UBS AG
Annual Report 2006

Plain-text annual report

Financial Report 2006 Introduction Our Financial Report comprises the audited financial state- ments of UBS for 2006, 2005 and 2004, 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 2006 and 2005, 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 required by Swiss and US regulations. The Financial Report should be read together with the other publications set out on page 4. We hope that you will find this Financial Report useful and informative. We believe that UBS is one of the leaders in cor- porate disclosure, and would be keen to hear your views on how we might improve the content, information or presen- tation of all our publications. Tom Hill Chief Communication Officer UBS Introduction UBS financial highlights Who we are More about us Contacts Presentation of Financial Information UBS reporting structure Measurement and analysis of performance Changes in accounting and presentation in 2007 UBS Results Risk factors 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  2 3 4 6 7 8 10 12 13 14 14 17 21 22 30 44 49 54 57 61 62 65 67 68 70 75 215 229  Introduction UBS financial highlights UBS income statement CHF million, except where indicated Net profit attributable to UBS shareholders Diluted earnings per share (CHF) 1 Basic earnings per share (CHF) 1 Return on equity attributable to UBS shareholders (%) 2,3 Performance indicators from continuing operations Diluted earnings per share (CHF) 1 Return on equity attributable to UBS shareholders (%) 3,4 Financial Businesses 5 Operating income Operating expenses Net profit attributable to UBS shareholders Net profit attributable to UBS shareholders from continuing operations Cost / income ratio (%) 6 Net new money (CHF billion) 7 Personnel (full-time equivalents) UBS balance sheet & capital management Total assets Equity attributable to UBS shareholders 3 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 As of or for the year ended 31.12.06 12,257 31.12.05 14,029 31.12.04 8,016 5.95 6.20 28.2 5.58 26.5 47,171 32,782 11,253 11,249 69.7 151.7 78,140 6.68 6.97 39.7 4.66 27.7 39,896 27,704 13,517 9,442 70.1 148.5 69,569 3.70 3.89 25.8 3.49 24.3 35,971 26,149 7,656 7,357 73.2 89.9 67,407 2,396,511 2,058,348 1,737,171 49,686 154,222 11.9 14.7 341,892 2,989 AA+ Aa2 AA+ 44,015 131,949 12.8 14.1 310,409 2,652 AA+ Aa2 AA+ 33,632 103,649 11.8 13.6 264,832 2,217 AA+ Aa2 AA+ % change from 31.12.05 (13) (11) (11) 20 18 18 (17) 19 12 16 13 10 13 1 For the EPS calculation, see note 8 to the financial statements. 2 Net profit attributable to UBS shareholders / average equity attributable to UBS shareholders less proposed distributions. 3 Equity attributable to UBS shareholders has been adjusted for the full-year periods ending 31 December 2006, 2005 and 2004 and is now different from the figure published in the Fourth Quarter 2006 Report. For more information, please refer to note 1 to the financial statements. 4 Net profit attributable to UBS shareholders from continuing operations / average equity attributable to UBS shareholders less proposed distributions. 5 Excludes results from Industrial Holdings. 6 Operating expenses / operating income less credit loss expense or recovery. 7 Excludes interest and dividend income. 8 Includes hybrid Tier 1 capital. Please refer to the BIS capital and ratios table in the capital management section and note 29 to the financial statements. All share and earnings per share figures throughout this report, unless otherwise indicated, reflect the 2-for-1 share split made on 10 July 2006. 2 Who we are What we do We are one of the world’s leading financial firms, serving a discerning international client base. Our business, global in scale, is focused on growth. As an integrated firm, we create added value for clients by drawing on the combined resourc- es and expertise of all our businesses. We are present in all major financial centers, with offices in more than 50 countries. We employ around 78,000 peo- ple, with 39% in the Americas, 35% in Switzerland, 16% in the rest of Europe and 10% in the Asia Pacific region. We are one of the best capitalized financial institutions in the world, with a BIS Tier 1 ratio of 11.9%, invested assets of CHF 3.0 trillion, equity attributable to UBS shareholders of around CHF 50 billion and market capitalization of roughly CHF 154 billion (on 31 December 2006). In wealth management, our services are designed for high net worth and affluent individuals around the world, whether investing internationally or in their home country. We pro- vide them with tailored, unbiased advice and investment ser- vices – ranging from asset management to estate planning and from corporate finance to art banking. As an asset manager, we offer innovative investment management solutions in nearly every asset class to private, institutional and corporate clients, and through financial intermediaries. Our investment capabilities comprise tradi- tional assets (for instance equities, fixed income and asset allocation), alternative and quantitative investments (multi- manager funds, funds of hedge funds, hedge funds) and real estate. In the investment banking and securities businesses, we provide securities products and research (in the areas of equities, fixed income, rates, foreign exchange, energy and metals) as well as advice and access to the world’s capital markets to corporate, institutional, intermediary and alter- native asset management clients. Our Swiss retail and corporate banking business provides a complete set of banking and securities services for domes- tic individual and corporate clients. Our vision We are determined to be the best global financial services company. We focus on wealth and asset management, and on investment banking and securities businesses. We continually earn recognition and trust from clients, shareholders, and staff through our ability to anticipate, learn and shape our future. We share a common ambition to succeed by delivering quality in what we do. Our purpose is to help our clients make financial decisions with confidence. We use our resources to develop effective solutions and services for our clients. We foster a distinctive, meritocratic culture of ambition, perfor- mance and learning as this attracts, retains and develops the best talent for our company. By growing both our client and our talent franchises, we add sustainable value for our shareholders. 3 Introduction More about us This Financial Report contains UBS’s audited financial statements for the year 2006 and related detailed analysis. This Financial Report is available in English and German. (SAP no. 80531). You can find out more about UBS from the sources shown below. Publications Annual Review 2006 Our Annual Review this year looks at some major global economic and financial trends, and the part we play in them. It also briefly reviews our financial performance in 2006, corporate governance, and approach to corporate responsibi- lity. It is available in English, German, French, Italian, Chinese and Japanese. (SAP no. 80530). Handbook 2006 / 2007 The Handbook contains a detailed description of UBS, its strategy, organization, businesses, employees, corporate governance and responsibility, as well as risk and treasury management. (SAP no. 80532). 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 avail- able in English. Compensation Report 2006 The Compensation Report 2006 provides detailed informa- tion on the compensation paid to the members of UBS’s Board of Directors (BoD) and the Group Executive Board (GEB). The report is available in English and German. (SAP no. 82307). The same information can also be read in the Corporate Gov- ernance chapter of the Handbook 2006 / 2007. 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 ante- cedent companies and their historical roots. It is available in English and German. (SAP no. 82252). How to order reports These reports are available in PDF format on the internet at www.ubs.com/investors in the reporting section. Printed 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/inves- tors offers a wide range of information about UBS, financial information (including SEC filings), corporate information, share price graphs and data, an event calendar, dividend in- formation and recent presentations given by senior manage- ment to investors at external conferences. Information on the internet is available in English and German, with some sections also in French and Italian. Messaging service On the Analysts and Investors website, you can register to receive news alerts about UBS via Short Messaging System (SMS) or e-mail. Messages are sent in either English or German and users are able to state their preferences for the topics of the alerts received. Results presentations Senior management presents UBS’s results every quarter. These presentations are broadcast live over the internet, and can be downloaded on demand. The most recent result webcasts can be found in the Financials section of our Ana- lysts and Investors website. 4 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 of 1934. Our Form 20-F filing is structured as a “wrap-around” document. Most sections of the filing are satisfied by refer- ring to parts of the Handbook 2006 / 2007 or to parts of this Financial Report 2006. However, there is a small amount of additional information in Form 20-F which is not presented elsewhere, and is particularly targeted at readers in the US. You are encouraged to refer to this additional disclosure. 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 by dialling +1-800-SEC-0330 (in the US) or +1 202 942 8088 (outside the US) for further information on the operation of its public reference room. You may also inspect our SEC reports and other information at the New York Stock Ex- change, 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 documents filed with the SEC may be obtained from UBS’s Investor Relations team at the address shown on the con- tacts 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, phone +41-44-234 11 11; and Aeschenvorstadt 1, CH-4051 Basel, Switzerland, phone +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 (NYSE) and on the Tokyo Stock Exchange (TSE). 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 Zurich London New York Hong Kong Hotline New York Fax (Zurich) 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 Zurich London New York Hong Kong Shareholder Services UBS Shareholder Services, a unit of the Company Secretary, is responsible for the registration of the Global Registered Shares. Hotline Fax +41-44-234 1111 +44-20-7568 0000 +1-212-821 3000 +852-2971 8888 +41-44-234 4100 +1-212-882 5734 +44-44-234 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 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 6 Presentation of Financial Information Presentation of Financial Information UBS reporting structure UBS reporting structure Changes to reporting structure and presentation in 2006 and other adjustments Dillon Read Capital Management (DRCM) On 5 June 2006, we transferred the principal finance and credit arbitrage and commercial real estate businesses in the fixed income, rates and currencies area of the Investment Bank to Global Asset Management. The business, now called Dillon Read Capital Management (DRCM), manages alter- native investment vehicles on behalf of the Investment Bank. Towards the end of 2006, it launched its first outside inves- tor fund. The Investment Bank continues to record the trad- ing revenues generated by the assets managed by DRCM on its fixed income, rates and currencies revenues line. DRCM personnel and general and administrative expenses are booked in Global Asset Management. DRCM charges the Investment Bank for providing investment management services. Those charges and expenses are reported in the “Services to / from other business units” line. This arrange- ment, also shown in the diagram below, has no impact on UBS’s consolidated financial results. Prime Brokerage Our prime brokerage activities have, until now, been treated differently in the United Kingdom than they have in the Unit- ed States. Transactions in the US prime brokerage business were booked as a secured loan balance in the Due to / from customer line, whereas in the United Kingdom they were treated as a securities borrowing / lending activity. Even though there is no regulatory guidance on how to present this particular business activity, we have decided to start reporting it consistently in all locations. In the future, we will report all of the transactions in the prime brokerage business as a secured loan in the Due to / from customer line in our balance sheet. This treatment best reflects most of the busi- ness activity in prime brokerage and the market’s under- standing of the business – which is to provide financing facilities to clients from which they can obtain custody and brokerage facilities, exposure to credit and interest rate de- rivatives and exposure to other financial instruments that the Investment Bank can provide. To reflect the changes, we have restated our consolidated financial statements and the segment reporting of business Reporting of Dillon Read Capital Management  Investment Bank Income DRCM revenues on Investment Bank capital Expenses DRCM personnel expenses DRCM general and administrative expenses Investment Bank Income DRCM revenues on Investment Bank capital Expenses Global Asset Management No impact on Global Asset Management Global Asset Management Income Revenues from DRCM’s external investor investment management business Expenses DRCM personnel expenses DRCM general and administrative expenses Charge from Global Asset Management for investment management services “Services to/from other business units” cost line Charge to Investment Bank for investment management services 6 0 0 2 e n u J 4 l i t n U 6 0 0 2 e n u J 5 m o r F 8 UBS Reporting Structure Global Asset Management Investment Bank Corporate Center Private Equity Industrial Holdings Financial Businesses Global Wealth Management & Business Banking Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland units affected for all prior periods. The figures and results presented in this report are based on restated numbers. While the restatement affected certain interest income and interest expense components, it did not have an impact on UBS’s income statement, its internal measures of credit ex- posure, or its regulatory capital. Obligations to employees UBS has adjusted its opening balance sheet per 1 January 2002 to reflect obligations for untaken holidays of employ- ees, sabbatical leave and service anniversary awards. The retained earnings for each full-year and interim period from 2002 to 2006 are affected by the same adjustment, which reduces the equity attributable to UBS shareholders by CHF 309 million. This has led to a recalculation of return on equity, which is reflected in the current ratio and all past ones published since 2002. Additional information is avail- able in note 1 to the financial statements. Changes to accounting At the start of 2006, we implemented accounting changes based on the revised IAS 39 Financial Instruments: Recog­ nition and Measurement; Amendment to the Fair Value Option. All financial instruments designated at fair value through profit or loss on 31 December 2005 continued to qualify for the use of the fair value option under the revised fair value option and we did not apply the fair value option to any previously recognized financial asset or financial liabil- ity for which the fair value option was not adopted under former guidance. Because of this, the adoption of the re- vised standard did not have any effect on our financial state- ments on the transition date, 1 January 2006. Until the beginning of 2006, we had mainly applied the fair value option to hybrid debt instruments. Starting in second quarter, in line with the revised fair value option, we also applied the fair value option to certain new loans and loan commitments made by the Investment Bank, which are substantially hedged with credit derivatives. By adopting this option, we reduce temporary profits and losses caused by the previous and different accounting treatments of the loans and loan commitments and the hedging credit deriva- tives (refer to Notes 1, 9 and 19 in the Financial Statements section). In second half 2006, we additionally applied the fair value option to certain hybrid instruments resulting from structured repurchase and reverse repurchase agreements and to a hedge fund investment which is part of a portfolio managed on a fair value basis. Changes in presentation in our credit risk disclosure We have stopped reporting non-performing loans as a key performance indicator for the Investment Bank and Business Banking Switzerland in our 2006 Financial Report. We will also stop disclosing them in quarterly reports from first quar- ter 2007. The disclosure and discussion of the impaired lend- ing portfolio, which is a key component of our internal cred- it risk management and control processes, will continue. As in previous years, non-performing loans, as defined under Swiss Federal Banking Commission (SFBC) regulation, will be reported in the notes to the annual financial statements. Other new disclosures We have made some minor enhancements to our disclosure in 2006 as part of our continuing effort to improve the trans- parency of our financial reporting and provide the best pos- sible understanding of our business. In first quarter 2006, we changed the name of our ad- justed regulatory capital performance indicator to “allocated regulatory capital”. The new term more accurately reflects the fact that capital is actually allocated to the Business Groups based on risk-weighted assets, goodwill and excess intangible assets. In our US wealth management business, the calculation of revenues includes net goodwill funding as acquisition costs are no longer disclosed separately when discussing results. 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). Our results dis- cussion and analysis comments on the underlying opera- tional performance of our business, focusing on continuing operations. As discontinued activities are no longer relevant to our management of the company, we do not consider them to be indicative of our future potential performance. They are therefore not included in our business planning de- cisions. This helps to better assess our performance against peers and to estimate future growth potential. In the last three years, two discontinued operations had a significant impact on our consolidated financial statements: – In fourth quarter 2005, we sold our Private Banks & GAM unit to Julius Baer at a gain of CHF 3,705 million after tax (pre-tax CHF 4,095 million). The unit comprised the Ban- co di Lugano, Ehinger & Armand von Ernst and Ferrier Lullin private banks as well as specialist asset manager GAM. After the sale, we retained a stake of 20.7% in the new Julius Baer. – On 23 March 2006, UBS sold its 55.6% stake in Motor- Columbus to a consortium representing Atel’s Swiss mi- nority shareholders, EOS Holding and Atel, as well as to French utility Electricité de France (EDF) for a sale price of approximately CHF 1,295 million, leading to an after-tax gain on sale of CHF 387 million. Up to and including 2005, we provided comments and analysis on an adjusted basis that also excluded the amorti- zation of goodwill and other acquired intangible assets. With the introduction of IFRS 3 Business Combinations at the be- ginning of 2005, we ceased amortizing goodwill, which was by far the largest adjustment made to our results. In this Fi- nancial Report, comments related to 2004 include goodwill amortization. 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 invest- ment banking. When discussing quarterly performance, we therefore compare the Investment Bank’s financial results of the reported 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 state- ments, 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 previous quarter basis. For all other Business Groups and Units, recent quarterly results are compared with the previous quarter’s, as they are only slightly impacted by seasonal components 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 seven years, we have consistently assessed our performance against a set of four measures that were de- signed to ensure the delivery of continuously improving returns to our shareholders. In that time, UBS has evolved, and its business and client base have grown. By late 2005 we had arrived at a point where we were steadily exceeding the original targets. That is why, starting in first quarter 2006, we modified our measures. On average through periods of varying mar- ket conditions, we: – seek to increase the value of UBS by achieving a sustain- able, 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 financial businesses, including Global Asset Man- agement and Business Banking Switzerland (this measure was previously only applied to our wealth management units). – use diluted earnings per share (EPS) instead of basic EPS as a reference for our EPS growth target that remains, as before, annual double-digit percentage growth. – continue our unchanged objective to manage our Busi- ness Group / Business Unit cost / income ratios at levels that compare well with our competitors. Our cost / income ratio target is limited to our financial businesses. Business Group Key Performance Indicators At the Business Group or Business Unit level, our perfor- mance is measured by carefully chosen Key Performance Indicators (KPIs). They indicate the Business Group’s or Busi- ness Unit’s success in creating value for shareholders but do not disclose 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 Key performance indicators Business Key performance indicators Definition Business groups (excluding Corporate Center) and business units within Financial Businesses Wealth & Asset Management businesses and Business Banking Switzerland Cost / income ratio (%) Total operating expenses / total operating income before adjusted expected credit loss. Invested assets (CHF billion) Net new money (CHF billion) Client assets managed by or deposited with UBS for investment purposes only (for further details please see below). Inflow of invested assets from new clients + inflows from existing clients – outflows from existing clients – outflows due to client defection Wealth & Asset Management businesses Gross margin on invested assets (bps) Operating income before adjusted expected credit loss / average invested assets. Wealth Management International & Switzerland Client advisors Expressed in full-time equivalents. Wealth Management US Recurring income (CHF million) Business Banking Switzerland Investment Bank Corporate Center Revenues per advisor (CHF thousand) Impaired lending portfolio, as a % of total lending portfolio, gross Return on allocated regulatory capital (%) Compensation ratio (%) Impaired lending portfolio, as a % of total lending portfolio, gross Return on allocated regulatory capital (%) Average VaR (10-day, 99% confidence, 5 years of historical data) IT infrastructure (ITI) cost per Financial Businesses full-time employee Interest, asset-based revenues for portfolio management and fund distribution, account-based and advisory fees (as opposed to transactional revenues). Income (including net goodwill funding) / average number of financial advisors. Net goodwill funding is defined as goodwill and intangible asset-related funding, net of risk-free return on the corresponding capital allocated. Impaired lending portfolio, gross / total lending portfolio, gross. Business Unit performance before tax / average allocated regulatory capital. Personnel expenses / operating income before adjusted expected credit loss. Impaired lending portfolio, gross / total lending portfolio, gross. Business Group performance before tax / average allocated regulatory capital. Value at Risk (VaR) expresses the potential loss on a trading portfolio over a 10-day time horizon, and measured to a 99% level of confidence, based on 5 years of historical data. ITI costs / average number of Financial Businesses employees. These Business Group KPIs are used for internal per- formance measurement and planning as well as external reporting. This ensures management accountability for per- formance by senior executives 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 investment purposes. Invested assets is our central measure and includes, for example, discretionary and advisory wealth management portfolios, 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 minimal advisory role for such clients and as asset flows are driven more by liquidity requirements than investment reasons. The same holds true for the corpo- rate cash management business of the Wealth Management US unit, which we excluded from invested assets towards the end of 2005. Non-bankable assets (for example art col- lections) and deposits from third-party banks for funding or trading purposes are excluded from both measures. Net new money in a reported period is the net amount of invested assets that are entrusted to the bank by new and existing clients less those withdrawn by existing clients and clients who terminate their relationship with UBS. Net new money is calculated using the direct method, by which in- and outflows to and from invested assets are determined at the client level based on transactions. Interest expenses clients pay on their loans are treated as net new money out- flows. Interest and dividend income from invested assets is  Presentation of Financial Information Measurement and analysis of performance not counted as net new money inflow. Market and currency movements as well as fees and commissions are excluded from net new money, as are the effects resulting from any acquisition or divestment of a UBS subsidiary or business. Reclassifications between invested assets and client assets as a result of a change in the service level delivered are treated as net new money flow. 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 Management 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 practice and our open architecture strategy and allows us to accurately reflect the performance of each individual business. Overall, CHF 371 billion of in- vested assets were double counted in 2006 (CHF 332 bil- lion in 2005). Changes in accounting and presentation in 2007 IFRS 7 Financial Instruments: Disclosures Effective 2007, we will adopt the disclosure requirements for financial instruments under IFRS 7. The new standard has no impact on recognition, measurement and presentation of financial instruments. Rather, it requires entities to provide disclosures in their financial statements that enable users to evaluate: a) the significance of financial instruments for the entity’s financial position and performance; and b) the nature and extent of the credit, market and liquidity risks arising from financial instruments during the period and at the reporting date, and how the entity manages those risks. The principles of IFRS 7 complement the principles for recognizing, measur- ing and presenting financial assets and financial liabilities in IAS 32 Financial Instruments: Presentation and IAS 39 Financial Instruments: Recognition and Measurement. UBS has entered into transactions for which fair value is determined using valuation models for which not all inputs are market observable prices or rates. Such financial instruments are initially recognized in UBS’s financial statements at the transaction price, which is generally the best indicator of fair value, although the value obtained from the relevant valuation model may differ. Where such differences arise, UBS will be required by IFRS 7 to disclose, by class of financial instru- ment: (a) its accounting policy for recognizing that difference in profit or loss to reflect a change in factors (including time) that market partici- pants would consider in setting a price, and (b) the aggregate difference yet to be recognized in profit or loss at the beginning and end of the period and a reconciliation of changes in the balance of this difference. 12 UBS UBS Results Results 2006 In 2006, attributable profit was CHF 12,257 million, down 13% from CHF 14,029 million a year earlier, which included a net gain of CHF 3,705 million from the sale of Private Banks & GAM. Our financial businesses contributed CHF 11,253 million to attributable profit, of which CHF 11,249 million was from continuing operations. This was an improvement of 19% from CHF 9,442 million in 2005. Discontinued operations contributed CHF 4 million net profit to financial businesses. Industrial Holdings added CHF 1,004 million to attributable profit, with CHF 242 million stemming from continuing op- erations. Dividend The Board of Directors will propose to the shareholders at the Annual General Meeting (AGM) that we raise the payout to CHF 2.20 a share in order to match our strong 2006 re- sult. Subject to approval, this is a 16% increase from the total payout last year, which included a par value repayment of CHF 0.30 a share for the gain realized from the sale of Private Banks & GAM. It is also 38% higher than last year’s regular dividend of CHF 1.60 a share (after the 2-for-1 share split). Our dividend for the 2004 financial year (paid in 2005) was CHF 1.50 a share (after the 2-for-1 share split). If the dividend is approved, the ex-dividend date will be 19 April 2007, with payment on 23 April 2007 for share- holders of record on 18 April 2007. 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 28% from CHF 7,357 million in 2004. Discontinued operations contributed CHF 4,075 million. Industrial Holdings added CHF 512 million to attributable profit, with CHF 334 million stemming from continuing operations. Risk factors Certain risk factors, including those described below, can impact our ability to carry out our business strategies and can directly affect our earnings. As a consequence, our revenues and operating profit have varied – and are likely to continue to vary – from period to period and revenues and operating profit for any particular period may not be indicative of sustainable results. Performance in our industry depends on the economic climate – negative developments can adversely affect our business activities The financial services industry prospers in conditions of economic growth, market liquidity and buoyancy and positive investor sentiment. An economic downturn, inflation or a severe financial crisis could negatively affect our revenues, and we would be unable to immediately adjust all our costs to the resulting deterioration in market or business conditions. A market downturn can be precipi- tated by geopolitical events, changes in monetary or fiscal policy, develop- ment of trade imbalances, natural disasters, pandemics and civil unrest, and war or terrorism. Because financial markets are global and highly interconnected, even local and regional events can have widespread impact well beyond their sources. A crisis could develop, regionally or globally, as a result of disruption in emerging markets, which are particu- larly susceptible to macro-economic and geopolitical developments, or as a result of the failure of a major market participant. As our presence and business in emerging markets increases, we may become more exposed to these risks. Adverse and extreme developments of this kind could affect our businesses in a number of ways: – a general reduction in business activity and market volumes affects fees, commissions and margins from market-making and customer- driven transactions and activities. A market downturn may reduce the volume and valuations of assets we manage on behalf of clients, reducing our asset- and perfor- mance-based fees – reduced market liquidity may limit trading and arbitrage opportunities or impede our ability to manage risks, impacting both trading income and performance-based fees 14 Risk factors (continued) – the assets we hold for our own account as investments or trading positions may fall in value – impairments and defaults on credit exposures and on trading and investment positions may increase. Losses may be exacerbated by falling collateral values – if individual countries impose restrictions on cross-border payments or other exchange or capital controls we may suffer losses from enforced default by counterparties, we may be unable to access our own assets, or we may be impeded in – or prevented from – managing our risks. We might be unable to identify or capture competitive opportunities The financial services industry is characterized by intense competition, continuous innovation, detailed – and sometimes fragmented – regulation and ongoing consolidation. We face competition at the level of local markets and individual business lines, and from global financial institutions comparable to UBS in their size and breadth. Barriers to entry in individual markets are being eroded by new technology. We expect these trends to continue and competition to increase in the future. If we are unable to identify market trends and developments, do not respond to them by devising and implementing adequate business strategies, or are unable to attract or retain the qualified people to carry them out, our competitive strength and market position might be eroded. Our risk management and control processes may not always protect us from loss Risk-taking is a major part of the business of a financial services firm. We derive a substantial part of our revenue from market making and proprietary trading in cash and derivatives markets and credit is an integral part of many of our retail and investment bank activities. Interest rates, equity prices, foreign exchange levels and other market fluctuations can adversely affect our earnings. Some losses from risk-taking activities are inevitable but to be successful over time we must balance the risks we take with the returns we generate. We must therefore diligently identify, assess, manage and control our risks, not only in normal market conditions but also as they might develop under more extreme – “stressed” – condi- tions, when concentrations of exposure can lead to severe losses. Our risk management and control culture, tools and processes for market and credit risk, including country risk, are described in the Risk Management chapter of our Handbook 2006 / 2007. We could, however, suffer losses if: – we do not fully identify the risks in our portfolio, in particular risk concentrations and correlated risks – our assessment of the risks we have identified, or our response to negative trends proves to be inadequate or incorrect – markets move in ways that are unexpected in terms of their speed, direction, severity or correlation and our ability to manage risks in the resultant environment is restricted – third parties to whom we have credit exposure or whose securities we hold for our own account or as collateral are severely affected by unexpected events and we suffer defaults and impairments beyond the level implied by our risk assessment -– collateral or other security provided by our counterparties proves inadequate to cover their obliga- tions at the time of their default. We also manage risk on behalf of our clients in our asset and wealth management businesses, and our performance in these activities could be harmed by the same factors. If clients suffer losses or our perfor- mance does not match that of our competitors, we may suffer reduced fee income and a decline in assets under management or withdrawal of mandates. Liquidity and funding management are critical to our ongoing performance A substantial part of our funding requirement is met using short-term unsecured funding sources, including wholesale and retail deposits and the regular issuance of money market paper. The volume of these funding sources is largely stable. If this situation were to change, we could be forced to liquidate assets, in particular from our trading portfolio, to meet maturing liabilities or deposit with- drawals. We might be forced to sell them at discounts that could adversely affect our profitability and our business franchises. A reduction in our credit rating could adversely affect our cost of borrowing, in particular from wholesale unsecured sources, and reduce our access to capital markets. It could also result in our having to make additional cash payments or post collateral, or in the premature termination of contracts with rating trigger clauses. Our approach to liquidity and funding management is described in the Treasury Management chapter of our Handbook 2006 / 2007. Operational risks may affect our business 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 operational risk management and control systems and processes, which are described in the Risk Management chapter of our Handbook 2006 / 2007 15 UBS Results Risk factors (continued) under “Operational Risk”, are designed to ensure that the risks associated with our activities, includ- ing those arising from process error, failed execution, fraud, systems failure, and failure of security and physical protection, are appropriately con- trolled. If these internal controls fail or prove ineffective in identifying and remedying such risks, we could suffer operational failures that might result in losses. Legal claims may arise in the conduct of our business In the ordinary course of our business we are involved in a variety of claims, disputes and legal proceedings in Switzerland and other jurisdictions where we are active, including the United States. Such legal proceedings may expose us to substantial mone- tary damages and legal defense costs, injunctive relief and criminal and civil penalties. Our global presence exposes us to other risks We operate in more than 50 countries, earn income and hold assets and liabilities in many different currencies and are subject to many different legal, tax and regulatory regimes. Changes in local tax laws or regula- tions may affect our clients’ ability or willingness to do business with us or the viability of our strategies and business model. Because we prepare our accounts in Swiss francs while a substantial part of our assets, liabilities, revenues and expenses are denominated in other currencies, changes in foreign exchange rates – particularly between the Swiss franc and the US dollar (US dollar income representing the major part of our non-Swiss franc income) – may have an effect on our reported earnings. Our approach to management of this currency risk is explained in the Treasury Manage- ment chapter of our Handbook 2006 / 2007 under “Corporate currency management”. 16 UBS Performance Indicators UBS Performance Indicators UBS Performance Indicators RoE (%) 1,2 as reported from continuing operations Diluted EPS (CHF) 3 as reported from continuing operations Cost / income ratio of the financial businesses (%) 4,5 Net new money, financial businesses (CHF billion) 6 For the year ended 31.12.06 31.12.05 31.12.04 28.2 26.5 5.95 5.58 69.7 151.7 39.7 27.7 6.68 4.66 70.1 148.5 25.8 24.3 3.70 3.49 73.2 89.9 RoE 1, 2  in % 40 30 20 10 0 2004 2005 2006 2004 2005 2006 Cost / income ratio of the financial businesses 4, 5 in % 39.7 27.7 28.2 26.5 25.8 24.3 80 70 60 50 40 73.2 70.1 69.7 As reported From continuing operations Diluted EPS 3  CHF Net new money, financial businesses 6 CHF billion 2004 2005 2006 2004 2005 8.00 6.00 4.00 2.00 0.00 6.68 4.66 5.95 5.58 3.70 3.49 As reported From continuing operations 160 120 80 40 0 148.5 89.9 2006 151.7 1 Net profit attributable to UBS shareholders / average equity attributable to UBS shareholders less proposed distributions. 2 RoE as reported and from continuing operations reflects the adjusted equity attributable to UBS shareholders. See note 1 to the financial statements for more information. 3 Details of the EPS calculation can be found in note 8 to the financial statements. 4 Excludes results from Industrial Holdings. 5 Operating expenses / operating income less credit loss expense or recovery. 6 Excludes interest and dividend income. 40 32 24 16 8 8.0 6.4 4.8 3.2 1.6 18 40 32 24 16 8 0 8.0 6.4 4.8 3.2 1.6 0.0 0 0.0 160 128 96 64 32 0 2006 For the last seven years, we have consistently focused on four performance indicators designed to ensure we deliver continually improving returns to our shareholders. We modi- fied some of them in 2006 to reflect the evolution of our business (see page 10). All are calculated based on results from continuing operations. The first two, return on equity and diluted earnings per share, are based on the results of the entire firm. The cost / income ratio and net new money indicators are limited to our financial businesses. On this ba- sis, performance indicators 2006 show: – return on equity in full-year 2006 at 26.5%, down from 27.7% in 2005, but well above our target of 20% mini- mum over the cycle. Higher attributable profit was offset by an increase in average equity following strong retained earnings. – diluted earnings per share in 2006 at CHF 5.58, up 20% from CHF 4.66 a year ago, reflecting increased earnings and a slight reduction in the average number of shares outstanding (–2%) following share repurchases. – a cost / income ratio for our financial businesses of 69.7% in 2006, down 0.4 percentage points from 70.1% a year ago. This reflects the increase in net trad- ing income and net fee and commission income, partly offset by higher personnel and general and administra- tive expenses. We have added over 8,500 employees during the last year in areas where we see long-term strategic opportunities. – net new money at a record CHF 151.7 billion, up from CHF 148.0 billion a year earlier (excluding Private Banks & GAM), corresponding to an annual growth rate of 5.7% of the as- set base at the end of 2005. Inflows remained strong world- wide. Wealth Management International & Switzerland Net new money 1 CHF billion Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Wealth Management & Business Banking Institutional Wholesale Intermediary Global Asset Management 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 Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Wealth Management & Business Banking Institutional Wholesale Intermediary Global Asset Management 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 31.12.06 31.12.05 31.12.04 97.6 15.7 1.2 114.5 29.8 7.4 37.2 151.7 151.7 68.2 26.9 3.4 98.5 21.3 28.2 49.5 148.0 0.5 148.5 42.3 18.1 2.6 63.0 23.7 (4.5) 19.2 82.2 7.7 89.9 As of % change from 31.12.06 31.12.05 31.12.04 31.12.05 1,138 824 161 2,123 519 347 866 2,989 0 2,989 982 752 153 1,887 441 324 765 2,652 0 2,652 778 606 140 1,524 344 257 601 2,125 92 2,217 16 10 5 13 18 7 13 13 13 19 UBS Performance Indicators recorded inflows of CHF 97.6 billion, driven by consistent- ly high inflows during the year, particularly in Asia Pacific and Europe, both a result of our growth strategy. Our US business contributed CHF 15.7 billion in net new money, CHF 11.2 billion below 2005 levels. Global Asset Manage- ment inflows fell to CHF 37.2 billion, down from the strong CHF 49.5 billion result a year earlier. The Swiss retail busi- ness recorded net new money inflows of CHF 1.2 billion. 2005 – diluted earnings per share in 2005 at CHF 4.66, up 34% from CHF 3.49 a year earlier, reflecting increased earnings and a slight reduction in the average number of shares outstanding (–3%) following share repurchases. – a cost / income ratio for our financial businesses of 70.1% in 2005, down 3.1 percentage points from 73.2% a year earlier. This reflects the increase in net fee and commis- sion income and net income from trading activities and the absence of goodwill amortization, partly offset by higher costs related to personnel – all related to the ex- pansion of business volumes. From our continuing operations, performance indicators show: – return on equity in full-year 2005 at 27.7%, up from 24.3% in 2004. The increase was driven by higher attributable profit, but was partially offset by an increase in average equity levels, reflecting the growth in retained earnings. – for the whole of 2005, net new money of CHF 148.0 bil- lion, up 80% from CHF 82.2 billion a year earlier. This amounts to an annual growth rate of 7.0% of the asset base at the end of 2004. All the figures above exclude Private Banks & GAM. 20 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 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) As of or for the year ended % change from 31.12.06 31.12.05 31.12.04 31.12.05 87,401 (80,880) 6,521 156 6,677 25,881 13,318 1,295 47,171 21,282 2,187 23,469 7,929 (9) 1,245 0 148 32,782 14,389 2,751 11,638 4 0 4 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 11,642 13,971 389 389 0 11,253 11,249 4 454 454 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 78,140 69,569 67,407 47 63 (32) (58) (33) 21 67 131 18 16 34 18 23 36 0 17 18 18 20 18 (100) (100) (100) (17) (14) (14) (17) 19 (100) 12 1 Excludes results from Industrial Holdings. 2 Additionally includes social security contributions and expenses related to alternative investment awards. 3 Includes goodwill amortization of CHF 68 million for the year ended 31 December 2004. 