBS has de- termined that the appropriate expense recognition period for such awards is the performance year, which is generally the period prior to grant. This is consistent with the approach ap- plied under APB 25. Compensation expense for awards with non-compete provisions is generally recognized over the vest- ing period under IFRS. Certain UBS awards contain provisions that permit the employee to retire, provided they meet certain eligibility con- ditions and continue to vest in their award. Under US GAAP, compensation expense for such awards must be recognized over the period from grant until the employee reaches retire- ment eligibility. Under IFRS 2 such awards are generally rec- ognized over the vesting period, with an acceleration of ex- pense at the actual retirement date. UBS also has employee beneﬁt trusts that are used in connection with share-based payment arrangements and deferred compensation plans. In connection with the issuance of IFRS 2, the IFRIC amended SIC 12 Consolidation – Special Purpose Entities, an interpretation of IAS 27, to eliminate the scope exclusion for equity compensation plans. Therefore, pursuant to the criteria set out in SIC 12, an entity that con- trols an employee beneﬁt trust (or similar entity) set up for the purposes of share-based payment arrangements will be re- quired to consolidate that trust. UBS consolidated such em- ployee beneﬁt trusts retrospectively to 1January 2003. For fur- ther details on the restatement, see Note 1aa). Under US GAAP prior to 1 January 2004, certain equity compensation trusts were already consolidated under US GAAP under the provisions of EITF-97-14, Accounting for Deferred Compen- sation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested. With the adoption of FASB Inter- pretation No. 46 Consolidation of Variable Interest Entities (revised December 2003), an interpretation of Accounting Research Bulletin No. 51 (FIN 46-R), on 1 January 2004, the remaining unconsolidated employee equity compensation trusts formed before 1 February 2003 were consolidated for US GAAP purposes for the ﬁrst time. Thus, from 1 January 2004 onwards, there is no difference between IFRS and US GAAP in regard to these trust consolidations. For 2003, the trust consolidations under IFRS only are shown in Note 41.3 in line i – Consolidation of Variable Interest Entities (VIEs) and deconsolidation of entities issuing preferred securities. With the consolidation of the additional trusts under FIN 46-R from 1 January 2004, UBS re-evaluated its account- ing for share-based compensation plans under APB 25 by taking into consideration the settlement methods and activi- ties of the trusts. Based on this review, most share plans is- sued prior to 2001 were 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. Under IFRS, UBS recognizes an obligation and related ex- pense for payroll taxes related to share-based payment trans- actions over the period that the related compensation ex- pense is recognized. This is generally the vesting period. US GAAP requires recognition of the liability on the date that the measurement of any payment of the tax to the taxing author- ity is triggered. This is generally the distribution date for share awards and the exercise date of options. 174 Note 41 Reconciliation of International Financial Reporting Standards (IFRS) to United States Generally Accepted Accounting Principles (US GAAP) (continued) Note 41.1 Valuation and Income Recognition Differences between IFRS and US GAAP (continued) i. Consolidation of Variable Interest Entities (VIEs) and deconsolidation of entities issuing preferred securities IFRS and US GAAP generally require consolidation of entities on the basis of controlling a majority of voting rights. However, in certain situations, there are no voting rights, or control of a majority of voting rights is not a reliable indicator of the need to consolidate, such as when voting rights are signiﬁcantly dis- proportionate to risks and rewards. There are differences in the approach of IFRS and US GAAP to those situations. Under IFRS, when control is exercised through means other than controlling a majority of voting rights, the consolidation 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 Interest 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 signiﬁ- cantly from economic interests, an entity is considered to be a “Variable Interest Entity” (“VIE”). An enterprise holding variable interests that will absorb a majority of a VIE’s “ex- pected losses”, receive a majority of a VIE’s “expected resid- ual returns”, or both, is known as the “primary beneﬁciary”, and must consolidate the VIE. Since 1 January 2004 UBS has fully applied FIN 46-R con- solidation requirements to its US GAAP Financial Statements. Until 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 differences. The entities consolidated for US GAAP purposes at 31 December 2005, which were not otherwise consolidated in UBS’s primary consolidated Financial Statements under IFRS, are mostly investment fund products and securitization VIEs. These are discussed in more detail in Note 42.1. The entities not consolidated for US GAAP purposes at 31 December 2005, which UBS consolidates under IFRS, are cer- tain entities which have issued preferred securities. Under IFRS these are equity instruments held by third parties and are treated as minority interests, with dividends paid also reported in Equity attributable to minority interests; the UBS-issued debt held by these entities and the respective interest amounts are eliminated in the UBS Group Financial Statements. Under US GAAP, these entities are not consolidated, and the UBS-is- sued debt is recognized as a liability in the UBS Group Financial Statements, with interest paid reported in interest expense. A discussion of FIN 46-R measurement requirements and disclosures is set out in Note 42.1. j. Financial assets and liabilities designated 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 compound instruments, con- sisting of a debt host with an embedded derivative. Regular debt instruments as well as compound instruments are car- ried in their entirety 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 compound instruments are separated from the debt hosts and accounted for as if they were freestanding derivatives. k. 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 op- tions on UBS shares changed. Previously, such put options were accounted for as derivatives whereas now the present value of the contractual amount is recorded as a liability, while the premium received is credited to equity. Subsequently, the liability is accreted over the life of the put option to its contractual 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 op- tions with the UBS share as underlying, are treated as deriva- tive instruments under both sets of accounting standards. l. Investment properties From 1 January 2004, UBS changed its accounting for invest- ment 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 depre- ciation is no longer recognized. Under US GAAP, investment properties continue to be carried at cost less accumulated de- preciation. 175 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) (continued) Note 41.2 Recently Issued US Accounting Standards 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). Further information on the impact of the adoption of SFAS 123-R can be found in Note 41.1. h. In March 2005, the SEC Staff issued Staff Accounting Bulletin No. 107, Share-Based Payment (SAB 107). SAB 107 expresses the SEC Staff’s views on certain aspects of SFAS 123-R and certain SEC rules and regulations including the types of valuation methods and associated inputs. SAB 107 outlines that a valuation technique should be applied in a manner consistent with the fair value measurement objectives and other requirements of SFAS 123-R, based on established principles of ﬁnancial economic theory, and reﬂect all sub- stantive characteristics of the instrument. SAB 107 did not have a material impact on UBS’s Financial Statements. Further information on the impact of the adoption of SFAS 123-R can be found in Note 41.1. h. In June 2005, the FASB ratiﬁed the consensus on EITF Issue No. 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights (EITF 04-5), which provides guidance in determining whether a general partner controls a limited partnership. EITF 04-5 provides that the general partner in a limited partner- ship is presumed to control that limited partnership unless the limited partners have either substantive kick-out rights or substantive participating rights. EITF 04-5 is effective after 29 June 2005 for new limited partnership agreements and for pre-existing limited partnership agreements that are modi- ﬁed; otherwise, effective no later than the beginning of the ﬁrst reporting period in ﬁscal years beginning after 15 December 2005. The adoption of EITF 04-05 is not expected to have a material impact on UBS's Financial Statements. Recently issued US accounting standards not yet adopted In May 2005, the FASB issued Statement No. 154, Accounting Changes and Error Corrections – a Replacement of APB Opinion No. 20 and FASB Statement No. 3 (Statement 154), which changes the requirements for the accounting and re- porting of a change in accounting principle. Statement 154 applies to all voluntary changes in accounting principle as well as to changes required by an accounting pronouncement that does not include speciﬁc transition provisions. Statement 154 requires retrospective application to prior periods’ ﬁnancial statements of a voluntary change in accounting principle un- less it is impracticable, whereas Opinion 20 previously required that the cumulative effect of most voluntary changes in ac- counting principle be recognized in the net income of the pe- riod of the change. Statement 154 is effective for accounting changes and corrections of errors made in ﬁscal years begin- ning after 15 December 2005. Statement 154 is not expected to have a material impact on UBS’s Financial Statements. In February 2006, the FASB issued Statement of Financial Accounting Standard No. 155, Accounting for Certain Hybrid Instruments (Statement 155), an amendment of FASB State- ments No. 133 and 140. Statement 155 permits UBS to elect to measure any hybrid ﬁnancial instrument at fair value, with changes in fair value recognized in Net proﬁt, if the hybrid in- strument contains an embedded derivative that would other- wise require bifurcation under Statement 133. The election to measure the hybrid instrument at fair value is made on an in- strument by instrument basis and is irreversible. Statement 155 is effective after the beginning of an en- tity’s ﬁrst ﬁscal year that begins after 15 September 2006, un- less it is applied as at the beginning of an entity’s ﬁscal year a year earlier. UBS has not yet decided whether it will early adopt Statement 155 as at 1 January 2006 nor whether it will make use of the fair value option for hybrid ﬁnancial instru- ments where it currently applies the fair value option provided in IAS 39. UBS is still assessing the impact of Statement 155. 