22 2006 Results On a continuing basis, 2006 was another record year for UBS, with all businesses reporting a stronger performance in 2006 compared with a year earlier. Attributable net profit in 2006 was CHF 11,253 million. Discontinued operations con- tributed CHF 4 million, compared with CHF 4,075 million in 2005, when we sold Private Banks & GAM. Net profit from continuing operations was CHF 11,249 million, up 19% from CHF 9,442 million in 2005. It was at the highest level ever, fueled by a 19% increase in income, which rose to CHF 47,015 million. Asset-based revenues showed particular strength, reflecting rising market levels as well as strong in- flows into our wealth and asset management businesses. Brokerage fees were up, reflecting brisk client activity. Cor- porate finance and underwriting fees rose, not just because of buoyant capital market conditions, but also as a result of our efforts to grow our market share in key sectors, such as large cap deals, emerging markets, technology and as a partner of financial sponsors. Overall, net fee and commis- sion income now contributes 55% to total operating income in 2006. Income from trading activities reached a record high as well, mainly driven by higher gains from equity de- rivatives, prime brokerage and equity proprietary trading. Fixed income activities saw stronger results driven by positive market conditions and improved performances in deriva- tives, mortgage-backed securities and commodities. Reve- nues from interest margin products increased to the highest level ever, reflecting the success and growth of lending ac- tivities to wealthy private clients worldwide. They also re- flected an increase in spreads for US dollar, euro and Swiss franc deposits and higher Swiss mortgage volumes. The wealth management business in the US saw the level of de- posits rise and benefited from higher spreads. In 2006, we continued to record credit loss recoveries, although they were lower than a year earlier. Expenses continued to increase in the context of our strate- gic expansion. In 2006, they rose 18% or CHF 5,078 million from 2005. Personnel expenses were up 18%, reflecting the 12% increase in personnel numbers across our businesses. Performance-related payments rose with revenues. For 2006, 53% of personnel expenses took the form of bonus or other variable compensation, up from 50% a year earlier. Average variable compensation per head in 2006 was 16% higher than in 2005. General and administrative expenses were up 23% from a year earlier. Provision expenses rose, mainly as a result of the settlement agreement with Sumitomo Corporation and the sublease of unused office space in New Jersey. Although we needed less office space than expected in New Jersey, we expanded our presence in other regions, leading to overall higher occupancy costs. Activity levels and business volumes increased worldwide, resulting in higher spending for IT out- sourcing, communication and travel. Investment in growth initiatives resulted in higher costs for IT and strategic proj- ects, in particular at the Investment Bank. The rise in costs was outpaced by the improvement in revenues, driving our cost / income ratio down to 69.7% – the lowest level ever recorded. Operating income Total operating income was CHF 47,171 million in 2006, up 18% from CHF 39,896 million in 2005. This was the highest level ever. Net interest income was CHF 6,521 million in 2006, down from CHF 9,528 million a year earlier. Net trading income was CHF 13,318 million, up from CHF 7,996 million in 2005. As well as income from interest margin-based activities (loans and deposits), net interest income includes income earned as a result of trading activities (for example, coupon and dividend income). This component is volatile from period to period, depending on the composition of the trading 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 15% or CHF 1,700 million from CHF 11,419 million in 2005 to CHF 13,119 million in 2006. At CHF 4,759 million, equities trading income in 2006 was up 21% or CHF 831 million from CHF 3,928 million in 2005. Last year saw a large increase in derivatives trading, mainly in Asia Pacific and in the US, as we experienced growing market demand in these regions. Our prime brokerage services continued to grow around the globe as we were able to further expand our client base. Ad- ditionally, our proprietary business recorded higher results. These gains were partially offset by lower revenues in our cash equity business, partly due to increased client facilita- tion requirements by clients in the US and Europe. Fixed in- come trading revenues, at CHF 6,204 million in 2006, were up 8% or CHF 463 million from CHF 5,741 million in 2005. Our rates business recorded significant increases with busi- ness expansion in energy trading and in mortgage backed securities driven by higher client activity and favorable mar- ket conditions. This was partially offset by lower derivatives income due to declining customer flows. The metals busi- ness was positively affected by active markets, with the pre- cious metals business benefiting from rising gold prices. Rev- enues from our credit fixed income business were up slightly compared with last year. We recorded a loss of CHF 245 mil- lion relating to Credit Default Swaps (CDSs) hedging existing credit exposure in the loan book, against a gain of CHF 103 million a year earlier. At CHF 1,745 million, revenues from our foreign exchange business were up in 2006 compared 23 Financial Businesses Results with CHF 1,458 million recorded a year earlier. Foreign ex- change trading revenues rose due to higher volumes. Net income from interest margin products was CHF 5,829 million in 2006, up 9% from CHF 5,355 million in 2005, reflecting the growth in collateralized lending to wealthy clients worldwide. It also reflected an increase in spreads for US dollar, euro and Swiss franc deposits and higher volumes of mortgages to Swiss clients. The wealth management business in the US achieved higher levels of deposits, and benefited from higher spreads on them. This increase was partially offset by lower income from our shrink- ing Swiss recovery portfolio, which dropped by CHF 0.7 bil- lion compared to year-end 2005. At CHF 891 million, net income from treasury and other activities in 2006 was CHF 141 million or 19% higher than CHF 750 million in 2005. Interest income increased due to a higher consolidated capital base, partially offset by lower interest rate spreads. Compared with last year, income benefited from mark-to-market gains on USD foreign ex- change options used to hedge the currency exposure arising from future earnings. The US dollar fell against the Swiss franc in 2006 while it increased in 2005. During 2005 trea- sury revenues were negatively affected by the accounting treatment of interest rate swaps, as these hedges were not fully effective. In 2006, we experienced a net credit loss recovery of CHF 156 million, compared to a net credit loss recovery of CHF 375 million in 2005. This result reflects the favorable credit market environment that has prevailed over a pro- longed period. World economic growth continued to be ro- bust, despite a moderate slowdown in the US. Credit spreads remained very tight in almost all major developed and emerg- ing capital markets, as healthy expansion of cash flows al- lowed the corporate sector to reduce leverage and build liquidity. The ongoing positive macro-economic environment in key emerging markets allowed the release of CHF 48 mil- lion of collective loan loss provisions for country risk. Net credit loss recovery at Global Wealth Management & Business Banking amounted to CHF 109 million in 2006 compared with a net credit loss recovery of CHF 223 million in 2005. The benign credit environment in Switzerland, where the corporate bankruptcy rate continued to fall in 2006, coupled with the measures taken in recent years to improve the quality of our credit portfolio has again resulted in a low level of new defaults. The management of our im- paired portfolio, which continues to shrink, has also contrib- uted to this result. The Investment Bank realized a net credit loss recovery of CHF 47 million in 2006, compared with a net credit loss re- covery of CHF 152 million in 2005. This continued strong performance was the result of further recoveries of previ- ously established allowances and provisions from the work- out of the impaired portfolio, and no new defaults in 2006. >> For further details on our risk management approach, how we measure credit risk and the development of our credit risk exposures, please see the “Risk Management” chapter of our Handbook 2006 / 2007. In 2006, net fee and commission income was CHF 25,881 million, up 21% from CHF 21,436 million a year ear- lier. The increase was driven by a strong contribution from recurring asset-based fees, higher investment fund fees and net brokerage fees, rising underwriting fees as well as cor- porate finance fees. Underwriting fees, at their highest lev- el ever, were CHF 3,538 million in 2006, up 24% from CHF 2,857 million in 2005. Equity underwriting fees, at CHF 1,834 million, increased by CHF 493 million or 37% in all regions, especially in Asia. This was partially due to our role in the initial public offering of the Bank of China during second quarter 2006, where we acted as joint coordinator and book- runner. Fixed income underwriting fees, at CHF 1,704 million, were up 12% or CHF 188 million, which reflects the strong market conditions and our enhanced competitive position in the leveraged finance business. At CHF 1,852 million, corpo- 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 24 For the year ended % change from 31.12.06 31.12.05 31.12.04 31.12.05 6,521 13,318 19,839 4,759 6,204 1,745 411 13,119 5,829 891 19,839 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 (32) 67 13 21 8 20 41 15 9 19 13 Credit loss (expense) / recovery CHF million Global Wealth Management & Business Banking Investment Bank UBS For the year ended % change from 31.12.06 31.12.05 31.12.04 31.12.05 109 47 156 223 152 375 94 147 241 (51) (69) (58) rate finance fees in 2006 were up 27% from CHF 1,460 mil- lion a year earlier. Advisory gross revenues increased during 2006, as clients took advantage of strategic opportunities in the brisk merger and acquisition environment and our grow- ing franchise in this area. Net brokerage fees were CHF 6,149 million in 2006, up 21% or CHF 1,062 million from CHF 5,087 million in 2005, reflecting the improved markets and the re- sulting higher confidence of institutional and individual cli- ents – especially in the first half and at the end of 2006. Ad- ditionally, higher income from exchange-traded derivatives was driven by the acquisition of ABN AMRO’s global futures and options business. Investment fund fees, at their highest level ever, were CHF 5,858 million in 2006, up 23% from CHF 4,750 million in 2005, mainly reflecting higher asset- based fees for our wealth and asset management businesses, driven by strong client money inflows and favorable market conditions. Fiduciary fees were slightly higher in 2006, increas- ing from CHF 212 million in 2005 to CHF 252 million, reflect- ing an increase in the underlying asset base. At CHF 1,266 million, custodian fees in 2006 were up 8% from CHF 1,176 million in 2005. This increase was due to an enlarged asset base. Portfolio and other management and advisory fees in- creased by 25% to CHF 6,622 million in 2006 from CHF 5,310 million in 2005. The increase is again the result of rising in- vested asset levels driven by market valuations and strong net new money inflows and to a lesser extent due to higher per- formance fees. Insurance-related and other fees, at CHF 449 million in 2006, increased by 21% from a year earlier, due to higher commissions from insurance related products. Credit- related fees and commissions decreased by 12% to CHF 269 million in 2006 from CHF 306 million in 2005, reflecting de- clining business volumes and lower income from loans. Commission income from other services increased by 4% from CHF 1,027 million in 2005 to CHF 1,064 million in 2006, mainly driven by equity derivative products and higher fees for credit cards. Other income increased by 131% to CHF 1,295 million in 2006 from CHF 561 million in 2005. This was driven by gains on our New York Stock Exchange membership seats, which were exchanged into shares when it went public in March 2006. In addition we sold our stakes in the London Stock Exchange, Babcock & Brown and EBS group. Operating expenses Total operating expenses increased by 18% to CHF 32,782 million in 2006 from CHF 27,704 million in 2005. Net fee and commission income CHF million Equity underwriting fees Debt 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 31.12.06 31.12.05 31.12.04 31.12.05 1,834 1,704 3,538 1,852 8,053 5,858 252 1,266 6,622 449 27,890 269 1,064 29,223 1,904 1,438 3,342 25,881 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 37 12 24 27 20 23 19 8 25 21 22 (12) 4 21 17 28 21 21 25 Financial Businesses Results Personnel expenses increased CHF 3,566 million or 18% to CHF 23,469 million in 2006 from CHF 19,903 million in 2005. The rise was driven by higher performance-related 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 12% increase in personnel over the year, exemplifying the continuous expansion of our business as well as annual pay rises. Share-based components were up 34% or CHF 559 million to CHF 2,187 million from CHF 1,628 million, mainly reflecting more share awards granted in 2006 and the higher fair value of options, driven by the rise in the share price. Contractors’ expenses, at CHF 822 million, were CHF 1 million below 2005’s. Insurance and social security contributions rose by 9% to CHF 1,374 million in 2006 com- pared with CHF 1,256 million in 2005, reflecting higher salary and bonus payments. Contributions to retirement benefit plans rose 13% or CHF 90 million to CHF 802 million in 2006 as a result of both higher salaries paid and the increased staff levels. At CHF 1,564 million in 2006, other personnel expenses increased CHF 174 million from 2005, mainly driven by increased headcount. At CHF 7,929 million in 2006, general and administrative expenses increased CHF 1,481 million from CHF 6,448 mil- lion a year ago. The increase was driven by a number of pro- visions, mainly for the Sumitomo settlement and the long term lease on an office building in New Jersey. Professional fees rose for projects that support our growth strategy. IT and other outsourcing costs, marketing and public relations as well as expenses for market data services were driven up by increased business volume. Higher staff levels resulted in increased costs for occupancy and for travel. Depreciation was CHF 1,245 million in 2006, almost un- changed from CHF 1,240 million in 2005. Higher deprecia- tion on real estate was partially offset by falling IT-related charges. There was no goodwill amortization in either 2006 or 2005. At CHF 148 million, amortization of intangible assets was up 17% from CHF 127 million a year earlier, related to acqui- sitions made during 2006. Tax Tax expense for 2006 was CHF 2,751 million, resulting in an effective tax rate of 19.1%, compared with the full-year 2005 tax rate of 18.8%. The tax rate for 2006 as a whole, and particularly in fourth quarter, was positively influenced by the release of deferred tax valuation allowances, mainly reflecting improved forecast earnings in certain group com- panies and branches. We believe that a tax rate of about 22% is a reasonable initial estimate for 2007. Business Group tax rates Indicative Business Group and Business Unit tax rates are cal- culated on an annual basis based on the results and statu- tory tax rates of the financial year. These rates are approxi- mate calculations, based upon the application to the year’s adjusted earnings of statutory tax rates for the locations in which the Business Groups operated. These tax rates, there- fore, give guidance on the tax cost of each Business Group doing business during 2006 on a stand-alone basis, without the benefit of tax losses brought forward from earlier years. The indicative tax rates for 2004 are presented pre-good- will. They give an indication of what the tax rate would have been if goodwill had not been charged for accounting pur- poses. It is the sum of the tax expense payable on net profit before tax and goodwill in each location, calculated on the above basis, divided by the total net profit before tax and goodwill. Tax rates post-goodwill are higher than the pre- goodwill rates, because in some jurisdictions there are limita- tions 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 2006 rose to CHF 1,858 million, up CHF 477 million or 35% from CHF 1,381 million a year earlier. The increase compared with 2005 is primarily driven by higher performance-based compensation and a rise in the proportion of bonuses being delivered in restricted shares. Indicative 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 1 The tax rates for 2004 are calculated based on pre-goodwill profits. 26 For the year ended 31.12.06 31.12.05 20 19 42 20 24 31 19 18 40 17 24 29 31.12.04 1 18 18 37 19 21 30 The fair value of options granted as of 31 December 2006 was CHF 564 million, up CHF 202 million or 56% from CHF 362 million in 2005. The increase reflects a higher fair value per option, primarily due to a higher UBS share price. 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 Our group combines global scale and focus on growth in a unique way. Our businesses occupy strong market positions in those segments of the financial industry that are expected to grow significantly faster than the economy as a whole over the long term. When we wrote to you on 13 February, we said that in the short term, as the economic cycle matures, investors might become more sensitive to any disappointing political or economic developments, so our top-class risk control re- mains paramount. Recent market developments appear to confirm this hightened level of sensitivity. However, for UBS, 2007 has started on a positive note, with a strong deal pipe- line and continued investor confidence and activity. With a global presence that is balanced across the Americas, Europe and Asia Pacific, the building blocks of our growth strategy are firmly in place. Last year we made a highly concentrated number of acquisitions while investing heavily in organic growth. In 2007, our focus will be on integrating our new areas of activity and we expect to start seeing the benefits from them materializing for our clients and shareholders. 2005 Results 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, up 28% from CHF 7,357 million in 2004. Higher revenues in practically all businesses drove the increase, clearly outpacing growth in costs. Asset-based revenues showed particular strength, reflecting rising market levels as well as strong inflows into the wealth and asset management businesses. We also saw a strong increase in brokerage, corporate finance and underwriting fees. Income from trading activi- ties was fueled by improved market opportunities, particu- larly in second half 2005. Revenues from interest margin products increased, reflecting the success and growth of lending activities to wealthy private clients worldwide. We also reported record credit loss recoveries. Personnel expen- ses were up 12% from a year earlier; performance-related payments rose with revenues and there was a general increase in staff numbers. For 2005, 50% of personnel expenses took the form of bonus or other variable compen- sation, up from 49% a year earlier. General and administrative expenses were up just 1% in 2005 from a year earlier. Because of the strength of revenue growth and due to the cessation of goodwill amortization in 2005, 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. 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. Business Group performance from continuing operations before tax CHF million Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Wealth Management & Business Banking Global Asset Management Investment Bank Corporate Center Financial Businesses For the year ended % change from 31.12.06 31.12.05 31.12.04 31.12.05 5,203 582 2,356 8,141 1,392 5,943 (1,087) 14,389 4,161 312 2,189 6,662 1,057 5,181 (708) 12,192 3,396 29 2,013 5,438 552 4,610 (778) 9,822 25 87 8 22 32 15 (54) 18 27 Financial Businesses Results 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 trad- ing income in 2005 was up 27% or CHF 830 million from CHF 3,098 million in 2004. These gains were partially 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 income and fixed income, partially offset by increased revenues in our rates, principal finance and commercial real estate business. Credit fixed income saw large revenue decreases in structured cred- it. Revenues in our rates business were up, driven mainly by structured LIBOR derivatives, European interest rates and US energy 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 com- pared with 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 higher 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 management collateralized lending business also grew during the year. In addition, revenues rose due to a rise in interest rates for client liabilities. They 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 offset by lower income from our shrinking Swiss recovery portfolio, which dropped by CHF 1.1 billion compared with 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 other 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 positive timing effect related to cash flow hedging. In 2005, we experienced a net credit loss recovery of CHF 375 million, compared with 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. The net credit loss recovery at Global Wealth Manage- ment & Business Banking was CHF 223 million in 2005 com- pared with a net credit loss recovery of CHF 94 million in 2004. The benign credit environment in Switzerland, where the corporate bankruptcy rate receded in 2005, coupled 28 with the measures taken in the years before to improve the quality of our credit portfolio, resulted in a continued low level of new defaults. The success we had in managing our impaired portfolio 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 with a net credit loss recovery of CHF 147 million in 2004. This continued strong performance was the result of minimal exposure to new defaults and strong recoveries of previously established allowances and provisions as we actively sold impaired assets at better than anticipated terms. In 2005, net fee and commission income was CHF 21,436 million, up 16% from CHF 18,506 million a year ear- lier. Underwriting fees were CHF 2,857 million in 2005, up 13% from CHF 2,531 million in 2004. Fixed income under- writing fees increased due to significantly improved market conditions and our enhanced competitive position, but were slightly offset by lower equity underwriting fees. Fixed in- come underwriting 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 increased notably during 2005, signalling the con- tinued strength of merger and acquisition markets, and our growing 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 improved markets and the resulting higher confidence of institutional and individu- al clients – especially in the second half of 2005. Investment fund fees were CHF 4,750 million in 2005, up 20% from CHF 3,948 million in 2004, mainly reflecting higher asset- based fees for our wealth and asset management business- es, driven by strong client money inflows and strong market conditions. Fiduciary fees were slightly higher in 2005, in- creasing 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 entirely 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 driven 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 commissions from insurance re- lated products. Credit-related fees and commissions in- creased 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 lower net gains from both disposals of associates and subsidiaries and from investments in property. This was partially offset by higher net gains from disposal of investments in financial assets available-for-sale. Operating expenses Total operating 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 million in 2004. The rise was driven by higher performance-related compensation reflecting the better performance in all our businesses. Salary expenses rose due to the 6% increase in personnel over the year (excluding the staff of Private Banks & GAM), showing the continuous expansion of our business as well as annual pay rises. Share-based components 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 expenses. Contractors’ expenses increased to CHF 823 million in 2005, up 45% from CHF 567 million in 2004, mainly related to the integration of former Perot employees into our central ITI function. They also reflects higher usage, mainly in our Invest- ment Bank in support of increased business flows. Insurance and social security contributions rose by 23% to CHF 1,256 million in 2005 compared with CHF 1,024 million in 2004. Contributions to retirement benefit plans were up 9% or CHF 61 million from CHF 651 million in 2004 to CHF 712 million in 2005. At CHF 1,390 million in 2005, other personnel expens- es increased CHF 25 million from CHF 1,365 million in 2004, mainly driven by increased headcount, partially offset by the end of retention payments in the Wealth Management US business and lower severance payments. 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 high- er employee levels and further increases in business activity. Marketing costs increased due to continued investment in our brand. This was partially offset by lower provisions (2004 in- cluded the civil penalty levied by the Federal Reserve Board relating to our banknote trading business) and reduced ex- penses 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 cease this so at the start of the year. In 2004, amortization of goodwill was CHF 646 million. At CHF 127 million, amortization of intangible assets was down 24% from CHF 168 million a year earlier, due to the reclassification of the Wealth Management US workforce 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%. The tax rate for full-year 2005 was posi- tively influenced by the absence of goodwill amortization and the successful conclusion of tax audits in the third and fourth quarters. Fair value disclosure of shares and options The fair value of shares granted in 2005 rose to CHF 1,381 million, 25% higher than CHF 1,109 million a year earlier. The increase compared with 2004 was 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 reflected a lower fair value per option, primarily due to a change in the valuation model, and a drop in the number of options granted. 29 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 5,203 million, up 25% from the result achieved in 2005. In the US, pre-tax profit rose to CHF 582 million from CHF 312 million a year earlier. Business Banking Switzerland’s pre-tax profit was CHF 2,356 million, up 8% from 2005. 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 intangible assets Total operating expenses Business Group performance before tax KPIs Cost / income ratio (%) 3 Capital return and BIS data Return on allocated regulatory capital (%) 4 BIS risk-weighted assets Goodwill and excess intangible assets 5 Allocated regulatory capital 6 Additional information Invested assets (CHF billion) Net new money (CHF billion) Client assets (CHF billion) Personnel (full-time equivalents) As of or for the year ended 31.12.06 21,775 156 21,931 9,043 306 9,349 3,028 1,118 232 0 63 13,790 8,141 31.12.05 19,131 107 19,238 8,252 237 8,489 2,845 960 226 0 56 12,576 6,662 31.12.04 17,506 (38) 17,468 7,630 235 7,865 2,473 1,137 202 238 115 12,030 5,438 63.3 65.7 68.7 39.3 155,158 5,978 21,494 2,123 114.5 3,337 48,034 34.7 147,348 5,407 20,142 1,887 98.5 2,895 44,612 31.3 134,004 3,648 17,048 1,524 63.0 2,306 42,570 % change from 31.12.05 14 46 14 10 29 10 6 16 3 13 10 22 5 11 7 13 15 8 1 In management accounts, adjusted expected credit loss rather than credit loss expense or recovery is reported for the business groups (see note 2 to the financial statements). 2 Additionally includes social security contributions and expenses related to alternative investment awards. 3 Operating expenses / income. 4 Business Group performance before tax / average allocated regulatory capital. 5 Goodwill and intangible assets in excess of 4% of BIS Tier 1 Capital. 6 10% of BIS risk-weighted assets plus goodwill and excess intangible assets. Marcel Rohner | Chairman and CEO Global Wealth Management & Business Banking 30 Wealth Management International & Switzerland Business Unit 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 intangible assets Total operating expenses Business Unit performance before tax 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 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) As of or for the year ended % change from 31.12.06 10,827 (29) 10,798 2,999 138 3,137 885 1,479 84 0 10 5,595 5,203 1,138 97.6 103 51.7 47.5 4,742 7,907 862 90.8 101 1,010 144 18.2 870 31.12.05 31.12.04 31.12.05 9,024 (13) 9,011 2,491 88 2,579 804 1,371 89 0 7 4,850 4,161 982 68.2 102 53.7 47.7 4,154 6,476 729 64.2 100 722 114 21.8 803 7,701 (8) 7,693 2,047 72 2,119 642 1,395 66 67 8 4,297 3,396 778 42.3 103 55.8 47.9 3,744 5,429 562 40.4 102 437 82 13.7 838 20 123 20 20 57 22 10 8 (6) 43 15 25 16 1 14 22 18 1 40 26 8 1 In management accounts, adjusted expected credit loss rather than credit loss expense or recovery is reported for the business groups (see note 2 to the financial statements). 2 Additionally includes 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. 31 Financial Businesses Global Wealth Management & Business Banking Business Unit reporting (continued) CHF million, except where indicated 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 allocated regulatory capital (%) 3 BIS risk-weighted assets Goodwill and excess intangible assets 4 Allocated regulatory capital 5 Additional information Recurring income 6 Client assets (CHF billion) Personnel (full-time equivalents) As of or for the year ended % change from 31.12.06 31.12.05 31.12.04 31.12.05 2,920 276 6.8 110 81.2 51,485 1,740 6,889 8,143 1,436 13,564 2,548 253 4.0 109 78.9 43,369 1,566 5,903 6,635 1,235 11,555 2,272 216 1.9 106 82.5 31,903 1,176 4,366 5,679 972 10,093 15 9 1 19 11 17 23 16 17 1 Excludes interest and dividend income. 2 Income / average invested assets. 3 Business Unit performance before tax / average allocated regulatory capital. 4 Goodwill and intangible assets in excess of 4% of BIS Tier 1 Capital. 5 10% of BIS risk-weighted assets plus goodwill and excess intangible assets. 6 Interest, asset-based revenues for portfolio management and fund distribution, account- based and advisory fees. Components of operating income Wealth Management International & Switzerland derives its operating income principally from: – – – – fees for financial planning and wealth management services; fees for investment management services; transaction-related fees; and interest income from client loans. These revenues 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 factors such as fluc- tuations in invested assets, changes in market conditions, investment performance, inflows and outflows of client funds, and investor activity levels. 2006 Key performance indicators In 2006, net new money was a record CHF 97.6 billion, compared with CHF 68.2 billion in 2005, representing an annual growth rate of 10% of the underlying invested asset base at end-2005. This outstanding result reflected increases Net new money CHF billion 2004 2005 2006 97.6 68.2 42.3 100 75 50 25 0 32 in all geographical regions throughout the year, particu- larly in Asia Pacific and Europe, both a result of our growth strategy. Invested assets, at CHF 1,138 billion on 31 December 2006, were up 16% from CHF 982 billion a year earlier, mainly reflecting the strong inflow of net new money and Invested assets  CHF billion 31.12.04 31.12.05 31.12.06 1,250 1,000 750 500 250 0 253 729 216 562 276 862 International Clients Swiss Clients rising financial markets, with CHF 4.8 billion coming from new assets gained from acquisitions we integrated in 2006. This increase was partially offset by negative currency ef- fects. The 7% fall of the US dollar against the Swiss franc contributed to this decrease – approximately 36% of invest- ed assets were denominated in US dollars at the end of 2006. The gross margin on invested assets was 103 basis points in 2006, up 1 basis point from 102 basis points a year earlier, as the increase in recurring margin due to higher fee income and increased Lombard lending was partly offset by a lower non-recurring margin. Overall, recurring income made up 78 basis points of the margin in 2006, up from 75 basis points in 2005. Non-recurring income comprised 25 basis points of the margin in 2006, down 2 basis points from 2005. Gross margin on invested assets  bps 2004 2005 2006 125 100 75 50 25 0 27 76 27 75 25 78 Excluding the European wealth management business, the 2006 cost / income ratio fell to 47.5% from 47.7% a year earlier. European wealth management Our European wealth management business continued to make good progress. With a good performance in the UK and Germany, particularly in the first half of the year, the inflow of net new money in 2006 was CHF 18.2 billion, down 17% from the 2005 intake of CHF 21.8 billion. The result reflects an annual net new money growth rate of 16% of the underlying asset base at year-end 2005, with positive contributions from all five target markets. Net new money European wealth management  CHF billion 2004 2005 2006 21.8 18.2 13.7 25 20 15 10 5 0 Gross margin on recurring income Gross margin on non-recurring income The cost / income ratio improved to 51.7% in 2006 from 53.7% a year earlier. The cost / income ratio has improved for the fourth consecutive year despite the rise in costs in pursuit of our global expansion strategy. This improvement reflects the strong rise in income due to a higher asset base and higher volumes in Lombard lending, which more than offset the increase in personnel expenses (mainly headcount in- crease and performance-related compensation) and higher general and administrative costs. Cost / income ratio in % 2004 2005 2006 55.8 53.7 51.7 60 50 40 30 20 The level of invested assets was a record CHF 144 billion on 31 December 2006, a 26% increase compared with CHF 114 billion a year earlier. This reflected rising equity markets and new inflows across Europe, particularly in the first half of the year. Invested assets European wealth management CHF billion 31.12.04 31.12.05 31.12.06 144 114 82 160 120 80 40 0 In 2006, income from our European wealth management business was CHF 1,010 million, up 40% from a year earlier, reflecting our growing asset and client base. The business was profitable in all quarters of 2006 and all five markets made a positive contribution. 33 Financial Businesses Global Wealth Management & Business Banking In 2006, the number of client advisors increased by 67. The increase in client advisors was mainly in Italy and France. We remain committed to growing our presence in our Euro- pean target markets and will continue to invest in qualified advisory staff. Results In 2006, pre-tax profit, at a record CHF 5,203 million, was up 25% compared with 2005. This increase reflects higher as- set-based fees as well as rising interest income, a reflection of higher volumes in our Lombard lending business. Operat- ing expenses, up 15% in 2006 from 2005, also rose as our business expanded. Personnel expenses rose 22% due to the hiring of an additional 2,009 employees. awards and the increased fair value of options. General and administrative expenses, at CHF 885 million, were up 10% in 2006 from CHF 804 million a year earlier due to investments in our physical and IT infrastructure, as well as travel and entertainment and marketing costs – all a consequence of our continuous business expansion. Expenses for services from other business units, at CHF 1,479 million in 2006, were up 8% from CHF 1,371 million the previous year, mainly due to higher information technology charges. Depreciation was CHF 84 million in 2006, down 6% from CHF 89 million a year earlier because of lower charges for information tech- nology equipment. Amortization of intangible assets was CHF 10 million, practically unchanged from CHF 7 million in 2005. Performance before tax  CHF million 2005 2004 2005 2006 Key performance indicators 5,203 4,161 3,396 6,000 4,800 3,600 2,400 1,200 0 Operating income Total operating income in 2006 was CHF 10,798 million, up 20% from CHF 9,011 million a year earlier. This was the highest level ever, reflecting a rise in recurring as well as in non-recurring revenues. Recurring income increased 23% on rising asset-based fees, benefiting from a buoyant market and net new money inflows. This was accentuated by higher interest income due to the expansion of our margin lending activities. Non-recurring income rose due to higher broker- age fees, reflecting high client activity levels. These positive effects were offset by the depreciation of the US dollar against the Swiss franc. Operating expenses At CHF 5,595 million, operating expenses in 2006 were up 15% from CHF 4,850 million a year earlier, reflecting higher personnel expenses and general and administrative expenses as well as the ongoing investment in our growth initiatives. Personnel expenses rose 22% to CHF 3,137 million in 2006 compared with CHF 2,579 million a year earlier, reflecting the increase in salaries from the expansion of our business as well as higher performance-related compensation. Share- based expenses in 2006 increased due to higher share 34 In 2005, net new money inflows totaled CHF 68.2 billion, up 61% from CHF 42.3 billion in 2004. This increase was driven by gains in all geographical areas, especially from Asian clients, and a particularly strong 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- mately 36% of invested assets were denominated in US dol- lars at the end of 2005. The gross margin on invested assets was 102 basis points in 2005, down 1 basis point from 103 basis points a year earlier, 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. The cost / income ratio improved to 53.7% in 2005 from 55.8% a year earlier, reflecting the strong rise in income, which more than offset the increase in personnel expenses (mainly performance-related compensation) and higher gen- eral and administrative costs. Excluding the European wealth management business, the 2005 cost / income ratio fell to 47.7% from 47.9% a year earlier. European wealth management In 2005, 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 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. The level of invested assets was 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 rising equity market levels and a 15% appreciation of the US dollar against the Swiss franc. In 2005, income from our European wealth management business was CHF 722 million, up 65% from a year earlier, reflecting 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 Sauerborn Trust employees, and the departure of less pro- ductive client advisors. Results Wealth Management International and Switzerland’s 2005 pre-tax profit, at CHF 4,161 million, increased 23% from 2004, mainly due to higher asset-based fees, and strength- ening client activity. Rising interest income, a reflection of the expansion of our margin lending activities, also bolstered revenues. At the same time, our expenses, up 13% in 2005 from 2004, reflect our ongoing growth strategy. Operating income Total operating income in 2005 was CHF 9,011 million, up 17% from CHF 7,693 million in 2004. Recurring income increased 17% on rising asset-based fees, benefiting from gains in asset levels. This was accentuated by higher interest income due to the expansion of our margin lending activi- ties. Non-recurring income rose due to higher brokerage fees and commissions for sales of investment funds, reflect- ing an increase in client activity levels. 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 13% from CHF 4,297 million a year earlier, reflecting higher personnel expenses as well as the ongoing investment 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. General and administrative 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. There was no amortization of goodwill in 2005, due to a change in accounting. In 2004, amortization of goodwill totaled CHF 67 million. Amortization of intangible assets was CHF 7 million, practically unchanged from CHF 8 million in 2004. 35 Financial Businesses Global Wealth Management & Business Banking Wealth Management US Business Unit 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 intangible assets Total operating expenses Business Unit performance before tax KPIs Invested assets (CHF billion) Net new money (CHF billion) 3 Interest and dividend income (CHF billion) 4 Gross margin on invested assets (bps) 5 Cost / income ratio (%) 6 Recurring income 7 Revenues per advisor (CHF thousand) 8 Capital return and BIS data Return on allocated regulatory capital (%) 9 BIS risk-weighted assets Goodwill and excess intangible assets 10 Allocated regulatory capital 11 Additional information Client assets (CHF billion) Personnel (full-time equivalents) Financial advisors (full-time equivalents) As of or for the year ended % change from 31.12.06 31.12.05 31.12.04 31.12.05 5,863 0 5,863 3,683 117 3,800 1,073 281 74 0 53 5,281 582 824 15.7 22.2 76 90.1 3,488 776 10.2 18,308 4,238 6,069 909 18,557 7,880 5,158 (2) 5,156 3,353 107 3,460 1,047 223 65 0 49 4,844 312 752 26.9 18.3 75 93.9 2,834 690 5.8 18,928 3,841 5,734 826 17,034 7,520 4,741 (5) 4,736 3,206 114 3,320 767 275 67 171 107 4,707 29 606 18.1 15.3 77 99.3 2,343 633 0.6 17,664 2,472 4,238 679 16,969 7,519 14 (100) 14 10 9 10 2 26 14 8 9 87 10 21 1 23 12 (3) 10 6 10 9 5 1 In management accounts, adjusted expected credit loss rather than credit loss expense or recovery is reported for the Business Groups (see note 2 to the financial statements). 2 Additionally includes social security contributions and expenses related to alternative investment awards. 3 Excludes interest and dividend income. 4 For purposes of comparison with US peers. 5 Income / average in- vested assets. 6 Operating expenses / income. 7 Interest, asset-based revenues for portfolio management and fund distribution, account-based and advisory fees. 8 Income (includes net goodwill funding) / average number of financial advisors. 9 Business Unit performance before tax / average allocated regulatory capital. 10 Goodwill and intangible assets in excess of 4% of BIS Tier 1 Capi- tal. 11 10% of BIS risk-weighted assets plus goodwill and excess intangible 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 revenues 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 fluc- tuations in invested assets, changes in market conditions, investment performance, inflows and outflows of client funds, and investor activity levels. 36 2006 Key performance indicators The inflow of net new money in 2006 was CHF 15.7 billion, down 42% from CHF 26.9 billion in 2005. Although the result was lower, the inflow of net new money compared favorably with peers in terms of growth rate relative to the asset base. Including interest and dividends, net new money in 2006 was CHF 37.9 billion, down from CHF 45.2 billion a year earlier. Net new money CHF billion Gross margin on invested assets1  bps 2004 2005 2006 125 100 75 50 25 0 39 38 34 41 31 45 30 25 20 15 10 2004 2005 2006 Gross margin on recurring income Gross margin on non-recurring income 1 Includes costs from the PaineWebber acquisition. 26.9 18.1 15.7 reflects higher operating income due to strong growth in recurring income, partially offset by a rise in expenses mainly reflecting higher personnel expenses in support of growth initiatives and the integration of the Piper Jaffray private client branch network. –12% in US dollar Cost / income ratio1 in % Wealth Management US had CHF 824 billion in invested assets on 31 December 2006, up 10% from CHF 752 billion on 31 December 2005. The increase was due to the strong market performance in 2006 as well as to the inclusion of the private client branch network of Piper Jaffray in the third quarter, adding CHF 54 billion of invested assets on a net basis. In US dollar terms, invested assets were 18% higher on 31 December 2006 than they were on the same date in 2005. 100 80 60 40 20 2004 99.3 2005 2006 93.9 90.1 1 Includes costs from the PaineWebber acquisition. Invested assets CHF billion 31.12.04 31.12.05 31.12.06 900 800 700 600 500 824 752 606 The gross margin on invested assets was 76 basis points in 2006, up from 75 basis points in 2005. The increase is mainly a result of the gain in revenues outpacing the increase in average invested asset levels over the year. The cost / income ratio was 90.1% for 2006, compared to 93.9% in 2005. The decrease in the cost / income ratio In 2006, recurring income was a record CHF 3,488 mil- lion, up 23% from CHF 2,834 million a year earlier. Excluding the impact of currency fluctuations, recurring income was also up 23% in 2006 from 2005. This increase mainly reflects +10% in US dollar Recurring income  CHF million 2004 2005 2006 3,488 +15% in US dollar 2,834 2,343 3,500 3,000 2,500 2,000 1,500 37 70 64 58 52 46 40 109.375007 93.750006 78.125005 62.500004 46.875003 30 31.250002 25 15.625001 0.000000 20 15 10 As reported Adjusted for goodwill and significant financial events As reported 6 Before goodwill and adjusted for significant financial events 7 3500 3000 2500 2000 1500 900 800 700 600 500 100 80 60 40 20 Financial Businesses Global Wealth Management & Business Banking higher levels of managed account fees on a record level of invested assets, higher investment advisory fees and higher net interest income. Recurring income represented 59% of income in 2006 compared with 55% in 2005. Revenue per advisor increased in 2006 to CHF 776,000 from CHF 690,000 in 2005 as a slightly higher average num- ber of financial advisors was able to produce significantly higher recurring income than a year earlier. The number of financial advisors rose by 5% compared to 2005, increasing by 360 advisors to 7,880 at the end of 2006. The increase was due to the Piper Jaffray private client group branch net- work acquisition in third quarter. Revenues per advisor1 CHF thousand Performance before tax1 CHF million 2004 2005 600 450 300 150 0 312 1 Includes costs from the PaineWebber acquisition. 29 2006 582 2004 2005 633 690 2006 776 1 Income (including net goodwill funding)/average number of financial advisors. 800 600 400 200 0 Financial advisors full-time equivalents 31.12.04 31.12.05 31.12.06 7,519 7,520 7,880 8,000 7,000 6,000 5,000 4,000 Results In 2006, we reported a pre-tax profit of CHF 582 million compared to CHF 312 million in 2005. Because this business is almost entirely conducted in US dollars, comparisons of results with prior periods are affected by the movements of the US dollar against the Swiss franc. In US dollar terms, per- formance in 2006 was up 86% from 2005. Performance in 2006 benefited from record levels of recurring income, and lower litigation provisions. Operating income In 2006, total operating income was CHF 5,863 million, up 14% compared to CHF 5,156 million in 2005. Excluding cur- rency effects, operating income also increased by 14% from 2005. The increase in operating income is primarily due to strong growth in recurring income based on higher levels of assets. Operating expenses Total operating expenses rose 9% to CHF 5,281 million in 2006 from CHF 4,844 million in 2005. Excluding currency effects, operating expenses were also 9% higher. This re- flects higher personnel costs and general and administra- tive expenses, both also related to strategic growth initia- tives in support of our business and the Piper Jaffray private client branch network inclusion and the New Jersey office provision that was made after the decision to sublet un- used office space instead of occupying it ourselves. This was offset by a lower impact of litigation provisions com- pared to 2005. Personnel expenses increased by CHF 340 million or 10%, with higher salaries as well as share-based compen- sation reflecting rising headcount and more financial advi- sor compensation related to higher compensable revenue. General and administrative expenses increased 2% to CHF 1,073 million in 2006 from CHF 1,047 million in 2005. In US dollar terms, they also rose 2%, reflecting higher occu- pancy and marketing expenses, partially offset by lower litigation provisions compared to 2005. Services from other business units increased by 26% from CHF 223 million in 2005 to CHF 281 million in 2006. Depreciation was also higher due to leasehold improvement. The amortization of intangibles was CHF 53 million in 2006, up 8% from CHF 49 million, mainly due to the acquisition of the Piper Jaffray private client branch network. 38 600 450 300 150 0 800 600 400 200 0 8000 7000 6000 5000 4000 2005 Results Key performance indicators In 2005, inflows of net new money were CHF 26.9 billion, up 49% from CHF 18.1 billion in 2004. Including interest and dividends, net new money in 2005 was CHF 45.2 billion, up from CHF 33.4 billion a year earlier. 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. The gross margin on invested assets was 75 basis points in 2005, down from 77 basis points in 2004. The cost / income ratio was 93.9% for 2005, compared to 99.3% in 2004. The decrease in the cost / income ratio reflects higher income which was slightly offset by higher expenses. 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 man- aged account fees on invested assets, and increased net in- terest income from the lending business. Flows into man- aged account products were USD 16.7 billion in full-year 2005, comparing favorably to the USD 12.7 billion flow for full-year 2004. Revenues per advisor increased in 2005 to CHF 690,000 from CHF 633,000 in 2004 as practically the same number of financial advisors were able to produce higher recurring income than a year earlier. The number of financial advisors increased by 1 to 7,520 at the end of 2005. Increases in highly efficient financial advisors and trainees were offset by attrition among less productive advisors. In 2005, we reported a pre-tax profit of CHF 312 million compared to CHF 29 million in 2004. This increase reflects mainly higher recurring income which was slightly offset by increased expenses. Operating income In 2005, total operating income was CHF 5,156 million, up 9% compared to CHF 4,736 million in 2004. Excluding currency effects, operating income increased by 8% from 2004. The increase in operating income is primarily due to higher recurring income based on higher levels of assets and rising net interest income in UBS Bank USA, which was slightly offset by lower transactional revenues. Operating expenses Total operating expenses rose 3% to CHF 4,844 million in 2005 from CHF 4,707 million in 2004. Excluding currency effects, operating expenses were 2% higher primarily due to the impact of increased litigation provisions in second half 2005. Personnel expenses increased by CHF 140 million due to higher variable compensation. Excluding the currency trans- lation effect, the increase in personnel expenses amounted to 3%. General and administrative expenses 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. 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). There was no goodwill amortization in 2005 due to accounting changes. In 2004, amortization of goodwill totaled CHF 171 million. The amortization of intan- gibles was CHF 49 million in 2005, down 54% due to the reclassification of certain intangible assets. Under the new accounting rules, these assets are classified as goodwill, which is no longer amortized. 39 Financial Businesses Global Wealth Management & Business Banking Business Banking Switzerland Business Unit reporting CHF million, except where indicated Interest income Non-interest income Income Adjusted expected credit loss 1 Total operating income 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 intangible assets Total operating expenses Business Unit performance before tax KPIs Invested assets (CHF billion) Net new money (CHF billion) 3 Cost / income ratio (%) 4 Impaired lending portfolio as a % of total lending portfolio, gross Capital return and BIS data Return on allocated regulatory capital (%) 5 BIS risk-weighted assets Goodwill and excess intangible assets 6 Allocated regulatory capital 7 Additional information Deferral (included in adjusted expected credit loss) Client assets (CHF billion) Personnel (full-time equivalents) As of or for the year ended % change from 31.12.06 31.12.05 31.12.04 31.12.05 3,339 1,746 5,085 185 5,270 2,361 51 2,412 1,070 (642) 74 0 0 2,914 2,356 161 1.2 57.3 1.7 27.5 85,365 0 8,537 512 992 15,913 3,317 1,632 4,949 122 5,071 2,408 42 2,450 994 (634) 72 0 0 2,882 2,189 153 3.4 58.2 2.3 25.6 85,051 0 8,505 485 834 16,023 3,390 1,674 5,064 (25) 5,039 2,377 49 2,426 1,064 (533) 69 0 0 3,026 2,013 140 2.6 59.8 3.0 23.2 84,437 0 8,444 411 655 15,508 1 7 3 52 4 (2) 21 (2) 8 (1) 3 1 8 5 0 0 6 19 (1) 1 In management accounts, adjusted expected credit loss rather than credit loss expense or recovery is reported for the Business Groups (see note 2 to the financial statements). 2 Additionally includes social security contributions and expenses related to alternative investment awards. 3 Excludes interest and dividend income. 4 Operating expenses / income. 5 Business Unit performance before tax / average allocated regulatory capital. 6 Goodwill and intangible assets in excess of 4% of BIS Tier 1 Capital. 7 10% of BIS risk-weighted assets plus goodwill and excess intangible assets. Components of operating income Business Banking Switzerland derives its operating income principally from: – net interest income from its lending 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. 40 2006 Key performance indicators Net new money was CHF 1.2 billion in 2006, CHF 2.2 billion lower than the inflow of CHF 3.4 billion in 2005. This was due to a decrease in inflows from existing clients, combined with transfers of client assets from discretionary to custody mandates. Invested assets rose to CHF 161 billion in 2006 from CHF 153 billion a year earlier, driven by positive market develop- ments and net new money inflows. This was slightly offset by the transfer of assets to Wealth Management Inter- national & Switzerland. Over the course of 2006, we trans- ferred CHF 8.2 billion in client assets from the Business Banking Switzerland unit to the Wealth Management Inter- national & Switzerland unit, reflecting the development of client relationships. In 2005, we transferred CHF 8.6 billion in client assets for the same reason. In 2006 the cost / income ratio stood at 57.3%, 0.9 per- centage points lower than the previous year’s ratio of 58.2%, as the rise in income outpaced the increase in expenses. Business Banking Switzerland’s gross lending portfolio was CHF 143.4 billion on 31 December 2006, up 1% from the previous year, due to an increase in volumes of private Cost / income ratio in % client mortgages, which more than offset the ongoing reduction of our recovery portfolio, which fell to CHF 2.6 billion from CHF 3.3 billion a year earlier. This positive devel- opment was also reflected in the key credit quality ratio of the impaired lending portfolio, gross, to the total lending portfolio, gross, which was 1.7% compared to 2.3% in 2005. The return on allocated regulatory capital was 27.5% for 2006, up 1.9 percentage points from 25.6% a year earlier. This reflects the increased profitability of the business unit, outpacing the increase in risk-weighted assets. Return on allocated regulatory capital in % 2004 2005 23.2 25.6 2006 27.5 28 21 14 7 0 Results 60 55 50 45 40 2004 59.8 2005 2006 58.2 57.3 Pre-tax profit in 2006, at a record level of CHF 2,356 mil- lion, was CHF 167 million or 8% above the result achieved in 2005. This was mainly due to income growth. In 2006 non-interest income rose due to higher asset-based and brokerage fees. The result also shows the continued tight management of our cost base, and an adjusted expected credit loss recovery of CHF 185 million. While personnel costs were at their lowest levels, general and administrative expenses increased, reflecting the outsourcing of Edelweiss facility management. Impaired lending portfolio, gross/ total lending portfolio, gross in % Performance before tax  CHF million 31.12.04 31.12.05 31.12.06 2004 2005 2006 As reported Adjusted for goodwill and significant financial events 5 4 3 2 1 0 3.0 2.3 1.7 2,500 2,000 1,500 1,000 500 0 2,189 2,356 2,013 70 64 58 52 46 40 41 28 21 14 7 0 As reported 6 Before goodwill and adjusted for significant financial events 7 2500 1875 1250 625 0 60 55 50 45 40 5.00 3.75 2.50 1.25 0.00 Financial Businesses Global Wealth Management & Business Banking Operating income Total operating income in 2006 was CHF 5,270 million, up slightly from 2005’s level of CHF 5,071 million. Interest income increased by 1% to CHF 3,339 million in 2006 from CHF 3,317 million in 2005. The slight increase reflects the expansion of our loan portfolio as well as higher invest- ment interest rates on our variable rate accounts, offset by lower revenues from our reduced recovery portfolio. Non- interest income increased by CHF 114 million to CHF 1,746 million in 2006 from CHF 1,632 million in 2005, reflecting a higher asset base as well as valuation gains from equity par- ticipations and divestment proceeds. Adjusted expected credit loss recoveries, at CHF 185 million in 2006, increased from recoveries of CHF 122 million in 2005. This positive re- sult reflects the deferred benefit of the structural improve- ment in our loan portfolio in recent years. Operating expenses Operating expenses in 2006 were CHF 2,914 million, up 1% from CHF 2,882 million in 2005. Personnel expenses, at CHF 2,412 million, were down 2% from CHF 2,450 million in 2006, due to lower salary costs reflecting the outsourcing of Edelweiss, partly offset by higher share-based expenses, mainly reflecting higher share awards and the higher fair value of options in 2006. General and administrative expens- es, at CHF 1,070 million in 2006, rose and were 8% higher than the CHF 994 million recorded in 2005, mainly due to the outsourcing of Edelweiss facility management at the end of 2005. Net charges to other business units continued to rise to CHF 642 million in 2006 from CHF 634 million in 2005 because of lower charges-in for IT services. Deprecia- tion in 2006 slightly increased to CHF 74 million from CHF 72 million in 2005 due to higher expenses for information technology equipment. 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. Business Banking Switzerland’s gross lending 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 mortgages and higher credit demand from corporate clients were 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. The ratio of the gross impaired lending portfolio to gross lending portfolio was 2.3% compared to 3.0% in 2004. The return on allocated 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, outpacing the increase in risk-weighted assets. Results Pre-tax profit in 2005 was CHF 2,189 million, CHF 176 mil- lion or 9% higher than the result achieved in 2004. It was achieved despite a CHF 115 million fall in income, driven mainly by lower interest income. The result shows the con- tinued tight management of our cost base, with an adjusted expected credit loss recovery of CHF 122 million reflecting the structural improvement in our loan portfolio in recent years. While general and administrative costs were at their lowest levels, personnel expenses increased slightly, reflect- ing an increase in staff levels. 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 reve- nues from our reduced recovery portfolio, as well as lower interest margins in our mortgage business. This was par- tially 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. Adjusted ex- pected credit loss recoveries, at CHF 122 million in 2005, increased from an adjusted expected 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 personnel, partly offset by lower share-based expenses as less share awards have been granted. General and admini- strative expenses, at CHF 994 million in 2005, continued to 42 drop and were 7% lower than the CHF 1,064 million re- corded in 2004, reflecting our continuing tight cost con- trols. Net charges to other business units rose to CHF 634 million in 2005 from CHF 533 million in 2004 because of lower charges-in for IT services and insurance. Depreciation in 2005 slightly increased to CHF 72 million from CHF 69 million in 2004 due to higher expenses for information technology equipment. 43 Financial Businesses Global Asset Management Global Asset Management Pre-tax profit was CHF 1,392 million in 2006, an increase of 32% from the 2005 profit of CHF 1,057 million. Compared with 2005, the increase reflects higher management fees in all businesses and alternative and quan- titative investment performance fees. The result was partly offset by higher operating expenses, reflecting increased staffing, performance-related compensation and investments in strategic initiatives and IT projects. 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 intangible assets Total operating expenses Business Group performance before tax KPI Cost / income ratio (%) 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 As of or for the year ended % change from 31.12.06 31.12.05 31.12.04 31.12.05 1,803 1,417 3,220 1,305 198 1,503 399 (105) 27 0 4 1,828 1,392 56.8 519 28 29.8 11.0 38 1,330 1,157 2,487 899 89 988 304 116 21 0 1 1,430 1,057 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 72.7 344 17 23.7 (1.2) 32 36 22 29 45 122 52 31 29 300 28 32 18 75 12 1 Additionally includes social security contributions and expenses related to alternative investment awards. 2 Operating expenses / operating income. 3 Excludes interest and dividend income. 4 Operating income / average invested assets. John A. Fraser | Chairman and CEO Global Asset Management 44 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 allocated regulatory capital (%) 3 BIS risk-weighted assets Goodwill and excess intangible assets 4 Allocated regulatory capital 5 Additional information Invested assets (CHF billion) Net new money (CHF billion) Personnel (full-time equivalents) As of or for the year ended % change from 31.12.06 31.12.05 31.12.04 31.12.05 347 59 7.4 (2.5) 43 84.8 2,723 1,677 1,949 866 37.2 3,436 324 62 28.2 (9.7) 40 69.9 1,570 1,438 1,595 765 49.5 2,861 257 64 (4.5) (20.6) 36 36.4 1,702 1,189 1,359 601 19.2 2,665 7 (5) 8 73 17 22 13 20 1 Excludes interest and dividend income. 2 Operating income / average invested assets. 3 Business Group performance before tax / average allocated regulatory capital. 4 Goodwill and intangible assets in excess of 4% of BIS Tier 1 Capital. 5 10% of BIS risk-weighted assets plus goodwill and excess intangible assets. Components of operating income Global Asset Management generates its revenue from the asset management and fund administration services it provides to financial intermediaries and institutional investors. Fees charged to institutional clients and wholesale intermediary clients are based on the market value of invested assets and on successful investment performance. As a result, revenues are affected by changes in market and cur- rency valuation levels, as well as flows of client funds, and relative investment performance. 45 Financial Businesses Global Asset Management 2006 Net new money, institutional CHF billion Key performance indicators 2004 2005 2006 For 2006, the cost / income ratio was 56.8%, a decrease of 0.7 percentage points from 2005. This was a result of im- proving operating income, representing higher management fees across all businesses, combined with significantly higher performance fees in alternative and quantitative invest- ments. This was partly offset by increased operating ex- penses from increased staff levels and higher variable per- sonnel expenses, in line with business growth. 30 20 10 0 (10) 24.9 24.3 18.8 11.0 (1.2) (3.0) Non-money market funds Money market funds Cost/income ratio in % 2004 2005 2006 57.5 56.8 Gross margin on invested assets, institutional  bps 2004 2005 2006 72.7 80 70 60 50 40 30 Institutional Institutional invested assets were CHF 519 billion on 31 De- cember 2006 – up 18% from CHF 441 billion on 31 Decem- ber 2005, reflecting positive market performance (mainly in equities), strong net new money inflow and the inclusion of Pactual. In 2006, net new money inflows were CHF 29.8 billion, up from the CHF 21.3 billion recorded in 2005. Strong in- flows were reported in most asset classes, partly offset by outflows from equity mandates. Invested assets, institutional  CHF billion 31.12.04 31.12.05 31.12.06 The gross margin on invested assets for 2006 was 38 basis points, up 4 basis points from 2005. The increase is due to income growth, mainly driven by strong performance fees and Dillon Read Capital Management (DRCM) revenues from outside clients, which outpaced the growth in average invested assets. 38 34 32 40 35 30 25 20 Wholesale intermediary Invested assets were CHF 347 billion on 31 December 2006, up by CHF 23 billion from 31 December 2005, reflecting positive market performance, net new money inflows and the inclusion of Pactual. Invested assets, wholesale intermediary  CHF billion 31.12.04 31.12.05 31.12.06 600 480 360 240 120 0 46 16 425 17 327 28 491 400 300 200 100 0 62 262 59 288 64 193 Non-money market funds Money market funds Non-money market funds Money market funds 600 450 300 150 0 400 300 200 100 0 30 20 10 0 -10 As reported 6 Before goodwill and adjusted for significant financial events 7 48.0 38.4 28.8 19.2 9.6 0.0 40 35 30 25 20 In 2006, net new money was CHF 7.4 billion, down from CHF 28.2 billion a year earlier. In 2005, net new money in- flows resulted from the large number of product launches across all major asset classes. In 2006 we experienced out- flows in fixed income and equities while continuing to expe- rience inflows into multi-asset funds. Net new money, wholesale intermediary CHF billion 2004 2005 2006 37.9 16.1 (20.6) (9.7) 9.9 (2.5) 45 30 15 0 (15) (30) Non-money market funds Money market funds The 2006 gross margin on invested assets was 43 basis points, up by 3 basis points from a year earlier, largely driven by increased management fees. Gross margin on invested assets, wholesale intermediary  bps 2004 2005 2006 40 43 36 50 40 30 20 10 Performance before tax CHF million 2004 2005 2006 1,600 1,200 800 400 0 1,392 1,057 552 Results We had a very strong full-year result in 2006. Pre-tax profit was CHF 1,392 million, up from CHF 1,057 million a year earlier. The increase reflects higher management fees in all businesses and alternative and quantitative investment per- formance fees. The result was partly offset by higher operat- ing expenses, reflecting increased staffing, performance-re- lated compensation and investments in strategic initiatives and IT projects. Operating income In 2006, operating income was CHF 3,220 million, up 29% from CHF 2,487 million a year earlier. Institutional revenues increased by 36% to CHF 1,803 million in 2006 from CHF 1,330 million in 2005, reflecting higher management fees in most investment areas, the result of net new money inflows and higher financial market valuations, combined with sig- nificantly higher performance in alternative and quantitative investments. Wholesale intermediary reve- nues rose by 22% to CHF 1,417 million in 2006 from CHF 1,157 million in 2005, reflecting higher management fees in most areas due to net new money inflows and higher market valuations. fees Operating expenses In 2006, operating expenses increased to CHF 1,828 million from CHF 1,430 million in 2005, due to higher staff levels and performance-related compensation. Personnel expenses were CHF 1,503 million in 2006, 52% above 2005, mainly due to the inclusion of DRCM. General and administrative expenses increased by 31% to CHF 399 million in 2006 from CHF 304 million in 2005 mainly due to investments in strate- gic initiatives. Other business units were charged CHF 105 million compared to the net charges from other business units of CHF 116 million a year earlier, mainly reflecting high- er net charges-out to the Investment Bank for investment management services provided by DRCM. Over the same pe- riod, depreciation increased by CHF 6 million to CHF 27 mil- lion. Amortization of intangible assets slightly increased to CHF 4 million in 2006. 2005 Key performance indicators For 2005, the cost / income ratio was 57.5%, a decrease of 15.2 percentage points from 2004. This was a result of improving operating income across all businesses, mainly in- duced by higher asset-based fees. This was also helped by declining operating expenses, mainly the result of the dis- continuation of goodwill amortization in 2005. 47 As reported 6 Before goodwill and adjusted for significant financial events 7 45.00 26.25 7.50 -11.25 -30.00 48.0 38.4 28.8 19.2 9.6 0.0 50 40 30 20 10 1600 1200 800 400 0 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 2004. Although inflows in traditional investments continued to grow, alternative and quantitative investments did not reach the same level as a year earlier. The gross margin on invested assets for full-year 2005 was 34 basis points, slightly above the 32 basis points of full- year 2004. 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. 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 income, asset allocation). The 2005 gross margin on invested assets was 40 basis points, up by 4 basis points from a year earlier, reflecting shifts into higher margin asset classes. Results Pre-tax profit was CHF 1,057 million, an increase of 91% from 2004. The increase was driven by higher operating in- come, which rose 23%, reflecting strong net new money inflows and a positive market environment that resulted in higher asset valuations. In addition, performance fees, particularly in alternative and quantitative investments, in- creased. Operating expenses decreased, mainly as a result of the discontinuation of goodwill amortization in 2005, which was partially offset by higher personnel expenses, which rose with the growth of the business. Operating income In 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 environ- ment resulting in higher asset valuations and consequently higher asset-based income across all businesses. In addition, performance fees, particularly in alternative and quantitative investments, increased significantly. Institutional revenues in- creased by 23% to CHF 1,330 million in 2005 from CHF 1,085 million in 2004, reflecting higher management fees in all ar- eas, and higher performance fees, mainly in alternative and quantitative investments. Wholesale intermediary revenues rose by 23% to CHF 1,157 million in 2005 from CHF 937 mil- lion in 2004, reflecting higher management fees in all areas due to net new money inflows and higher market valuations. Operating expenses In 2005, operating expenses decreased to CHF 1,430 million from CHF 1,470 million in 2004, primarily due to the discon- tinuation of goodwill amortization and partially offset by high- er personnel costs, which rose with the growth of the business. Personnel 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 de- creased by CHF 10 million to CHF 116 million in 2005 from CHF 126 million in 2004, partly due to higher charges-out to the wealth management businesses reflecting the higher demand for specialized investment research. Over the same period, depreciation remained virtually unchanged at CHF 21 million, down by only CHF 2 million. There was no amortiza- tion of goodwill in 2005 due to a change in accounting. In 2004, amortization of goodwill totaled CHF 129 million. Amor- tization of intangible assets increased slightly to CHF 1 million due to the acquisition of Siemens’ real estate business. 48 Financial Businesses Investment Bank Investment Bank In 2006, the Investment Bank’s pre-tax profit was CHF 5,943 million, up 15% from a year earlier. Revenues increased in all three business areas, particularly in equities and investment banking. This was matched by higher costs, for both personnel and general and administrative expenses, as we continued to expand our range of products and services. 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 intangible assets Total operating expenses Business Group performance before tax For the year ended % change from 31.12.06 31.12.05 31.12.04 31.12.05 9,397 9,056 3,273 21,726 61 21,787 9,801 1,552 11,353 3,260 956 203 0 72 15,844 5,943 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 5,906 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 35 14 31 25 69 25 22 30 23 47 49 49 36 29 15 1 In management accounts, adjusted expected credit loss rather than credit loss expense or recovery is reported for the Business Groups (see note 2 to the financial statements). 2 Additionally includes social security contributions and expenses related to alternative investment awards. Huw Jenkins | Chairman and CEO Investment Bank 49 Financial Businesses Investment Bank Business Group reporting (continued) CHF million, except where indicated KPIs Compensation ratio (%) 1 Cost / income ratio (%) 2 Impaired lending portfolio as a % of total lending portfolio, gross 3 Average VaR (10-day 99% confidence, 5 years of historical data) Capital return and BIS data Return on allocated regulatory capital (%) 4 BIS risk-weighted assets Goodwill and excess intangible assets 5 Allocated regulatory capital 6 Additional information Deferral (included in adjusted expected credit loss) Client assets (CHF billion) Personnel (full-time equivalents) As of or for the year ended % change from 31.12.06 31.12.05 31.12.04 31.12.05 52.3 72.9 0.1 420.5 29.4 174,599 5,465 22,925 232 174 21,899 53.1 70.5 0.2 346.4 28.6 151,313 4,309 19,440 155 164 18,174 50.7 71.3 0.5 358.0 30.5 116,512 3,579 15,230 85 147 16,970 21 15 27 18 50 6 20 1 Personnel expenses / income. 2 Operating expenses / income. 3 Figures reflect the prime brokerage reclassification as explained in note 1 to the financial statements. 4 Business Group performance before tax / average allocated regulatory capital. 5 Goodwill and intangible assets in excess of 4% of BIS Tier 1 Capital. 6 10% of BIS risk-weighted assets plus goodwill and excess intangible assets. 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 trans- actions; – mergers and acquisitions and other advisory fees; – interest income on principal transactions and from the loan portfolio; 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. 2006 Key performance indicators The cost / income ratio rose to 72.9% in 2006 from 70.5% a year earlier. The increase in performance-related personnel expenses and higher general and administrative expenses Cost / income ratio in % 2004 2005 2006 71.3 70.5 72.9 80 75 70 65 65 50 was only partly offset by revenue growth in all of our three businesses. Compensation ratio in % 2004 2005 2006 53.1 52.3 50.7 55 50 45 40 35 The full-year compensation ratio, at 52.3%, fell 0.8 per- centage points between 2005 and 2006. Higher revenues more than offset higher performance-related compensation and increased staff levels. As reported Adjusted for goodwill and significant financial events As reported Adjusted for goodwill and significant financial events 70 64 58 52 46 40 70 64 58 52 46 40 80 75 70 65 60 55 50 45 40 35 Average Value at Risk (VaR – 10-day, 99% confidence, 5 years of historical data) increased to CHF 420 million, up from CHF 346 million in 2005. Year-end VaR was also higher at CHF 473 million, up from CHF 355 million a year earlier, following the integration of Pactual from 1 December 2006. Average VaR (10-day, 99% confidence, 5 years of historical data) CHF million The return on allocated regulatory capital was 29.4% in 2006, up from 28.6% a year earlier, reflecting the increase in profit. Risk-weighted assets grew, mainly driven by higher credit exposures from OTC derivatives, collateral trading and the leveraged finance portfolio, in line with the rise in busi- ness activity. Goodwill and excess intangible assets rose com- pared with last year due to the acquisitions of ABN AMRO’s futures and options business and Pactual. 2004 2005 2006 Results 450 400 350 300 250 420 358 346 Total gross lending portfolio at the Investment Bank was CHF 134 billion on 31 December 2006 compared with CHF 97 billion on 31 December 2005, reflecting our expanding prime brokerage and exchange traded derivatives businesses. The gross impaired lending portfolio to total gross lending portfolio ratio fell to 0.1% from 0.2% in the same period. Impaired lending portfolio, gross/ total lending portfolio, gross1 in % 31.12.04 31.12.05 31.12.06 0.8 0.6 0.4 0.2 0.0 0.5 0.2 0.1 1 Figures reflect the prime brokerage reclassification as explained in Note 1 to the financial statements. Return on allocated regulatory capital in % 2004 2005 2006 30.5 28.6 29.4 32 24 16 8 0 This was our most profitable year ever. Pre-tax profit in 2006 was CHF 5,943 million, up 15% from 2005. This result was driven by strong revenues in equities (up 35%), due to the improved market conditions starting in second half 2005 and continuing throughout 2006. It was also helped by our investment banking business (up 31%), which saw strong performances across all regions. The increase in fixed in- come, rates and currencies (up 14%) reflects progress in our plan to expand our global syndicated finance, mortgage- backed securities, structured credit and commodities busi- nesses as well as strong revenues in foreign exchange and cash and collateral trading. DRCM‘s business activities managed on behalf of the Investment Bank achieved reve- nues at a level consistent with 2005. We also invested in our IT infrastructure and incurred more professional fees. 2006 5,943 Performance before tax  CHF million 2004 2005 5,181 4,610 6,000 5,000 4,000 3,000 2,000 Operating income Total operating income in 2006 was CHF 21,787 million, up 25% from CHF 17,484 million a year earlier. Equities revenues, at CHF 9,397 million in 2006, were up 35% from CHF 6,980 million in 2005. Overall, cash equity revenues were higher, with results benefiting from positive market conditions generating strong revenues in emerging markets. Increased cash commissions were partially offset by greater facilitation requirements from our clients. Revenues in our derivatives business increased globally due to higher business demand. Equity capital markets revenues rose with increased capital raising activities. Prime brokerage services continued to grow as client numbers and balances increased. Exchange-traded derivatives revenues rose, boosted by the 51 As reported 6 Before goodwill and adjusted for significant financial events 7 6000 5000 4000 3000 2000 450 400 350 300 250 0.8 0.6 0.4 0.2 0.0 32 24 16 8 0 Financial Businesses Investment Bank impact of the acquisition of ABN AMRO’s global futures and options business towards the end of the year. Our proprie- tary as well as our equity-linked businesses contributed also higher returns compared to the previous year. Fixed income, rates and currencies revenues were CHF 9,056 million, up 14% from CHF 7,962 million a year ear- lier. Revenues in the rates business were up against the pri- or year as a result of higher revenues in energy trading and mortgage backed securities, partially offset by lower in- come from derivatives. Credit fixed income saw strong growth in structured credit and secondary loan activity. Syndicated finance also recorded higher income as the business benefited from increased market activity. Credit default swaps hedging loan exposures recorded a loss of CHF 245 million compared with gains of CHF 103 million a year earlier. While municipal securities revenues were lower in 2006, the foreign exchange and cash collateral trading business, especially the metals business, saw a significant increase in revenues. Investment banking revenues, at CHF 3,273 million in 2006, increased 31% from CHF 2,506 million a year earlier. This reflected growth in each region, especially in Asia. The debt and equity capital markets groups reported significant gains over the prior year. Our leveraged finance franchise continued to grow, demonstrating our strengthened com- mitment to this part of the business. Revenues from the ad- visory business also increased compared with last year, as clients took advantage of strategic opportunities. Income by business area  CHF million 2004 2005 2006 25,000 20,000 15,000 10,000 5,000 0 1,915 5,906 2,506 6,980 8,269 7,962 3,273 9,397 9,056 Fixed income, rates and currencies (1,602) Equities Investment banking Operating expenses Operating expenses rose by CHF 3,541 million to CHF 15,844 million in 2006, a 29% increase from CHF 12,303 million a year earlier. Personnel expenses, at CHF 11,353 million in 2006, in- creased 23% from a year earlier, reflecting an increase in the bonus accrual and additional salaries due to higher staff levels. Share-based compensation rose 30% from prior year as a result of higher share awards in 2006, and the increased 52 fair value of options granted in 2006 – driven by the rise in UBS’s share price. General and administrative expenses were CHF 3,260 million in 2006, up 47% from 2005’s CHF 2,215 million. In 2006 we recorded a number of new provisions. IT and other outsourcing costs as well as professional fees rose, driven by higher project spending in support of future business growth in fixed income, prime brokerage and emerging markets. Administration, travel and entertainment and, to a lesser ex- tent, occupancy expenses, increased as well. Provision levels in 2006 rose from 2005. Charges from other business units increased to CHF 956 million in 2006 from CHF 640 million in 2005. The rise reflects the charges by Global Asset Management for man- aging the Investment Bank’s funds invested in DRCM as well as higher charges from ITI (IT infrastructure unit) as a result of the increased levels of staff. Depreciation rose by 49% to CHF 203 million in 2006 from CHF 136 million in 2005 due to higher IT write-offs, of- fice expansion and renewal costs. The amortization of intangible assets, at CHF 72 million in 2006, was up 36% from CHF 53 million a year earlier due to the two acquisitions – ABN AMRO’s futures and options business and Pactual. 2005 Key performance indicators The cost / income ratio fell to 70.5% in 2005 from 71.3% a year earlier. Revenue growth, driven by strong performances in investment banking and equities, was partly offset by higher personnel expenses. The full-year compensation ratio, at 53.1%, rose 2.4 per- centage points between 2004 and 2005. This reflects higher performance-related compensation and increased staff lev- els. Share-based compensation was also higher, since awards made in 2005 for the 2004 financial year contained an in- creased proportion of stock. 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. The total gross lending portfolio was CHF 97 billion on 31 December 2005 compared with CHF 78 billion on 31 De- cember 2004, reflecting our expanding prime brokerage and equity finance businesses as well as increased underwriting activity. The gross impaired lending portfolio to total gross lending portfolio ratio fell to 0.2% at the end of 2005 from 0.5% on 31 December 2004. The return on allocated regulatory capital in 2005 was 28.6%, down 1.9 percentage points from the return of 20000 16000 12000 8000 4000 0 30.5% 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 increased lending activity to the Investment Bank’s growing client base. Results Pre-tax profit was CHF 5,181 million, up 12% from 2004. The result was driven by strong revenues in investment bank- ing (up 31%) and in equities (up 18%), reflecting our suc- cessful expansion in significant growth areas such as M&A, in particular in Asia Pacific, equity derivatives and prime bro- kerage. Results in the fixed income, rates and currencies business were slightly lower than last year. Lower revenues in structured credit – mainly driven by lower volumes and fol- lowing the turmoil in the automotive sector in second quar- ter 2005 – were offset by an increase in the rates business. At the same time, costs increased as our business continued to expand, partially offset by the cessation of goodwill amor- tization. Operating income Total operating income in 2005 was CHF 17,484 million, up 9% from CHF 16,083 million a year earlier. 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 Europe as well as prime brokerage, where we saw an impressive revenue gain in the US. Our proprietary and equity-linked businesses contributed slightly lower re- turns than the previous year. Fixed income, rates and currencies revenues were CHF 7,962 million, down 4% from CHF 8,269 million a year earlier. Revenues in the rates business were up against the prior year as a result of rising revenues in energy trading and derivatives. Credit fixed income saw lower revenues in struc- tured 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 vola- tility levels. This was partially offset by rising cash and col- lateral trading revenues due to higher market share and volumes. 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 transac- tions. During 2005, our Investment Bank advised on a total of 343 transactions with a deal volume of USD 496 billion, more than doubling from a year earlier. 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 prompted total operating expenses in 2005 to rise to CHF 12,303 million, 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 salaries from higher staff levels. Share-based compensation rose 17% from prior year due to an increase in share-based awards and the higher 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. Provisions 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 increase 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 million in 2005 from CHF 243 million in 2004 due to the transfer of further IT infrastructure functions into our central ITI unit in Corporate Center. There was no amortiza- tion of goodwill in 2005, following a change in accounting. In 2004, amortization of goodwill totaled CHF 278 million. Amortization of intangible assets was CHF 53 million in 2005, 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 Prediction, which became part of UBS in 2005. 53 Financial Businesses Corporate Center Corporate Center In 2006 Corporate Center recorded a pre-tax loss of CHF 1,083 million, compared with the pre-tax gain of CHF 3,856 million in 2005. The swing between 2005 and 2006 was due to the sale of Private Banks & GAM at the end of 2005. The continuing operations of Corporate Center reported a pre-tax loss of CHF 1,087 million, compared with a loss of CHF 708 million in 2005. 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 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 Additional information BIS risk-weighted assets Personnel (full-time equivalents) Personnel excluding ITI (full-time equivalents) Personnel for ITI (full-time equivalents) As of or for the year ended % change from 31.12.06 31.12.05 31.12.04 31.12.05 294 (61) 233 1,133 131 1,264 1,242 (1,978) 783 0 9 1,320 (1,087) 4 (1,083) 8,969 4,771 1,716 3,055 455 232 687 1,059 108 1,167 1,084 (1,730) 857 0 17 1,395 (708) 4,564 3,856 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) 9,841 5,202 2,848 2,354 (35) (66) 7 21 8 15 (14) (9) (47) (5) (54) (100) 10 22 25 20 1 In order to show the relevant Business Group performance over time, the adjusted expected credit loss rather than credit loss expense or recovery is reported for all Business Groups. The difference between the adjusted expected credit loss and the credit loss expense or recovery recorded at Group level is reported in the Corporate Center (see note 2 to the financial statements). 2 Additionally includes 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 Group Chief Financial Officer and Head of the Corporate Center 54 2006 Results Corporate Center recorded a pre-tax loss from continuing operations of CHF 1,087 million in full-year 2006, compared with a loss of CHF 708 million a year earlier. The increase was mainly driven by a CHF 454 million decline in operating in- come. The main reason for the decrease was the credit loss expense for 2006, which contrasts with the recovery we re- corded in 2005. Additionally, 2006 was negatively impacted by losses from cash flow hedges that were not fully effec- tive. Operating income Total operating income decreased to CHF 233 million in 2006 from CHF 687 million in 2005. This reflects the credit loss expense recorded this year, which contrasts with the credit recovery we reported a year earlier. It is also a result of lower income from treasury activities. The credit loss result booked in Corporate Center repre- sents the difference between the adjusted expected credit loss result recorded in the business units and the credit loss expense or recovery recognized in the UBS financial state- ments. In 2006, UBS recorded a credit loss recovery of CHF 156 million, compared to a recovery of CHF 375 million in 2005. In 2006, the adjusted expected credit loss recoveries of CHF 217 million credited to the Business Units exceeded UBS’s credit recovery. The difference of CHF 61 million was recorded in Corporate Center as a credit loss expense compared with the recovery of CHF 232 million re- corded in 2005. loss Income decreased by CHF 161 million to CHF 294 million in 2006 compared to CHF 455 million in 2005, mainly due to lower real estate gains and losses related to cash flow hedg- ing (that were gains in 2005). This was slightly offset by gains from FX options in 2006. Operating expenses Total operating expenses were CHF 1,320 million in 2006, down CHF 75 million from CHF 1,395 million in 2005. At CHF 1,264 million in 2006, personnel expenses were up 8% from CHF 1,167 million in 2005, mainly reflecting the higher personnel numbers in ITI driven by higher business demand and hiring of people to address the growing com- plexity of regulatory requirements. Personnel costs increased due to higher performance-related compensation as well as higher expenses for share-based components as the UBS share price increased compared with 2005. In the same pe- riod, general and administrative expenses increased 15% to CHF 1,242 million from CHF 1,084 million. In ITI, expenses for rent and maintenance of IT equipment, occupancy and communications increased with higher staff levels. Costs also increased as a small portion of the provision for sub- leasing office space in the US was booked in Corporate Center. Other businesses were charged CHF 1,978 million compared to CHF 1,730 million, reflecting the business driv- en cost increases of UBS’s IT infrastructure. Depreciation of property and equipment decreased to CHF 783 million by CHF 74 million or 9%, as several software components came to the end of their depreciation cycle. Amortization of intan- gible assets was CHF 9 million in 2006, CHF 8 million below the level a year earlier. IT infrastructure In 2006, the information technology infrastructure cost per average number of financial business employees was CHF 28,072, up CHF 1,341 from CHF 26,731 in 2005, reflecting the impact of supporting businesses in their growth plans. This was partially offset by cost savings from managing our information technology infrastructure centrally. 