176 Note 41.3 Reconciliation of IFRS Equity Attributable to UBS Shareholders to US GAAP Shareholders’ Equity and IFRS Net Proﬁt Attributable to UBS Shareholders to US GAAP Net Proﬁt Equity attributable to UBS shareholders (IFRS) / Shareholders’equity (US GAAP) as at Net proﬁt attributable to UBS shareholders (IFRS) / Net proﬁt (US GAAP) for the year ended 31.12.05 31.12.04 31.12.05 31.12.04 31.12.03 44,324 33,941 14,029 8,016 5,904 Note 41.1 Reference a b c d e f g h i j k l 15,116 2,373 15,152 2,603 (86) (40) 325 230 (1) (792) (98) (197) 131 (8) 74 (876) (88 ) (75 ) 605 372 (1 ) 86 47 197 93 (8 ) (50 ) (206 ) 16,151 60,475 18,727 52,668 (36) 0 35 (455) (486) (18) 0 358 0 (436) 8 0 (118) (529) (1,677) 12,352 (44 ) 778 3 (217 ) 217 (110 ) 0 62 18 100 9 14 (50 ) 22 802 8,818 (89 ) 808 0 188 (243 ) (235 ) 0 267 (10 ) 78 5 88 0 (248 ) 609 6,513 CHF million Amounts determined in accordance with IFRS Adjustments in respect of: SBC purchase accounting goodwill and other purchase accounting adjustments Goodwill 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 Consolidation of variable interest entities (VIEs) and deconsolidation of entities issuing preferred securities Financial assets and liabilities designated 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 Under both IFRS and US GAAP, basic earnings per share (“EPS”) is computed by dividing income available to common share- holders 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 2005, 31 December 2004 and 31 December 2003 are presented in the following table. For the year ended 31.12.05 31.12.04 31.12.03 Net proﬁt (US GAAP) / Net proﬁt attributable to UBS share- holders (IFRS) – available for ordinary shares (CHF million) from continuing operations from discontinued operations Net proﬁt (US GAAP) / Net proﬁt attributable to UBS shareholders – for diluted EPS (CHF million) from continuing operations from discontinued operations US GAAP IFRS US GAAP IFRS US GAAP 12,352 8,499 3,853 12,330 8,500 3,830 14,029 9,844 4,185 14,007 9,845 4,162 8,818 8,446 372 8,813 8,449 364 8,016 7,609 407 8,011 7,612 399 6,513 6,263 250 6,514 6,264 250 IFRS 5,904 5,510 394 5,905 5,511 394 Weighted-average shares outstanding 1,006,929,991 1,006,993,877 1,029,895,610 1,029,918,463 1,116,602,289 1,086,161,476 Diluted weighted-average shares outstanding 1,048,595,770 1,048,595,770 1,081,961,360 1,081,961,360 1,138,800,625 1,138,800,625 Basic earnings per share (CHF) from continuing operations from discontinued operations Diluted earnings per share (CHF) from continuing operations from discontinued operations 12.27 8.44 3.83 11.76 8.11 3.65 13.93 9.78 4.15 13.36 9.39 3.97 8.56 8.20 0.36 8.15 7.81 0.34 7.78 7.39 0.39 7.40 7.04 0.36 5.83 5.61 0.22 5.72 5.50 0.22 5.44 5.07 0.37 5.19 4.84 0.35 177 Financial Statements Notes to the Financial Statements 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 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 accordance with US GAAP. The following is a summary of presentation differences that relate to the basic IFRS Financial Statements. 1. Settlement date vs. trade date accounting UBS’s transactions from securities activities are recorded under IFRS on the settlement date. This results in recording a forward transaction during the period between the trade date and the settlement date. Forward positions relating to trading activities are revalued to fair value and any unrealized proﬁts 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. 2. Financial investments Under IFRS, UBS’s private equity investments and non-mar- ketable equity ﬁnancial investments are included in Financial investments available-for-sale. For US GAAP presentation, non-marketable equity ﬁnancial investments are reclassiﬁed to Other assets, and private equity investments accounted for under the AICPA Audit and Accounting Guide, Audits of Investment Companies or accounted for at cost less “other than temporary” impairment are shown separately on the balance sheet. 3. Securities received as collateral 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 obligation to return them. These securities are reﬂected on the US GAAP balance sheet in the line Securities received as collateral on the asset side of the balance sheet. The offset- ting liability is presented in the line Obligation to return secu- rities received as collateral. 4. Reverse repurchase, repurchase, securities borrowing and securities lending transactions UBS enters into certain types of reverse repurchase, repur- chase, securities borrowing and securities lending transactions that result in a difference between IFRS and US GAAP. Under IFRS, they are considered ﬁnancing transactions which do not result in the recognition of the borrowed ﬁnancial assets or derecognition of the ﬁnancial assets lent. The cash collateral received or delivered in such transactions is reﬂected in the bal- ance sheet with a corresponding receivable or obligation to re- turn it. Under US GAAP, however, certain transactions are considered purchase and sale transactions due to the fact that the contracts do not meet speciﬁc collateral or margining re- quirements or the repurchase of the transferred securities is not before maturity of these securities. Due to the different treatment of these transactions under IFRS and US GAAP, in- terest income and expense recorded under IFRS must be reclas- siﬁed to Net trading income for US GAAP. Additionally under US GAAP, the securities received are recognized on the balance sheet as a spot purchase (Trading portfolio assets or Trading portfolio assets pledged as collateral) with a corresponding forward sale transaction (Replacement values) and a receivable (Cash collateral on securities borrowed) is reclassiﬁed, as ap- plicable. The securities delivered are recorded as a spot sale, which means that the securities are derecognized if they are on-balance sheet securities or recorded as a short sale if the delivered securities are off-balance sheet securities (Trading portfolio liabilities). Additionally, a corresponding forward re- purchase transaction (Replacement values) and a liability (Cash collateral on securities lent) is reclassiﬁed, as applicable. 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 contractual rights to the cash ﬂows and no longer retains any risk or re- ward coming from them nor maintains control over the ﬁnan- cial assets. The provisions of this guidance were applied pros- pectively from 1 January 2004. As a result of the new require- ments, certain transactions are now accounted for as secured ﬁnancing transactions instead of purchases or sales of trad- ing portfolio assets with an accompanying swap derivative. Under US GAAP, these transactions continue to be shown as purchases and sales of trading portfolio assets and were re- classiﬁed accordingly. 178 Note 41.6 Consolidated Income Statement The following is a Consolidated Income Statement of the Group, for the years ended 31 December 2005, 31 December 2004 and 31 December 2003, restated to reﬂect the impact of valuation and income recognition differences and presentation dif- ferences between IFRS and US GAAP. CHF million, for the year ended 31.12.05 31.12.04 31.12.03 Reference US GAAP IFRS US GAAP IFRS US GAAP IFRS 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 Revenues 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 from continuing operations before tax Tax expense Minority interests (US GAAP) Net proﬁt from continuing operations Net proﬁt from discontinued operations Net proﬁt (IFRS) Net proﬁt attributable to minority interests (IFRS) Cumulative adjustment due to the adoption of SFAS123 (revised 2004), “Share-Based Payment” on 1 January 2005, net of tax Cumulative adjustment of accounting for certain equity- based compensation plans as cash settled, net of tax Net proﬁt (US GAAP) / Net proﬁt attributable to UBS shareholders (IFRS) a, d, e, i, j, 1, 4, 5 59,039 59,286 a, c, d,e, i, j, k,1, 4, 5 (49,588) (49,758) e e d, e, i, j, k, 4 c, e, i e 9,451 375 9,826 9,528 375 9,903 21,436 21,436 6,864 793 8,674 47,593 7,996 1,125 10,515 50,975 e, f, g, h 20,220 21,049 7,047 1,493 0 334 8,003 37,926 13,049 2,549 10,500 4,190 14,690 (661) 6,667 1,414 0 201 7,142 35,644 11,949 3,078 (410) 8,461 3,853 38 c, e a, c, e b b, c, e e c, e, i c, e, i h h 38,991 (27,245 ) 11,746 334 12,080 18,435 4,795 1,180 3,648 39,228 (27,484 ) 11,744 241 11,985 18,506 4,902 932 6,086 39,802 (27,628 ) 12,174 (74 ) 12,100 16,606 3,944 382 40,045 (27,784 ) 12,261 (102 ) 12,159 16,673 3,670 225 2,900 40,138 42,411 33,032 35,627 17,234 5,917 1,368 0 110 0 24,629 8,403 1,790 (350) 6,263 250 18,612 7,160 1,477 653 337 3,885 32,124 10,287 2,224 8,063 407 8,470 (454 ) 18,218 6,630 1,498 703 193 1,113 28,355 7,272 1,419 5,853 400 6,253 (349 ) 18,297 6,545 1,365 0 180 2,861 29,248 10,890 2,015 (435 ) 8,440 372 6 12,352 14,029 8,818 8,016 6,513 5,904 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. 179 Financial Statements Notes to the Financial Statements Note 41.7 Condensed Consolidated Balance Sheet The following is a Condensed Consolidated Balance Sheet of the Group, as at 31 December 2005 and 31 December 2004, 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 (US GAAP) / Equity attributable to UBS shareholders (IFRS) Total equity (IFRS) Reference US GAAP IFRS US GAAP IFRS 31.12.05 31.12.04 e, i, j, 1, 5 4 e, i, j, 1, 4, 5 5 i, j, 1, 4, 5 j a, e, j, 1, 5 e, j, 2 3 e, i, j c, e a, c, e, l a, b, e b, c, e e, 2 5,359 33,427 274,099 404,432 607,432 152,237 337,409 267,530 3,407 67,430 8,853 2,554 9,282 28,104 1,665 2,210 5,359 33,644 300,331 404,432 499,297 154,759 333,782 1,153 269,969 6,551 8,918 2,956 9,423 11,313 2,173 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 35,419 220,242 357,164 389,487 159,115 284,577 653 232,167 4,188 6,309 2,675 9,510 8,865 3,336 c, d, e, f, h, i, j, 1, 2, 5 116,831 2,322,261 16,190 2,060,250 101,068 1,903,186 17,375 1,737,118 e, j, 1, 5 4 i, 4 i, j, 1, 4 3 i, j, k, 1, 4 i, j e, i, j, 1, 5 e, i, j a, c, e, i, 1 c, d, e, f, g, h, i, j, k, 1 c, e, i 127,252 66,916 482,843 193,965 67,430 432,171 466,410 18,707 240,212 163,872 124,328 77,267 478,508 188,631 337,663 117,401 451,533 18,392 160,710 53,874 119,021 57,792 423,513 190,907 12,950 360,345 386,913 14,830 164,744 117,743 120,026 61,545 422,587 171,033 303,712 65,756 376,076 15,040 117,856 44,120 2,259,778 2,008,307 1,848,758 1,697,751 2,008 60,475 7,619 44,324 51,943 1,760 52,668 5,426 33,941 39,367 Total liabilities, minority interests and shareholders’ equity 2,322,261 2,060,250 1,903,186 1,737,118 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. 180 Note 41.8 Comprehensive Income Comprehensive income under US GAAP is deﬁned as the C change in shareholders’ equity excluding transactions with shareholders. Comprehensive income has two major compo- nents: 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 des- ignated as cash ﬂow hedges and additional minimum pension liability. The components and accumulated other compre- hensive income amounts on a US GAAP basis for the years ended 31 December 2005, 31 December 2004 and 31 December 2003 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 (849) 263 (3) (1,223) 131 (1,681) CHF million Balance at 1 January 2003 Net proﬁt Other comprehensive income: Foreign currency translation Net unrealized gains / (losses) on available-for-sale investments Impairment charges reclassiﬁed to the income statement Reclassiﬁcation of (gains) / losses on available-for-sale investments realized in net proﬁt Reclassiﬁcation of (gains) / 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 / (losses) on available-for-sale investments Impairment charges reclassiﬁed to the income statement Reclassiﬁcation of (gains) / losses on available-for-sale investments realized in net proﬁt Additional minimum pension liability Other comprehensive income / (loss) Comprehensive income Balance at 31 December 2004 Net proﬁt Other comprehensive income: Foreign currency translation Net unrealized gains / (losses) on available-for-sale investments Impairment charges reclassiﬁed to the income statement Reclassiﬁcation of (gains) / losses on available-for-sale investments realized in net proﬁt Additional minimum pension liability Other comprehensive income / (loss) Comprehensive income Balance at 31 December 2005 (966 ) (130 ) 111 (69 ) (966 ) (88 ) (1,815) 175 (1,062 ) (1,062 ) 32 10 (5 ) 37 (2,877) 212 2,380 2,380 (497) 130 19 (19 ) 130 342 3 3 0 0 0 0 0 Compre- hensive income / (loss) 6,513 (845 ) (81 ) 93 (58 ) 2 835 (54 ) 6,459 8,818 17 8 (4 ) (798 ) (1,603 ) 7,215 12,352 2,088 124 16 (16 ) (109 ) 2,103 14,455 121 49 (18 ) 11 (1 ) (82 ) (80 ) (845 ) (81 ) 93 (58 ) 2 835 (54 ) 917 917 (306) 211 (1,735) (826 ) (826 ) 236 (15 ) (2 ) 1 21 241 (819 ) (819 ) 17 8 (4 ) (798 ) (1,603 ) (1,125) 452 (3,338) (292 ) (6 ) (3 ) 3 18 (280 ) 2,088 124 16 (16 ) (109 ) 2,103 (127 ) (127 ) (1,252) 172 (1,235) 181 Financial Statements Notes to the Financial Statements Note 42 Additional Disclosures Required under US GAAP and SEC Rules Note 42.1 Variable Interest Entities Introduction Since 1 January 2004, UBS has 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). Until 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, US GAAP requires that control over an entity be assessed ﬁrst based on voting interests; if voting in- terests do not exist, or differ signiﬁcantly from economic in- terests, the entity is considered a VIE under FIN 46-R, and con- trol 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 summa- rized four different general approaches to the application of FIN 46-R in EITF issue No. 04-7. In applying FIN 46-R, UBS has adopted 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 in- terests. Under View A, investments or derivatives in a VIE either create (increase), or absorb (decrease) variability in the fair value of a VIE’s net assets. The VIE counterparty is a risk cre- ator (risk maker), or risk absorber (risk taker), respectively. Only risk absorption (risk taker) positions are assessed; risk creation interests 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 maximum loss which could be incurred before considering offsetting positions or hedges entered into outside of the VIE. However, 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 28 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 0.7 billion of investment fund products, and CHF 1.1 billion of securitization VIEs, which includes some third-party VIEs mentioned below. The other signiﬁcant group of VIEs which have previously been consolidated for US GAAP but not under IFRS were em- ployee equity compensation trusts, for which UBS is the pri- mary beneﬁciary because of the variable interests of employ- ees. For US GAAP purposes, these trusts have been consoli- 182 Note 42 Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.1 Variable Interest Entities (continued) dated since 1 January 2004. For IFRS purposes, on 1 January 2005, these trusts were retrospectively consolidated from 1 January 2003. See Note 41.1h) Equity Participation Plans for further details. this population is approximately CHF 13.9 billion, mostly com- prising investment funds managed by UBS, other investment fund products, employee equity compensation trusts men- tioned previously, and private equity investments. UBS has reviewed the population of potential third-party VIEs it is involved with. Those identiﬁed in which UBS is the primary beneﬁciary, and which are consolidated for US GAAP purposes, have combined assets of approximately CHF 3.5 bil- lion and are included in the table below. 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 perfor- mance, are already consolidated under IFRS. Many entities consolidated under US GAAP due to FIN 46-R are already consolidated under IFRS, based on the de- termination of exercise of control under IFRS. The total size of 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. 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 Credit protection vehicles Passive intermediary to a derivative transaction Trust vehicles for awards to UBS employees Private equity investments Other miscellaneous structures Total 31.12.05 1,140 4,079 5,290 220 157 2,882 500 1,521 15,789 Consolidated assets that are collateral for the VIEs’ obligations Classiﬁcation Loan receivables, government debt securities, corporate debt securities Investment funds Debt, equity Corporate debt securities Loan receivables, corporate debt securities UBS shares and derivatives thereon Private equity investments Equity, derivatives, investment funds Amount 1,140 4,079 5,015 220 47 2,882 242 1,488 15,113 Entities which are de-consolidated for US GAAP purposes In certain cases, an entity consolidated under IFRS is not consolidated under FIN 46-R. UBS consolidates under IFRS several entities that have issued preferred securities amounting to CHF 5.1 billion, which are de-consolidated for US GAAP purposes. Under IFRS the preferred securities are equity instruments held by third parties and are treated as minority interests, with div- idends paid also reported in minority interests; the UBS-issued debt held by these entities and the respective interest amounts are eliminated in consolidation. Under US GAAP, these entities are not consolidated and the UBS-issued debt is recognized as a liability in the UBS Group Financial Statements, 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 mostly 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 sig- niﬁcant variable interest have combined assets of approximately CHF 3.3 billion, for which UBS has a maximum exposure to loss of approximately CHF 1.9 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 31.12.05 Total assets Nature of involvement Maximum exposure to loss 1,162 1,476 3,425 894 778 7,735 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 1,056 633 936 633 186 3,444 183 Financial Statements Notes to the Financial Statements Note 42 Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.1 Variable Interest Entities (continued) 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 transactions. UBS has identiﬁed that it holds variable interests in 88 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 required to consolidate the VIE was held by third parties, and was not available to UBS. Additional disclosures for these VIEs are pro- vided in the table below. VIEs not originated by UBS – information determining VIE status unavailable from third parties (CHF million) Nature, purpose and activities of VIEs Securitizations Investment fund products Total 31.12.05 Total assets Nature of involvement 1,917 4,730 6,647 UBS acts as swap counterparty UBS acts as swap counterparty Net income from VIE in current period (1 ) 200 199 Maximum exposure to loss 1,917 4,711 6,628 Future developments As the guidance for FIN 46-R has seen considerable continued 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. 