2005 Results Corporate Center’s result from continuing operations was a loss of CHF 708 million in full-year 2005, compared to a loss of CHF 778 million a year earlier. The improvement was driv- en by a CHF 343 million increase in income. Private Banks & GAM (discontinued operations) The sale of Private Banks & GAM to Julius Baer was com- pleted on 2 December 2005. The disposal gain and the op- erating result realized during the year before the deal closed is reported as pre-tax profit from discontinued operations of CHF 4,564 million in 2005. Operating income Total operating income increased to CHF 687 million in 2005 from CHF 398 million in 2004. The result was driven by higher revenues, partially offset by lower credit loss recover- ies. In 2005, the credit loss recovery was CHF 375 million. The adjusted expected credit loss recovery at the Business Unit level was CHF 143 million. This resulted in a credit loss recov- ery in Corporate Center of CHF 232 million. In 2004, the Group credit loss recovery was CHF 241 mil- lion. The adjusted expected credit loss expense at Business Unit level was CHF 45 million in the same year, resulting in a Corporate Center credit loss recovery of CHF 286 million. Income increased by CHF 343 million to CHF 455 million in 2005 mainly due to the diversification of capital into US dollars. The higher average equity base produced a positive impact on treasury income, as did a timing effect related to cash flow hedging. 55 Financial Businesses Corporate Center 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 integra- tion of UBS’s IT infrastructure into ITI. The figure was also due to additional hiring and accruals for performance-related com- pensation. In the same period, general and administrative ex- penses increased 1% to CHF 1,084 million from CHF 1,077 million. Lower 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 regulatory requirements. Additionally, we saw higher ex- penses for our brand initiative and corporate real estate. Other businesses were charged CHF 1,730 million compared to CHF 1,509 million, reflecting the further integration of UBS’s IT in- frastructure into ITI. Amortization of 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 average 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 tech- nology infrastructure centrally. 56 Industrial Holdings Industrial Holdings Industrial Holdings Income statement 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 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 / (benefit) Net profit from discontinued operations Net profit Net profit / (loss) attributable to minority interests from continuing operations from discontinued operations Net profit attributable to UBS shareholders from continuing operations from discontinued operations Additional information Private Equity 1 Investments, at cost 2 Unrecognized gains Portfolio fair value Cost / income ratio (%) 3 BIS risk-weighted assets Personnel (full-time equivalents) As of or for the year ended % change from 31.12.06 31.12.05 31.12.04 31.12.05 693 301 994 202 187 9 18 0 5 295 716 278 35 243 852 (13) 865 1,108 104 1 103 1,004 242 762 344 517 861 72.0 443 4,241 675 561 1,236 245 184 14 21 0 4 283 751 485 175 310 496 87 409 719 207 (24) 231 512 334 178 744 264 1,008 60.8 2,035 21,636 640 275 915 185 176 20 22 27 2 263 695 220 51 169 385 101 284 453 93 (21) 114 360 190 170 1,219 467 1,686 76.0 2,773 29,453 3 (46) (20) (18) 2 (36) (14) 25 4 (5) (43) (80) (22) 72 111 54 (50) (55) 96 (28) 328 (54) 96 (15) (78) (80) 1 Only comprises financial investments available-for-sale. 2 Historical cost of investments made, less divestments and impairments. 3 Operating expenses / operating income. 58 Major participations Our private equity investments were moved to our Industrial 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 sale of UBS’s 55.6% stake of 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), which was included in this segment, was successfully completed on 23 March 2006. The sale price was set at approximately CHF 1,295 million. The disposal gain of CHF 387 million and the operating result of CHF 71 million real- ized during the quarter before the deal closed are reported as discontinued operations after tax. All prior periods have been restated accordingly. 2006 In 2006, the Industrial Holdings segment reported a net profit of CHF 1,108 million, of which CHF 1,004 million was attributable to UBS shareholders. In 2006, we completed the sale of four fully consolidated investments. The realized divestment gains are presented as discontinued operations for Industrial Holdings. Previous in- come statements have also been restated to reflect these divestments. In 2006, unconsolidated private equity investments, including those accounted for under the equity method, recorded total divestment gains of CHF 391 million. The level of financial investments available-for-sale fell to CHF 344 million on 31 December 2006 from CHF 744 million 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 portfolio decreased to CHF 861 mil- lion in 2006 from CHF 1,008 million in 2005 reflecting re- valuations and successful divestments. Unfunded commit- ments on 31 December 2006 were CHF 227 million, down from CHF 367 million at the end of December 2005. 2005 In 2005, the Industrial Holdings segment reported a net profit attributable to UBS shareholders of CHF 512 million. In 2005, it completed the sale of four fully consolidated investments. The operating profit or loss and gains on disposal are pre- sented as discontinued operations for Industrial Holdings. In 2005, unconsolidated private equity investments, including those accounted for under the equity method, recorded total divestment gains of CHF 684 million. The level of financial investments available-for-sale fell to CHF 744 million on 31 December 2005 from CHF 1,219 million a year earlier due to a number of exits which were partially offset by the funding of existing commitments. The fair val- ue of this part of the portfolio decreased to CHF 1,008 mil- lion in 2005 from CHF 1,686 million 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 investment. 59 60 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 2,396.5 billion on 31 Decem- ber 2006, up from CHF 2,058.3 billion on 31 December 2005. The increase was driven by the growth in the trading portfolio (up CHF 225 billion), collateral trading (up CHF 65 billion) and the loan portfolios (up CHF 33 billion), while positive and negative replacement values each were down CHF 5 billion. Currency movements against the Swiss franc (mainly the 7% depreciation of the US dollar) partially offset the rise. Total li- abilities rose due to higher borrowing (up CHF 241 billion), collateral trading liabilities (up CHF 70 billion) and trading li- abilities (up CHF 16 billion). Lending and borrowing Lending Cash was CHF 3.5 billion on 31 December 2006, down CHF 1.9 billion from a year earlier, mainly from lower sight de- posit balances held with central banks. At CHF 50.4 billion on 31 December 2006, the Due from banks line increased by CHF 16.8 billion, largely related to the integration of ABN AMRO’s futures and options business, and higher lending by the cash and collateral trading business, which is the central funding instance of the bank. The increase was partially off- set by lower current account balances in Industrial Holdings relating to the divestment of Motor-Columbus at the begin- ning of 2006. Our loans to customers stood at CHF 312.5 billion on 31 December 2006, up by CHF 32.6 billion from a year earlier, reflecting higher mortgage volumes in Switzer- land and increased secured lending, mainly in our interna- tional wealth management businesses. This was further ac- centuated by a substantial increase in the Investment Bank’s secured lending to prime brokerage clients and to a lesser extent by the integration of ABN AMRO’s futures and op- tions business. This was partially offset by lower secured lending balances to US mortgage originators. Borrowing The Due to banks line rose by CHF 79.4 billion mainly due to increased time deposits. Major movements in the Investment Bank’s cash and collateral trading activities were related to a shift from repos to uncollateralized borrowing in connection with the funding of Dillon Read Capital Management (DRCM) assets and the accommodation of the firm’s general growth. Further growth was driven by the integration of ABN AMRO’s futures and options business. Total debt issued (including fi- nancial liabilities designated at fair value) increased to CHF 335.8 billion on 31 December 2006, up CHF 57.7 billion from a year earlier. Money market paper issuance increased by CHF 16.9 billion, mainly in Europe and the US. The amount of long-term debt issued (including financial liabilities designated at fair value) grew by CHF 40.9 billion to CHF 216.3 billion. The Due to customers line was up CHF 103.7 billion, mainly reflecting larger time deposits from private clients in our wealth management franchise around the globe and in Switzerland for our retail banking business. Growth from our Investment Bank’s prime brokerage and exchange traded de- rivative business related to the integration of ABN AMRO’s futures and options business. Repo and securities borrowing / lending In 2006, cash collateral on securities borrowed and reverse repurchase agreements increased by CHF 65 billion or 9% to CHF 757 billion, while the sum of securities lent and repos grew by CHF 70 billion or 13% to CHF 609 billion. The in- crease stems primarily from the Investment Bank’s matched book (a repo portfolio comprised of assets and liabilities with equal maturities and equal value, so that the risks substan- tially cancel each other out), and equity securities borrowing activities. Securities lending and repos rose, largely to finance the growth in trading inventory. Trading portfolio Trading assets increased by CHF 225 billion to CHF 879 billion on 31 December 2006 from CHF 654 billion on 31 December 2005. Increases were registered in debt instruments (up CHF 124 billion), mainly in asset-backed securities in our mortgage trading and securitized products business and in government securities (within the rates business). Assets in cash and col- lateral proprietary trading increased and were mostly pledged to central banks. Equity instruments were up by CHF 52 bil- lion, largely driven by the derivatives business on the back of rising equity markets. Money market paper inventories rose in our fixed income, rates and currencies business by CHF 29 bil- lion. Traded loans rose by CHF 11 billion, mainly in the securi- tization business, while precious metals grew by CHF 8 billion. Over the same period, short trading positions increased by CHF 16 billion to CHF 205 billion. Replacement values In 2006 positive and negative replacement values declined by CHF 5 billion to CHF 328 billion and CHF 333 billion re- spectively. This was the net result of increases in the Equities business from the integration of ABN Amro’s futures and op- tions business and movements in exchange rates in major currencies, slightly outweighed by the decline in replace- ment values driven by movements in interest rates. 62 Other assets / liabilities Investments in associates decreased by 48%, to CHF 1.5 bil- lion on 31 December 2006, mainly due to the sale of UBS’s stake in Motor-Columbus. Property and equipment was down 27% to CHF 6.9 billion, mainly driven by write-offs, partially offset by new investments. Goodwill and other in- tangible assets, at CHF 14.8 billion on 31 December 2006, rose 10% from a year earlier, reflecting the acquisitions of several businesses during 2006, partially offset by a negative currency impact and the disposal of Motor- Columbus. Equity At CHF 49.7 billion on 31 December 2006, equity attribut- able to UBS shareholders increased by CHF 5.7 billion from 2005. The increase reflects the attributable profit of CHF 12.3 billion, partially offset by dividend payments and share repurchases. Equity attributable to minority interests decreased by 20% to CHF 6.1 billion on 31 December 2006 from CHF 7.6 billion on the same date a year ago, mainly reflecting the new issuance of preferred securities and the sale of Motor- Columbus. Contractual obligations The table below summarizes our contractual obligations as of 31 December 2006. All contracts, with the exception of purchase obligations (those where we are committed to purchasing 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 27 to the Financial Statements. The following liabilities recognized on the balance sheet are excluded from the table because we do not consider these obligations to be contractual: provisions, current and deferred tax liabilities, liabilities to employees for equity participation plans, settlement and clearing accounts and amounts due to banks and customers. Within purchase obligations, we have excluded our obli- gation to employees under the mandatory notice period, during which we are required to pay employees contractu- ally agreed salaries. UBS has entered into firm commitments for the acquisi- tion of certain businesses. The terms and conditions of these agreements are disclosed in Note 37 to the Financial State- ments – Business Combinations. 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 they do not become onerous, UBS does not incur an obligation from them or become entitled to a specific asset. As soon as such an obligation is incurred, it is recognized on the balance sheet, with the resulting loss recorded in the income state- ment. It should be noted, however, that the amount recog- nized on the balance sheet does not, in many instances, rep- resent the full loss potential inherent in such arrangements. For the most part, the arrangements discussed below ei- ther meet the financial needs of customers or offer invest- ment opportunities through entities that are not controlled by UBS. The importance of such arrangements to us, with respect to liquidity, capital resources or market and credit risk support, is minimal. We do not rely on such arrangements as a major source of revenue. They have also not resulted in significant expenses for UBS and we do not expect them to do so in the future. The following paragraphs discuss three distinct areas of off-balance sheet arrangements and any po- tential obligations that may arise from them as of 31 Decem- ber 2006. Guarantees In the normal course of business, we issue various forms of guarantees to support our customers. With the exception of related premiums, these guarantees are kept off-balance sheet unless a provision is needed to cover probable losses. The maximum claim subject to credit risk arising from these guarantees is disclosed in Note 26 to the Financial State- ments. On 31 December 2006 the amount is slightly above the level of a year earlier. Fee income from issuing guaran- tees is not material to our total revenues. Losses incurred under guarantees and income from the release of related provisions were insignificant for each of the last three years. Contractual obligations CHF million Long-term debt Capital lease obligations Operating leases Purchase obligations Other long-term liabilities Total Payment due by period Less than 1 year 37,086 154 1,003 712 419 39,374 1–3 years 52,263 324 1,919 528 2,079 57,113 3–5 years More than 5 years 32,435 115 1,561 279 39 34,429 84,421 0 4,280 103 1,775 90,579 63 Balance Sheet and Cash Flows Balance sheet and off-balance sheet Retained interests UBS sponsors the creation of Special Purpose Entities (SPEs) that facilitate the securitization of acquired residential and commercial mortgage loans and related securities. We also securitize customers’ debt obligations in transactions that involve SPEs which issue collateralized debt obligations. A typical securitization transaction of this kind would involve the transfer of assets into a trust or corporation in return for beneficial interests in the form of securities. Generally, the beneficial interests are sold to third parties shortly after secu- ritization. We do not provide guarantees or other forms of credit support to these SPEs. Financial assets are no longer reported in our consolidated financial statements once their risks and rewards are transferred to a third party. For further discussion of our securitization activities, see Note 42.2 to the Financial Statements. Derivative instruments recorded in equity We have no derivative contracts linked to our own shares that are accounted for as equity instruments. With the ex- ception of physically settled written put options (see Note 1 to the Financial Statements), derivative contracts linked to our shares are accounted for as derivative instruments and are carried at fair value on the balance sheet under positive replacement values or negative replacement values. 64 Balance Sheet and Cash Flows Cash Flows Cash flows 2006 At end-2006, the level of cash and cash equivalents rose to CHF 136.1 billion, up CHF 45.1 billion from CHF 91.0 billion at end-2005. Operating activities Net cash flow used in operating activities was CHF 4.7 billion in 2006 compared to a cash outflow of CHF 63.2 billion in 2005. Operating cash inflows (before changes in operating assets and liabilities and income taxes paid) totaled CHF 15.3 billion in 2006, an increase of CHF 0.7 billion from 2005. Our net profit decreased by CHF 1.9 billion compared to 2005. Cash of CHF 98.7 billion was used to fund the net in- crease in operating assets, while a net increase in operating liabilities generated cash inflows of CHF 81.3 billion. The in- crease in cash was used to fund operating assets – in line with the expansion of our business. Payments to tax author- ities were CHF 2.6 billion in 2006, up CHF 0.2 billion from a year earlier. Investing activities Investing activities generated a cash inflow of CHF 4.4 bil- lion. The net cash inflow for investments in associates and subsidiaries was CHF 2.9 billion. This reflected cash outflows of CHF 3.5 billion for acquisitions, which were more than offset by cash inflows of CHF 6.4 billion relating to them. Purchases of property and equipment totaled CHF 1.8 billion and the net divestment of financial investments available- for-sale was CHF 1.7 billion. Disposals of subsidiaries and as- sociates in 2006 generated a cash inflow of CHF 1.2 billion, mainly due to the sale of Motor-Columbus. In 2005, we saw a net cash outflow from investing activities of CHF 2.4 bil- lion. This was because we acquired new businesses worth CHF 1.5 billion and made CHF 1.6 billion in net purchases of property and equipment. This was only partially offset by disposals of subsidiaries and associates. Financing activities In 2006, financing activities generated cash flow of CHF 47.4 billion, which were used to finance the expansion of our business activities. This reflected the net issuance of money market paper of CHF 16.9 billion and the issuance of CHF 97.7 billion in long-term debt – the latter significantly out- pacing long-term debt repayments, which totaled CHF 60.0 billion. That inflow was partly offset by outflows attributable to net movements in treasury shares and own equity deriva- tive activity (CHF 3.6 billion), and dividend payments (CHF 3.2 billion). In 2005, we also had a net cash inflow of CHF 64.5 billion from our financing activities. The difference be- tween the two years was mainly due to a net decrease in is- suance of long-term debt and money market paper by CHF 14.4 billion in 2006. 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 billion in 2005 compared to CHF 24.1 billion in 2004. Op- erating cash inflows (before changes in operating assets and liabilities and income taxes paid) totaled CHF 14.6 bil- lion in 2005, an increase of CHF 3.4 billion from 2004. Our net profit rose by CHF 6.2 billion compared to 2004. Dis- continued operations contributed CHF 3.8 billion which had to be reclassified to cash flow from investing activi- ties. Cash of CHF 155.5 billion was used to fund the net in- crease in operating assets, while a net increase in operating liabilities generated cash inflows of CHF 80.1 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 recovery seen in the financial markets. Pay- ments 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 totaling 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 contrast, in 2004 we saw a net cash outflow from investing activities of CHF 1.0 billion mainly due to the acquisitions of new businesses of CHF 2.5 billion and 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 financial investments. 65 Balance Sheet and Cash Flows Cash Flows Financing activities In 2005, financing activities generated cash flow 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 also had 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. 66 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 42 to the Financial Statements of the significant dif- ferences which would arise were our accounts to be pre- sented under the United States Generally Accepted Account- ing Principles (US GAAP), and a detailed reconciliation of equity attributable to shareholders under IFRS and net profit to US GAAP. Except where clearly identified, all of UBS’s financial infor- mation presented in this document is presented on a con- solidated basis under IFRS. Pages 215 to 228 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 pre- pared in order to meet Swiss regulatory requirements and in compliance with Swiss Banking Law. Except in those pages, or where otherwise explicitly stated, all references to “UBS” refer to the UBS Group and not to the Parent Bank. All references to 2006, 2005 and 2004 refer to the UBS Group and the Parent Bank’s fiscal years ended 31 December 2006, 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 deter- mine the revenues and expenses directly attributable to each business unit. The presentation of the business segments reflects UBS’s organizational structure and management responsibilities. Internal charges and transfer pricing adjust- ments are reflected in the performance of each business unit. Transactions between Business Units are conducted at inter- nally agreed transfer prices or at arm’s length. Corporate Center expenses are allocated to the operating Business Units to the extent 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 their regulatory capital requirements add- ing goodwill and excess intangible assets (see below). Commissions are credited to the Business Unit with the corresponding customer relationship, with revenue-sharing agreements for the allocation of customer revenues where several business units are involved in value creation. For internal management reporting purposes and in the results discussion, we measure credit loss using an expected loss concept. Expected credit loss reflects the average an- nual 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 be- tween credit loss expense and expected credit loss, amor- tized over a three-year period (shown as ‘deferral’ in the table). The difference between the sum of these adjusted expected credit loss figures, which are charged to the Busi- ness Groups or Units, and the credit loss expense recorded at Group level for financial reporting purposes is reported in Corporate Center. 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 and excess intangible assets allo- cated. Return on allocated regulatory capital is a key perfor- mance indicator for the Investment Bank and the Business Banking Switzerland unit. Inter-business unit revenues and expenses. Revenue- sharing agreements are used to allocate external customer revenues to business units on a reasonable basis. Inter-busi- ness unit charges are reported in the line “Services to / from other Business Units” for both Business Units concerned. 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 individual. Per- sonnel includes all staff and trainees other than contractors. 68 Credit loss result recorded at Business Group / Unit level CHF million Global Wealth Management & Business Banking Investment Bank UBS total For the year ended 31.12.06 Expected credit loss Deferral Adjusted expected credit loss Credit loss (expense) / recovery Balancing item recorded as credit loss (expense) / recovery in Corporate Center Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland (78) 49 (29) 1 (8) 8 0 (1) (327) 512 185 109 (171) 232 61 47 (584) 801 217 156 (61) 69 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 ac- counting principles in the United States (US GAAP). The ap- plication of certain of these accounting principles requires considerable judgment based upon estimates and assump- tions that involve significant uncertainty at the time they are made. Changes in assumptions may have a significant im- pact on the Financial Statements in the periods where as- sumptions are changed. Accounting treatments where sig- nificant assumptions and estimates are used are discussed in this section, as a guide to understanding how their appli- cation affects our reported results. A broader and more de- tailed description of the accounting policies we employ is shown in Note 1 to the Financial Statements. The application of assumptions and estimates means that any selection of different assumptions would cause our re- ported 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. Liquidity is discussed in more detail in the Treasury Manage- ment chapter of the Handbook 2006 / 2007. Fair value of financial instruments Financial assets and financial liabilities in our trading port- folio, financial assets and liabilities designated 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 af- fecting this accounting policy relate to how we determine fair value for such assets and liabilities. Where no active market exists, or where quoted prices are not otherwise available, we determine fair value using a variety 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 derivatives, and unlisted securities with embedded deriva- tives. All valuation models are validated before they are used as a basis 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 instruments, and with actual values when realized, in order to further validate and calibrate our models. A variety of factors are incorporated into our models, including actual or estimated market prices and rates, such as time value and volatility, and market depth and liquidity. Where available, we use market observable prices and rates derived from market verifiable data. Where such factors are not market observable, changes in assumptions could affect the reported fair value of financial instruments. We apply our models consistently from one period to the next, ensuring comparability and continuity of valuations over time, but estimating fair value inherently involves a significant degree of judgment. Management therefore establishes valuation adjustments to cover the risks associated with the estimation of unobservable input parameters and the assumptions within the models themselves. Valuation adjustments are also made to reflect such elements as deteriorating creditworthiness (in- cluding country-specific risks), concentrations in specific types of instruments and market risk factors (interest rates, curren- cies etc), and market depth and liquidity. Although a signifi- cant degree of judgment is, in some cases, required in estab- lishing fair values, management believes that the fair values recorded in the balance sheet and the changes in fair values recorded in the income statement are prudent and reflective of the underlying economics, based on our established fair value and model governance policies and the related controls and procedural safeguards we employ. Nevertheless, for valu- ations 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 all financial instruments carried at fair value which rely on assumptions for their valuation, we estimate that fair value could lie in a range from CHF 1,038 million lower to CHF 955 million higher than the fair values recognized in the Financial Statements. In 2005 the estimate of that range was CHF 1,094 million lower to CHF 1,176 million higher than the amounts recognized on the balance sheet. 70 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 in the long term, where we determine fair value using valuation models for which not all inputs are market observable prices or rates. We initially recognize such a fi- nancial instrument at the transaction price, which is the best indicator of fair value, although the value obtained from the relevant valuation model may differ. Such a difference be- tween the transaction price and the model value is com- monly referred to as "Day 1 P / L". We do not immediately recognize that initial difference, usually a gain, in profit and loss because the applicable accounting literature prohibits immediate recognition of Day 1 profit. The accounting litera- ture does not, however, address its subsequent recognition prior to the time when fair value can be determined using market observable inputs or by reference to prices for similar instruments in active markets. It also does not address sub- sequent measurement of these instruments and recognition of subsequent fair value changes indicated by the model. Our decisions regarding recognizing deferred Day 1 profit are made after careful consideration of facts and circum- stances to ensure we do not prematurely release a portion of the deferred profit to income. For each transaction, we de- termine, individually, the appropriate method of recognizing the Day 1 profit amount in the income statement. It may be amortized over the life of the transaction, or deferred until fair value can be determined using market observable in- puts, or realized through settlement. In all instances, any un- recognized Day-1 profit is immediately released to income if fair value of the financial instrument in question can be de- termined either by using market observable model inputs or by reference to a quoted price for the same product in an active market. Changes in fair value after Day 1 resulting from changes in observable parameters or otherwise indicated by the mod- el are recognized immediately in the income statement inde- pendently of the release of deferred Day 1 profits. Special Purpose Entities and securitizations UBS sponsors the formation of Special Purpose Entities (SPEs) primarily to allow clients to hold investments in separate legal entities, to allow clients to jointly invest in alternative assets, 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. In order to deter- mine whether we control an SPE or not, we have to make judgments about risks and rewards and assess our ability to make operational decisions for the SPE in question. In many instances, elements are present that, considered in isolation, indicate control or lack of control over an SPE, but when considered together make it difficult to reach a clear conclu- sion. When assessing whether we have to consolidate an SPE we evaluate a range of factors, including whether (a) the activities of the SPE are being conducted on our behalf ac- cording to our specific business needs so that we obtain the benefits from the SPE’s operations, or (b) we have decision- making powers to obtain the majority of the benefits of the activities of the SPE, or UBS has delegated these decision- making powers by setting up an autopilot mechanism, or (c) we have the rights to obtain the majority of the benefits of the activities of an SPE and therefore may be exposed to risks arising from the activities of the SPE, or (d) we retain the majority of the residual or ownership risks related to the SPE or its assets in order to obtain the benefits from its activities. We consolidate an SPE if our assessment of the relevant fac- tors indicates that we control the SPE. SPEs used to allow clients to hold investments are struc- tures that allow one or more clients to invest in an asset or set of assets, which are generally purchased by the SPE in the open market and not transferred from UBS. The risks and rewards of the assets held by the SPE reside with the clients. Typically, UBS will receive service and commission fees for creation of the SPE, or because it acts as investment man- ager, custodian 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. 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 assets, e.g. feeder funds, for which generally no active mar- kets 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 discretion about investment and other administra- tive decisions, but has no or only a nominal amount of capi- tal invested. UBS typically receives service and commission fees for its services as general partner, but does not, or only to a minor extent, participate in the risks and rewards of the vehicle, which reside with the limited partners. In most in- stances, limited partnerships are not consolidated under IFRS because UBS’s legal and contractual rights and obligations indicate that UBS does not have the power to govern the financial and operating policies of these entities and concur- rently does not have the objective of obtaining benefits from its activities through such power. SPEs used for securitization. SPEs for securitization are created when UBS has assets (for example a portfolio of loans) which it sells to an SPE, and the SPE in turn sells inter- ests in the assets as securities to investors. Consolidation of these SPEs depends mainly on whether UBS retains the ma- jority of the benefits or risks of the assets in the SPE. 71 Accounting Standards and Policies Critical accounting policies We do not consolidate SPEs for securitization if UBS has no control over the assets and no longer retains any signifi- cant exposure (for gain or loss) to the income or investment returns on the assets sold to the SPE or the proceeds of their liquidation. This type of SPE is a bankruptcy remote entity – if UBS were to go bankrupt the holders of the securities would clearly be owners of the asset, while if the SPE were to go bankrupt the securities holders would have no re- course 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 pro- tection to UBS. The SPE in turn has investors who provide it with capital 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 Financial assets accounted for at amortized cost are assessed for objective evidence of impairment and required allowan- ces are estimated in accordance with IAS 39. Impairment exists if the book value of a claim or a portfolio of claims exceeds the present value of the cash flows actually expect- ed in future periods. These cash flows include scheduled in- terest payments, principal repayments, or other payments due (for example from guarantees), including liquidation of collateral where available. The total allowance for recognized financial assets and credit loss provision for off-balance sheet obligations con- sists of two components: specific counterparty allowances and provisions, and collectively assessed allowances and pro- visions. The specific counterparty component applies to claims evaluated individually for impairment and is based upon management’s best estimate of the present value of the cash flows which are expected to be received. In estimat- ing these cash flows, management makes judgments about a counterparty’s financial situation and the net realizable value of any underlying collateral or guarantees in our favor. Each impaired financial asset is assessed on its merits, and the workout strategy and estimate of cash flows considered recoverable are independently approved by the Credit Risk Control function. Collectively assessed credit loss allowances and provisions cover credit losses inherent in portfolios of claims with similar economic characteristics where there is objective evidence to suggest that they contain impaired claims but the individual impaired items cannot yet be identi- fied. In assessing the need for collective loan loss allowances and provisions, management considers factors such as credit quality, portfolio size, concentrations, and economic factors. In order to estimate the required allowance or provision, we make assumptions both to define the way we model inher- ent losses and to determine the required input parameters, based on historical experience and current economic condi- tions. The accuracy of the allowances and provisions we make depends on how well we estimate future cash flows for spe- cific counterparty allowances and provisions and the model assumptions and parameters used in determining collective allowances and provisions. While this necessarily involves judgment, we believe that our allowances and provisions are reasonable and supportable. Further details on this subject are given in Note 1a10) to the Financial Statements and in the Risk Management chap- ter of the Handbook 2006 / 2007. Equity compensation IFRS 2, Share-based Payments, addresses the accounting for share-based employee compensation and was adopted by UBS on 1 January 2005 on a fully retrospective basis. The effect of applying IFRS 2 is disclosed in Note 1b) to the Finan- cial Statements, and further information on UBS equity com- pensation plans, including inputs used to determine the fair value of options, is disclosed in Note 32. IFRS 2 requires that share options awarded to employees are recognized as compensation expense based on their fair value at grant date. The share options we issue to our em- ployees have features that make them incomparable to op- tions on our shares traded in active markets. Accordingly, we cannot determine 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 interest rates, expected dividends, volatility measures and specific employee exercise behavior patterns based on statistical data. Some of the model inputs we use are not market-observ- able and have to be estimated or derived from available data. Use of different estimates would produce different op- tion values, which in turn would result in higher or lower compensation expense recognized. Several recognized models for the valuation of options exist but none can be singled out as the best or most correct. The model we apply has been selected because it is able to handle some of the specific features included in the options granted to our employees. If we were to use a different model, the option values produced would be different, even if we used the same inputs. Using both different inputs and a different valuation model could have a significant impact on the fair value of employee share options, which could be either higher or lower than the values produced by the model we apply and the inputs we have used. 72 Financial Statements Financial Statements Table of Contents Financial Statements Table of Contents Management’s Report on Internal Controls over Financial Reporting Report of Independent Registered Public Accounting Firm – Internal Control over Financial Reporting Report of the Group Auditors Financial Statements Income Statement Balance Sheet Statement of Changes in Equity Statement of Recognized Income and Expense Statement of Cash Flows 77 78 80 82 82 83 84 85 86 74 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 9 Financial Assets Designated at Fair Value 10a Due from Banks and Loans 10b Allowances and Provisions for Credit Losses 10c Impaired Due from Banks and Loans 10d Non-Performing Due from Banks and Loans 11 Securities Borrowing, Securities Lending, Repurchase and Reverse Repurchase Agreements 12 13 14 15 16 17 Trading Portfolio Financial Investments Available-for-Sale Investments in Associates Property and Equipment Goodwill and Other Intangible Assets Other Assets 88 88 105 112 113 113 114 115 115 115 116 117 117 118 119 119 120 120 121 122 124 125 126 127 75 128 128 128 130 130 131 133 139 139 139 140 142 143 143 143 154 159 165 169 171 172 176 177 183 185 186 187 201 Financial Statements Table of Contents Balance Sheet: Liabilities 18 19 20 21 22 23 Due to Banks and Customers Financial Liabilities Designated at Fair Value and Debt Issued Other Liabilities Provisions Income Taxes Derivative Instruments and Hedge Accounting Off-Balance Sheet Information 24 25 26 27 Pledgeable Off-Balance Sheet Securities Fiduciary Transactions Commitments and Contingent Liabilities Operating Lease Commitments Additional Information Pledged Assets Financial Instruments Risk Position Fair Value of Financial Instruments and Continued Recognition of Transferred Financial Assets Pension and Other Post-Retirement Benefit Plans Equity Participation and Other Compensation Plans Related Parties Post–Balance Sheet Events Significant Subsidiaries and Associates Invested Assets and Net New Money Business Combinations Discontinued Operations Currency Translation Rates Swiss Banking Law Requirements Reconciliation to US GAAP Additional Disclosures Required under US GAAP and SEC Rules 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 76 Financial Statements Management’s report on internal control over financial reporting Management’s report on internal control over financial reporting The Board of Directors and management of UBS AG (UBS) are responsible for establishing and maintaining adequate internal control over financial reporting. UBS’s internal con- trol over financial reporting is designed to provide reason- able assurance regarding the preparation and fair presenta- tion of published financial statements in accordance with International Financial Reporting Standards (IFRS) including a reconciliation of net profit and equity attributable to UBS shareholders to US Generally Accepted Accounting Principles (US GAAP). UBS’s internal control over financial reporting includes those policies and procedures that: – Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispo- sitions of assets; – Provide reasonable assurance that transactions are re- corded as necessary to permit preparation and fair pre- sentation of financial statements, and that receipts and expenditures of the company are being made only in ac- cordance with authorizations of UBS management; and – Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or dis- position of the company’s assets that could have a mate- rial effect on the financial statements. Because of its inherent limitations, internal control over fi- nancial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. UBS management assessed the effectiveness of UBS’s internal control over financial reporting as of December 31, 2006 based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on this assessment, management believes that, as of Decem- ber 31, 2006, UBS’s internal control over financial reporting was effective. The audited consolidated financial statements of UBS in- clude the results of Banco UBS Pactual S.A. but manage- ment’s assessment does not include an assessment of the internal control over financial reporting of this entity because it was acquired on December 1, 2006. This approach is con- sistent with published SEC guidance on the permissible scope of management’s internal control report. The financial statements for this entity reflect total assets and operating income constituting less than 1% of the related consolidated financial statement amounts as of and for the year ended December 31, 2006. Management’s assessment of the effectiveness of UBS’s internal control over financial reporting as of December 31, 2006 has been audited by Ernst & Young Ltd, UBS’s indepen- dent registered public accounting firm, as stated in their re- port appearing on page 78, which expressed unqualified opinions on management’s assessment and on the effective- ness of UBS’s internal control over financial reporting as of December 31, 2006. 