184 Note 42 Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.2 Industrial Holdings’ Income Statement In 2004, following the acquisition of an additional 20% stake in Motor-Columbus, a Swiss holding company whose most signiﬁcant asset is a 59.3% interest in Atel, a Swiss-based European energy provider, UBS now holds a majority owner- ship interest in the company. As a result, UBS has fully con- solidated Motor-Columbus in its Financial Statements since 1 July 2004. In addition, due to the adoption of IAS 27 Con- solidated and Separate Financial Statements which is further described in Note 1aa), UBS retrospectively consolidated certain private equity investments to 1 January 2003. 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: Note 42.2 Industrial Holdings’ Income Statement CHF million Operating income Net sales Operating expenses Cost of products sold Marketing expenses General and administrative expenses Amortization of goodwill Amortization of other intangible assets Other operating expenses Total operating expenses Operating proﬁt / (loss) Non-operating proﬁt Interest income Interest expense Other non-operating income, net Non-operating proﬁt / (loss) Net proﬁt / (loss) from continuing operations before tax Income taxes Equity in income of associates, net of tax Net proﬁt / (loss) from continuing operations Net proﬁt from discontinued operations Net proﬁt / (loss) Net proﬁt / (loss) attributable to minority interests Net proﬁt / (loss) attributable to UBS shareholders Accounts receivables trade, gross Allowance for doubtful receivables Accounts receivables trade, net 1 Includes results for the six-month period beginning on 1 July 2004 for Motor-Columbus. For the year ended or as at 31.12.05 31.12.04 1 31.12.03 10,515 6,086 2,900 9,044 5,028 2,161 283 478 0 207 210 10,222 293 26 (138) 582 470 763 247 88 604 115 719 207 512 2,068 (62) 2,006 144 553 7 169 74 5,975 111 40 (141 ) 430 329 440 117 22 345 108 453 93 360 2,084 (39 ) 2,045 77 610 26 8 76 2,958 (58 ) 7 (113 ) (138 ) (244 ) (302 ) 11 15 (298 ) 232 (66 ) (11 ) (55 ) 185 Financial Statements Notes to the Financial Statements Note 42 Additional Disclosures Required under US GAAP and SEC Rules (continued) 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 applicable tax laws or to adverse interpretations of tax laws. The purpose 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 is asset securitizations. UBS gener- ally represents that certain securitized assets meet speciﬁc requirements, for example documentary attributes. UBS may be required to repurchase the assets and/or indemnify the purchaser 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 2005, 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, losses incurred on such repurchases and / or indemniﬁcations have been insigniﬁcant. Management expects the risk of ma- terial loss to be remote. No liabilities related to such represen- tations, warranties, and indemniﬁcations are included in the balance sheet at 31 December 2005 and 2004. 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 Secu- rities”) of PaineWebber. Prior to the acquisition, PaineWebber was an SEC Registrant. Upon the acquisition, PaineWebber was merged into UBS Americas Inc., a wholly owned sub- sidiary 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 pay- ment in full of the deposit liabilities of UBS and all other lia- bilities of UBS. At 31 December 2005, the amount of senior liabilities of UBS to which the holders of the subordinated debt securities would be subordinated is approximately CHF 1,997 billion. The information presented in this note is prepared in accor- dance with IFRS and should be read in conjunction with the Consolidated Financial Statements of UBS of which this infor- mation is a part. At the bottom of each column, Net proﬁt 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. 186 Note 42 Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.4 Supplemental Guarantor Information (continued) Supplemental Guarantor Consolidating Income Statement CHF million For the year ended 31 December 2005 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) / recovery Net interest income after credit loss expense Net fee and commission income Net trading income Income from subsidiaries Other income Revenues from industrial holdings Total operating income Operating expenses Personnel expenses General and administrative expenses Depreciation of property and equipment Amortization of other intangible assets Goods and materials purchased Total operating expenses Operating proﬁt from continuing operations before tax Tax expense / (beneﬁt) Net proﬁt / (loss) from continuing operations Net proﬁt / (loss) from discontinued operations Net proﬁt / (loss) Net proﬁt / (loss) attributable to minority interests Net proﬁt / (loss) attributable to UBS shareholders Net proﬁt / (loss) US GAAP 2 39,779 (33,892 ) 5,887 370 6,257 9,670 7,453 (675 ) 2,635 0 25,340 9,962 2,330 988 24 0 13,304 12,036 1,712 10,324 3,705 14,029 0 14,029 14,490 27,782 (24,803 ) 2,979 (3 ) 2,976 7,420 (123 ) 0 476 0 10,749 6,587 2,667 140 70 0 9,464 1,285 1,079 206 0 206 122 84 20,729 (20,067 ) 662 8 670 4,346 666 0 (1,986 ) 10,515 14,211 4,500 2,050 365 240 8,003 15,158 (947 ) (242 ) (705 ) 485 (220 ) 539 (759 ) (891 ) (1,247 ) (29,004 ) 29,004 59,286 (49,758 ) 0 0 0 0 0 675 0 0 675 0 0 0 0 0 0 675 0 675 0 675 0 675 0 9,528 375 9,903 21,436 7,996 0 1,125 10,515 50,975 21,049 7,047 1,493 334 8,003 37,926 13,049 2,549 10,500 4,190 14,690 661 14,029 12,352 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. Note 41 for a description of the differences between IFRS and US GAAP. 2 Refer to 187 Financial Statements Notes to the Financial Statements Note 42 Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.4 Supplemental Guarantor Information (continued) Supplemental Guarantor Consolidating Balance Sheet CHF million For the year ended 31 December 2005 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 Equity attributable to UBS shareholders Equity attributable to minority interests Total equity Total liabilities and equity Total shareholders’ equity – US GAAP 2 UBS AG Parent Bank 1 UBS Americas Inc. Subsidiaries Consolidating entries UBS Group 2,712 127,321 110,001 240,762 299,750 79,333 330,894 2,186 289,577 3,198 5,720 31,250 5,462 641 7,456 1,536,263 181,592 102,698 132,073 113,171 337,172 93,207 419,301 10,090 87,267 10,431 1,487,002 49,261 0 49,261 1,536,263 32,577 5 14,684 257,943 162,069 174,707 36,956 6,656 737 41,901 910 3,135 173 592 11,095 3,758 715,321 126,834 50,395 360,932 69,460 7,274 0 63,243 7,494 19,496 3,594 708,722 6,485 114 6,599 715,321 7,893 2,642 156,999 118,415 284,360 24,840 38,470 158,514 (1,770 ) 33,987 2,443 4,877 1,974 3,369 1,750 7,468 0 (265,360 ) (186,028 ) (282,759 ) 0 0 (162,282 ) 0 (95,496 ) 0 (4,814 ) (30,441 ) 0 0 (2,492 ) 5,359 33,644 300,331 404,432 499,297 154,759 333,782 1,153 269,969 6,551 8,918 2,956 9,423 13,486 16,190 838,338 (1,029,672 ) 2,060,250 81,262 110,202 268,262 6,000 155,499 24,194 64,485 5,622 53,947 42,341 811,814 19,019 7,505 26,524 838,338 20,005 (265,360 ) (186,028 ) (282,759 ) 0 (162,282 ) 0 (95,496 ) (4,814 ) 0 (2,492 ) (999,231 ) (30,441 ) 0 (30,441 ) 124,328 77,267 478,508 188,631 337,663 117,401 451,533 18,392 160,710 53,874 2,008,307 44,324 7,619 51,943 (1,029,672 ) 2,060,250 0 60,475 2 Refer to 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. Note 41 for a description of the differences between IFRS and US GAAP. 188 Note 42 Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.4 Supplemental Guarantor Information (continued) Supplemental Guarantor Consolidating Cash Flow Statement CHF million For the year ended 31 December 2005 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 with original maturity of less than three months Total UBS AG Parent Bank 1 (29,118 ) UBS Americas Inc. Subsidiaries UBS Group (15,771 ) (18,318 ) (63,207 ) (1,540 ) 3,240 (1,153 ) 71 (4,667 ) (4,049 ) 22,698 (2,416 ) 2 (3,105 ) 50,587 (17,780 ) 0 0 (1,591 ) 48,395 3,283 18,511 50,037 68,548 2,712 47,838 17,998 68,548 0 0 (155 ) 6 (40 ) (189 ) 615 0 0 0 14,635 (753 ) 8 (175 ) (214 ) 14,116 (720 ) (2,564 ) 16,095 13,531 5 8,991 4,535 13,531 0 0 (584 ) 193 2,220 1,829 (92 ) 0 0 0 11,085 (11,924 ) 1,564 (400 ) 1,805 2,038 2,455 (11,996 ) 20,959 8,963 2,642 997 5,324 8,963 (1,540 ) 3,240 (1,892 ) 270 (2,487 ) (2,409 ) 23,221 (2,416 ) 2 (3,105 ) 76,307 (30,457 ) 1,572 (575 ) 0 64,549 5,018 3,951 87,091 91,042 5,359 57,826 27,857 91,042 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 4,744 million was pledged at 31 December 2005. Guarantee of other securities In October 2000, UBS AG, acting through a wholly owned subsidiary, issued USD 1.5 billion of 8.622% UBS Trust Pre- ferred Securities. In June 2001, UBS issued an additional USD 800 million 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 Non-Cumulative Trust Preferred Securities at 0.7% above one-month LIBOR of such securities. UBS AG has fully and unconditionally guaranteed these secu- rities. 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 2005, the amount of senior liabilities of UBS to which the holders of the subordinated debt securities would be subordinated is approximately CHF 1,997 billion. 