77 Financial Statements Report of Independent Registered Public Accounting Firm – Internal Control over Financial Reporting 78 79 Financial Statements Report of the Group Auditors 80 81 Financial Statements Financial Statements Income Statement CHF million, except per share data Note 31.12.06 31.12.05 31.12.04 31.12.05 For the year ended % change from 3 3 3 4 3 5 6 7 15 16 16 22 38 22 8 8 87,401 (80,880) 59,286 (49,758) 6,521 156 6,677 25,881 13,318 1,596 693 48,165 23,671 8,116 1,263 0 153 295 33,498 14,667 2,786 11,881 856 (13) 869 9,528 375 9,903 21,436 7,996 1,122 675 41,132 20,148 6,632 1,261 0 131 283 28,455 12,677 2,471 10,206 5,060 576 4,484 12,750 14,690 493 390 103 12,257 11,491 766 6.20 5.81 0.39 5.95 5.58 0.37 661 430 231 14,029 9,776 4,253 6.97 4.85 2.12 6.68 4.66 2.02 39,228 (27,484) 11,744 241 11,985 18,506 4,902 853 640 36,886 17,891 6,563 1,284 673 170 263 26,844 10,042 2,155 7,887 781 198 583 8,470 454 340 114 8,016 7,547 469 3.89 3.66 0.23 3.70 3.49 0.21 47 63 (32) (58) (33) 21 67 42 3 17 17 22 0 17 4 18 16 13 16 (83) (81) (13) (25) (9) (55) (13) 18 (82) (11) 20 (82) (11) 20 (82) 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 Operating profit from discontinued operations before tax Tax expense / (benefit) 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 82 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 available-for-sale 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 income recognized directly in equity, 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 31.12.06 31.12.05 31.12.05 % change from 10 11 11 12 12 23 9 10 13 14 15 16 17, 22 18 11 11 12 23 19 18 19 20, 21, 22 3,495 50,426 351,590 405,834 627,036 251,478 328,445 5,930 312,521 8,937 10,361 1,523 6,913 14,773 17,249 5,359 33,644 288,435 404,432 499,297 154,759 333,782 1,153 279,910 6,551 8,918 2,956 9,423 13,486 16,243 2,396,511 2,058,348 203,689 63,088 545,480 204,773 332,533 145,687 570,565 21,527 190,143 63,251 124,328 59,938 478,508 188,631 337,663 117,401 466,907 18,791 160,710 53,837 2,340,736 2,006,714 211 9,870 815 38 49,151 (185) (10,214) 49,686 6,089 55,775 871 9,992 (182) 101 44,105 (133) (10,739) 44,015 7,619 51,634 2,396,511 2,058,348 (35) 50 22 0 26 62 (2) 414 12 36 16 (48) (27) 10 6 16 64 5 14 9 (2) 24 22 15 18 17 17 (76) (1) (62) 11 (39) 5 13 (20) 8 16 83 Financial Statements Statement of Changes in Equity CHF million Share capital Balance at the beginning of the year Issue of share capital Capital repayment by par value reduction Cancellation of second trading line treasury shares Balance at the end of the year Share premium Balance at the beginning of the year Premium on shares issued and warrants exercised Net premium / (discount) on treasury share and own equity derivative activity Employee share and share options plans Tax benefits from exercise of employee share options Balance at the end of the year Net income recognized directly in equity, net of tax Foreign currency translation Balance at the beginning of the year Movements during the year Subtotal – balance at the end of the year 1 Net unrealized gains / (losses) on financial investments available-for-sale, net of tax Balance at the beginning of the year Net unrealized gains / (losses) on financial investments available-for-sale 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 Changes 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 unrealized (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 tax 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 Net profit attributable to UBS shareholders for the year Dividends paid 2 Cancellation of second trading line treasury shares Balance at the end of the year 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 Acquisitions Disposals Cancellation of second trading line treasury shares Balance at the end of the year Equity attributable to UBS shareholders 31.12.06 For the year ended 31.12.05 31.12.04 871 1 (631) (30) 211 9,992 46 (271) (508) 611 9,870 (432) (1,186) (1,618) 931 2,574 19 (649) 1 2,876 (681) 1 237 (443) 815 101 (63) 38 44,105 12,257 (3,214) (3,997) 49,151 (133) (52) (185) (10,739) (8,314) 4,812 4,027 (10,214) 49,686 901 2 (32) 871 9,231 36 (309) 768 266 9,992 (2,520) 2,088 (432) 761 463 96 (396) 7 931 (322) (474) 115 (681) (182) 90 11 101 36,692 14,029 (3,105) (3,511) 44,105 (96) (37) (133) (11,105) (8,375) 5,198 3,543 (10,739) 44,015 946 2 (47) 901 7,595 70 (20) 1,244 342 9,231 (1,694) (826) (2,520) 399 501 192 (353) 22 761 (144) (223) 45 (322) (2,081) 90 90 35,951 8,016 (2,806) (4,469) 36,692 (49) (47) (96) (9,654) (9,368) 3,401 4,516 (11,105) 33,632 1 Net of CHF 83 million, CHF (292) million and CHF 236 million of related taxes for the years ended 2006, 2005 and 2004 respectively. 2 Dividends of CHF 1.60 per share, CHF 1.50 per share and CHF 1.30 per share were paid on 24 April 2006, 26 April 2005 and 20 April 2004, respectively. 84 Statement of Changes in Equity (continued) CHF million Equity attributable to minority interests Balance at the beginning of the year 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 Cancellation of second trading line treasury shares Balance at the end of the year Treasury shares Number of shares Balance at the beginning of the year Acquisitions Disposals Cancellation of second trading line treasury shares Balance at the end of the year 31.12.06 For the year ended 31.12.05 31.12.04 7,619 1,219 131 (3,191) (182) 493 6,089 55,775 5,426 1,539 44 (595) 544 661 7,619 51,634 3,879 1,922 (523) (306) 454 5,426 39,058 31.12.06 2,177,265,044 2,208,242 (74,200,000) 2,105,273,286 For the year ended 31.12.05 2,253,716,354 3,418,878 (79,870,188) 2,177,265,044 31.12.04 2,366,093,528 6,586,826 (118,964,000) 2,253,716,354 % change from 31.12.05 (3) (35) 7 (3) 31.12.06 208,519,748 117,160,339 (87,004,388) (74,200,000) 164,475,699 For the year ended 31.12.05 249,326,620 156,436,070 (117,372,754) (79,870,188) 208,519,748 31.12.04 273,482,454 192,278,008 (97,469,842) (118,964,000) 249,326,620 % change from 31.12.05 (16) (25) 26 7 (21) In July 2006, UBS made a distribution of CHF 0.60 per share to shareholders which reduced the par value of UBS shares from CHF 0.80 to CHF 0.20 per share. At the same time, UBS split its share 2-for-1, resulting in a new par value of CHF 0.10 per share. During the year a total of 74,200,000 shares acquired under the second trading line buyback program 2005 were cancelled. Out of the total number of 164,475,699 trea- sury shares, 22,600,000 shares (CHF 1,615 million) have been repurchased for cancellation. The Board of Directors will propose to the Annual General Meeting on 18 April 2007 to reduce the outstanding number of shares and the share capital by the number of shares purchased for cancel- lation. On 31 December 2006, a maximum of 1,437,410 shares 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. In addition, during 2006, shareholders ap- proved the creation of conditional capital of up to a maxi- mum of 150 million shares to fund UBS's employee share option programs. As of 31 December 2006, no shares have been issued under this program. All issued shares are fully paid. Statement of Recognized Income and Expense For the year ended CHF million Net unrealized gains / (losses) on financial investments available-for-sale, before tax Change in fair value of derivative instruments designated as cash flow hedges, before tax Foreign currency translation Tax on items transferred to / (from) equity Net income recognized directly in equity Net income recognized in the income statement Total recognized income and expense 31.12.06 Attributable to UBS  share-  holders minority  interests Total 31.12.05 Attributable to UBS share- holders minority interests 31.12.04 Attributable to UBS share- holders minority interests Total Total 2,610 9 2,619 152 (58) 94 444 79 523 332 (1,186) (759) 997 12,257 13,254 0 (21) 0 (12) 493 481 332 (1,207) (759) 985 12,750 13,735 (479) 2,088 138 1,899 14,029 15,928 0 62 0 4 661 665 (479) 2,150 138 1,903 14,690 16,593 (238) (826) (50) (670) 8,016 7,346 0 (184) 0 (105) 454 349 (238) (1,010) (50) (775) 8,470 7,695 85 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, net replacement values and financial assets designated at fair value Loans / due to customers Accrued income, prepaid expenses and other assets Net increase / (decrease) in operating liabilities: Repurchase agreements, cash collateral on securities lent Accrued expenses and other liabilities Income taxes paid Net cash flow from / (used in) operating activities Cash flow from / (used in) investing activities Investments in subsidiaries and associates Disposal of subsidiaries and associates Purchase of property and equipment Disposal of property and equipment Net (investment in) / divestment of financial investments available-for-sale Net cash flow from / (used in) investing activities Cash flow from / (used in) financing activities Net money market paper issued / (repaid) Net movements in treasury shares and own equity derivative activity Capital issuance Capital repayment by par value reduction Dividends paid Issuance of long-term debt, 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, at the 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 For the year ended 31.12.06 31.12.05 31.12.04 12,750 14,690 8,470 1,325 196 (156) (117) (517) (2,092) 3,870 80,269 (61,382) (177,087) 64,029 (4,536) 66,370 14,975 (2,607) (4,710) 2,856 1,154 (1,793) 499 1,723 4,439 16,921 (3,624) 1 (631) (3,214) 97,675 (59,951) 1,331 (1,072) 47,436 (2,117) 45,048 91,042 136,090 3,495 87,144 45,451 136,090 1,556 340 (374) (152) (382) (5,062) 4,025 (1,690) (125,097) (74,799) 47,265 (1,227) 64,558 15,536 (2,394) (63,207) (1,540) 3,240 (1,892) 270 (2,487) (2,409) 23,221 (2,416) 2 0 (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 1,576 1,066 (241) (67) 171 (1,008) 1,203 (7,471) (40,752) (19,733) 13,108 (10,809) 9,753 22,019 (1,345) (24,060) (2,511) 1,277 (1,149) 704 703 (976) 21,379 (4,999) 2 0 (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 1 Includes issuance of preferred securities of CHF 1,219 million and CHF 1,539 million for the years ended 31 December 2006 and 31 December 2005, respectively. 2 Money market paper is included in the balance sheet under Trading portfolio assets and Financial investments available-for-sale. CHF 7,183 million, CHF 4,744 million and CHF 5,289 million were pledged at 31 December 2006, 31 December 2005 and 31 December 2004, respectively. 86 Statement of Cash Flows (continued) CHF million Additional information Cash received as interest Cash paid as interest Cash received as dividends on equities (incl. Associates, see Note 14) Significant non-cash investing and financing activities Motor-Columbus, Baden, from valuation at equity to full consolidation Financial investments available-for-sale 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 available-for-sale 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 available-for-sale Property and equipment Goodwill and other intangible assets Minority interests Motor-Columbus, deconsolidation Financial investments available-for-sale Property and equipment Goodwill and other intangible assets Debt issued Minority interests Acquisition of ABN AMRO's Global Futures and Options Business Property and equipment Goodwill and other intangible assets Acquisition of Banco Pactual Financial investments available-for-sale Property and equipment Goodwill and other intangible assets Debt issued Acquisition of Piper Jaffray Goodwill and other intangible assets For the year ended 31.12.06 31.12.05 31.12.04 79,805 76,109 4,839 53,117 44,392 3,869 60 180 362 5 248 3 27 35 112 377 6 264 62 178 2,229 951 718 2,057 13 428 36 9 2,218 1,496 605 36,063 24,192 2,934 644 261 2,083 1,194 727 1,742 336 87 Financial Statements Notes to the Financial Statements Notes to the Financial Statements Note 1 Summary of Significant Accounting Policies a) Significant Accounting Policies 1) 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 Inter- national 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 8 March 2007, the Board of Directors approved them for issue. 2) Use of estimates in the preparation of Financial Statements In preparing the Financial Statements, management is required to make estimates and assumptions that affect reported income, expenses, assets, liabilities and disclosure of contingent assets and liabilities. Use of available informa- tion and application of judgment are inherent in the forma- tion of estimates. Actual results in the future could differ from such estimates, and the differences may be material to the Financial Statements. 3) Subsidiaries and associates The Financial Statements comprise those of the parent com- pany (UBS AG) and its subsidiaries including certain special purpose entities, presented as a single economic entity. The effects of intra-group transactions are eliminated in prepar- ing the Financial Statements. Subsidiaries including special purpose entities that are directly or indirectly controlled by the Group are consolidated. Subsidiaries acquired are con- solidated from the date control is transferred to the Group. Subsidiaries to be divested are consolidated up to the date of disposal (i. e. loss of control). Assets held in an agency or fiduciary capacity are not assets of the Group and are not reported in the Financial Statements. Equity and net income attributable to minority interests are shown separately in the balance sheet and income statement. 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 UBS owns 20% or more of a company’s voting rights. Invest- ments 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 net profit or loss (including net profit or loss recognized directly in equity) after the date of acquisition. Assets and liabilities of subsidiaries and investments in associates 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 exclusively with the intent for resale are pre- sented as discontinued 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 opera- tions are presented in the income statement as a single amount comprising the total of profit or loss 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 defined objectives. These companies may acquire assets directly or indirectly from UBS or its affiliates. Some of these companies are bankruptcy-remote entities whose assets are not available to satisfy the claims of creditors of the Group or any of its subsidiaries. Such companies are consolidated in the Group’s Financial Statements when the substance of the relationship between the Group and the company indicates that the company is controlled by the Group. Certain transactions of consolidated entities meet the criteria for derecognition of financial assets – see part 4). 4) Recognition and derecognition of financial instruments UBS recognizes financial instruments on its balance sheet when, and only when, the Group becomes a party to the contractual provisions of the instrument. UBS enters into transactions where it transfers financial assets recognized on its balance sheet but retains either all risks and rewards of the transferred financial assets or a portion of them. If all or substantially all risks and rewards are retained, the transferred financial assets are not derec- ognized from the balance sheet. Transfers of financial 88 assets with retention of all or substantially all risks and rewards include, for example, securities lending and repur- chase transactions described under parts 12) and 13). They further include transactions where financial 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 of the risks and rewards of ownership of a financial asset are neither retained nor transferred, UBS derecognizes the financial asset if con- trol over the asset is lost. The rights and obligations retained in the transfer are recognized separately as assets and liabili- ties as appropriate. In transfers where control over the finan- cial asset is retained, the Group continues to recognize the asset to the extent of its continuing involvement, determined by the extent to which it is exposed to changes in the value of the transferred asset. Examples of such transactions are transfers of financial assets involving guarantees, writing put options, acquiring call options, or specific types of swaps linked to the performance of the asset. UBS removes a financial liability from its balance sheet when, and only when, it is extinguished, i.e. when the obli- gation specified in the contract is discharged or cancelled or expires. 5) Determination of fair value For financial instruments traded in active markets, the de- termination of fair values of financial assets and financial liabilities is based on quoted market prices or dealer price quotations. For all other financial instruments, fair value is determined using valuation techniques. Valuation tech- niques include net present value techniques, the discounted cash flow method, comparison to similar instruments for which market observable prices exist and valuation models. UBS uses widely recognized valuation models for determin- ing fair values of common and more simple financial instru- ments like options or interest rate and currency swaps. For these financial instruments, 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 market-observable and are therefore estimated based on as- sumptions. When entering into a transaction where model inputs are unobservable, the financial instrument is initially recognized at the transaction price, which is generally the best indicator of fair value. This may differ from the value obtained from the valuation model. The timing of the recog- nition 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 ob- servable. Refer to Note 30 Fair Value of Financial Instruments for further details. 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 addition- al factors including model risks, liquidity risk and counter- party credit risk. Based on the established fair value and model governance policies and related controls and proce- dures applied, management believes that these valuation adjustments are necessary and appropriate to fairly state the values of financial instruments carried at fair value on the balance sheet. 6) Trading portfolio Trading portfolio assets consist of money market paper, other debt instruments, including traded loans, equity in- struments, precious metals and other commodities owned by the Group (“long” positions). Trading portfolio liabilities consist of obligations to deliver financial instruments such as money market paper, other debt instruments and equity instruments which the Group has sold to third parties but does not own (“short” positions). The trading portfolio is carried at fair value. Gains and losses realized on disposal or redemption and un- realized gains and losses from changes in the fair value of trading portfolio assets and liabilities are reported as Net trading income. Interest and dividend income and ex- pense 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 financial asset transactions. From the date the transaction is entered into (trade date), UBS recognizes any unrealized profits and losses arising from revaluing that con- tract to fair value in Net trading income. The corresponding receivable or payable is presented on the balance sheet as a positive or negative replacement value. When the trans- action is consummated (settlement date), a resulting finan- cial asset is recognized on or derecognized from 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 (settle- ment date). Trading portfolio assets transferred to external parties that do not qualify for derecognition (see part 4) ) are reclas- sified on UBS‘s balance sheet from Trading portfolio assets to Trading portfolio assets pledged as collateral, if the trans- feree has received the right to sell or repledge them. 89 Financial Statements Notes to the Financial Statements 7) Financial assets and Financial liabilities designated at fair value through profit or loss (“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 (“Revised Fair Value Option”). UBS adopted the Revised Fair Value Option for financial instru- ments on a prospective basis on 1 January 2006. Prior to 1 January 2006, UBS designated almost all of its issued hybrid debt instruments as Financial liabilities desig- nated at fair value through profit or loss. These liabilities are presented in a separate line on the face of the balance sheet. A small amount of financial assets was also designated as Financial assets designated at fair value through profit or loss, and they are likewise presented in a separate line. A financial instrument may only be designated at fair value through profit or loss at inception and this designation cannot subsequently be changed. Under the revised accounting standard, UBS continues to apply the fair value option for these existing financial instru- ments. The conditions for such designation are still met ei- ther on the basis that they are hybrid instruments which would otherwise have to be bifurcated into debt host con- tracts and embedded derivatives or because they are items that are part of a portfolio which is risk managed on a fair value basis and reported to senior management as such. In 2006, UBS started applying the fair value option to certain new loans and loan commitments which are substantially hedged with credit derivatives, to certain hybrid instruments resulting from structured repurchase and reverse repurchase agreements and to a hedge fund investment which is part of a portfolio managed on a fair value basis. All fair value changes related to financial instruments designated at fair value through profit or loss are recognized in Net trading income. Interest and dividend income and interest expense on fi- nancial assets and liabilities designated at fair value through profit or loss are included in Interest income or Interest ex- pense. UBS applies the same recognition and derecognition principles to financial instruments designated at fair value as for financial instruments held for trading (refer to parts 4) and 6)). 8) Financial investments available-for-sale Financial investments available-for-sale are non-derivative financial assets that are not classified as held for trading, designated at fair value through profit or loss, or loans and receivables. They are recognized on a settlement date basis. Financial investments available-for-sale are instruments that, in management’s opinion, 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 invest- ments available-for-sale consist mainly of equity instruments, including certain private equity investments. In addition, cer- tain debt instruments are classified as financial investments available-for-sale. Financial investments available-for-sale are carried at fair value. Unrealized gains or losses are reported in Equity, net of applicable income taxes, until such investments are sold, collected or otherwise disposed of, or until any such invest- ment is determined to be impaired. On disposal of an invest- ment, the accumulated unrealized gain or loss included in Equity 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 financial investments available-for-sale are included in Interest and dividend in- come from financial investments available-for-sale. If a financial investment available-for-sale is determined to be impaired, the cumulative unrealized loss previously recognized in Equity is included in Net profit and loss for the period and reported in Other income. UBS assesses at each balance sheet date whether there is objective evidence that a financial investment available-for-sale is impaired. In case of such evidence, it is considered impaired if its cost exceeds the recoverable amount. For a quoted financial investment available-for-sale, the recoverable amount is determined by reference to the market price. It is considered impaired if objective evidence indicates that the decline in market price has reached such a level that recovery of the cost value can- not be reasonably expected within the foreseeable future. For non-quoted financial instruments (debt and equity in- struments), the recoverable amount is determined by apply- ing recognized valuation techniques. The standard method applied for non-quoted equity investments available-for-sale is based on the multiple of earnings observed in the market for comparable companies. Management may adjust valua- tions determined in this way based on its judgment. For non- quoted debt instruments, UBS typically determines the re- coverable amount by applying the discounted cash flow method. After the recognition of impairment on a financial invest- ment available-for-sale, a) increases in fair value of equity instruments are reported in Equity and b) increases in fair value of debt instruments up to original cost are recognized in Other income, provided the fair value increase has been triggered by a specific event (as defined by IFRS). 9) 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 generally recorded as Trading portfolio assets. 90 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 ef- fective interest rate method. Interest on loans is included in Interest earned on loans and advances and is recognized on an accrual basis. Fees and direct costs relating to loan origination, refinancing or restructuring and to loan commitments are deferred and amortized to Interest earned on loans and advances over the life of the loan using the straight-line method which approx- imates 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. 10) 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, or a commitment such as a letter of credit, a guarantee, a commitment to extend credit or other credit products. An allowance for credit losses is reported as a reduction of the carrying value of a claim on the balance sheet. For an off-balance sheet item, such as a commitment, a provision for credit loss is reported in Other liabilities. Additions to al- lowances 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 future cash flows, including amounts that may result from restructuring or the liquidation of collateral. Impairment is measured and allowances for credit losses are established for the difference between the carrying amount and the esti- mated recoverable amount. Upon impairment, the accrual of interest income based on the original terms of the claim is discontinued, but the increase of the present value of impaired claims due to the passage of time is reported as Interest income. All impaired claims are reviewed and analyzed at least an- nually. Any subsequent changes to the amounts and timing of the expected future cash flows compared with the prior estimates 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 reasonable assurance of timely collection of principal and interest in accordance with the original contractual terms of the claim or equivalent value. 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 written off are credited to Credit loss expense. A loan is classified as non-performing when the payment of interest, principal or fees is overdue by more than 90 days and there is no firm evidence that it 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 identi- fied on a counterparty-specific level are grouped into sub- portfolios with similar credit risk characteristics to collectively assess whether impairment exists within a portfolio. Allow- ances from collective assessment of impairment are recog- nized as Credit loss expense and result in an offset to the aggregated loan position. As the allowance cannot be allo- cated to individual loans, the loans are not considered to be impaired and interest is accrued on each loan according to its contractual terms. 11) Securitizations UBS securitizes various consumer and commercial financial assets, which generally results in the sale of these assets to special purpose entities, which in turn issue securities to investors. Interests in the securitized financial assets may be retained in the form of senior or subordinated tranches, in- terest-only strips or other residual interests (‘retained inter- ests’). Retained interests are primarily recorded in Trading portfolio assets and carried at fair value. Gains or losses on securitization are recorded in Net trading income. 12) Securities borrowing and lending Securities borrowing and securities lending transactions are generally entered into on a collateralized basis. In such trans- actions, UBS typically lends or borrows securities in exchange for securities or cash collateral. Additionally, UBS borrows securities from its clients’ custody accounts in exchange for a fee. The majority of securities lending and borrowing agree- 91 Financial Statements Notes to the Financial Statements ments involve shares, and the remainder typically involve bonds and notes. The transactions are conducted under standard agreements employed by financial market partici- pants and are undertaken with counterparties subject to UBS’s normal credit risk control processes. UBS monitors the market value of the securities received or delivered on a dai- ly basis and requests or provides additional collateral or returns or recalls surplus collateral in accordance with the underlying agreements. The securities which have been transferred, whether in a borrowing / lending transaction or as collateral, are not rec- ognized on or derecognized from 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 balance sheet from Trading portfolio assets 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 receivable reflecting UBS’s right to receive it back (Cash collateral 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 actually resold or repledged also disclosed separately (see Note 24). Additionally, the sale of securities received in a borrowing or lending transaction triggers the recognition of a trading liability (short sale). Consideration exchanged (i. e. interest received or paid) is recognized on an accrual basis and recorded as Interest in- come or Interest expense. 13) 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. Nearly all repurchase and reverse repurchase agreements involve debt instru- ments, such as bonds, notes or money market paper. The transactions are conducted under standard agreements em- ployed by financial market participants and are undertaken with counterparties subject to UBS’s normal credit risk con- trol processes. UBS monitors the market value of the securi- ties received or delivered on a daily basis and requests or provides additional collateral or returns or recalls surplus col- lateral in accordance with the underlying agreements. In reverse repurchase agreements, the cash delivered is derecognized and a corresponding receivable, including accrued interest, is recorded under the balance sheet line Reverse repurchase agreements, recognizing UBS’s right to receive it back. In Repurchase agreements, the cash received, including accrued interest, is recognized on the balance sheet with a corresponding obligation to return it (Repur- chase agreements). Securities received under reverse repur- chase agreements and securities delivered under repurchase agreements are not recognized on or derecognized from the balance sheet, unless the risks and rewards of ownership are obtained or relinquished. In repurchase agreements where UBS transfers owned securities and where the recipient is granted the right to resell or re-pledge them, the securities are reclassified in the balance sheet from Trading portfolio assets to Trading portfolio assets pledged as collateral. Secu- rities received in a reverse repurchase agreement are dis- closed as off-balance sheet items if UBS has the right to resell or repledge them, with securities that UBS has actually resold or repledged also disclosed separately (see Note 24). Additionally, the sale of securities received in reverse repur- chase transactions triggers the recognition of a trading liabil- ity (short sale). Interest earned on reverse repurchase agreements and interest incurred on repurchase agreements is recognized as interest income or interest expense over the life of each agreement. The Group offsets reverse repurchase agreements and repurchase agreements with the same counterparty for transactions covered by legally enforceable master netting agreements when net or simultaneous settlement is intended. 14) Derivative instruments and hedge accounting 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, including exposures arising from forecast transactions. The Group applies either fair value or cash flow hedge account- ing when transactions meet the specified criteria to obtain hedge accounting treatment. At the time a financial instrument is designated as a hedge, the Group formally documents the relationship between the hedging instrument(s) and hedged item(s), 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 derivatives have been “highly effec- tive” in offsetting changes in the fair value or cash flows of the hedged items. UBS regards a hedge as highly effective only if the following criteria are met: a) at inception of the hedge and throughout its life, the hedge is expected to be 92 highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk, and b) actual results of the hedge 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 reported Net profit or loss. The Group discontin- ues hedge accounting 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, is sold or repaid; or when a forecast transaction is no longer deemed highly probable. Hedge ineffectiveness represents the amount by which the changes in the fair value of the hedging derivative differ from changes in the fair value of the hedged item or the amount by which changes in the present value of cash flows of the hedging derivative differ from changes (or expected changes) in the present value of cash flows of the hedged item. Such ineffectiveness is recorded in current period earn- ings in Net trading income, as are gains and losses on com- ponents of a hedging derivative that are excluded from assessing hedge effectiveness. For qualifying fair value hedges, the change in fair value of the hedging derivative is recognized in the income state- ment. Those changes in fair value of the hedged item that are attributable to the risks hedged with the derivative in- strument are reflected in an adjustment to the carrying value of the hedged item, which is also recognized in the income statement. The fair value change of the hedged item in a portfolio hedge of interest rate risks is reported separately from the hedged portfolio 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 existed (the “unamortized fair value adjustment”), is, in the case of interest-bearing instru- ments, amortized to the income statement over the remain- ing term of the original hedge, while for non-interest bear- ing 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 adjustment is recognized immediately in the income statement. A fair value gain or loss associated with the effective portion of a derivative designated as a cash flow hedge is recognized initially in Equity. When the cash flows that the derivative is hedging materialize, resulting in income or expense, then the associated gain or loss on the hedging derivative is simultaneously transferred from Equity to the corresponding income or expense line item. If a cash flow hedge for a forecast transaction is deemed to be no longer effective, or if the hedge relationship is terminated, the cumulative gain or loss on the hedging derivative previously reported in Equity remains there until the committed or forecast transaction occurs or is no longer expected to occur, at which point it is transferred to the income statement. Derivative instruments which are transacted as economic hedges but do not qualify 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 except that, in certain cases, the forward points on short duration foreign exchange contracts are presented in Net interest income. In particular, the Group has entered into economic hedges of credit risk within the loan portfolio using credit default swaps to which it cannot apply hedge accounting. In the event that the Group recognizes an impairment on a loan that is economi- cally hedged in this way, the impairment is recognized in Credit loss expense, whereas any gain on the credit default swap is recorded in Net trading income. See Note 23 for ad- ditional information. Where UBS designates an economically hedged item at fair value through profit or loss, all fair value changes, including impairments, on both the hedged item and the hedging instrument are reflected in Net trading income (refer to part 7)). A derivative may be embedded in a ‘host contract’. Such combinations are known as hybrid instruments and arise predominantly from the issuance of certain structured debt instruments. If the host contract is not carried at fair value with changes in fair value reported in the income statement, the embedded derivative is generally required to be sepa- rated from the host contract and accounted for as a stand- alone derivative instrument at fair value if the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host contract and the embedded derivative actually meets the definition of a derivative. Typically, UBS applies the fair value option to hybrid instruments (see part 7)), so that bifurcation of an embedded derivative component is not required. 15) 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 available-for-sale. 16) Physical commodities Physical commodities (precious metals, base metals, energy and other commodities) held by UBS as a result of its broker- trader activities are accounted for at fair value less costs to sell and presented within the Trading portfolio. Changes in fair value less costs to sell are reflected in Net trading income. 93 Financial Statements Notes to the Financial Statements 17) 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 separately ac- counted 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 Group 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 lia- bility is recognized to reflect the obligation incurred. Rein- statement costs are recognized in profit and loss through depreciation 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 software meeting these criteria and purchased software are classified within IT, software and communication. With the exception of investment properties, Property and equipment is carried at cost less accumulated deprecia- tion and accumulated impairment losses, and is periodically reviewed for impairment. The useful life of property and equipment is estimated on the basis of the economic utiliza- tion of the asset. 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 Not exceeding 50 years Residual lease term, but not exceeding 10 years Not exceeding 10 years Not exceeding 5 years Property formerly own-used or leased to third parties under an operating lease and equipment the Group has de- cided 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 properties are included in Properties held for sale and recorded in Other assets. They are carried at the lower of cost and net realiz- able 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 to determine the fair value of investment property by applying recognized valuation techniques. In cases where prices of recent market transactions of comparable properties are available, fair value is determined by reference to these transactions. 18) 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. 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. Since 31 December 2004, goodwill has not been amortized but is tested annu- ally for impairment. The impairment test is conducted at the segment level as reported in Note 2a. The segment has been determined as the cash generating unit for impairment test- ing purposes as this is the level at which the performance of investments is reviewed and assessed by management. Other intangible assets comprise separately identifiable intangible items arising from acquisitions and certain pur- chased trademarks and similar items. Other intangible assets acquired in business combinations are recognized on the balance sheet with their fair value at the date of acquisition and, if they have a definite useful life, are amortized using the straight-line method over their estimated useful eco- nomic life, generally not exceeding 20 years. At each bal- ance sheet date, other intangible 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 carrying amount is fully recoverable. A write-down is made if the carrying amount exceeds the recoverable amount. Intangible assets are classified into two categories: a) in- frastructure, and b) customer relationships, contractual rights and other. Infrastructure consists of an intangible asset recognized in connection with the acquisition of PaineWeb- ber Group, Inc. Customer relationships, contractual rights and other includes mainly intangible assets for client rela- tionships, non-compete agreements, favorable contracts, proprietary software, trademarks and trade names acquired in business combinations. 94 19) Income taxes Income tax payable on profits is recognized as an expense based on the applicable tax laws in each jurisdiction in the period in which profits arise. The tax effects of income tax losses available for carry forward are recognized as a de- ferred tax asset if it is probable that future taxable profit will be available against which those losses can be utilized. Deferred tax liabilities are recognized for temporary dif- ferences between the carrying amounts of assets and liabili- ties in the balance sheet and their amounts as measured for tax purposes, which will result in taxable amounts in future periods. Deferred tax assets are recognized for temporary differences 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 differ- ences 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. Tax assets and liabilities of the same type (current or de- ferred) are offset when they arise from the same tax report- ing group, they 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, (ii) unrealized gains or losses on financial investments avail- able-for-sale and changes in fair value of derivative instru- ments designated as cash flow hedges, and (iii) certain tax benefits on deferred compensation awards. Items (ii) and (iii) are recorded in Net income recognized directly in equity. 20) Debt issued Debt issued is initially measured at fair value, which is the consideration received, net of transaction costs incurred. Subsequent measurement is at amortized cost, using the ef- fective interest rate method to amortize cost at inception to the redemption value over the life of the debt. Hybrid debt instruments that are related to non-UBS AG equity instruments, foreign exchange, credit instruments or indices are considered structured instruments. If such instru- ments have not been designated at fair value through profit or loss, the embedded derivative is separated from the host contract and accounted for as a stand-alone derivative if the criteria for separation are met. The host contract is subse- quently measured at amortized cost. UBS has designated most of its structured debt instruments at fair value through profit or loss – see part 7). The fair value option is not applied to certain hybrid in- struments which contain bifurcatable embedded derivatives with references to foreign exchange rates and precious met- al prices and which are not hedged by derivative instruments. Those hybrids are still subject to bifurcation of the embed- ded derivative. 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 liability and an equity component at issue date if they require physical settlement. When the hybrid debt instru- ment is issued, a portion of the net proceeds is allocated to the debt component based on its fair value. The determina- tion of fair value is generally based on quoted market prices for UBS debt instruments with comparable terms. The debt component is subsequently measured at amortized cost. The remaining amount of the net proceeds is allocated to the equity component and reported in Share premium. Sub- sequent changes in fair value of the separated equity com- ponent are not recognized. However, if the hybrid instru- ment or the embedded derivative related to UBS AG shares is to be 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 Net trading income unless the entire hybrid debt instrument is designated at fair value through profit or loss with changes in fair value of the entire hybrid instrument also reflected in Net trading income (see part 7)). 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 23), and to apply fair value hedge accounting, if the fair value option is not applied to such fi- nancial instruments – see part 7). When hedge accounting is applied to fixed-rate debt instruments, the carrying values of debt issues are adjusted for changes in fair value related to the hedged exposure rather than carried at amortized cost – refer to part 14). Derivative instruments and hedge ac- counting for further discussion. Bonds issued by UBS held as a result of market making activities or deliberate purchases in the market are treated as a redemption of debt. A gain or loss on redemption is record- ed depending on whether the repurchase price of the bond is 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 Inter- est on debt issued. 21) Retirement benefits UBS sponsors a number of retirement benefit plans for its employees worldwide. These plans include both defined benefit and defined contribution plans and various other retirement benefits such as post-employment medical benefits. Contributions to defined contribution plans are expensed when employees have rendered services in ex- change for such contributions, generally in the year of con- tribution. 95 Financial Statements Notes to the Financial Statements The Group uses the projected unit credit actuarial method to determine the present value of its defined benefit plans and the related service cost and, where applicable, past service cost. The principal actuarial assumptions used by the actuary are set out in Note 31. The Group recognizes a portion of its actuarial gains and losses as income or expense if the net cumulative unrecog- nized actuarial gains and losses at the end of the previous reporting period are outside the corridor defined as the greater of: a) 10% of present value of the defined benefit obligation at that date a) (before deducting plan assets); and b) 10% of the fair value of any plan assets at that date. The unrecognized actuarial gains and losses exceeding the greater of these two values are recognized in the income 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 recovered fully through refunds or reductions in future con- tributions, 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 actuarial gain in the current period. 22) Equity participation plans UBS provides various equity participation plans in the form of share plans and share option plans. UBS recognizes the fair value of share and share 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 share awards is equal to the market price at the date of grant. For share options, fair value is determined using a Monte Carlo valuation model which takes into ac- count the specific terms and conditions under which the share options are granted. Equity settled awards are classi- fied as equity instruments and are not re-measured subse- quent to the grant date, unless an award is modified such that its fair value immediately after modification exceeds its fair value immediately prior to modification. Any increase in fair value resulting from a modification is recognized as com- pensation 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 outstanding. Decreases in fair value reduce com- pensation expense, and no compensation expense, on a cu- mulative basis, is recognized for awards that expire worth- less or remain unexercised. Up to and including 2004, certain plans gave participants the ability to roll their share-based awards into alternative investments. These plans are treated as cash-settled. UBS no longer provides this roll-over option to its employees. 23) Equity, treasury shares and contracts on UBS shares UBS AG shares held by the Group are classified in Equity as Treasury shares and accounted for at weighted average cost. The difference between the proceeds from sales of Treasury shares and their cost (net of tax, if any) is classified as Share premium. Contracts that require physical settlement in UBS AG shares are classified as Equity and reported as Share premi- um. Upon settlement of such contracts, the proceeds re- ceived – 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 the counterparty with a choice of settle- ment are classified as trading instruments, with changes in fair value reported in the income statement. An exception to this treatment is physically settled written put options and forward share purchase contracts, including contracts where physical settlement is a settlement alter- native. In both cases, the present value of the obligation to purchase own shares in exchange for cash is transferred out of Equity and recognized as a liability at inception of a con- tract. The liability is subsequently accreted, using the effec- tive interest rate method, over the life of the contract to the nominal purchase obligation by recognizing interest ex- pense. Upon settlement of a contract, the liability is derecog- nized, and the amount of equity originally transferred to li- ability is reclassified within Equity to Treasury shares. The premium received for writing put options is recognized di- rectly in Share premium. UBS has issued trust preferred securities through consoli- dated preferred funding trusts, which hold debt issued by UBS. UBS AG has fully and unconditionally guaranteed all of these securities. UBS’s obligations under these guarantees are subordinated to the prior payment in full of the deposit liabilities of UBS and all other liabilities of UBS. The trust pre- ferred securities represent equity instruments which are owned by third parties. They are presented as minority inter- ests in UBS’s consolidated financial statements with divi- dends paid also reported under Equity attributable to minor- ity interests. UBS bonds held by preferred funding trusts are eliminated in consolidation. 24) Discontinued operations and non-current assets held for sale UBS classifies non-current non-financial assets (or disposal groups) as held for sale, e.g. properties, if their carrying amount will be recovered principally through a sale transac- tion rather than through continuing use – see part 17). Such assets (or disposal groups) are available for immediate sale in 96 their present condition subject to terms that are usual and customary for sales of such assets (or disposal groups) and their sale is considered highly probable. These assets are mea- sured at the lower of their carrying amount and fair value less costs to sell. UBS presents discontinued operations under a separate line in the income statement if an entity or a component of an entity has been disposed of or is classified as held for sale and a) represents a separate major line of business or geo- graphical area of operations, or b) is a subsidiary acquired exclusively with a view to resale (e.g. certain private equity investments). A component of an entity comprises opera- tions and cash flows that can be clearly distinguished, opera- tionally and for financial reporting purposes, from the rest of UBS’s operations and cash flows. If an entity or a component of an entity is classified as a discontinued operation, UBS restates prior periods in the income statement – see part 3). 25) Leasing UBS enters into lease contracts, predominately of premises and equipment, as a lessor as well as a lessee. The terms and conditions of these contracts are assessed and the leases are classified as operating leases or finance leases according to their economic substance. When making such an assess- ment, the Group focuses on the following aspects: a) Is own- ership of the asset transferred to the lessee by the end of the lease term?; b) Is a bargain purchase option held by the les- see?; c) Is the lease term for the major part of the economic life of the asset?; d) Does the present value of the minimum lease payments amount to at least substantially all of the fair value of the leased asset at inception of the lease term? The existence of such conditions, individually or in combination with others, normally leads to a lease being classified as a finance lease, while the non-existence normally leads to a lease being classified as an operating lease. Lease contracts classified as operating leases where UBS is the lessee are disclosed in Note 27 Operating Lease Com- mitments. These contracts include non-cancellable long- term leases of office buildings in most UBS locations. Lease contracts classified as operating leases where UBS is the les- sor, and finance lease contracts where UBS is the lessor or the lessee, are not material. 26) 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 recognition 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. 27) Foreign currency translation Foreign currency transactions are recorded at the rate of exchange on the date of the transaction. At the balance sheet date, monetary assets and liabilities denominated in foreign currencies are reported using the closing exchange rate. Exchange differences arising on the settlement of 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 com- ponent of the change in their entire fair value. For a non- monetary financial asset held for trading and for non- monetary financial assets designated at fair value through profit or loss, unrealized exchange differences are recog- nized in the income statement. For non-monetary financial investments 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, as- sets 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 net asset balance at the closing rate are recognized directly in Foreign currency translation within Equity. 28) 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, warrants, convertible debt securities or other contracts to issue ordinary shares were converted or exercised into ordi- nary shares. 97 Financial Statements Notes to the Financial Statements 29) Segment reporting 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 Business Groups Investment Bank and Global Asset Management constitute one segment each. The Corporate Center represents one segment in 2006, as Private Banks & GAM was sold on 2 December 2005. Addi- tionally, the Industrial Holdings segment holds all industrial operations controlled by the Group. In total, UBS reports sev- en business segments. 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. 30) Revenues from Industrial Holdings and Goods and materials purchased Revenues from Industrial Holdings include sales of goods and services from three consolidated entities and are derived from various businesses. Revenue is generally recognized upon customer acceptance of goods delivered and when services have been rendered. Expenses from Goods and materials purchased include costs for raw materials, parts and finished goods purchased from third-party suppliers to produce the goods and services sold. b) Changes in accounting policies, comparability and other adjustments Effective in 2006 IAS 39 Financial Instruments: Recognition and Measure- ment – Amendment to the fair value option In June 2005, the IASB issued amendments to IAS 39 Finan- cial Instruments: Recognition and Measurement in regard to the fair value option. UBS adopted the revised IAS 39 fair value option on 1 January 2006. Under the amended guid- ance, the use of the fair value option requires that at least one of three defined criteria is satisfied, which is more restric- tive than the previous guidance. All financial instruments designated at fair value through profit or loss at 31 Decem- ber 2005 continued to qualify for the use of the fair value option under the revised fair value option. On transition date of the revised standard, 1 January 2006, UBS did not apply the fair value option to any previously recognized financial asset or financial liability, for which the fair value option had not been used under the previous fair value option guidance. Therefore, the initial adoption of the revised standard did not have an impact on UBS’s financial statements. See part 7) for details on the use of the revised fair value option during the year 2006. In addition, effective 1 January 2006, the disclo- sure requirements for financial instruments designated at fair value through profit or loss have been amended due to the revision of IAS 32 Financial Instruments: Presentation. Prime Brokerage UBS has reclassified certain receivables and payables resulting from its Prime Brokerage business for the years ended 2002 through 2006 to ensure consistent presentation of identical items throughout UBS. See the next page for reclassifications that have been made to previously disclosed amounts. The adjustments had no effect on Net profit, Basic earn- ings per share and Diluted earnings per share in all years presented. UBS’s internal measures of credit exposure and regulatory capital are unaffected by the reclassification. Cash collateral on securities borrowed Counterparty information on receivables resulting from cash paid as collateral in securities borrowing transactions is disclosed in Note 11. For comparability reasons, UBS reclas- sified CHF 183 billion from receivables against banks to re- ceivables against customers on 31 December 2005. Staff Accounting Bulletin (SAB) 108 In response to the release of the Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) 108, Con- sidering the Effects of Prior Year Misstatements when Quan- tifying Misstatements in Current Year Financial Statements, UBS elected to adopt a modified quantitative framework for assessing whether the financial statement effect of a mis- statement is material because it renders a better evaluation of those effects. The new method, which UBS adopted in De- cember 2006, uses a dual approach for quantifying the effect of a misstatement. Prior to 2006, UBS applied only one of those methods, the “roll-over” method, which focused on the current-year income-statement impact of a misstatement. Under the new policy, UBS applies a dual approach that con- siders both the carryover and reversing effects of prior year misstatements. As a result of the new policy, the opening bal- ance of Accrued expenses and deferred income at 1 January 2002 was increased by CHF 399 million, Retained earnings were reduced by CHF 309 million and Deferred taxes of CHF 90 million were recognized on balance sheet. The adjust- ments relate to the under-accrual of unused vacation, sab- batical leave and service anniversary awards. The restatement impact of adopting this new policy is immaterial to all quar- terly and annual income statements, earnings per share amounts, and balance sheets since 1 January 2002. Amendments to existing standards and new interpretations Minor amendments have been made to the following exist- ing International Accounting Standards, which were effec- tive and have been adopted by UBS at 1 January 2006. 98 Prime Brokerage Reclassification Balance sheet CHF million Assets Cash collateral on securities borrowed Loans Total Liabilities Cash collateral on securities lent Due to customers Total Off-Balance Sheet CHF million Fair value of securities sold or repledged in connection with financing activities, disclosed in Note 24 31.12.05 31.12.04 31.12.03 31.12.02 (11,896) 9,941 (1,955) (17,329) 15,374 (1,955) (9,636) 9,636 0 (10,244) 10,244 0 (7,413) 7,413 0 (5,006) 5,006 0 0 0 0 0 0 0 31.12.05 31.12.04 31.12.03 31.12.02 20,769 14,338 0 0 In addition, the following reclassifications have been made within interest income and expense: Income statement CHF million Interest income Interest earned on loans and advances Interest earned on securities borrowed and reverse repurchase agreements 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 Total 31.12.05 31.12.04 31.12.03 31.12.02 290 (279) (11) 0 146 (146) 0 313 (307) (6) 0 108 (108) 0 30 (25) (5) 0 (1) 1 0 120 (115) (5) 0 92 (92) 0 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 part a 21). Other amendments made to IAS 19 have no impact on UBS. IAS 39 Financial Instruments: Measurement and Recognition and IFRS 4 Insurance Contracts have been amended in rela- tion 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 did not have a material impact on UBS’s Financial Statements. IAS 21 The Effects of Changes in Foreign Exchange Rates has been amended to require that exchange differences arising in consolidation on loan financings that form part of a net investment in a foreign operation and are denominated in a currency other than the functional currencies of both the reporting 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 con- tains, a lease should be made; and c) if an arrangement is, or contains, a lease, how the payments for the lease should be separated from payments for any other elements in the ar- rangement. If an arrangement contains a lease element, the interpretation requires that the payments for the lease ele- ment are accounted for in accordance with IAS 17 Leases. UBS adopted the interpretation on 1 January 2006, its effec- tive date. The interpretation had no material effect on UBS’s Financial Statements. 99 Financial Statements Notes to the Financial Statements Effective in 2005 and earlier Private equity investments On 1 January 2005, UBS adopted revised IAS 27 Consoli- dated and Separate Financial Statements and revised IAS 28 Investments in Associates. cussed on the next page. Gains on sale of CHF 90 million were reported in 2004 in connection with private equity in- vestments sold. On a restated basis, the Net profit from dis- continued operations related to these entities was CHF145 million in 2004. IAS 27 was amended to eliminate the exemption from consolidating a subsidiary where control is exercised tempo- rarily. UBS has several private equity investments where it owns a controlling interest that used to be classified and accounted for as Financial investments available-for-sale. UBS adopted IAS 27 on 1 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 inter- ests was reduced by CHF 723 million, representing the dif- ference between the carrying value as Financial investments available-for-sale and the book value on a consolidated basis. Consolidation led to recognition of total assets in the amount of CHF 1.7 billion and CHF 2.9 billion at 31 Decem- ber 2004 and 2003 respectively. Significant balance sheet line items affected include Property and equipment, Intan- gible assets, Goodwill and Other assets. These investments generated additional operating income of CHF 2.5 billion and additional Net profit attributable to UBS shareholders of CHF 142 million in 2004. 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 equity 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 meth- od of accounting for these investments had the following effects: on 1 January 2003, opening equity was debited by CHF 266 million, 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 mil- lion and CHF 393 million at 31 December 2004 and 2003 respectively, which includes equity in losses of CHF 55 million recognized in the income statement in 2004. Gains on sale recognized in 2004 were CHF 1 million. When accounted for as Financial investments available-for-sale, gains on sale recognized were CHF 70 million in 2004. 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 seg- ment effective 1 January 2005. In addition, nine of the newly consolidated investments held at 1 January 2003 were sold after that date (but before 1 January 2006) and are pre- sented as Discontinued operations in the restated compara- tive prior periods in accordance with IFRS 5, which is dis- 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 financial statements based on the fair value of these awards mea- sured 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 requirements of the standard to all prior period awards that affect income statements commencing 1 January 2003. This includes all unvested equity-settled awards and all out- standing cash-settled awards on 1 January 2003. The effects of restatement were as follows: the opening balance of retained earnings at 1 January 2003 was credited by CHF 559 million. Additional compensation expense of zero was recognized in 2004. 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 com- pensation expense in the performance year, which is gener- ally the year prior to grant. The reason for the zero impact in 2004 was that a significantly higher amount of bonus pay- ments were made in the form of share awards rather than cash. The reversal of compensation expense 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 options 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 models. As a result of this review, a valuation model was identified that better reflects the exercise behavior of em- ployees and the specific terms and conditions under which the share options are granted. Concurrent with the introduc- tion 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 en- 100 tity that controls an employee benefit trust (or similar entity) set up for the purpose of a share-based payment arrange- ment 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 liabilities of the trusts were equal. Consolidation led to recognition of total assets in the amount of CHF 1.1 billion and CHF1.3 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 45,991,908 in 2004, 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 standards for goodwill and intangible assets existing at 31 March 2004 on 1 January 2005,whereas goodwill and intangible assets recognized from business combinations entered into after 31 March 2004 were accounted for im- mediately in accordance 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. 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 re- classified 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 stan- dard requires that non-current assets or disposal groups be classified as held for sale if their carrying amount is recov- ered principally through a sale transaction rather than through continuing use. Such assets are measured at the lower of carrying amount and fair value less costs to sell and are classified separately from other assets in the balance sheet. Netting of assets and liabilities is not permitted. Dis- continued operations are presented on the face of the in- come statement as a single 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 measure- ment to fair value less costs to sell of the net assets constitut- ing the discontinued operations. In the period where an op- eration is presented for the first time as discontinued, the income statements for all comparative prior periods present- ed 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. Private Banks & GAM, Motor-Columbus and certain private equity investments meet this definition and were reclassified to Discontinued operations. UBS adopted the new standard on 1 January 2005 and restated the comparative prior year 2004. The income statement is now divided into two sec- tions: Net profit from continuing operations and Net profit from discontinued operations. Refer to Note 38 Discontin- ued Operations for details. 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 presented including minority interests. Net profit is split into Net profit attributable to UBS shareholders and Net profit at- tributable to minority interests. Earnings per share continue to be calculated based on Net profit attributable to UBS shareholders, but they are split into Earnings per share from continuing operations and from discontinued operations. Minority interests 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. 101 Financial Statements Notes to the Financial Statements Revised IAS 32 amended the accounting for certain de- rivative contracts linked to an entity’s own shares. Physically settled written put options and forward purchase contracts with UBS shares as their underlying are recorded as liabili- ties – see part a 23). UBS currently has physically settled written put options linked to own shares. The present value of the contractual 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 at- tributable to UBS shareholders due to written put options. The impact on the income statement of all periods present- ed is insignificant. All other existing derivative contracts linked to own shares are accounted for as derivative instru- ments and are carried at fair value on the balance sheet under Positive replacement values or Negative replacement values. instruments its compound Revised IAS 39 permits any financial instrument to be des- ignated at inception, or at adoption of revised IAS 39, as carried at fair value through profit or loss. Upon adoption of revised IAS 39, UBS made that designation for the majority of issued. Previously, UBS separated the embedded derivative from the host contract and accounted 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 re- ported in that line. Also, at 31 December 2005 and 2004 assets in the amount of CHF 1,153 million and CHF 653 mil- lion 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 pro- cess to determine whether derecognition is appropriate. See part a 4) for a discussion of the accounting policies regarding derecognition. As a result, certain transactions are now ac- counted for as secured financing transactions instead of pur- chases or sales of trading portfolio assets with an accompa- nying swap derivative. The provisions of this guidance were applied prospectively from 1 January 2004. 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 changed. All such credit losses are now reported in Net trading 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 de- ferred over a three-year period in the Business Group seg- ment reporting, whereas, under the changed method of 102 accounting, losses in trading income are not subject to such a deferral. In the segment report, therefore, losses on OTC derivatives are now reported as they are incurred. Segment reporting On 1 July 2005, UBS integrated its two wealth management businesses into one Business Group, Global Wealth Manage- ment & Business Banking. As part of the integration, the municipal securities unit within the former Wealth Manage- ment US was transferred into the Investment Bank. The inte- gration had no effect on the presentation of segments in Note 2a, and Wealth Management US continues to be re- ported as a separate 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 securities unit. In 2005 and 2004, the munici- pal 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 was consolidated on 1 July 2004, when UBS gained control over the company. Due to its size and the nature of its business (production, distribution and trading of electricity) a new business seg- ment, Industrial Holdings, was added in which Motor-Co- lumbus was reported. Motor-Columbus is presented as a discontinued operation in these Financial Statements due to the sale on 23 March 2006. Also included in the Indus- trial Holdings segment are all private equity investments, which comprise businesses of a predominantly industrial nature. c) International Financial Reporting Standards and Interpretations to be adopted in 2007 and later IFRS 7 Financial Instruments: Disclosures Effective 1 January 2007, UBS will adopt the disclosure re- quirements for financial instruments under IFRS 7. The new standard has no impact on recognition, measurement and presentation of financial instruments. Accordingly, it will have no effect on Net profit and Equity. Rather, it requires entities to provide disclosures in their financial statements that enable users to evaluate: a) the significance of financial instruments for the entity’s financial position and perfor- mance; and b) the nature and extent of the credit, market and liquidity risks arising from financial instruments during the period and at the reporting date, and how the entity manages those risks. The principles of IFRS 7 complement the principles for recognizing, measuring and presenting financial assets and financial liabilities in IAS 32 Financial Instruments: Presentation and IAS 39 Financial Instruments: Recognition and Measurement. UBS has entered into transactions for which fair value is determined using valuation models for which not all inputs are market-observable prices or rates. Such financial instru- ments are initially recognized in UBS’s Financial Statements at the transaction price, which is generally the best indicator of fair value, although the value obtained from the relevant val- uation model may differ. Where such differences arise, UBS will be required by IFRS 7 to disclose, by class of financial in- strument: (a) its accounting policy for recognizing that differ- ence in profit or loss to reflect a change in factors (including time) that market participants would consider in setting a price, and (b) the aggregate difference yet to be recognized in profit or loss at the beginning and end of the period and a reconciliation of changes in the balance of this difference. IFRS 8 Operating Segments The new standard on segment reporting, IFRS 8 Operating Segments, comes into force on 1 January 2009, replacing IAS 14 Segment Reporting. It sets out requirements for dis- closure of information about a firm’s operating segments, its products and services, the geographical areas in which it operates, and its major customers. The new standard intro- duces changes to previous requirements for identification of segments, measurement of segment information and disclo- sures. Specifically, it requires a firm to provide financial and descriptive information about its reportable segments – the operating segments or aggregations of operating segments based on which the senior management of the firm (the “chief operating decision maker”) regularly evaluates sepa- rate financial information in deciding how to allocate re- sources and how to assess performance. Generally, under IFRS 8, the information to be reported will be the same infor- mation that is used internally, which might differ from amounts reported in the financial statements. The new stan- dard therefore requires an explanation of the basis on which the segment information is prepared, and reconciliations to the amounts presented in the income statement and the bal- ance sheet. UBS is currently assessing the impact of IFRS 8 on the structure and content of the segment reporting in its financial statements, and whether, as permitted by the stan- dard, to apply it from 1 January 2008. IFRIC 7 Applying the Restatement Approach under IAS 29 Financial Reporting in Hyperinflationary Economies will be applied on 1 January 2007. This Interpretation provides guid- ance on how to apply the requirements of IAS 29 in a report- ing period in which an entity (this could be a subsidiary) identifies the existence of hyperinflation in the economy of its functional currency, when that economy was not hyperin- flationary in the prior period, and the entity therefore restates its financial statements in accordance with IAS 29. It is not expected that this guidance will have an impact on UBS’s Financial Statements. IFRIC 8 Scope of IFRS 2 IFRIC 8 was issued in January 2006. This IFRIC addresses whether IFRS 2 applies to transactions in which the entity cannot identify specifically some or all of the goods or ser- vices received. The Interpretation requires that IFRS 2 be ap- plied to transactions in which goods or services are received, such as transactions in which an entity receives goods or ser- vices as consideration for equity instruments of the entity. This includes transactions in which the entity cannot identify specifically some or all of the goods or services received. The unidentifiable goods or services received (or to be received) should be measured as the difference between the fair value of the share-based payment and the fair value of any identi- fiable goods or services received (or to be received). Mea- surement of the unidentifiable goods or services received should take place at the grant date. However, for cash- settled transactions, the liability should be re-measured at each reporting date until it is settled. UBS will adopt the Interpretation on 1 January 2007. This Interpretation will have no significant impact on UBS’s Financial Statements. IFRIC 9 Reassessment of Embedded Derivatives The Interpretation clarifies that an entity should not reassess whether an embedded derivative needs to be separated from the host contract after the initial hybrid contract is recog- nized, unless there is a change in the terms of the contract that significantly modifies the cash flows that otherwise would be required under the contract, in which case reas- sessment is required. UBS will adopt this Interpretation of IAS 39 on 1 January 2007. It is not expected that this Inter- pretation will have a significant impact on UBS’s Financial Statements. IFRIC 10, Interim Financial Reporting and Impairment The new Interpretation of IAS 39 requires that impairment losses recognized in a previous interim period in respect of goodwill or an investment in either an equity instrument or a financial asset carried at cost must not be reversed at a subsequent balance sheet date. UBS will adopt this Inter- pretation from 1 January 2007 onwards. It is not expected that this interpretation will have a significant impact on UBS’s Financial Statements. IFRIC 11, IFRS 2: Group and Treasury Share Transactions IFRIC 11 was issued in November 2006 and provides guid- ance on (a) how to account for share-based payment ar- rangements between entities within the same group; (b) de- termining whether a transaction should be accounted for as equity-settled or cash-settled when an entity either chooses or is required to buy equity instruments (i.e. treasury shares) from another party, to satisfy its obligations to its employees; and (c) determining whether a transaction should be ac- counted for as equity-settled or cash-settled when an entity’s 103 Financial Statements Notes to the Financial Statements employees are granted rights to equity instruments of the entity (e.g. share options), either by the entity itself or by its shareholders, and the shareholders of the entity provide the equity instruments needed. The Interpretation requires that share-based payment transactions in which an entity receives services as consideration for its own equity instruments be accounted for as an equity-settled transaction. This applies regardless of whether the entity chooses or is required to buy those equity instruments from another party to satisfy its obligations to its employees under the share-based payment arrangement. UBS will adopt the interpretation on 1 January 2007. It is not expected to have a significant impact on UBS’s Financial Statements. 104 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 & Swit- zerland, Wealth Management US and Business Banking Switzerland. The Business Groups Investment Bank and Global Asset Management constitute one segment each. The Corporate Center is now comprised of only one seg- ment, after the sale of Private Banks & GAM on 2 Decem- ber 2005. Prior to this, Corporate Center consisted of two segments, Corporate Functions and Private Banks & GAM. In addition, the Industrial Holdings segment holds all indus- trial operations controlled by the Group. In total, UBS now reports seven 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 services individually tailored to affluent international and Swiss clients and operates from offices around the world. Wealth Management US is a US financial services firm pro- viding sophisticated wealth management services to afflu- ent US clients through a highly trained financial advisor network. Business Banking Switzerland provides individual and corporate clients in Switzerland with a complete port- folio of banking and securities services, focused on cus- tomer service excellence, profitability and growth, using a multi-channel distribution. The segments share technologi- cal and physical infrastructure, and have joint departments supporting major functions such as e-commerce, financial planning and wealth management, 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, charities, foundations and individual investors. 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 ensures that the Business Groups operate as a coherent and effective whole with a common set of val- ues and principles in such areas as risk management and control, financial reporting, marketing and communications, funding, capital and balance sheet management, manage- ment of foreign currency earnings, information technology infrastructure and service centers. Private Banks & GAM, which was shown as a separate segment within Corporate Center in prior years, was sold on 2 December 2005 and is presented as discontinued operations. Industrial Holdings The Industrial Holdings segment comprises the non-financial businesses of UBS, including the private equity business which primarily invests UBS and third-party funds in unlisted companies. The most significant business in this segment, Motor-Columbus, was sold on 23 March 2006 and is pre- sented as discontinued operations. Additionally, certain private equity investments sold in 2006 and prior years are presented as discontinued operations. 105 Financial Statements Notes to the Financial Statements Note 2a Reporting by Business Group (continued) For the year ended 31 December 2006 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, credit loss is measured using an expected loss concept. This table shows Business Group performance consistent with the way the businesses are managed and the way Business Group perfor- mance 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 expected credit loss, amortized over a three year period. The difference between these adjusted expected credit loss figures and the credit loss expense recorded at Group level for reporting purposes is reported in Corporate Center as Adjusted expected credit loss. 106 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 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 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 Corporate Center Financial Businesses Industrial Holdings UBS Wealth Management International & Switzerland Management Business Banking Switzerland 5,233 581 2,280 1,392 5,929 Wealth US 5,863 (1) 5,862 3,800 1,073 281 74 53 5,281 581 63,249 57,681 273 5,863 0 5,863 3,800 1,073 281 74 53 5,281 582 10,827 1 10,828 3,137 885 1,479 84 10 5,595 5,233 286,241 281,327 257 10,827 (29) 10,798 3,137 885 1,479 84 10 5,595 5,203 5,085 109 5,194 2,412 1,070 (642) 74 0 2,914 2,280 5,085 185 5,270 2,412 1,070 (642) 74 0 2,914 2,356 3,220 0 3,220 1,503 399 (105) 27 4 1,828 1,392 3,220 0 3,220 1,503 399 (105) 27 4 1,828 1,392 21,726 47 21,773 11,353 3,260 956 203 4 72 15,844 5,929 21,726 61 21,787 11,353 3,260 956 203 4 72 15,844 5,943 5,203 582 2,356 1,392 5,943 294 0 294 1,264 1,242 (1,978) 783 9 1,320 (1,026) 4 (1,022) 294 (61) 233 1,264 1,242 (1,978) 783 9 1,320 (1,087) 4 (1,083) 994 0 994 202 187 9 18 5 295 716 278 852 1,130 994 0 994 202 187 9 18 5 295 716 278 852 1,130 211,123 205,747 14 48,616 46,589 498 2,108,828 2,089,140 593 (323,434) (343,152) 1,385 1,888 3,404 97 2,396,511 2,340,736 3,117 48,009 156 48,165 23,671 8,116 0 1,263 153 295 33,498 14,667 856 15,523 2,786 (13) 12,750 48,009 156 48,165 23,671 8,116 0 1,263 153 295 33,498 14,667 856 15,523 2,786 (13) 12,750 1 Impairments of financial investments available-for-sale for the year ended 31 December 2006 were as follows: Global Wealth Management & Business Banking CHF 8 million; Global Asset Management CHF 1 million; Investment Bank CHF 5 million; Corporate Center CHF (2) million and Industrial Holdings CHF 23 million. 2 For further information regarding goodwill and other intangible assets by Business Group, please see Note 16: Goodwill and Other Intangible Assets. 3 The funding surplus or requirement is reflected in each Business Group and adjusted in Corporate Center. 4 Includes a CHF 34 million software impairment. Note 2a Reporting by Business Group (continued) For the year ended 31 December 2006 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, credit loss is measured using an expected loss concept. This table shows Business Group performance consistent with the way the businesses are managed and the way Business Group perfor- mance 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 expected credit loss, amortized over a three year period. The difference between these adjusted expected credit loss figures and the credit loss expense recorded at Group level for reporting purposes is reported in Corporate Center as Adjusted expected credit loss. 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 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 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 Corporate Center Financial Businesses Industrial Holdings UBS Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland 10,827 1 10,828 3,137 885 1,479 84 10 5,595 5,233 5,863 (1) 5,862 3,800 1,073 281 74 53 5,281 581 5,085 109 5,194 2,412 1,070 (642) 74 0 2,914 2,280 3,220 0 3,220 1,503 399 (105) 27 4 1,828 1,392 21,726 47 21,773 11,353 3,260 956 203 4 72 15,844 5,929 5,233 581 2,280 1,392 5,929 294 0 294 1,264 1,242 (1,978) 783 9 1,320 (1,026) 4 (1,022) 994 0 994 202 187 9 18 5 295 716 278 852 1,130 48,009 156 48,165 23,671 8,116 0 1,263 153 295 33,498 14,667 856 15,523 2,786 (13) 12,750 211,123 205,747 14 48,616 46,589 498 2,108,828 2,089,140 593 (323,434) (343,152) 1,385 1,888 3,404 97 2,396,511 2,340,736 3,117 286,241 281,327 257 10,827 (29) 10,798 3,137 885 1,479 84 10 5,595 5,203 63,249 57,681 273 5,863 0 5,863 3,800 1,073 281 74 53 5,281 582 5,085 185 5,270 2,412 1,070 (642) 74 0 2,914 2,356 3,220 0 3,220 1,503 399 (105) 27 4 1,828 1,392 21,726 61 21,787 11,353 3,260 956 203 4 72 15,844 5,943 5,203 582 2,356 1,392 5,943 294 (61) 233 1,264 1,242 (1,978) 783 9 1,320 (1,087) 4 (1,083) 994 0 994 202 187 9 18 5 295 716 278 852 1,130 48,009 156 48,165 23,671 8,116 0 1,263 153 295 33,498 14,667 856 15,523 2,786 (13) 12,750 1 Impairments of financial investments available-for-sale for the year ended 31 December 2006 were as follows: Global Wealth Management & Business Banking CHF 8 million; Global Asset Management CHF 1 million; Investment Bank CHF 5 million; Corporate Center CHF (2) million and Industrial Holdings CHF 23 million. 2 For further information regarding goodwill and other intangible assets by Business Group, please see Note 16: Goodwill and Other Intangible Assets. 3 The funding surplus or requirement is reflected in each Business Group and adjusted in Corporate Center. 4 Includes a CHF 34 million software impairment. 107 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, credit loss is measured using an expected loss concept. This table shows Business Group performance consistent with the way the businesses are managed and the way Business Group perfor- mance 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 expected credit loss, amortized over a three year period. The difference between these adjusted expected credit loss figures and the credit loss expense recorded at Group level for reporting purposes is reported in Corporate Functions as Adjusted expected credit loss. 108 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 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 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 Corporate Center Financial Businesses Wealth Management Wealth International & Switzerland Management Business Banking Switzerland Private Banks & GAM Corporate Functions Industrial Holdings UBS 4,166 314 2,298 1,057 5,297 4,556 4,556 9,024 (8) 9,016 2,579 804 1,371 89 7 4,850 4,166 9,024 (13) 9,011 2,579 804 1,371 89 7 4,850 4,161 5,158 US 0 5,158 3,460 1,047 223 65 49 4,844 314 5,158 (2) 5,156 3,460 1,047 223 65 49 4,844 312 4,949 231 5,180 2,450 994 (634) 72 0 2,882 2,298 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 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 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 0 455 1,167 1,084 (1,730) 857 17 1,395 (940) 8 (932) 455 232 687 1,167 1,084 (1,730) 857 17 1,395 (708) 56 (652) 1,236 0 1,236 245 184 14 21 4 283 751 485 496 981 11,549 11,814 299 1,236 0 1,236 245 184 14 21 4 283 751 485 496 981 223,790 219,140 81 64,896 59,567 84 176,837 170,668 58 40,782 39,191 16 1,766,563 1,748,934 138 (226,069) (242,600) 1,264 25 2,058,348 2,006,714 1,965 40,757 375 41,132 20,148 6,632 0 1,261 131 283 28,455 12,677 5,060 17,737 2,471 576 14,690 40,757 375 41,132 20,148 6,632 0 1,261 131 283 28,455 12,677 5,060 17,737 2,471 576 14,690 1 Impairments of financial investments available-for-sale for the year ended 31 December 2005 were as follows: Global Wealth Management & Business Banking CHF 10 million; Global Asset Manage- ment 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 16: Goodwill and Other Intangible Assets. 3 The funding surplus or requirement is reflected in each Business Group and adjusted in Corporate Center. 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, credit loss is measured using an expected loss concept. This table shows Business Group performance consistent with the way the businesses are managed and the way Business Group perfor- mance 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 expected credit loss, amortized over a three year period. The difference between these adjusted expected credit loss figures and the credit loss expense recorded at Group level for reporting purposes is reported in Corporate Functions as Adjusted expected credit loss. 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 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 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 Corporate Center Financial Businesses Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland 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) 223,790 219,140 81 64,896 59,567 84 176,837 170,668 58 40,782 39,191 16 1,766,563 1,748,934 138 (226,069) (242,600) 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) 1,236 0 1,236 245 184 14 21 4 283 751 485 496 981 11,549 11,814 299 1,236 0 1,236 245 184 14 21 4 283 751 485 496 981 40,757 375 41,132 20,148 6,632 0 1,261 131 283 28,455 12,677 5,060 17,737 2,471 576 14,690 2,058,348 2,006,714 1,965 40,757 375 41,132 20,148 6,632 0 1,261 131 283 28,455 12,677 5,060 17,737 2,471 576 14,690 1 Impairments of financial investments available-for-sale for the year ended 31 December 2005 were as follows: Global Wealth Management & Business Banking CHF 10 million; Global Asset Manage- ment 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 16: Goodwill and Other Intangible Assets. 3 The funding surplus or requirement is reflected in each Business Group and adjusted in Corporate Center. 