189 Financial Statements Notes to the Financial Statements Note 42 Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.5 Pro-Forma Effect of the Fair Value Method of Accounting on US GAAP Net Proﬁt The following table presents US GAAP Net proﬁt and earnings per share for the years ended 31 December 2004 and 31 December 2003 as if UBS had applied the fair value method of accounting for its share-based compensation plans in that period. With the adoption of SFAS 123-R on 1 January 2005, UBS adopted the fair value method of accounting for its share- based compensation plans using the modiﬁed prospective method. See Note 41.1 h) for details. CHF million, except per share data Net proﬁt under US GAAP, 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 31.12.03 8,818 1,209 (1,717 ) 8,310 8.56 8.07 8.15 7.68 6,513 752 (1,191) 6,074 5.83 5.44 5.72 5.33 190 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 Allowances 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 Personnel 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 7,551 million from CHF 5,946 million to CHF13,497 million. Income from investments in associated companies increased to CHF 3,943 million from CHF 461 million in 2004 mainly due to higher distributions received. The increase in extraordinary income and expenses is explained on page 198. Total assets increased by CHF 224 billion to CHF 1,360 billion at 31 December 2005. This movement is mainly caused by increased positions in Money market paper of CHF17 billion, Due from banks of CHF 81 billion and Due from customers of CHF 25 billion. A considerable increase resulted as well in Trading balances in securities and precious metals of CHF 70 billion (thereof debt instruments CHF 23 billion and equities CHF 44 billion). 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 31.12.05 31.12.04 31.12.04 27,320 12,482 36 18,902 10,457 13 (33,972) (21,659 ) 5,866 244 9,751 773 (1,349) 9,419 7,289 95 3,943 38 46 (234) 3,888 26,462 10,999 4,113 15,112 11,350 1,265 27 10,058 5,274 0 1,835 13,497 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 45 19 177 57 (24 ) 7 22 5 19 20 110 9 755 (17 ) (97 ) 800 96 26 13 7 12 52 24 (85 ) 61 419 (100 ) 43 127 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 Allowances 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 31.12.05 31.12.04 % change from 31.12.04 2,712 47,840 431,071 185,331 153,387 358,600 4,216 22,016 4,527 5,359 136,503 7,980 4,152 31,262 350,055 159,988 132,941 288,170 4,503 20,547 4,212 3,129 128,300 8,550 1,359,542 1,135,809 6,094 557,355 52,335 482,134 86,997 406,724 1,464 102,386 11,451 160,002 5,648 4,249 871 7,927 10,562 13,295 13,497 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 1,359,542 1,135,809 16,022 404,108 12,695 357,311 (35 ) 53 23 16 15 24 (6 ) 7 7 71 6 (7 ) 20 23 25 77 13 4 29 (13 ) 70 51 1 (5 ) 8 (3 ) 5 17 (16 ) 127 20 26 13 195 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 2005 as per the Parent Bank’s Income Statement Appropriation to general statutory reserve Appropriation to other reserves Proposed dividends Total appropriation Dividend Distribution 13,497 334 9,788 3,375 13,497 The Board of Directors will recommend to the Annual General Meeting on 19 April 2006 that UBS should pay a dividend of CHF 3.20 per share of CHF 0.80 par value. If the dividend is approved, the payment of CHF 3.20 per share, after deduc- tion of 35% Swiss withholding tax, would be made on 24 April 2006 for shareholders who hold UBS shares on 19 April 2006. In addition to the already increased dividend of CHF 3.20, the Board of Directors proposes that a repayment of CHF 0.60 per share be made to shareholders by means of a reduction in the par value from CHF 0.80 to CHF 0.20 for all registered shares. This payout will not be subject to the 35% Swiss with- holding tax. Subject to the approval by the shareholders and the entry of the capital reduction in the Commercial Register, the payout will be made on 12 July 2006, to those sharehold- ers in possession of UBS shares on 7 July 2006. 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 Note1, 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 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 in- cluded in the Income statement. Treasury shares included in Financial investments are carried at the lower of cost or market value. Foreign currency translation 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. 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 telecommunications 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, Summary 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 or they are included in net proﬁt from discontinued operations, if required. These items are separately identiﬁed 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 31.12.05 31.12.04 31.12.04 3,068 1,540 2,681 7,289 2,262 (266 ) 1,473 3,469 36 82 110 Extraordinary income includes a CHF 3,183 million gain on sale of Private Banks & GAM compared to a gain on sale of asso- ciated companies of CHF 72 million in 2004. Additionally 2005 included a write-up of investments in associated companies of CHF 1,263 million, a gain of CHF 370 million resulting from a merger with a subsidiary and releases of provisions of CHF 452 million (2004: CHF 334 million). 2004 further included the CHF 609 million ﬁrst-time adoption 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. Extraordinary expense contained a CHF 48 million loss from the liquidation of investments in associated companies in 2004. 198 Additional Balance Sheet Information Allowances and Provisions CHF million Default risks (credit and country risk) Trading portfolio risks Litigation risks Operational risks Capital and income taxes Total allowances and provisions Allowances deducted from assets Total provisions as per balance sheet Provisions applied in accordance with their speciﬁed purpose Recoveries, doubtful interest, currency translation differences Balance at 31.12.04 (629 ) (80 ) (56 ) (1,658 ) (2,423) 61 534 148 (105 ) 72 710 2,777 3,337 233 1,508 1,858 9,713 5,784 3,929 Provisions released to income (971 ) (62 ) (247 ) (1,280) New provisions charged to income 598 9 89 562 1,839 3,097 Balance at 31.12.05 1,836 3,880 328 1,662 2,111 9,817 5,568 4,249 Statement of Shareholders’ Equity CHF million Share capital 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 As at 31.12.04 and 1.1.05 Cancellation of own shares Capital increase Increase in reserves Prior year dividend Proﬁt for the period Changes in reserves for own shares 946 (47 ) 2 901 (32 ) 2 General statutory reserves: Share premium General statutory reserves: Retained earnings 6,141 1,071 Reserves for own shares 8,024 72 288 6,213 1,359 33 322 Total shareholders’ equity (before Other reserves distribution of proﬁt) 24,388 (4,469 ) (288 ) (2,806 ) 5,946 (1,032 ) 21,739 (3,511 ) (322 ) (3,105 ) 13,497 (1,506 ) 26,792 40,570 (4,516) 74 (2,806) 5,946 39,268 (3,543) 35 (3,105) 13,497 46,152 1,032 9,056 1,506 10,562 As at 31.12.05 871 6,246 1,681 Share Capital As at 31.12.05 Issued and paid up Conditional share capital As at 31.12.04 Issued and paid up Conditional share capital Par value Ranking for dividends No. of shares Capital in CHF No. of shares Capital in CHF 1,088,632,522 870,906,018 1,054,747,522 843,798,018 1,823,501 1,458,801 1,126,858,177 901,486,542 1,086,923,083 869,538,466 3,533,012 2,826,410 199 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 31.12.05 31.12.04 Change in % Book value Effective liability Book value Effective liability Book value Effective liability 26,513 64 102,330 128,907 6,120 38 48,580 54,738 15,387 175 79,534 95,096 4,633 60 41,310 46,003 72 (63 ) 29 36 32 (37 ) 18 19 Assets are pledged as collateral for securities borrowing and repurchase 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 31.12.05 184,665 68,071 130 2,004 31.12.04 123,429 50,552 104 1,820 % change from 31.12.04 50 35 25 10 Derivative Instruments CHF million Interest rate contracts Credit derivative contracts Foreign exchange contracts Precious metal contracts Equity / index contracts Commodity contracts Total derivative instruments Replacement values netting Replacement values after netting PRV 1 222,508 15,811 57,705 3,616 25,663 10,677 335,980 199,477 136,503 31.12.05 NRV 2 221,437 16,427 58,600 3,444 49,924 9,647 359,479 199,477 160,002 Notional amount CHF bn 20,656 1,557 4,757 82 706 194 27,952 PRV 174,994 7,895 81,377 1,919 20,487 1,739 288,411 160,111 128,300 31.12.04 NRV 183,210 9,353 79,046 1,590 44,107 1,616 318,922 160,111 158,811 Notional amount CHF bn 15,398 671 3,729 61 721 41 20,621 1 PRV (Positive replacement values). 2 NRV (Negative replacement values). 200 Fiduciary Transactions CHF million Deposits: with other banks with Group banks Loans and other ﬁnancial transactions Total 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 31.12.05 31.12.04 % change from 31.12.04 37,171 1,382 0 38,553 30,581 740 6 31,327 22 87 (100 ) 23 31.12.05 31.12.04 % change from 31.12.04 719 2,222 21 1,329 3,778 16 (46 ) (41 ) 31 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. The employees of UBS AG are covered through the pension plans of UBS Group. The major Group pension plans are disclosed in Note 30 of the Group’s Financial Statements. a) Deﬁned beneﬁt plans Swiss pension plan In 2005, UBS AG contributed CHF 372 million (2004: CHF 336 million) to the Swiss pension plan of UBS Group. Foreign pension plans UBS Group operates various other pension plans in foreign locations which cover the employees of UBS AG and other em- ployees of UBS Group at these locations. In 2005, UBS AG contributed CHF 82 million (2004: CHF 59 million) to these plans. b) Deﬁned contribution plans UBS Group also sponsors a number of deﬁned contribution plans, primarily in the UK and the US. In 2005, UBS AG contributed CHF 60 million (2004: CHF 73 million) to these plans. Personnel Parent Bank personnel was 38,189 on 31 December 2005 and 35,542 on 31 December 2004. 