109 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, credit loss is measured using an expected loss concept. This table shows Business Group performance consistent with the way the businesses are managed and the way Business Group perfor- mance 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 expected credit loss, amortized over a three year period. The difference between these adjusted expected credit loss figures and the credit loss expense recorded at Group level for reporting purposes is reported in Corporate Functions as Adjusted expected credit loss. 110 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 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 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 Wealth Management Wealth International & Switzerland Management Business Banking Switzerland Financial Businesses Global Asset Management Investment Bank Corporate Center Private Banks & GAM Corporate Functions Industrial Holdings 1 UBS 7,701 (1) 7,700 2,119 642 1,395 66 67 8 4,297 3,403 3,403 7,701 (8) 7,693 2,119 642 1,395 66 67 8 4,297 3,396 3,396 4,741 US 3 4,744 3,320 767 275 67 171 107 4,707 37 37 4,741 (5) 4,736 3,320 767 275 67 171 107 4,707 29 29 2,130 552 4,764 386 386 5,064 92 5,156 2,426 1,064 (533) 69 0 0 3,026 2,130 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 29,698 28,311 8 0 2,022 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 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 0 112 796 794 1 17 1,077 (1,509) 1,176 (1,064) 10 (1,054) 112 286 398 796 794 1 17 1,077 (1,509) 1,176 (778) (42) (820) 915 0 915 185 176 20 22 27 2 263 695 220 385 605 915 0 915 185 176 20 22 27 2 263 695 220 385 605 36,645 241 36,886 17,891 6,563 0 1,284 673 170 263 26,844 10,042 781 10,823 2,155 198 8,470 36,645 241 36,886 17,891 6,563 0 1,284 673 170 263 26,844 10,042 781 10,823 2,155 198 8,470 164,716 161,042 304 48,058 43,879 48 210,223 204,569 212 1,477,402 1,463,596 415 8,043 7,480 19 (210,363) (220,730) 599 9,394 9,966 1,484 1,737,171 1,698,113 3,089 1 Results for Motor-Columbus include the six month period beginning on 1 July 2004. 2 Impairments of financial investments available-for-sale 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 16: Goodwill and Other Intangible Assets. 4 The funding surplus or requirement is reflected in each Business Group and adjusted in Corporate Center. 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, credit loss is measured using an expected loss concept. This table shows Business Group performance consistent with the way the businesses are managed and the way Business Group perfor- mance 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 expected credit loss, amortized over a three year period. The difference between these adjusted expected credit loss figures and the credit loss expense recorded at Group level for reporting purposes is reported in Corporate Functions as Adjusted expected credit loss. 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 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 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 Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Financial Businesses Global Asset Management Investment Bank Corporate Center Private Banks & GAM Corporate Functions Industrial Holdings 1 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) 915 0 915 185 176 20 22 27 2 263 695 220 385 605 36,645 241 36,886 17,891 6,563 0 1,284 673 170 263 26,844 10,042 781 10,823 2,155 198 8,470 164,716 161,042 304 48,058 43,879 48 210,223 204,569 212 29,698 28,311 8 1,477,402 1,463,596 415 8,043 7,480 19 (210,363) (220,730) 599 9,394 9,966 1,484 1,737,171 1,698,113 3,089 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) 915 0 915 185 176 20 22 27 2 263 695 220 385 605 36,645 241 36,886 17,891 6,563 0 1,284 673 170 263 26,844 10,042 781 10,823 2,155 198 8,470 1 Results for Motor-Columbus include the six month period beginning on 1 July 2004. 2 Impairments of financial investments available-for-sale 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 16: Goodwill and Other Intangible Assets. 4 The funding surplus or requirement is reflected in each Business Group and adjusted in Corporate Center. 111 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, is a more meaningful represen- tation of the way in which the Group is managed. For the year ended 31 December 2006 Switzerland Rest of Europe / Middle East / Africa Americas Asia Pacific Total 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 Total operating income Total assets Capital expenditure CHF million Share % CHF million Share % CHF million Share % 12,987 12,771 18,367 4,040 48,165 27 27 38 8 211,565 734,986 1,243,933 206,027 100 2,396,511 9 31 51 9 100 650 385 1,754 328 3,117 21 12 56 11 100 Total operating income Total assets Capital expenditure CHF million Share % CHF million Share % CHF million Share % 13,793 9,236 15,293 2,810 41,132 34 22 37 7 203,907 687,963 1,004,230 162,248 10 33 49 8 973 467 386 139 100 2,058,348 100 1,965 49 24 20 7 100 Total operating income Total assets Capital expenditure CHF million Share % CHF million Share % CHF million Share % 13,438 7,535 13,787 2,126 36,886 37 20 37 6 193,464 561,390 830,350 151,967 11 32 48 9 1,993 556 376 164 100 1,737,171 100 3,089 65 18 12 5 100 112 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 tables below and on the next page). This required disclosure, however, does not take into account that net interest and trading income are generated by a range of different business activities. In many cases, a particular business activity can generate both net in- terest and trading income. Fixed income trading activity, for example, generates both trading profits and coupon income. UBS management therefore analyzes net interest and trading income according to the business activity generating it. The second 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 income, Foreign exchange and Other. These activities generate both types of income (interest and trading revenue) and there- fore this analysis is not comparable with the breakdown pro- vided in the third table below and the table on the next page. 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 1 CHF million Interest income Interest earned on loans and advances 2 Interest earned on securities borrowed and reverse repurchase agreements Interest and dividend income from trading portfolio Interest income on financial assets designated at fair value Interest and dividend income from financial investments available-for-sale 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 31.12.06 6,521 13,318 19,839 For the year ended 31.12.05 9,528 7,996 17,524 31.12.06 4,759 6,204 1,745 411 13,119 5,829 891 19,839 For the year ended 31.12.05 3,928 5,741 1,458 292 11,419 5,355 750 17,524 31.12.04 11,744 4,902 16,646 31.12.04 3,098 6,264 1,467 203 11,032 5,070 544 16,646 % change from 31.12.05 (32) 67 13 % change from 31.12.05 21 8 20 41 15 9 19 13 31.12.06 For the year ended 31.12.05 31.12.04 % change from 31.12.05 15,266 39,771 32,211 25 128 87,401 20,024 34,021 14,533 4,757 7,545 80,880 6,521 11,678 23,362 24,134 26 86 59,286 11,226 20,480 10,736 2,390 4,926 49,758 9,528 9,220 10,699 19,271 0 38 39,228 5,583 9,906 7,993 1,168 2,834 27,484 11,744 31 70 33 (4) 49 47 78 66 35 99 53 63 (32) 1 Figures in comparative periods reflect the prime brokerage reclassification as explained in Note 1. 2 Includes interest income on impaired loans and advances of CHF 158 million for 2006, CHF 123 million for 2005 and CHF 172 million for 2004. Interest includes forward points on foreign exchange swaps used to manage short-term interest rate risk on foreign currency loans and deposits. 113 Financial Statements Notes to the Financial Statements Note 3 Net Interest and Trading Income (continued) Net trading income 1 CHF million Equities Fixed income 2 Foreign exchange and other Net trading income Thereof: Net gains / (losses) from financial assets designated at fair value Net gains / (losses) from financial liabilities designated at fair value For the year ended % change from 31.12.06 31.12.05 31.12.04 31.12.05 7,064 2,945 3,309 13,318 (397) (3,869) 3,900 1,256 2,840 7,996 70 (4,024) 2,254 131 2,517 4,902 0 (1,203) 81 134 17 67 1 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. Financial liabilities designated at fair value include the impact of UBS’s own credit where market information indicates that it is reflected in the price at which UBS transacts with third par- ties. Products with UBS’s own credit as a valuation input include certain structured debt instruments where either at inception or over their life, UBS receives cash flows that pro- vide funding and thereby expose the counterparty to UBS credit risk. In all periods presented, for counterparties entering into products which are financial liabilities from UBS’s perspec- tive, the perception of UBS’s credit risk has remained stable. Note 4 Net Fee and Commission Income CHF million Equity underwriting fees Debt 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 31.12.06 31.12.05 31.12.04 31.12.05 1,834 1,704 3,538 1,852 8,053 5,858 252 1,266 6,622 449 27,890 269 1,064 29,223 1,904 1,438 3,342 25,881 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 37 12 24 27 20 23 19 8 25 21 22 (12) 4 21 17 28 21 21 114 Note 5 Other Income CHF million Associates and subsidiaries Net gains / (losses) 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 31.12.06 31.12.05 31.12.04 31.12.05 (11) 21 10 921 (12) 909 61 106 5 204 1,295 301 1,596 1 26 27 231 (26) 205 42 57 12 218 561 561 1,122 83 1 84 132 (34) 98 65 43 11 277 578 275 853 (19) (63) 299 54 343 45 86 (58) (6) 131 (46) 42 1 Includes net rent received from third parties and net operating expenses. 2 Includes unrealized and realized gains 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 31.12.06 19,076 822 1,376 802 1,595 23,671 For the year ended 31.12.05 15,930 823 1,257 713 1,425 20,148 31.12.04 14,254 567 1,025 652 1,393 17,891 % change from 31.12.05 20 0 9 12 12 17 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 Total general and administrative expenses For the year ended 31.12.06 1,435 31.12.05 1,278 31.12.04 1,256 653 907 861 653 937 924 1,095 651 8,116 602 840 758 576 737 625 871 345 653 812 634 488 614 683 919 504 6,632 6,563 % change from 31.12.05 12 8 8 14 13 27 48 26 89 22 115 Financial Statements Notes to the Financial Statements Note 8 Earnings per Share (EPS) and Shares Outstanding For the year ended % change from 31.12.06 31.12.05 31.12.04 31.12.05 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 12,257 11,491 766 12,257 (8) 12,249 11,483 766 14,029 9,776 4,253 14,029 (22) 14,007 9,777 4,230 8,016 7,547 469 8,016 (5) 8,011 7,550 461 Weighted average shares outstanding Weighted average shares outstanding 1 Potentially dilutive ordinary shares resulting from unvested exchangeable shares, options and warrants outstanding 2 Weighted average shares outstanding for diluted EPS 1,976,405,800 2,013,987,754 2,059,836,926 82,429,012 83,203,786 104,085,794 2,058,834,812 2,097,191,540 2,163,922,720 Earnings per share (CHF) Basic from continuing operations from discontinued operations Diluted from continuing operations from discontinued operations 6.20 5.81 0.39 5.95 5.58 0.37 6.97 4.85 2.12 6.68 4.66 2.02 3.89 3.66 0.23 3.70 3.49 0.21 (13) 18 (82) (13) 64 (13) 17 (82) (2) (1) (2) (11) 20 (82) (11) 20 (82) 1 Includes an average of 143,809 exchangeable shares for the year ended 31 December 2006 that can be exchanged into the same number of UBS shares. 2 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 37,229,136; 29,117,750; and 37,956,398 for the years ended 31 Decem- ber 2006, 31 December 2005 and 31 December 2004 respectively. Shares outstanding Total ordinary shares issued Second trading line treasury shares 2004 program 2005 program 2006 program Other treasury shares Total treasury shares Shares outstanding As of % change from 31.12.06 31.12.05 31.12.04 31.12.05 2,105,273,286 2,177,265,044 2,253,716,354 (3) 79,870,188 67,770,000 140,749,748 208,519,748 169,456,432 249,326,620 22,600,000 141,875,699 164,475,699 1,940,797,587 1,968,745,296 2,004,389,734 1 (21) (1) All shares and earnings per share figures reflect the 2-for-1 share split made on 10 July 2006. 116 Balance Sheet: Assets Note 9 Financial Assets Designated at Fair Value CHF million Loans Structured loans Reverse repurchase agreements Banks Customers Other financial assets Total financial assets designated at fair value 31.12.06 31.12.05 2,104 148 2,942 307 429 5,930 737 229 0 0 187 1,153 The maximum exposure to credit loss of all items in the above table except for Other financial assets is equal to the fair value (CHF 5,501 million at 31 December 2006). Other financial assets are generally comprised of equity invest- ments and are not directly exposed to credit risk. The maxi- mum exposure to credit loss at 31 December 2006 is miti- gated by collateral of CHF 3,712 million. The amount by which credit derivatives or similar instru- ments mitigate the maximum exposure to credit loss of loans and structured loans designated at fair value is as follows: CHF million Notional amount of loans and structured loans Credit derivatives related to loans and structured loans – notional amounts1 Credit derivatives related to loans and structured loans – fair value1 Additional information CHF million Change in fair value of loans and structured loans designated at fair value, attributable to changes in credit risk3 Change in fair value of credit derivatives and similar instruments which mitigate the maximum exposure to credit loss of loans and structured loans designated at fair value3 31.12.06 2,348 663 2 For the year ended 2 31.12.06 2 (8) 2 1 Credit derivatives and similar instruments include credit default swaps, credit linked notes, total return swaps, put options, and similar instruments. These are generally used to manage credit risk when UBS has a direct credit exposure to the counterparty, which has not otherwise been collateralized. 2 Also equals the cumulative amount from inception for the year ended 31 December 2006. 3 Current and cumulative changes in the fair value of loans attributable to changes in their credit risk are only calculated for those loans oustanding at balance sheet date. Current and cumulative changes in the fair value of credit derivatives hedging such loans include all the derivatives which have been used to mitigate credit risk of these loans since designation at fair value. For loans reported under the fair value option, changes in fair value due to changes in the credit standing of the borrower are calculated using counterparty credit information obtained from independent market sources. 117 Financial Statements Notes to the Financial Statements Note 10a Due from Banks and Loans (Held at Amortized Cost) 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 (held at amortized cost) 1 Includes due from banks and loans from Industrial Holdings in the amount of CHF 93 and CHF 728 million for 2006 and 2005 respectively. Additional information about due from banks, loans (held at amortized cost) and loans designated at fair value CHF million Net due from banks and loans (held at amortized cost) Loans designated at fair value 2 Total 2 Equals the sum of Loans and Structured loans in Note 9. 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, loans (held at amortized cost) and loans designated at fair value 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, loans (held at amortized cost) and loans designated at fair value 31.12.06 50,456 (30) 50,426 124,548 19,989 169,210 313,747 (1,226) 312,521 362,947 31.12.06 362,947 2,252 365,199 31.12.06 163,090 67,584 117,447 18,334 366,455 (1,256) 365,199 31.12.06 146,518 99,879 27,000 93,058 366,455 (1,256) 365,199 31.12.05 33,689 (45) 33,644 127,990 18,509 135,022 281,521 (1,611) 279,910 313,554 31.12.05 313,554 966 314,520 31.12.05 158,465 50,898 94,192 12,621 316,176 (1,656) 314,520 31.12.05 148,412 55,334 24,567 87,863 316,176 (1,656) 314,520 118 Note 10b Allowances and Provisions for Credit Losses CHF million Balance at the beginning of the year Write-offs Recoveries Increase / (decrease) in credit loss allowances and provisions Acquisitions Foreign currency translation and other adjustments Balance at the end of the year 1 Specific allowances   and provisions Collective loan   loss allowances   and provisions Total 31.12.06 Total 31.12.05 1,690 (363) 62 (108) 3 10 1,294 86 0 0 (48) 0 0 38 1,776 (363) 62 (156) 3 10 1,332 2,802 (651) 63 (374) (61) (3) 1,776 1 Includes country provisions of CHF 65 million at 31 December 2005. During 2006, all country provisions were released. 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 allowances   and provisions Total 31.12.06 Total 31.12.05 30 1,188 0 1,218 76 1,294 0 38 0 38 0 38 30 1,226 0 1,256 76 1,332 45 1,611 11 1,667 109 1,776 Note 10c Impaired Due from Banks and Loans CHF million Total gross impaired due from banks and loans 1 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 2 1 All impaired due from banks and loans have a specific allowance for credit losses. 2 Average balances are calculated from quarterly data. CHF million Total gross impaired due from banks and loans Estimated liquidation proceeds of collateral Net impaired due from banks and loans Total allowances for credit losses related to impaired due from banks and loans 31.12.06 31.12.05 2,628 30 1,188 1,218 3,003 3,434 32 1,561 1,593 4,089 31.12.06 31.12.05 2,628 (1,059) 1,569 1,218 3,434 (1,366) 2,068 1,593 119 Financial Statements Notes to the Financial Statements Note 10d 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 it will be made good by later payments or the 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 Secured by real estate 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 liquidation of collateral; or 2) when insolvency proceedings have commenced; or 3) when obligations have been restruc- tured on concessionary terms. 31.12.06 31.12.05 1,918 1,112 2,135 2,363 1,393 3,082 31.12.06 31.12.05 2,363 (157) (288) 1,918 31.12.06 29 561 1,328 1,889 1,918 3,555 (515) (677) 2,363 31.12.05 27 621 1,715 2,336 2,363 31.12.06 31.12.05 1,744 106 62 6 1,918 2,106 155 94 8 2,363 Note 11 Securities Borrowing, Securities Lending, Repurchase and Reverse Repurchase Agreements The Group enters into collateralized reverse repurchase and repurchase agreements and securities borrowing and securi- ties lending transactions that may result in credit exposure in the event that the counterparty to the transaction is unable to fulfill its contractual obligations. The Group controls cred- it risk associated with these activities by monitoring counter- party credit exposure and collateral values on a daily basis and requiring additional collateral to be deposited with or returned to the Group when deemed necessary. Balance sheet assets CHF million By counterparty Banks Customers Total 120 Cash collateral on   Reverse repurchase   securities borrowed 31.12.06 agreements 31.12.06 Cash collateral on securities borrowed 31.12.05 Reverse repurchase agreements 31.12.05 53,538 298,052 351,590 209,606 196,228 405,834 52,814 235,621 288,435 259,608 144,824 404,432 Note 11 Securities Borrowing, Securities Lending, Repurchase and Reverse Repurchase Agreements (continued) Balance sheet liabilities CHF million By counterparty Banks Customers Total Note 12 Trading Portfolio Cash collateral on   securities lent 31.12.06 Repurchase   agreements 31.12.06 Cash collateral on securities lent 31.12.05 Repurchase agreements 31.12.05 44,118 18,970 63,088 274,910 270,570 545,480 46,766 13,172 59,938 278,287 200,221 478,508 The Group trades in debt instruments (including money mar- ket paper and tradable loans), equity instruments, precious metals, other commodities and derivatives to meet the fi- nancial needs of its customers and to generate revenue. Note 23 provides a description of the various classes of de- rivative instruments. CHF million Trading portfolio assets Money market paper thereof pledged as collateral with central banks 1 thereof pledged as collateral (excluding central banks) 1 thereof pledged as collateral and can be repledged or resold by counterparty 2 Debt instruments Swiss government and government agencies US Treasury and government agencies Other government agencies Corporate listed Other – unlisted Total thereof pledged as collateral 1 thereof can be repledged or resold by counterparty 2 Equity instruments Listed Unlisted Total thereof pledged as collateral 1 thereof can be repledged or resold by counterparty 2 Traded loans Precious metals and other commodities 3 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 31.12.06 31.12.05 86,790 20,053 45,356 38,173 340 114,714 71,170 214,129 111,001 511,354 190,153 158,549 183,731 27,938 211,669 56,760 54,756 47,630 21,071 878,514 129 81,385 58,538 21,788 2,101 163,941 40,832 204,773 57,685 11,717 16,307 11,563 589 77,569 64,823 169,841 74,253 387,075 170,917 110,857 139,101 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 1 Financial assets pledged to third parties for liabilities with and without the right of rehypothecation are CHF 312 billion at 31 December 2006 and CHF 233 billion at 31 December 2005. 2 Financial assets pledged to third parties with right of rehypothecation of CHF 251 billion at 31 December 2006 and CHF 155 billion at 31 December 2005 are presented on the balance sheet in the line Trading portfolio assets pledged as collateral. 3 Other commodities predominantly consist of energy. 121 Financial Statements Notes to the Financial Statements Note 13 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 available-for-sale thereof eligible for discount at central banks 31.12.06 31.12.05 354 260 261 521 5,880 819 6,699 1,363 8,937 41 141 587 91 678 2,548 1,738 4,286 1,446 6,551 40 The following tables show the unrealized gains and losses recognized directly in Equity in 2006 and 2005: CHF million 31 December 2006 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 instruments Equity instruments Private equity investments Total 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 instruments Equity instruments Private equity investments Total Unrealized gains / (losses) recognized directly in Equity Fair value Gross gains Gross losses Net, before tax Tax effect Net, after tax 354 3 0 0 97 28 160 233 6,699 1,363 8,937 0 0 0 0 0 0 0 5 3,102 634 3,741 0 0 0 0 0 0 (3) 0 (2) (13) (18) 0 0 0 0 0 0 (3) 5 0 0 0 0 0 0 0 0 0 0 0 0 0 0 (3) 5 3,100 621 3,723 (636) (182) (818) 2,464 439 2,905 Unrealized gains / (losses) recognized directly in Equity 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) 0 589 359 940 122 Note 13 Financial Investments Available-for-Sale (continued) The unrealized losses recognized directly in Equity are con- sidered to be temporary on the basis that the investments are intended to be held for a period of time sufficient to re- cover their cost, and UBS believes that the evidence indicat- ing that the cost of the investments should be recoverable within a reasonable period of time outweighs the evidence to the contrary. Factors considered include the nature of the investments, valuations and research undertaken by UBS, the current outlook for each investment, offers under nego- tiation at favorable prices and the duration of the unrealized losses. The following table shows the duration of unrealized losses recognized directly in Equity in 2006 and 2005: CHF million 31 December 2006 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 instruments Equity instruments Private equity investments Total 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 instruments Equity instruments Private equity investments Total Fair value Investments with unrealized loss less than 12 months Investments with unrealized loss more than 12 months Unrealized losses Investments with unrealized loss less than 12 months Investments with unrealized loss more than 12 months Total 0 0 0 0 0 0 28 0 2 74 104 0 0 0 0 0 0 132 0 25 123 280 Fair value Investments with unrealized loss less than 12 months Investments with unrealized loss more 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 0 0 0 0 0 0 160 0 27 197 384 Total 0 0 0 55 0 272 143 0 2,048 151 2,669 0 0 0 0 0 0 0 0 0 (3) (3) 0 0 0 0 0 0 (3) 0 (2) (10) (15) Unrealized losses Investments with unrealized loss less than 12 months Investments with unrealized loss more 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 0 0 0 (3) 0 (2) (13) (18) Total 0 0 0 (1) 0 (11) (3) 0 (16) (15) (46) 123 Financial Statements Notes to the Financial Statements Note 13 Financial Investments Available-for-Sale (continued) Contractual maturities of the investments in debt instruments1 CHF million, except percentages 31 December 2006 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 instruments Total fair value Within 1 year 1-5 years 5-10 years Over 10 years Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) 2.22 0.00 0.00 1.48 7.00 0.00 0.00 2 0 0 38 26 0 0 66 0.00 0.00 0.00 1.89 0.00 0.00 9.28 0 0 0 2 0 0 233 235 0.00 0.00 0.00 4.47 0.00 4.48 0.00 0 0 0 57 2 10 0 69 1 0 0 0 0 150 0 151 4.00 0.00 0.00 0.00 0.00 5.10 0.00 1 Money market paper has a contractual maturity of less than one year. Proceeds from sales of Financial investments available-for-sale, excluding private equity, were as follows: CHF million Proceeds Gross realized gains Gross realized losses Note 14 Investments in Associates CHF million Carrying amount at the beginning of the year Additions Disposals Transfers Income 1 Impairments 2 Dividend paid Foreign currency translation Carrying amount at the end of the year 31.12.06 31.12.05 1,380 832 5 298 60 1 31.12.06 31.12.05 2,956 542 (2,043) 13 156 (27) (33) (41) 2,675 938 (935) (13) 156 (4) (59) 198 1,523 2,956 1 Income of CHF 50 million and CHF 99 million is related to Industrial Holdings for 2006 and 2005 respectively, of which CHF 11 million and CHF 70 million is related to discontinued operations for 2006 and 2005 respectively. 2 Impairments of CHF 27 million and CHF 4 million are related to Industrial Holdings for 2006 and 2005 respectively. At 31 December 2006, significant associated companies of the Group had the following balance sheet and income statement totals on an aggregated basis, not adjusted for the Group’s proportionate interest: assets CHF 27 billion; liabilities CHF 23 billion; revenues CHF 1.9 billion; and net profit CHF 318 million. See Note 35 for a list of significant associates. 124 Note 15 Property and Equipment At historical cost less accumulated depreciation CHF million Historical cost Own-used properties Leasehold improve- ments IT, software and com- munication Other machines and equipment Plant and manu- facturing equipment Projects in progress 31.12.06 31.12.05 Balance at the beginning of the year 9,446 3,050 4,261 1,596 2,904 Additions Additions from acquired companies Disposals / write-offs 1 Reclassifications Foreign currency translation Balance at the end of the year Accumulated depreciation Balance at the beginning of the year Depreciation 2 Disposals / write-offs 1 Reclassifications Foreign currency translation Balance at the end of the year Net book value at the end of the year 3 140 0 (407) 102 5 206 5 (110) 119 (60) 662 19 (539) 116 (42) 9,286 3,210 4,477 4,781 244 (108) 11 2 4,930 4,356 1,999 237 (86) (18) (36) 2,096 1,114 3,474 676 4 (225) 0 (38) 3,887 590 240 4 (817) (97) (33) 893 1,349 103 (807) (3) (19) 623 270 36 1 (2,960) 18 54 53 672 65 (716) 0 21 42 11 413 509 0 (82) (284) 2 558 0 0 0 0 0 0 558 21,670 1,793 29 21,428 1,865 116 (4,915) (2,363) (26) (74) 50 574 18,477 21,670 12,275 1,325 11,998 1,556 (1,942) (1,702) (10) (70) 11,578 6,899 32 391 12,275 9,395 1 Includes write-offs of fully depreciated assets. 2 Depreciation expense of CHF 62 million and CHF 295 million is related to discontinued operations for 2006 and 2005 respectively. 3 Fire insurance value of property and equipment is CHF 13,596 million (2005: CHF 16,050 million). 4 Includes a CHF 34 million software impairment. At fair value CHF million Balance at the beginning of the year Additions Sales Revaluations Reclassifications Foreign currency translation Balance at the end of the year 31.12.06 31.12.05 28 0 (14) 0 0 0 14 80 26 (25) 0 (55) 2 28 125 Financial Statements Notes to the Financial Statements Note 16 Goodwill and Other Intangible Assets At year-end 2006, five out of seven segments carry goodwill, of which Industrial Holdings has less than 1% of the total balance. Business Banking Switzerland and Corporate Cen- ter carry no goodwill. 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 recov- erable amount is determined by estimating streams of earn- ings available to shareholders in the next four quarters based on a rolling forecast process, discounted to their present val- ues. The terminal value reflecting all periods beyond the first year is calculated on the basis of the estimated individual return on equity for each segment, which is derived from the forecast first-year profit, the underlying equity, the cost of equity and the long-term growth rate. The recoverable amount of the segments is the sum of earnings available to shareholders from the first year and the terminal value. The model is most sensitive to changes in the forecast earnings available to shareholders in year one, the estimated return on equity, the underlying equity, the cost of equity and to changes in the long-term growth rate. The applied long- term growth rate is based on long-term risk free interest rates. Earnings available to shareholders are estimated based on forecast results, business initiatives and planned capital investments and returns to shareholders. Validation param- eters used within the Group’s impairment test model are linked to external market information, where applicable. Dis- count rates applied range from 8% for Wealth Management International & Switzerland and for Business Banking Swit- zerland 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 Balance at the beginning of the year Amortization 2 Reallocations Disposals Write-offs 1 Foreign currency translation Balance at the end of the year Goodwill Other intangible assets Customer relationships, contractual rights and other Total Infrastructure Total 31.12.06 31.12.05 11,313 2,015 (142) 0 (722) 12,464 1,016 0 0 0 (74) 942 263 48 0 0 0 (20) 291 651 2,056 1,321 (1,231) (28) (31) 2,087 636 148 0 (301) (28) (26) 429 3,072 1,321 (1,231) (28) (105) 3,029 899 196 0 (301) (28) (46) 720 14,385 3,336 (1,373) (28) (827) 15,493 899 196 0 (301) (28) (46) 720 13,096 92 (395) (112) 1,704 14,385 895 340 (307) (30) (112) 113 899 1,658 2,309 14,773 13,486 Net book value at the end of the year 12,464 1 Represents write-offs of fully amortized other intangible assets. 2 Amortization expense of CHF 43 million and CHF 209 million is related to discontinued operations for 2006 and 2005, respectively. 126 Note 16 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 2006. Balance at the beginning of the year Additions and reallocations Disposals Amortization Foreign currency translation Balance at the end of the year CHF million Goodwill Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Asset Management Investment Bank Corporate Center Industrial Holdings UBS Other intangible assets Wealth Management International & Switzerland Wealth Management US Business Banking Switzerland Global Asset Management Investment Bank Corporate Center Industrial Holdings UBS 1,566 3,841 0 1,438 4,309 0 159 116 444 0 190 1,260 0 5 11,313 2,015 141 753 0 8 296 9 966 184 148 0 488 483 0 18 2,173 1,321 0 0 0 0 0 0 (142) (142) 0 0 0 0 0 0 (930) (930) (10) (53) 0 (4) (72) (9) (48) (196) The estimated, aggregated amortization expenses for other intangible assets are as follows: CHF million Estimated, aggregated amortization expenses for: (37) (279) 0 (97) (307) 0 (2) (722) 10 (55) 0 6 (19) 0 (1) (59) 1,645 4,006 0 1,531 5,262 0 20 12,464 325 793 0 498 688 0 5 2,309 Other intangible assets 334 238 238 219 187 1,093 2,309 2007 2008 2009 2010 2011 2012 and thereafter Total Note 17 Other Assets CHF million Deferred tax assets Settlement and clearing accounts VAT and other tax receivables Prepaid pension costs Properties held for sale Accounts receivable trade Inventory – Industrial Holdings Other receivables Total other assets Note 22 31.12.06 31.12.05 3,686 3,159 318 814 1,254 114 68 7,836 17,249 2,811 3,528 312 832 578 364 2,007 5,811 16,243 127 Financial Statements Notes to the Financial Statements Balance Sheet: Liabilities Note 18 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 31.12.06 203,689 114,264 456,301 570,565 774,254 31.12.05 124,328 113,889 353,018 466,907 591,235 Note 19 Financial Liabilities Designated at Fair Value and Debt Issued The Group issues both CHF and non-CHF denominated fixed-rate and floating-rate debt. Subordinated debt securities are unsecured obligations of the Group that are subordinated in right of payment to all present and future senior indebtedness and certain other obligations of the Group. At 31 December 2006 and 31 December 2005, the Group had CHF 14,774 million and CHF 10,001 million, respectively, in subordinated debt. Sub- ordinated debt usually pays fixed interest annually or float- ing rate interest based on three-month or six-month London Interbank Offered Rate (LIBOR) and provides for single prin- cipal payments upon maturity. At 31 December 2006 and 31 December 2005, the Group had CHF 191,431 million and CHF 157,771 million, respectively, in unsubordinated debt (excluding money mar- ket paper, compound debt instruments – OTC and loan commitments designated at fair value). 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 discussed in Note 1 a14) and Note 23 – Derivative Instru- ments and Hedge Accounting. As a result of applying hedge accounting, at 31 December 2006 and 31 December 2005, the carrying value of debt issued was CHF 256 million higher and CHF 294 million higher, respectively, reflecting changes in fair value due to interest rate movements. The contractual redemption amount at maturity of Finan- cial liabilities designated at fair value through profit or loss approximates the carrying value at 31 December 2006 and 31 December 2005. 128 Note 19 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 Loan commitments 1 Total 31.12.06 135,646 9,967 74 145,687 31.12.05 109,724 7,677 0 117,401 1 Loan commitments recognized as Financial liabilities designated at fair value, until drawn down and recognized as loans. See Note 1 a7) for additional information. 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 31.12.06 119,584 31.12.05 102,662 53,509 14,774 38 2,238 70,559 190,143 46,545 10,001 38 1,464 58,048 160,710 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 dates1 CHF million, except where indicated 2007 2008 2009 2010 2011 2012–2016 Thereafter 31.12.06 Total   Total 31.12.05 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 %) 64,379 0–27 38,947 1,402 0–8 0 8,307 0–20 17,589 0 0 9,279 0–13.5 6,717 511 5.875 0 6,173 6,277 0–13.25 0–10.25 4,835 2,444 7,391 0–12 6,139 103,700 128,504 1,894 0–10 14,513 91,184 25,300 0 0 0 0 4,946 2,555 9,414 7,658 0–7.375 4.125–8.75 5,360 23,836 0 5,360 2,326 18,962 209,658 163,788 104,728 25,896 16,507 11,008 8,721 48,728 0–15 2,666 1,265 0–8.5 3,655 1,696 0–18.5 3,785 1,946 0–8 5,822 494 0–20 4,449 2,037 0–35 4,745 29,662 85,828 93,332 0–35 5,181 30,303 13,297 0 0 0 0 0 0 0 0 17 Subtotal Total 51,394 156,122 4,920 30,816 5,481 21,988 7,768 18,776 4,943 13,664 6,782 30,618 34,843 53,805 116,131 325,789 106,646 270,434 1 Compound debt instruments – OTC designated at fair value and loan commitments designated at fair value are excluded from the table. The table above indicates fixed interest rate coupons ranging from 0 up to 35% on the Group’s bonds. The high or low coupons generally relate to structured debt issues pri- or to the separation of embedded derivatives. As a result, the stated interest 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 sep- arated and, where applicable, the application of hedge ac- counting. 129 Financial Statements Notes to the Financial Statements Note 20 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 21 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 subsidiaries Reclassifications Foreign currency translation Balance at the end of the year Note 21 10b 22 Other 1 1,146 1 233 22 0 (113) (607) 2 108 (2) 788 31.12.06 31.12.05 1,672 76 4,258 2,674 931 3,715 33,645 91 16,189 63,251 2,072 109 3,592 2,596 712 2,707 30,224 1,425 10,400 53,837 Total 31.12.06 2,072 Total 31.12.05 2 2,020 26 630 22 5 (466) (607) 36 (46) 1,672 1 520 3 25 (588) (11) 0 102 2,072 Operational Litigation 334 0 (7) 0 3 (63) 0 (72) (10) 185 592 25 404 0 2 (290) 0 0 (34) 699 1 In 2006, in connection, with a strategy review of its business and a review of its office space planning, Wealth Management US decided not to use office space rented by UBS under a long-term contract in a new building in New Jersey. Senior management approved a proposal to enter into a 10-year sublease contract with an external party for the unused office space. Under the terms of this contract, the sublease income is not sufficient to cover the rent UBS pays under its original contract and costs incurred for arranging the sublease. UBS recorded a provision to cover the shortfall of this onerous lease contract which amounted to CHF 185 million on 31 December 2006. 2 Comprises provisions mainly for annual cost liabilities related to power purchases from joint venture companies where production costs exceed market prices; reinstatement costs; subleases. Legal Proceedings UBS Group operates in a legal and regulatory environment that exposes it to potentially significant litigation risks. As a result, UBS is involved in various disputes and legal proceed- ings, including litigation, arbitration, and regulatory and criminal investigations. Such cases are subject to many un- certainties, and their outcome is often difficult to predict, particularly in the earlier stages of a case. In certain circum- stances, to avoid the expense and distraction of legal pro- ceedings, UBS may, based on a cost benefit analysis, enter a settlement even though UBS denies any wrongdoing. The Group makes provisions for cases brought against it only when after seeking legal advice, in the opinion of manage- ment, it is probable that a liability exists, and the amount can be reasonably estimated (see table above). No provision is made for claims asserted against the Group that in the opin- ion of management are without merit and where it is not likely that UBS will be found liable. At 31 December 2006, UBS is involved in the following legal proceedings which could be material to the Group in a given reporting period: (a) InsightOne: In December 2006, the New York State Attorney General (NYAG) filed a civil complaint regard- ing InsightOne, the Firm’s fee-based brokerage program for private clients in the United States. The InsightOne program is a fee-based brokerage program, in which clients pay an asset-based fee for trading activity rather than commissions on a per trade basis and was designed to align more closely the interests of financial advisors and clients. UBS denies that the program was part of a scheme to disadvantage clients and intends to defend itself vigorously in this matter. (b) Tax Shelter: In connection with a criminal investigation of tax shelters, the United States Attorney’s Office for the Southern District of New York (U.S. Attorney’s Of- fice) is examining UBS’s conduct in relation to certain tax-oriented transactions in which UBS and others en- gaged during the years 1996–2000. Some of these transactions were a subject of the Deferred Prosecution Agreement which the accounting firm KPMG LLP en- tered into with the U.S. Attorney’s Office in August 2005, and are at issue in United States v. Stein, S1 05 Cr. 130 Note 21 Provisions (continued) 888 (LAK). UBS is cooperating with the government’s investigation. (c) Municipal Bonds: In November 2006, UBS and others re- ceived subpoenas from the U.S. Department of Justice, Antitrust Division, and the U.S. Securities and Exchange Commission. These subpoenas concern UBS’s conduct relating to derivative transactions entered into with mu- nicipal bond issuers, and to the investment of proceeds of municipal bond issuances. UBS is cooperating with these investigations. (d) HealthSouth: UBS is defending itself in two purported securities class actions brought in the U.S. District Court of the Northern District of Alabama by holders of stock and bonds in HealthSouth Corp. UBS also is a defendant in HealthSouth derivative litigation in Alabama state court and has responded to an SEC investigation relating to UBS’s role as a banker for HealthSouth. (e) Bankruptcy Estate of Enron: In November 2003, Enron brought adversarial proceedings against UBS and others in the U.S. Bankruptcy Court for the Southern District of New York seeking avoidance and recovery of payments that Enron made prior to filing for bankruptcy in connec- tion with equity forward and swap transactions The Bankruptcy Court dismissed UBS’s motion for summary judgment in August 2005. Discovery is ongoing. (f) Parmalat: UBS is involved in a number of proceedings in Italy related to the bankruptcy of Parmalat. These pro- ceedings include, inter alia, clawback proceedings against UBS Limited in connection with a structured finance transaction. Further, UBS is a defendant in two civil dam- ages claims brought by Parmalat, of which one relates to the same structured finance transaction against UBS Lim- ited, while the other against UBS AG relates to certain derivative transactions. In addition, UBS Limited and two UBS employees are the subject of criminal proceedings in Milan. Finally, UBS is a defendant in civil actions brought by individual investors in those criminal proceedings. All proceedings still are in an early stage. UBS denies the al- legations made against itself and against its employees in these matters, and is defending itself vigorously. Note 22 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 31.12.06 31.12.05 31.12.04 1,758 (87) 1,545 (430) 2,786 (12) (1) (13) 2,773 1,403 87 1,428 (447) 2,471 554 22 576 3,047 1,184 5 815 151 2,155 156 42 198 2,353 The Group made net tax payments, including domestic and foreign taxes, of CHF 2,607 million, CHF 2,394 million and CHF 1,345 million for the full years 2006, 2005 and 2004 respectively. 131 Financial Statements Notes to the Financial Statements Note 22 Income Taxes (continued) The components of operating profit before tax, and the differences between income tax expense reflected in the Financial Statements and the amounts calculated at the Swiss statutory rate, are as follows: CHF million Operating profit from continuing operations before tax Domestic Foreign Income taxes at Swiss statutory rate of 22% for 2006 and 2005 and 24% for 2004 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 Change in deferred tax valuation allowance Other items Income tax expense from continuing operations 31.12.06 14,667 5,564 9,103 3,227 For the year ended 31.12.05 12,677 5,854 6,823 2,789 829 21 (680) (941) 21 183 316 (548) 358 2,786 388 71 (97) (555) 22 212 (283) (156) 80 2,471 31.12.04 10,042 5,675 4,367 2,410 128 103 (249) (657) 262 215 (98) 239 (198) 2,155 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 Financial investments and associates Trading assets Intangible assets Other Total deferred tax liabilities 31.12.06 31.12.05 2,611 1,508 768 598 5,485 (1,799) 3,686 122 201 1,221 684 55 391 2,674 1,904 2,235 586 804 5,529 (2,718) 2,811 55 515 633 448 264 681 2,596 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 effects of exchange rate changes on tax assets and liabilities denominated in curren- cies other than CHF and the booking of some of the tax benefits related to deferred compensation through Equity. For the above purposes, the valuation allowance represents amounts that are not expected to provide future benefits, either be- cause they are offset against tax contingencies or due to insufficiency of future taxable income. 132 Note 22 Income Taxes (continued) Certain branches and subsidiaries of the Group have de- ferred 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 1,799 million (CHF 2,718 million at 31 December 2005). For companies that suffered tax losses in either the cur- rent or preceding years, an amount of CHF 212 million (CHF 442 million at 31 December 2005) has been recognized as deferred tax assets based on expectations that sufficient tax- able income will be generated in future years to utilize the tax loss carry-forwards. The carry-forwards expire as follows: Within 1 year From 2 to 4 years After 4 years Total The Group provides deferred income taxes on undistrib- uted earnings of non-Swiss subsidiaries except to the extent that such earnings are indefinitely invested. In the event that these earnings were distributed, additional taxes of approxi- mately CHF 18 million would be due. At 31 December 2006, net operating loss carry-forwards totaling CHF 4,140 million (not recognized as a deferred tax asset) are available to be offset against tax contingencies or future taxable income. 