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 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 and Non-performing 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 207 207 209 210 211 211 211 212 212 212 214 216 217 218 219 220 221 222 223 225 226 227 A B C D 206 A – Introduction The following pages contain additional disclosure about 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 Uni- ted States Generally Accepted Accounting Principles (US GAAP). B – Selected Financial Data The tables below set forth, for the periods and dates indi- cated, 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 2006, the noon buying rate was 0.7627 USD per 1 CHF. Year ended 31 December 2001 2002 2003 2004 2005 Month September 2005 October 2005 November 2005 December 2005 January 2006 February 2006 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 0.5910 0.6453 0.7493 0.8059 0.8039 0.5857 0.7229 0.8069 0.8712 0.7606 High 0.6331 0.7229 0.8189 0.8843 0.8721 High 0.8139 0.7855 0.7825 0.7820 0.7940 0.7788 Low 0.5495 0.5817 0.7048 0.7601 0.7544 Low 0.7712 0.7679 0.7544 0.7570 0.7729 0.7575 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 Total operating income Total operating expenses Operating proﬁt from continuing operations before tax Tax expense Net proﬁt from continuing operations Net proﬁt from discontinued operations Net proﬁt Net proﬁt attributable to minority interests Net proﬁt attributable to UBS shareholders 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 (%) Rates of return (%) Return on equity attributable to UBS shareholders 4 Return on average equity Return on average assets 31.12.05 31.12.04 31.12.03 31.12.02 31.12.01 For the year ended 59,286 (49,758) 9,528 375 9,903 21,436 7,996 1,125 10,515 50,975 37,926 13,049 2,549 10,500 4,190 14,690 661 14,029 70.1 13.93 13.36 12.96 3.20 23.0 39.4 36.9 0.67 39,228 (27,484 ) 11,744 241 11,985 18,506 4,902 932 6,086 42,411 32,124 10,287 2,224 8,063 407 8,470 454 8,016 73.2 7.78 7.40 9.99 3.00 2.54 38.6 25.5 23.6 0.44 40,045 (27,784 ) 12,261 (102 ) 12,159 16,673 3,670 225 2,900 35,627 28,355 7,272 1,419 5,853 400 6,253 349 5,904 76.8 5.44 5.19 6.70 2.60 2.00 47.8 17.8 16.8 0.38 39,896 (29,417 ) 10,479 (112 ) 10,367 17,481 5,381 285 1,245 34,759 31,007 3,752 597 3,155 210 3,365 348 3,017 84.7 2.59 2.54 3.22 2.00 1.46 77.2 8.2 7.6 0.20 52,187 (44,236 ) 7,951 (499 ) 7,452 19,440 8,732 609 1,691 37,924 31,723 6,201 1,359 4,842 445 5,287 356 4,931 79.1 4.05 3.90 5.09 0.00 0.00 12.4 11.9 0.36 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 2001 an 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, CHF 2.60 on 20 April 2004 and CHF 3.00 on 26 April 2005. A dividend of CHF 3.20 per share will be paid on 24 April 2006, and a par value reduction of CHF 0.60 per share will be distributed in July 2006 subject to approval by shareholders at the Annual General Meeting. The USD amount per share will be determined on 20 April 2006. 4 Net proﬁt attributable to UBS shareholders / average equity attributable to UBS shareholders less distributions. 2 For EPS calculation, see Note 8 to the Financial Statements. 208 B – Selected Financial Data (continued) CHF million, except where indicated 31.12.05 31.12.04 As at 31.12.03 31.12.02 31.12.01 Balance sheet data Total assets Equity attributable to UBS shareholders Average equity to average assets (%) Market capitalization Shares Registered ordinary shares Treasury shares BIS capital ratios Tier 1 (%) Total BIS (%) Risk-weighted assets Invested assets (CHF billion) Personnel 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 2,060,250 1,737,118 1,553,979 1,350,852 1,258,093 44,324 1.81 131,949 33,941 1.86 103,638 33,659 2.25 95,401 36,010 2.67 79,448 40,873 3.03 105,475 1,088,632,522 1,126,858,177 1,183,046,764 1,256,297,678 1,281,717,499 104,259,874 124,663,310 136,741,227 141,230,691 89,804,451 12.9 14.1 310,409 2,652 26,028 11,007 27,136 5,398 69,569 AA+ Aa2 AA+ 11.9 13.8 264,832 2,217 25,990 10,764 26,232 4,438 67,424 AA+ Aa2 AA+ 12.0 13.5 252,398 2,098 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+ 1 See the Handbook 2005/2006, page 57 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 and Equity 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 Equity attributable to UBS shareholders 31.12.05 31.12.04 As at 31.12.03 31.12.02 31.12.01 2,060,250 1,737,118 1,553,979 1,350,852 1,258,093 33,644 300,331 404,432 499,297 154,759 333,782 269,969 124,328 77,267 478,508 188,631 337,663 117,401 451,533 160,710 44,324 35,419 220,242 357,164 389,487 159,115 284,577 232,167 120,026 61,545 422,587 171,033 303,712 65,756 376,076 117,856 33,941 31,959 213,932 320,499 354,558 120,759 248,206 212,670 129,084 53,278 415,863 143,957 254,768 35,286 346,577 88,874 33,659 32,777 139,049 294,067 261,080 110,365 247,421 211,707 83,561 36,870 366,858 106,453 247,206 14,516 306,876 115,798 36,010 27,736 162,938 269,256 397,888 73,447 226,535 107,031 30,317 368,620 105,798 71,443 333,781 158,307 40,873 209 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 Revenues 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 from continuing operations before tax Tax expense Minority interests Net proﬁt from continuing operations Net proﬁt from discontinued operations 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 Cumulative adjustment due to the adoption of SFAS 123 (revised 2004), “Share-Based Payment” on 1 January 2005, net of tax Net proﬁt 31.12.05 31.12.04 31.12.03 31.12.02 31.12.01 For the year ended 59,039 (49,588) 9,451 375 9,826 21,436 6,864 793 8,674 47,593 20,220 6,667 1,414 0 201 7,142 0 35,644 11,949 3,078 (410) 8,461 3,853 38 12,352 39,802 (27,628 ) 12,174 (74 ) 12,100 16,606 3,944 382 39,612 (29,334 ) 10,278 (112 ) 10,166 17,481 5,870 (65 ) 51,817 (44,096 ) 7,721 (499 ) 7,222 19,440 8,889 504 33,032 33,452 36,055 17,234 5,917 1,368 0 110 0 24,629 8,403 1,790 (350 ) 6,263 250 19,294 7,465 1,759 2,385 298 112 31,313 4,742 1,323 (344 ) 3,075 159 18,224 6,953 1,573 0 1,443 0 28,193 5,259 456 (331 ) 4,472 435 639 38,991 (27,245 ) 11,746 334 12,080 18,435 4,795 1,180 3,648 40,138 18,297 6,545 1,365 0 180 2,861 0 29,248 10,890 2,015 (435 ) 8,440 372 6 8,818 6,513 5,546 3,234 210 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 and Equity 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 31.12.05 31.12.04 As at 31.12.03 31.12.02 31.12.01 2,322,261 1,903,186 1,699,007 1,296,938 1,361,920 33,427 274,099 404,432 607,432 152,237 337,409 267,530 28,104 1,665 116,831 127,252 66,916 482,843 193,965 67,430 432,171 466,410 18,707 240,212 60,475 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 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’s ratio of earnings to ﬁxed charges for the periods indicated. Ratios of earnings to com- bined ﬁxed charges and preferred stock dividend 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 31.12.05 31.12.04 31.12.03 31.12.02 31.12.01 1.24 1.23 1.35 1.37 1.24 1.28 1.11 1.17 1.13 1.10 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 2005, UBS Financial Businesses operated about 1,061 business and banking locations worldwide, of which about 44% were in Switzerland, 44% in the Americas, 10% in the rest of Europe, Middle East and Africa 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 2005, the Industrial Holdings segment operated about 303 business locations worldwide, of which about 21% were in Switzerland, 71% in the rest of Europe, Middle East and Africa, 7% in the Americas and 1% in Asia- Paciﬁc. 76% of the business locations worldwide were held under commercial leases. These premises are subject to continuous maintenance and upgrading and are considered suitable and adequate for current and anticipated operations. 211 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 (continued) 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 2005, 31 Decem- ber 2004 and 31 December 2003 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 2005, 2004 and 2003. 31.12.05 Average balance Interest Average rate (%) Average balance 31.12.04 Interest 31.12.03 Average rate (%) Average balance Interest Average rate (%) 15,467 25,497 270 1,334 33,012 787,389 1,079 22,562 15,545 457 580,763 23,630 3,390 58 584,153 23,688 616 691 0 26 174,299 81,264 5,424 3,241 1,036 3,546 3,546 1,722,515 3 83 83 58,167 1,119 1.7 5.2 3.3 2.9 2.9 4.1 1.7 4.1 3.8 3.1 4.0 0.3 2.3 2.3 3.4 12,463 23,843 154 397 17,969 710,065 10,122 513,922 2,309 457 10,549 336 18,914 27 516,231 18,941 196 0 0 0 168,456 60,145 5,308 1,813 1,132 3,000 0 3,000 1,523,622 17 21 0 21 37,993 1,235 1.2 1.7 2.5 1.5 3.3 3.7 1.2 3.7 3.2 3.0 1.5 0.7 0.0 0.7 2.5 11,417 21,317 158 1,064 6,576 200 582,066 10,948 7,990 219 421,413 18,151 1,668 21 423,081 18,172 0 0 0 0 165,397 51,459 6,357 1,805 1,988 2,880 0 2,880 27 30 0 30 1,274,171 38,980 1,065 1,722,515 59,286 3.4 1,523,622 39,228 2.6 1,274,171 40,045 319,698 9,308 55,125 2,106,646 246,952 8,808 53,087 1,832,469 249,155 12,874 29,750 1,565,950 1.4 5.0 3.0 1.9 2.7 4.3 1.3 4.3 3.8 3.5 1.4 1.0 0.0 1.0 3.1 3.1 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 Total interest-earning assets Net interest on swaps Interest income and average interest-earning assets Non-interest-earning assets Positive replacement values Fixed assets Other Total average assets 212 D – Information Required by Industry Guide 3 (continued) 31.12.05 Average balance Interest Average rate (%) Average balance 31.12.04 Interest 31.12.03 Average rate (%) Average balance Interest Average rate (%) 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 35,713 92,431 897 3,321 40,772 881 661,722 19,745 3,632 145 173,394 10,591 638 5 86,688 2,385 67,987 86,373 24,245 178,605 236,228 1,584 96,767 4,250 43,035 292 404 386 1,082 5,760 20 2,905 117 1,904 Total interest-bearing liabilities 1,655,459 49,758 Non-interest-bearing liabilities Negative replacement values Other Total liabilities Total equity Total average liabilities and equity Net interest income Net yield on interest-earning assets 335,992 70,292 2,061,743 44,903 2,106,646 1 Due to customers in foreign ofﬁces consists mainly of time deposits. 2.5 3.6 2.2 3.0 4.0 6.1 0.8 2.8 0.4 0.5 1.6 0.6 2.4 1.3 3.0 2.8 4.4 3.0 31,129 96,335 33,846 614,295 3,717 161,286 385 1,582 489 9,525 180 7,813 85 1 49,234 1,167 67,005 84,112 19,052 170,169 192,992 246 79,902 10,358 28,259 167 414 250 831 2,677 0 1,338 168 1,328 1,471,853 27,484 260,629 60,482 1,792,964 39,505 1,832,469 1.2 1.6 1.4 1.6 4.8 4.8 1.2 2.4 0.2 0.5 1.3 0.5 1.4 28,719 74,695 116 1,747 23,287 515,665 3,252 127,104 0 22,445 55,496 81,963 21,125 158,584 161,738 295 9,328 156 9,769 0 751 100 527 357 984 2,149 64 0 1.7 73,193 1,015 1.6 4.7 1.9 6,413 30,805 188 1,286 1,225,964 27,784 254,819 46,025 1,526,808 39,142 1,565,950 0.4 2.3 1.3 1.8 4.8 7.7 3.3 0.2 0.6 1.7 0.6 1.3 0.0 1.4 2.9 4.2 2.3 9,528 11,744 12,261 0.6 0.8 1.0 The percentage of total average interest-earning assets attrib- utable to foreign activities was 86% for 2005 (86% for 2004 and 85% for 2003). The percentage of total average interest- bearing liabilities attributable to foreign activities was 84% for 2005 (83% for 2004 and 82% for 2003). All assets and liabilities 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 currency mix included in the assets and liabilities. This is espe- cially true for foreign assets and liabilities. Tax-exempt income is not recorded on a tax-equivalent basis. For all three years presented, tax-exempt income is considered to be insigniﬁcant and the impact from such income is therefore 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-earn- ing assets and interest-bearing liabilities, the changes in inter- est income and expense due to changes in volume and inter- est rates for the year ended 31 December 2005 compared with the year ended 31 December 2004, and for the year ended 31 December 2004 compared with the year ended 31 December 2003. Volume and rate variances have been calcu- lated on movements in average balances and changes in in- terest 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 im- paired, non-performing and restructured loans. 2005 compared with 2004 2004 compared with 2003 Increase / (decrease) due to changes in Increase / (decrease) due to changes in Average volume Average rate Net change Average volume Average rate Net change 36 28 376 1,160 179 2,473 13 2,486 0 26 187 634 (1) 4 0 4 80 909 246 116 937 622 10,853 12,013 (58) 2,243 18 2,261 0 0 (71) 794 (13) 58 0 58 121 4,716 31 4,747 0 26 116 1,428 (14) 62 0 62 961 19,213 20,174 (116) 20,058 777 4,338 5,115 184 14,875 15,059 15 126 342 2,432 58 3,978 8 3,986 0 0 116 304 (12 ) 1 0 1 519 6,849 7,368 (19 ) (793 ) (85 ) (2,831 ) 59 (3,215 ) (2 ) (3,217 ) 0 0 (4 ) (667 ) 257 (399 ) 117 763 6 769 0 0 (1,165 ) (296 ) (1,049 ) 8 2 (10 ) 0 (10 ) (1,208 ) (7,147 ) (8,355 ) (10 ) (9 ) 0 (9 ) (689 ) (298 ) (987 ) 170 (817 ) 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 2005 compared with 2004 2004 compared with 2003 Increase / (decrease) due to changes in Increase / (decrease) due to changes in Average volume Average rate Net change Average volume Average rate Net change 55 (62) 97 759 (4) 581 7 899 2 11 68 81 605 20 287 (98) 694 158 3,763 3,921 457 1,801 295 9,461 (31) 2,197 (3) 319 123 (21) 68 170 512 1,739 392 10,220 (35) 2,778 4 1,218 125 (10) 136 251 2,478 3,083 0 1,280 47 (118) 20 1,567 (51) 576 935 17,418 18,353 1,093 21,181 22,274 10 498 137 1,775 22 2,632 0 884 23 13 (35 ) 1 406 0 94 114 (107 ) 284 6,182 6,466 259 (663 ) 57 (1,578 ) 2 269 (165 ) 194 197 24 (4,588 ) (1,956 ) 1 (468 ) 44 (126 ) (72 ) (154 ) 122 0 229 (134 ) 149 31 (6,797 ) (6,766 ) 1 416 67 (113 ) (107 ) (153 ) 528 0 323 (20 ) 42 315 (615 ) (300 ) 215 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 (continued) Deposits The following table analyzes average deposits and the aver- age rates on each deposit category listed below for the years ended 31 December 2005, 2004 and 2003. 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 54,968 million, CHF 49,699 mil- lion and CHF 49,857 million at 31 December 2005, 31 December 2004 and 31 December 2003, respectively. CHF million, except where indicated 31.12.05 31.12.04 31.12.03 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. 8,491 6,976 15,467 25,497 40,964 67,987 86,373 24,245 178,605 236,228 414,833 0.1 3.3 1.5 3.6 2.8 0.4 0.5 1.6 0.6 2.4 1.6 7,770 4,693 12,463 23,843 36,306 67,005 84,112 19,052 170,169 192,992 363,161 0.1 1.7 0.7 1.6 1.3 0.2 0.5 1.3 0.5 1.4 1.0 3,836 7,581 11,417 21,317 32,734 55,496 81,963 21,125 158,584 161,738 320,322 0.0 0.6 0.4 2.4 1.7 0.2 0.6 1.7 0.6 1.3 1.0 At 31 December 2005, the maturity of time deposits exceeding CHF 150,000, or an equivalent amount in other currencies, was as follows: Domestic 26,427 1,588 823 581 296 Foreign 179,430 3,779 2,745 1,606 60 29,715 187,620 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 the period-end, average and maximum month-end outstanding amounts for short-term bor- rowings, along with the average rates and period-end rates at and for the years ended 31 December 2005, 2004 and 2003. CHF million, except where indicated 31.12.05 31.12.04 31.12.03 31.12.05 31.12.04 31.12.03 31.12.05 31.12.04 31.12.03 Money market paper issued Due to banks Repurchase agreements 1 Period-end balance Average balance Maximum month-end balance Average interest rate during the period (%) Average interest rate at period-end (%) 102,662 98,351 112,217 3.0 4.0 79,442 80,148 94,366 1.7 2.1 58,115 90,651 73,257 87,180 84,351 91,158 90,615 667,317 557,892 500,592 70,680 628,362 587,988 498,679 92,605 101,178 115,880 96,694 719,208 637,594 593,738 1.4 1.3 3.3 3.0 1.6 2.0 2.8 1.5 3.0 2.6 1.5 2.0 1.8 1.3 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 Investments in Debt Instruments 1,2 CHF million, except percentages 31 December 2005 Swiss national government and agencies Swiss local governments US Treasury and agencies Foreign governments and ofﬁcial institutions Corporate debt securities Mortgage-backed securities Other debt securities Total fair value CHF million, except percentages 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 CHF million, except percentages 31 December 2003 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 Within 1 year 1–5 years 5–10 years Over 10 years Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) 0.00 0.00 0.00 1.91 3.20 0.00 0.00 0 0 0 38 13 0 0 51 4.36 0.00 5.51 1.90 4.25 0.00 0.00 2 0 42 2 239 0 0 285 0.00 0.00 5.77 5.64 5.38 3.92 0.00 0 0 10 5 66 14 0 95 4.00 0.00 6.03 6.17 5.66 4.80 0.00 1 0 12 2 103 129 0 247 Within 1 year 1–5 years 5–10 years Over 10 years Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) 5.50 3.97 2.13 2.74 2.50 0.00 1 10 36 57 3 0 107 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 (%) 6.61 3.90 1.89 1.09 0.00 0.00 3 5 45 81 0 4 138 2.92 2.01 1.49 3.53 0.00 0.00 4 20 9 68 0 8 109 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 1 Money market paper has a contractual maturity of less than one year. 2 Average yields are calculated on an amortized cost basis for all years presented. 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 Switzerland. With the exception of private house- holds (foreign and domestic), banks and ﬁnancial institutions outside Switzerland, and real estate and rentals in Swit- zerland, there is no material concentration of loans. For fur- ther discussion of the loan portfolio, see the Handbook 2005/2006. The following table illustrates the diversiﬁcation of the loan portfolio among industry sectors at 31 December 2005, 2004, 2003, 2002 and 2001. 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 1 Banks 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 1 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 31.12.05 31.12.04 31.12.03 31.12.02 31.12.01 1,407 1,816 4,213 2,044 5,038 111,549 5,494 11,792 4,808 9,300 1,004 1,406 1,943 4,332 2,269 5,485 105,160 5,460 11,466 4,908 9,110 591 619 2,175 4,009 2,440 6,478 102,180 5,251 12,449 6,062 9,493 1,014 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 1,860 158,465 152,130 152,170 151,588 158,996 32,282 2,716 295 1,637 52,365 3,899 2,694 38,280 1,501 2,707 1,257 5,596 1,419 156 146,804 305,269 34,269 31,405 366 122 745 35,459 2,758 1,695 30,237 1,228 940 1,102 8,002 762 318 118,003 270,133 245 84 249 23,493 2,421 1,114 21,195 1,224 473 1,880 7,983 3,658 432 95,856 248,026 31,882 519 153 1,105 18,378 2,300 868 33,063 2,628 616 1,367 1,654 676 2,314 26,728 1,080 266 977 14,458 4,258 1,313 25,619 6,454 10,227 1,732 4,786 2,117 2,956 97,523 249,111 102,971 261,967 1 Includes Due from banks and Loans from Industrial Holdings of CHF 728 million at 31 December 2005, CHF 909 million at 31 December 2004 and CHF 220 million at 31 December 2003. chemicals, food and beverages. water supply. 3 Includes transportation, communication, health and social work, education and other social and personal service activities. 2 Includes 4 Includes mining and electricity, gas and 6 Includes hotels and restaurants. 5 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 2005, 2004, 2003, 2002 and 2001. Mortgages are included in the industry categories mentioned above. CHF million Mortgages Domestic Foreign Total gross mortgages Mortgages Residential Commercial Total gross mortgages 31.12.05 31.12.04 31.12.03 31.12.02 31.12.01 130,880 15,619 146,499 127,990 18,509 146,499 124,496 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 Due from Banks and Loan Maturities (gross) The following table discloses loans by maturity at 31 December 2005. The determination of maturities is based on contract terms. Information on interest rate sensitivities can be found in Note 28 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 1,101 51,060 19,372 71,533 30,542 13,956 88,568 133,066 204,599 294 65,686 5,318 71,298 1,523 1,381 8,155 11,059 82,357 12 14,134 1,488 15,634 217 282 2,180 2,679 18,313 1,407 130,880 26,178 158,465 32,282 15,619 98,903 146,804 305,269 At 31 December 2005, 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 728 million at 31 December 2005. 1 to 5 years Over 5 years 79,139 3,218 82,357 16,923 1,390 18,313 Total 96,062 4,608 100,670 220 D – Information Required by Industry Guide 3 (continued) Impaired and Non-performing 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 restruc- tured on concessionary terms. The gross interest income that would have been re- corded on non-performing loans was CHF 81 million for domestic loans and CHF 8 million for foreign loans for the year ended 31 December 2005, 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 million for foreign loans for the year ended 31 December 2002 and CHF 336 million for all non-perform- ing loans for the year ended 31 December 2001. The amount of interest income that was included in net in- come for those loans was CHF 72 million for domestic loans and CHF 9 million for foreign loans for the year ended 31 December 2005, CHF 106 million for domestic loans and CHF 8 million for foreign loans for the year ended 31 December 2004, CHF 163 million for domestic loans and CHF 8 million for foreign 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-perform- ing loans for the year ended 31 December 2001. The table below provides an analysis of the Group’s non-performing loans. For further information see the Handbook 2005/2006. CHF million Non-performing loans: Domestic Foreign Total non-performing loans 31.12.05 31.12.04 31.12.03 31.12.02 31.12.01 2,106 257 2,363 2,772 783 3,555 4,012 746 4,758 4,609 1,170 5,779 6,531 1,882 8,413 UBS does not, as a matter of policy, typically restructure loans to accrue interest at rates different from the original contrac- tual terms or reduce the principal amount of loans. Instead, speciﬁc loan allowances are established as necessary. Unrecognized interest related to restructured loans was not material to the results of operations in 2005, 2004, 2003, 2002 or 2001. In addition to the non-performing loans shown above, the Group had CHF 1,071 million, CHF 1,144 million, CHF 2,241 million, CHF 3,875 million and CHF 5,990 million in “other impaired loans” for the years ended 31 December 2005, 2004, 2003, 2002 and 2001, respectively. For the years ended 31 December 2003, 2002 and 2001, 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 2005 and 2004, these are loans not considered “non-performing” in accordance with Swiss regulatory guidelines, but where the Group’s credit ofﬁcers have ex- pressed doubts as to the ability of the borrowers to repay the loans. As at 31 December 2005 and 31 December 2004, speciﬁc allowances of CHF 200 million and CHF 241 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 prod- ucts such as loans (including unutilized commitments) and de- posits 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 and Loans from Industrial Holdings. Claims that are secured by third-party guarantees are recorded against the guarantor’s country of domicile. Out- standings that are secured by collateral are recorded against the country where the asset could be liquidated. This follows the “Guidelines for the Management of Country Risk”, which are applicable to all banks that are supervised by the Swiss Federal Banking Commission. The following tables list those countries for which cross- border outstandings exceeded 0.75% of total assets at 31 December 2005, 2004 and 2003. At 31 December 2005, 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 2005/2006. Private Sector Public Sector Total % of total assets 31.12.05 140,905 10,202 8,975 13,351 3,012 171,638 28,577 22,660 20,490 17,814 23,855 1,338 11,015 624 11,370 31.12.04 8.3 1.4 1.1 1.0 0.9 Private Sector Public Sector Total % of total assets 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 8,138 18,289 1,270 550 4,271 4,001 126,724 25,269 24,654 20,234 14,716 13,477 8.2 1.6 1.6 1.3 0.9 0.9 Banks 6,878 17,037 2,670 6,515 3,432 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 CHF million United States Germany Japan United Kingdom Italy CHF million United States Germany Italy Japan United Kingdom France CHF million United States Italy Germany United Kingdom France Japan 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 al- lowances and provisions for credit losses. The following analy- sis includes Due from banks from Industrial Holdings. UBS writes off loans against allowances only on ﬁnal set- tlement of bankruptcy proceedings, the sale of the underly- ing 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 31.12.05 2,802 31.12.04 3,775 31.12.03 5,015 31.12.02 7,992 31.12.01 10,581 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 (16) (14) (26) (39) (131) 0 (56) (25) (35) (4) (346) (164) 0 0 0 (50) (8) (23) (21) (22) (3) (9) 0 0 (5) (305) (651) 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 (21 ) (128) (856) 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 ) (1,772) (2,328) (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) 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. CHF million Net foreign exchange Subsidiaries sold and other adjustments Total adjustments 31.12.05 31.12.04 31.12.03 31.12.02 31.12.01 53 10 63 (588) (298) (76) (64) 1,776 54 5 59 (797) (216 ) (25 ) 65 2,802 49 38 87 (1,349) 102 7 3,775 43 27 70 (2,466) 115 (626 ) 5,015 58 23 81 (2,927) 498 (160 ) 7,992 31.12.05 31.12.04 31.12.03 31.12.02 31.12.01 50 (114) (64) 2 63 65 (57 ) 64 7 (269 ) (357 ) (626) 44 (204 ) (160) 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 2005, 2004, 2003, 2002 and 2001. For a description of procedures with respect to allowances and provisions for credit losses, see the Handbook 2005/2006. 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 31.12.05 31.12.04 31.12.03 31.12.02 31.12.01 10 91 75 49 174 262 8 168 330 196 61 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 1,425 1,891 2,649 3,484 35 5 2 15 8 57 1 30 72 3 1 27 0 8 265 86 1,776 246 4 1 15 140 112 14 48 66 5 95 32 1 (75) 704 207 2,802 256 5 0 0 168 359 19 48 69 7 51 32 195 (345) 864 262 3,775 24 5 6 96 153 314 148 58 0 6 13 262 144 (394) 835 696 5,015 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 25 1,970 1,006 8,001 1 Includes chemicals, food and beverages. electricity, gas and water supply. provisions for 2005 and CHF 17 million for 2004. 161 million, CHF 262 million, CHF 696 million and CHF 1,006 million, respectively, of country provisions. CHF 290 million, CHF 366 million and CHF 305 million, respectively, of provisions for unused commitments and contingent claims. 3 Includes mining and 4 Counterparty allowances and provisions only. Country provisions with banking counterparties amounting to CHF 37 million are disclosed under Collective loan loss 7 The 2005, 2004, 2003, 2002 and 2001 amounts include CHF 48 million, CHF 8 The 2005, 2004, 2003, 2002 and 2001 amounts include CHF 109 million, CHF 214 million, 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 losses by industry sector to evaluate the credit risks in each of the categories. in % Domestic 1 Banks 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 1 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 31.12.05 31.12.04 31.12.03 31.12.02 31.12.01 0.5 0.6 1.4 0.7 1.6 36.5 1.8 3.9 1.6 3.0 0.3 51.9 10.6 0.9 0.1 0.5 17.1 1.3 0.9 12.5 0.5 0.9 0.4 1.8 0.5 0.1 0.5 0.7 1.6 0.8 2.0 39.0 2.0 4.3 1.8 3.4 0.2 56.3 12.7 0.1 0.1 0.3 13.1 1.0 0.6 11.2 0.5 0.3 0.4 3.0 0.3 0.1 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 4.7 0.7 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 48.1 100.0 43.7 100.0 38.6 100.0 39.1 100.0 39.3 100.0 1 Includes Due from banks and Loans from Industrial Holdings in the amount of CHF 728 million for 2005, CHF 909 million for 2004 and CHF 220 million for 2003. beverages. 5 Includes food and beverages. 3 Includes transportation, communication, health and social work, education and other social and personal service activities. 6 Includes hotels and restaurants. 2 Includes chemicals, food and 4 Includes mining and electricity, gas and water supply. 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 31.12.05 305,269 1 31.12.04 270,133 1 31.12.03 248,026 1 31.12.02 249,111 3,434 2,363 1,776 588 375 1.1 0.8 0.6 51.7 75.2 46.4 59.0 0.2 0.2 33.1 3.02 4,699 3,555 2,802 797 241 1.7 1.3 1.0 59.6 78.8 51.6 61.4 0.3 0.3 28.5 3.51 6,999 4,758 3,775 1,349 (102 ) 2.8 1.9 1.5 53.9 79.3 46.8 55.1 0.5 0.5 35.7 2.80 9,654 5,779 5,015 2,466 (115 ) 3.9 2.3 2.0 52.7 86.8 44.8 56.0 1.0 1.0 49.2 2.03 31.12.01 261,967 14,403 8,413 8,001 2,927 (498 ) 5.5 3.2 3.1 55.6 95.1 46.1 60.8 1.1 2.2 36.6 2.73 1 Includes Due from banks and Loans from Industrial Holdings in the amount of CHF 728 million for 2005, CHF 909 million for 2004 and CHF 220 million for 2003. provisions. 4 Allowances relating to non-performing loans only. 3 Allowances relating to impaired loans only. 2 Includes collective loan loss 227 228 On the cover “Hand in hand we are worldclass.” What “You & Us” means to Christian Mutzner, who works for us in Zurich. 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 development 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, governmental and regulatory trends, (2) movements in local and international securities markets, currency exchange rates and interest rates, (3) competitive pressures, (4) technological developments, (5) changes in the ﬁnancial position or 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 2005. 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-0601 ab Financial Report 2005 ab UBS AG P.O. Box, CH-8098 Zurich P.O. Box, CH-4002 Basel www.ubs.com 5 0 0 2 t r o p e R l a i c n a n i F S B U

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