31.12.06 3 181 3,956 4,140 Note 23 Derivative Instruments and Hedge Accounting A derivative is a financial instrument, the value of which is derived from the value of another (“underlying”) financial instrument, an index or some other variable. Typically, the underlying 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 mar- kets (exchange-traded contracts). The notional amount of a derivative is generally the quan- tity of the underlying instrument on which the derivative contract 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 replaced instantaneously. Negative replacement values rep- resent 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 replace- ment values of derivative instruments are recognized in the income statement unless they meet the criteria for certain hedge accounting relationships, as explained in Note 1a14) Derivative instruments and hedge accounting. Types of derivative instruments The Group uses the following derivative financial instru- ments 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 payments based on two different currency principal bal- ances and reference interest rates and generally also 133 Financial Statements Notes to the Financial Statements Note 23 Derivative Instruments and Hedge Accounting (continued) entail exchange of principal amounts at the start and / or end of the contract. – Credit default swaps (CDSs) are the most common form of credit derivative, under which the party buying pro- tection makes one or more payments to the party selling protection 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 obli- gations of the credit entity and is made regardless of whether the protection 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 exposure 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, typi- cally, 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 struc- tures 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 arbi- trage activities. Market making involves quoting bid and of- fer prices to other market participants with the intention of generating revenues based on spread and volume. Position- ing means managing market risk positions with the expecta- tion of profiting from favorable movements in prices, rates or indices. Arbitrage activities involve identifying and profit- ing from price differentials between the same product in dif- ferent markets or the same economic factor in different products. of hedge transactions varies according to the nature of the instrument hedged and whether the hedge qualifies as such for accounting purposes. Derivative transactions may qualify as hedges for account- ing purposes. These are described under the corresponding headings in this note. The Group’s accounting policies for de- rivatives designated and accounted for as hedging instru- ments are explained in Note 1a14) Derivative instruments and hedge accounting, 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 accounting 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 accounting. The fair value changes of such swaps are booked to Net trading income. The Group limits the resultant in- come volatility by selecting short- to medium-term swaps only. Longer term swaps continue to be supported by the cash flow hedging model explained in a subsequent section of this note. 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 2006, the Group recognized a net loss of CHF 18 million, for the year ended 31 December 2005 a net loss of CHF 22 million and for the year ended 31 December 2004 a net gain of CHF 22 million, representing the ineffective portions, as defined in Note 1a14), of fair value hedges. The fair values of out- standing derivatives designated as fair value hedges were a CHF 222 million net positive replacement value at 31 De- cember 2006 and a CHF 380 million net positive replace- ment value at 31 December 2005. In addition, the Group has entered into a fair value hedge accounting relationship to protect a certain portion of avail- able-for-sale equity investments from foreign currency expo- sure using FX derivatives. For the year ended 31 December 2006, the Group recognized a net gain of CHF 5 million as hedge ineffectiveness. The time value associated with the FX derivatives is excluded from the evaluation of hedge inef- fectiveness. The fair value of outstanding FX derivatives des- ignated as fair value hedges was a CHF 1 million net positive replacement value at 31 December 2006. Derivatives transacted for hedging purposes The Group enters into derivative transactions for the pur- poses of hedging assets, liabilities, forecast transactions, cash flows and credit exposures. The accounting treatment Fair value hedge of portfolio of interest rate risk The Group has applied fair value hedge accounting of port- folio interest rate risk since September 2005. For the year 134 Note 23 Derivative Instruments and Hedge Accounting (continued) ended 31 December 2006, the Group recognized a net loss of CHF 8 million and for the year ended 31 December 2005 a net loss of CHF 22 million, representing the ineffective por- tions of fair value hedges. The change in fair value of the hedged items is recorded separately from the hedged item on the balance sheet. The fair value of derivatives designated for this hedge method at 31 December 2006 was a CHF 8 million net positive replacement value. There were no deriva- tive contracts designated as hedges under this method at 31 December 2005, as all the hedges had become ineffec- tive and the hedge relationships were de-designated at the end of 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 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 of 31 December 2006 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 228 88 140 420 156 264 294 109 185 267 151 116 7 41 (34) Gains and losses on the effective portions of derivatives des- ignated as cash flow hedges of forecast transactions are ini- tially recorded in Equity as Net income recognized directly in equity 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 rec- ognized immediately in the income statement. A CHF 36 million loss, CHF 35 million gain and a CHF 13 million gain were recognized in 2006, 2005 and 2004, respectively, due to hedge ineffectiveness. As of 31 December 2006 and 2005, the fair values of outstanding derivatives designated as cash flow hedges of forecast transactions were a CHF 462 million net negative replacement value and a CHF 1,124 million net negative replacement value, respectively. Swiss franc hedging interest rate swaps terminated during 2006 and 2005 had a replace- ment value of CHF 0 million and a positive replacement val- ue of CHF 80 million, respectively. At the end of 2006 and 2005, unrecognized income of CHF 214 million and CHF 346 million associated with terminated swaps 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 Net income recognized directly in Equity to current period earnings due to discontinuation of hedge accounting were a CHF 132 million net gain in 2006, 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 port- folios, which generally include several types of instruments, not just derivatives. The market risk of derivatives is man- aged and controlled as an integral part of the market risk of these portfolios. The Group’s approach to market risk is de- scribed in Note 29, Financial Instruments Risk Position, part b) Market Risk. Derivative instruments are transacted with many differ- ent counterparties, most of whom are also counterparties for other types of business. The credit risk of derivatives is managed and controlled in the context of the Group’s over- all credit exposure to each counterparty. The Group’s ap- proach to credit risk is described in Note 29, Financial Instru- ments Risk Position, part c) Credit Risk. It should be noted that, although the positive replacement values shown on the balance sheet can be an important component of the Group’s credit exposure, the positive replacement values for any one counterparty 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 increase over time (“potential fu- ture exposure”), while on the other hand, exposure may be mitigated by entering into master netting agreements and bilateral collateral arrangements with counterparties. Both the exposure measures used by the Group internally to con- trol credit risk and the capital requirements imposed by reg- ulators reflect these additional factors. There are additional 135 Financial Statements Notes to the Financial Statements capital requirements shown in Note 29 e) Capital Adequacy under Off-balance sheet and other positions as Forward and swap contracts and Purchased options, which reflect the additional potential future exposure. In Note 29 c) Credit Risk, the Derivatives positive replacement values shown un- der Traded products, and in Note 29 part e) Capital Adequa- cy, the Positive replacement values shown under balance sheet assets are lower than those shown in the balance sheet because they reflect close-out netting arrangements accepted by the Swiss Federal Banking Commission (SFBC) as being enforceable in insolvency. The impact of such net- ting agreements on the gross replacement values shown in the tables on the next two pages is to reduce both positive and negative replacement values by CHF 219,820 million and CHF 252,192 million at 31 December 2006 and 2005 respectively. As a result, positive replacement values after netting for UBS Group were CHF 108,625 million at 31 De- cember 2006 and CHF 81,590 million at 31 December 2005. These figures differ from those shown in Note 29 e) because they cover the whole UBS Group, whereas the rel- evant tables in Note 29 cover only those entities which are subject to consolidation for regulatory capital purposes. 136 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 Over-the-counter (OTC) contracts Forward contracts Options Exchange-traded contracts 3 Futures Options Total Note 23 Derivative Instruments and Hedge Accounting (continued) As of 31 December 2006 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 CHF bn 1,001 5,629 273 764 4,784 308 172 177 38 34 9,891 10,134 46,690 47,128 127 440 2,252 3,563 1,211 975 1,848.0 87,079 13,529 81,719 149,289 143,765 22,643.4 15,148 16,181 19,459 1,432.5 406 438 474 485 96 96 976 1,019 2,904.4 34.7 7,309 6,294 10,664 11,236 49,076 50,821 100,608 96,867 167,657 165,218 28,863.0 35 54 89 54 63 117 363 100 463 673 74 747 12,874 14,035 583 1,606 7,425 4,284 7,953 3,512 20,697 22,715 2,536.6 5,021 5,255 103.0 13,457 15,641 11,709 11,465 25,718 27,970 2,639.6 Forward contracts 4,565 4,322 1,765 1,968 827 531 17 103 7,174 6,924 Interest and currency swaps 24,724 22,977 10,363 10,599 14,641 12,366 12,821 11,831 62,549 57,773 2,877 2,624 2,987 3,042 828 1,041 51 49 6,743 6,756 12 16 2 2 14 18 32,178 29,939 15,117 15,611 16,296 13,938 12,889 11,983 76,480 71,471 6,145.7 348 293 333 974 339 580 573 676 355 784 757 1,554 371 1,281 37 118 48 68 1,715 2,641 1,113 2,713 400 427 381 1,319 1,676 1,520 1,050 3,361 1,087 2,739 155 116 1,810 6,166 1,868 5,694 1,179 1,073 1,464 3,485 386 3,702 1,217 5,655 506 6,121 8 14 103 2,085 2,792 8,821 1,605 2,795 12,501 20,756 4,277 6,529 4,602 8,238 8,396 9,978 10,458 453 433 22,946 23,889 9,551 12,326 15,268 16,605 19,287 2,072 3,331 37,532 47,437 3,254 221 3,223 236 2,894 447 3,155 368 1,724 595 1,579 654 766 1 840 27 8,638 1,264 8,797 1,285 Commodities contracts, excluding precious metals contracts 784.0 4,064.6 1,276.2 20.8 0.1 25.6 70.6 1.0 23.9 121.1 107.8 258.0 72.4 270.7 708.9 86.3 13.0 236.7 67.1 403.1 Total derivative instruments 52,180 52,316 45,751 1,626 5,101 1,637 5,096 2,164 5,505 1,967 1,200 1,057 4,990 4,661 5,490 14,743 767 49,872 102,314 105,716 128,200 124,629 328,4454 332,5335 14,892 3,519 3,290 867 1 PRV: Positive replacement value. 2 NRV: Negative replacement value. 3 Exchange-traded products include own account trades only. 4 The impact of netting agreements accepted by the Swiss Federal Banking Commission (SFBC) for capital adequacy calculations is to reduce positive replacement values to CHF 108,625 million. 5 The impact of netting agreements accepted by the SFBC for capital adequacy calculations is to reduce negative replacement values to CHF 112,713 million. 137 Financial Statements Notes to the Financial Statements Note 23 Derivative Instruments and Hedge Accounting (continued) As of 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 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 2,418.3 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 13 50 63 21 74 95 290 30 320 195 143 338 7,911 10,691 757 778 8,668 11,469 4,247 713 4,960 2,472 12,461 13,379 1,481.0 820 1,550 1,815 44.4 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 2,146 164 2,099 185 4,208 354 3,908 300 2,301 599 2,488 457 3 1 0 4 8,658 1,118 8,495 946 28 42 64 47 26 23 118 112 17.4 56.9 1.6 4.4 80.3 101.8 204.7 59.5 345.3 711.3 70.7 6.8 105.4 12.2 195.1 Total derivative instruments 39,905 40,293 41,327 2,338 2,326 4,626 4,255 9,553 42,056 127,198 130,144 125,352 125,170 333,7824 337,6635 9,894 2,968 2,926 4 4 1 PRV: Positive replacement value. 2 NRV: Negative replacement value. 3 Exchange-traded products include own account trades only. 4 The impact of netting agreements accepted by the Swiss Federal Banking Commission (SFBC) for capital adequacy calculations is to reduce positive replacement values to CHF 81,590 million. 5 The impact of netting agreements accepted by the SFBC for capital adequacy calculations is to reduce negative replacement values to CHF 85,471 million. 138 Commodities contracts, excluding precious metals contracts Off-Balance Sheet Information Note 24 Pledgeable Off-Balance Sheet Securities The Group obtains securities which are not recorded on the balance sheet 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 thereof sold or repledged in connection with financing activities to satisfy commitments under short sale transactions in connection with derivative and other transactions Note 25 Fiduciary Transactions 31.12.06 1,436,827 1,342,733 94,094 1,069,795 969,608 87,288 12,899 31.12.05 1,255,176 1,183,238 71,938 1,023,192 939,571 70,174 13,447 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 Total fiduciary transactions 31.12.06 43,366 43,366 31.12.05 40,603 40,603 The Group also acts in its own name as trustee or in fidu- ciary capacities for the account of third parties. The assets managed in such capacities are not reported on the balance sheet unless they are invested with UBS. UBS earns commis- sion and fee income from such transactions and assets. These activities potentially expose UBS to liability risks in cas- es of gross negligence with regard to non-compliance with its fiduciary and contractual duties. UBS has policies and pro- cesses in place to control these risks. 139 Financial Statements Notes to the Financial Statements Note 26 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 assurances, subject to the satisfaction of certain conditions, that the Group will make payment in the event that customers fail to fulfill their obligations to third parties. The Group also enters into commitments to extend credit in the form of credit lines that are available to secure the liquid- ity needs of customers but have not yet been drawn on by them, the majority of which range in maturity from one month to five years. The maximum amount at risk for the Group if customers fail to meet their obligations is the con- tractual amount of these instruments. 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 2006, 2005 and 2004 the Group recognized net credit loss recoveries of CHF 10 million, CHF 39 million and CHF 31 million respectively, related to obliga- tions incurred for contingencies and commitments. Provi- sions recognized for guarantees, documentary credits and similar instruments were CHF 76 million at 31 December 2006 and CHF 109 million at 31 December 2005. See also Note 21 Provisions. The Group generally enters into sub-participations to mitigate 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 obligation is not fulfilled by the obligor and, where applicable, to fund a part of the credit facility. The Group retains the contractual rela- tionship with the obligor, and the sub-participant has only an indirect relationship. The Group will only enter into sub- participation agreements with banks to which UBS ascribes a credit rating equal to or better than that of the obligor. Effective 1 January 2006, Swiss Banking Law and the newly established deposit insurance system require Swiss banks and securities dealers to jointly guarantee an amount of up to CHF 4 billion for privileged client deposits in the event that another Swiss bank or securities dealer becomes insolvent. For the period from 1 January 2006 to 30 June 2007, the Swiss Federal Banking Commission estimates UBS´s share in the deposit insurance system to be CHF 953 million. The deposit insurance is a guarantee and exposes UBS to additional credit risk which is not reflected in the ta- ble on the next page. UBS considers the probability of a loss due to this contingency to be remote. UBS is a member of numerous securities and futures ex- changes and clearinghouses. Associated with some of those memberships, UBS may be required to pay a share of the financial obligations of, or otherwise be exposed to ad- ditional financial obligations as a result of, another mem- ber who defaults. While the membership rules vary, obliga- tions generally would arise only if the exchange or clearinghouse had exhausted its resources. The maximum exposure to credit loss is not reflected in the table on the next page. UBS considers the probability of a material loss due to such obligations to be remote. As part of its trading and market making activities, UBS writes put options on a broad range of underlyings. The writing of put options is subject to UBS‘s risk control frame- work. For writing put options, UBS receives a premium, re- presenting the fair value of the option at inception, which is recognized as negative replacement value on the balance sheet. A written put option is considered a market price guarantee issued, because the option holder is entitled to make UBS purchase the underlying at the stated exercise price. The contract volume, which is the number of units of the underlying multiplied by the exercise price per unit, therefore represents the maximum potential payment UBS could be required to make upon exercise of the puts. The total negative replacement value of written put options is significantly lower than the underlying total contract vol- ume. It changes over time with changes in market parame- ters. Accordingly, neither the underlying total contract vol- ume nor the negative replacement value is indicative of the actual risk exposure arising from written put options. The market value of guarantees in the form of written put op- tions and other forms of market value guarantees amounted to CHF 481,656 million at 31 December 2006 and CHF 317,973 million at 31 December 2005. 140 Note 26 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 Contingent liabilities and irrevocable commitments Gross contingent liabilities and irrevocable commitments Sub-participations Net contingent liabilities and irrevocable commitments 31.12.06 31.12.05 Guaranteed amounts 12,142 (813) 11,329 3,199 (333) 2,866 2,567 (238) 2,329 17,908 (1,384) 16,524 11,526 (719) 10,807 2,805 (335) 2,470 2,235 (207) 2,028 16,566 (1,261) 15,305 Committed amounts 97,287 (2) 97,285 20 97,307 (2) 97,305 115,215 (1,386) 113,829 3 72,905 (2) 72,903 20 72,925 (2) 72,923 89,491 (1,263) 88,228 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. 3 Includes CHF 11,816 million of loan commitments designated at fair value. The fair value of CHF 74 million is shown as Financial liabilities designated at fair value until drawn down. See Note 19 for details. CHF million Overview of collateral Gross contingent liabilities Gross irrevocable commitments Liabilities for calls on shares and other equities Total 31.12.06 Total 31.12.05 Mortgage collateral Other collateral Unsecured Total 318 6,817 0 7,135 3,688 10,257 43,412 0 53,669 43,280 7,333 47,058 20 54,411 42,523 17,908 97,287 20 115,215 89,491 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 committed to fund these investments at 31 December 2006 and 31 December 2005 was CHF 766 million and CHF 884 million respectively. 141 Financial Statements Notes to the Financial Statements Note 27 Operating Lease Commitments At 31 December 2006, UBS was obligated under a number of non-cancellable operating leases for premises and equip- ment used primarily for banking purposes. The significant premises leases usually include renewal options and escala- tion clauses in line with general office rental market condi- tions as well as rent adjustments based on price indices. However, the lease agreements do not contain contingent rent payment clauses and purchase options. The leases also do not impose any restrictions on UBS’s ability to pay divi- dends, engage in debt financing transactions or enter into further lease agreements. The minimum commitments for non-cancellable leases of premises and equipment are presented as follows: CHF million Operating leases due 2007 2008 2009 2010 2011 2012 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 31.12.06 1,003 995 924 839 722 4,280 8,763 849 7,914 31.12.06 31.12.05 31.12.04 1,178 1,165 13 56 1,122 1,109 13 1,232 1,092 140 51 1,181 1,041 140 1,309 1,197 112 43 1,266 1,154 112 Operating lease contracts include non-cancellable long-term leases of office buildings in most UBS locations. At 31 De- cember 2006, the minimum lease commitments for sixteen office locations each exceeded CHF 100 million. Non-cancel- lable minimum lease commitments for four office locations in New Jersey, London, Zurich and New York each exceeded CHF 500 million. 142 Additional Information Note 28 Pledged Assets Financial assets are pledged in securities borrowing and lending transactions, in repurchase and reverse repurchase transac- tions, under collateralized credit lines with central banks, against loans from mortgage institutions and for security deposits relating to stock exchange and clearinghouse memberships. CHF million Financial assets pledged 1 Mortgage loans Other financial assets Total financial assets pledged Other assets pledged Property and equipment Carrying amount 31.12.06 31.12.05 81 0 81 0 64 474 538 520 1 Securities pledged to third parties with and without the right of rehypothecation are disclosed in footnote 1 of Note 12 and are not included in the table above. Note 29 Financial Instruments Risk Position This Note presents information about UBS’s management and control of risks from financial instruments. Part a) presents an overview of UBS’s risk management – liquidity risk – part d) – is the risk that UBS is unable to meet its payment obligations when due. Part e) presents and explains the Group’s regulatory capi- and control objectives. tal position. Parts b) to d) provide more detailed explanations of the pri- mary risks associated with UBS’s use of financial instruments: – market risk – part b) – is exposure to market variables in- cluding general market risk factors such as interest rates, exchange rates, equity market indices and commodity prices, and factors specific to individual names affecting the values of securities and other obligations in tradable form, and derivatives referenced to these names – credit risk – part c) – is the risk of loss as a result of failure by a client or counterparty to meet its contractual obliga- tions This Note generally refers only to UBS’s Financial Business- es, and those tables which are based on risk information in- clude only the Financial Businesses of the Group. Those which present an analysis of the whole balance sheet also cover the positions of the Industrial Holdings segment which, for the 2005 tables, includes Motor-Columbus. Any representation of risk at a specific date offers only a snapshot of the risks taken, since both trading and non-trading positions can vary significantly on a daily basis, for a variety of reasons, including active risk management. As such, it may not be representative of the level of risk at other times. a) Risk Management & Control Objectives Taking risk is core to a financial services business. UBS’s risk management and control objective is not, therefore, to elim- inate all risks but to achieve an appropriate balance between risk and return. In day-to-day business and in the strategic management of the balance sheet and capital position, UBS seeks, through its risk management and control framework, to limit the scope for adverse variations in earnings and ex- posure to “stress” events. The underlying objective is the creation and protection of shareholder value and the framework is built around the following principles: – business management is accountable for all risks assumed and is responsible for their continuous and active man- agement – an independent control process is implemented to pro- vide an objective check on risk-taking activities when re- quired by the nature of the risks, in particular to balance short term profit incentives and the long term interests of UBS. All exposures are independently monitored and re- viewed and, depending on the nature of the risks, may also require pre-approval 143 Financial Statements Notes to the Financial Statements Note 29 Financial Instruments Risk Position (continued) a) Risk Management & Control Objectives (continued) – comprehensive, transparent and objective risk disclosure to senior management, the Board of Directors, share- holders, regulators, rating agencies and other stake- holders is the cornerstone of the risk control process – risks are controlled at the level of individual exposures, at a portfolio level, and in aggregate across all businesses and risk types to protect the Group’s earnings – managing and controlling risks, and in particular avoiding undue concentrations of exposure, limiting potential losses from stress events, and restricting significant posi- tions in less quantifiable risk areas, are essential elements b) Market Risk of the risk management and control framework and the protection of UBS’s reputation. Excellence in risk management is fundamentally based upon a management team that makes risk identification and control critical components of its processes and plans. The Group Chief Risk Officer (CRO) has overall responsi- bility for the development and implementation of the Group’s risk control principles, frameworks, limits and processes, in- cluding formulation of risk policies and risk measurement and assessment methodologies. (i) Overview Market risk is exposure to market variables including general market risk factors such as interest rates, exchange rates, equity indices, and commodity prices, and factors specific to individual names affecting the values of securities and other obligations in tradable form, and derivatives referenced to those names (“issuer risk”). Market risk arises primarily in UBS’s trading activities, which are mainly in the Investment Bank, with limited activity in wealth management to facilitate private client business, and in asset management in support of the alternative and quantitative investments area. Additionally the Treasury department (part of Corporate Center) assumes market risk through its balance sheet and capital management activi- ties. The trading activities of the Investment Bank include mar- ket making, facilitation of client business and proprietary position taking. UBS is active in cash and derivatives markets for equities, fixed income and interest rate products, and for foreign exchange, energy, metals and commodities. Treasury assumes non-trading market risks. Interest rate risk arises from the funding of non-business items such as property and investments and from long-term interest rate risk trans- ferred from other Business Groups. Foreign exchange risk arises from the management of foreign currency profits and losses. Treasury also manages the Group’s consolidated equity in such a way as to protect UBS’s capital ratios and to generate a stable interest income flow. Other market risks from non-trading activities, predominantly interest rate risk, arise in all Business Groups, but they are not significant. The Group Head of Market Risk, reporting to the Group CRO, has overall responsibility for formulating the Group’s market risk control framework. There is a CRO in each Busi- ness Group and a designated CRO for Treasury. The Group Head of Market Risk, the Business Group CROs and their teams are responsible for the independent control of market risk. They ensure that all market risks are identified and cap- tured in risk systems. They establish the necessary controls, including limits, and monitor positions and exposures. An important element of the CRO’s role is the assessment of market risk in new businesses and products, and in struc- tured transactions. Market risk authority is vested in the Chairman’s Office and is further delegated to the GEB and ad personam to the Group CRO, the Group Head of Market Risk and CROs 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 applied 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. The VaR measure captures both “general” and “idiosyncratic” market risks. General market risk factors are variables which are driven by macroeconomic, geopolitical and other market- wide considerations, independent of any instrument or single name. They include movements in interest rates, widening or tightening of general spread levels and directional move- ments in equity market indices, exchange rates, and energy, metal and commodity prices. Changes in associated volatili- ties, and correlations between these risk factors – some of which may be unobservable or only indirectly observable – are also general market risks. Idiosyncratic components are those that cannot be explained by general market moves – broadly, changes in the prices of debt and equity instruments and derivatives linked to them, resulting from factors and events specific to individual names. 144 Note 29 Financial Instruments Risk Position (continued) b) Market Risk (continued) VaR expresses potential loss, but only to a certain level of confidence (99%), and there is therefore a specified statisti- cal probability (1%) that actual loss could be greater than the VaR estimate. UBS’s VaR model measures risk over a 10-day time horizon and it assumes that market moves occurring over this horizon will follow a similar pattern to those that have occurred over 10-day periods in the past. For general market risk, 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. For idio- syncratic risk, including event risk, the methods and time hori- zons are adjusted to most appropriately capture the risks. Stress loss measures are run daily. They 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 and restrictions are placed on risk concentra- tions in trading books, taking into account variations in price volatility and market liquidity. They include measures of exposure to individual market risk variables, such as the exchange rates and interest rates of particular currencies (“market risk factors”), and on positions in the securities and other tradable obligations of individual names or groups, or derivatives referenced to such names (“issuer risk” – see section b)(v)). (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 section b)(i). Interest rate sensitivity is one of the key inputs to VaR. One way of expressing this sensitivity for all interest rate sensitive positions, whether marked to market or subject to amortized cost accounting, is the impact on their fair values of a one basis point (0.01%) change in interest rates. This sensi- tivity, analyzed by time band, is set out in the table below. Interest rate sensitivity position1 CHF thousand, gain / (loss) per basis point increase CHF USD EUR GBP JPY Other Trading Non-trading Trading Non-trading Trading Non-trading Trading Non-trading Trading Non-trading Trading Non-trading CHF thousand, gain / (loss) per basis point increase 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. Interest rate sensitivity by time band at 31.12.06 within 1 month 1 to 3 months 3 to 12 months 1 to 5 years over 5 years 183 (47) 13 68 (261) (16) 123 0 46 1 47 (3) (256) (16) (202) 30 648 (5) (93) (7) 386 1 469 1 (377) (206) (716) (208) (409) (31) (272) (142) (117) 2 (209) 1 202 (3,677) (602) (2,896) (6,707) (359) (194) (266) (118) (7) (708) (1) (116) (3,524) (1,663) (5,452) 5,756 (333) 141 256 4 0 (10) (4) Interest rate sensitivity by time band at 31.12.05 within 1 month 1 to 3 months 3 to 12 months 1 to 5 years over 5 years 167 (258) (306) 70 536 (2) 169 (1) 194 (0) 2 (3) (526) (57) (103) (159) (344) (33) (653) (8) 367 (0) (48) (1) 120 (883) 122 (546) (302) (18) 131 (78) (435) (3) 69 (0) 213 (6,514) (3,238) (7,847) (2,792) (271) (310) (437) 406 (4) (125) (1) (322) (287) 3,329 35 2,725 1,174 (9) 536 (704) 0 (371) (3) Total (364) (7,470) (3,170) (8,458) (973) (744) (295) (159) 201 (3) (411) (6) Total (349) (7,998) (196) (8,447) (178) 850 (672) 12 (172) (7) (473) (8) 145 Financial Statements Notes to the Financial Statements Note 29 Financial Instruments Risk Position (continued) b) Market Risk (continued) The table sets out the extent to which UBS was exposed to interest rate risk at 31 December 2006 and 2005. 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 interest rate sensitive positions, both on- and off-balance sheet. The impact of such an increase in interest rates de- pends on UBS’s net asset or net liability position in each category, currency and time band in the table. A negative amount in the table reflects a potential reduction in fair value, while a positive 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 part e). “Non-trading” includes all other interest rate sensitive as- sets and liabilities including derivatives designated as hedg- es for accounting purposes (as explained in Note 23) and off-balance sheet commitments on which an interest rate has been fixed. The regulatory capital definition of the trad- ing book is broadly consistent with, but not identical to, the accounting definition of the trading portfolio. Most notably, loans originated by UBS for distribution in the cash markets are classified as held for trading for accounting purposes, but are risk controlled under the credit risk framework – see part c) – and are not eligible for trading book regulatory capital treatment. Information about money market paper and debt instru- ments classified as trading portfolio for accounting purposes is included in Note 12 and of debt instruments defined as financial investments available-for-sale for accounting purpos- es in Note 13. Information about derivatives is shown in Note 23. 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 commitments on which an interest rate has been fixed are primarily forward starting fixed-term loans. Trading The major part of this risk arises in the Investment Bank in par- ticular in the Fixed Income, Rates and Currencies business area, which includes the Cash and Collateral Trading unit (CCT). 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 are transferred from the originating business units to one of the two core interest rate risk management units – Treasury and CCT. The risks are then managed within the market risk limits and controls described in section b)(i). 146 The largest non-trading interest rate exposures arise in the Global Wealth Management & Business Banking Busi- ness Group. Many of their retail banking products have no contractual maturity date or directly market-linked rate. Their interest rate risk is transferred on a pooled basis through “replicating” portfolios. A replicating portfolio is a series of loans or deposits at market rates and fixed terms between the originating business unit and Treasury, struc- tured to approximate – on average – the interest rate cash flow and re-pricing behaviour of the pooled client transac- tions. The portfolios are rebalanced monthly. Their structure and parameters are based on long-term market observations and client behavior, and are reviewed periodically. Product margin remains with, and is subject to additional analysis and control by the originating business units. 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 transferred to Treasury through replicating portfolios which, in this case, are designed to approximate the mandated funding profile. The Group’s consolidated equity is managed in accor- dance with strategic targets set by senior management and is placed at fixed interest rates in Swiss franc, US dollar, euro and UK sterling with an average duration of between three and four years. These positions account for CHF 17.1 million of the non-trading interest rate sensitivity shown in the table on the previous page, with CHF 7.4 million arising in Swiss franc, CHF 8.4 million in US dollar and the remainder in euro and UK sterling. The interest rate sensitivity of the positions is directly related to the chosen duration, and although adopting significantly shorter maturities would lead to a re- duction in apparent interest rate sensitivity, it would lead to higher volatility in interest earnings. The economic value sensitivity of non-trading interest rate positions is defined as the impact of a large (100 basis point) instantaneous rise in interest rates across all curren- cies, on the net present value of all future cashflows from these positions. At 31 December 2006 the economic value sensitivity was a loss of CHF 1,771 million. (iii) Currency risk Currency risk is the risk of loss resulting from changes in exchange rates. Trading UBS is an active participant in currency markets and carries currency risk from these trading activities, conducted primar- ily in the Investment Bank. These trading exposures are sub- ject to the VaR, stress and concentration limits described in section b)(i). Information about foreign exchange contracts, Note 29 Financial Instruments Risk Position (continued) b) Market Risk (continued) most of which arise from trading activities and contribute to currency risk, is provided in Note 23. Non-trading UBS’s reporting currency is the Swiss franc, but its assets, li- abilities, income and expense are denominated in many cur- rencies, with significant amounts in US dollar, euro and UK sterling, as well as Swiss franc. Reported profits or losses are exchanged monthly, and in some cases more frequently, into Swiss francs, reducing volatil- ity in the Group’s earnings from subsequent changes in ex- change rates. Treasury also, from time to time, proactively hedges significant expected foreign currency earnings/costs (mainly US dollar, euro and UK sterling) in accordance with the instructions of the Group Executive Board. Economic hedging strategies employed include a cost-efficient options purchase program, which provides protection against unfavorable cur- rency fluctuations while preserving some upside potential. Al- though these positions are intended to economically hedge future earnings, they can cause volatility in financial results be- cause they are marked to market. Within clearly defined toler- ances, such fluctuations are accepted. The positions are, how- ever, treated as currency exposure, are subject to Treasury’s VaR limit and are included in VaR for regulatory capital pur- poses. The hedge program has a time horizon of up to twelve months and is not restricted to the current financial year. The Group’s consolidated equity is managed – as de- scribed in section b)(ii) – in such a way as to protect UBS’s capital ratios from exchange rate movements, based on a tar- get profile that broadly reflects the currency distribution of its risk-weighted assets. This creates structural foreign currency exposures. Exchange rate movements lead to increases or de- creases in the Swiss franc value of the Group’s risk-weighted assets. They also generate translation gains or losses on the structural foreign currency exposures. These are recorded in Equity in the Group’s Financial Statements, thereby protect- ing the BIS Tier 1 capital ratio – see part e). At 31 December 2006, the largest combined trading and non-trading currency exposures against the Swiss franc were short USD 436 million, short EUR 195 million and long AUD 128 million. At 31 December 2005, the largest exposures were short USD 695 million, short EUR 36 million and long GBP 6 million. (iv) Equity risk Equity risk is the risk of loss resulting from changes in the levels of equity indices and values of individual stocks. The Investment Bank is a significant player in major equity markets and is increasingly active in the newer markets. It carries equity risk from these activities. These exposures are subject to the VaR, stress and concentration limits described in section b)(i) and, in the case of individual stocks, to the issuer risk controls described in section b)(v). Information about equities held for trading for account- ing purposes is given in Note 12. Information about equity derivatives contracts (on indices and individual equities), which arise primarily from the Investment Bank’s trading ac- tivities, is provided in Note 23. (v) Issuer risk Issuer risk is the risk of loss on securities and other obliga- tions in tradable form (including traded loans), and on de- rivatives based on such assets. It arises from credit-related and other events and, ultimately, default of the issuer, obli- gor or reference name. As an active trader and market maker, the Investment Bank holds positions in these instruments, which are includ- ed in VaR and are also subject to controls on concentrated exposure to individual names and groups. Exposures arising from security underwriting commit- ments are, additionally, subject to targeted processes prior to commitment, generally including review by a commitment committee with representation from both business manage- ment and the control functions. All commitments are ap- proved under specific delegated authorities. (vi) Investment positions UBS makes equity investments for a variety of purposes. Some are made for revenue generation or as part of strate- gic initiatives, while others, such as exchange and clearing- house memberships, are held in support of other business activities. Private equity positions were, in the past, the ma- jor component of equity investments but the portfolio is be- ing managed down. UBS made an investment in Bank of China as part of a major strategy initiative, and acquired a stake in Julius Baer when Private Banks & GAM was sold to them in December 2005. Most seed money and co-invest- ments in UBS funds are considered investment positions. Many equity investments are unlisted and therefore illiquid. Others are intended to be held medium- or long- term. The fair values are often driven more by factors spe- cific to the individual companies than movements in general equity markets. For these reasons, equity investments are controlled outside the market risk measures and controls de- scribed in sections b)(iv) and b)(v). Instead they are subject to control and reporting processes, including pre-approval of new investments by business management and risk control. Where investments are made as part of an ongoing business they are also subject to portfolio and concentration limits. Debt investments, including money market paper, are not significant in amount. They are included in the measures of interest rate risk described in section b)(ii). 147 Financial Statements Notes to the Financial Statements Note 29 Financial Instruments Risk Position (continued) c) 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 Fi- nancial Statements at fair value. Banking products are gen- erally carried at amortized cost, but loans are carried at fair value if they have been originated by the Group for subse- quent syndication or distribution through the cash markets or (with effect from June 2006) are to be substantially hedged. OTC derivatives are carried at fair value. Repos and securities borrowing and lending transactions are accounted for on an amortized cost basis. All banking and traded prod- ucts are governed by the same credit risk management and control framework, regardless of accounting treatment. The Group Chief Credit Officer (CCO), reporting to the Group CRO, has overall responsibility for formulating the Group’s credit risk control framework. Global Wealth Man- agement & Business Banking and the Investment Bank, which take material credit risk, have independent credit risk control units, headed by CCOs reporting functionally to the Group CCO. They are responsible for the rating of counter- parties, for credit risk assessment and for the continuous monitoring of counterparty and portfolio credit exposures. Credit risk authority, including authority to establish allow- ances, provisions and credit valuation adjustments for im- paired claims, is vested in the Chairman’s Office and is fur- ther delegated to the GEB and ad personam to the Group CCO and to the Business Group CCOs and credit officers. For credit risk control purposes, credit exposure is mea- sured for banking products as the nominal amount. For trad- ed products, credit exposure is based on the replacement value of contracts, taking account of master netting agree- ments with individual counterparties where they are consid- ered enforceable in insolvency. The potential replacement value is projected over the life of the contracts (or over a shorter time frame where UBS has the ability to reduce expo- sure or close out, for example by calling or liquidating col- lateral) reflecting changes in credit exposure resulting from market movements and from maturing contracts. UBS ac- tively uses credit risk mitigation techniques to manage credit exposure. These include risk transfers and participations, hedging with credit derivatives, taking of security in the form of financial collateral (cash or marketable securities) or other assets such as real estate, and guarantees and other third party support. For internal credit risk control, credit risk miti- gation is reflected – depending on the product and type of 148 mitigation – by recognizing its existence in determining the exposure UBS is prepared to carry or by reflecting its risk- reducing effect in the reported credit exposure. In the table, the amounts shown as credit exposure for banking products are based on accounting classification and include some items which are not considered to be credit exposures for internal purposes, notably cash collateral post- ed by UBS with market counterparties against negative re- placement values on derivatives. Credit risk mitigation is recognized only to the extent that assets are derecog- nized for accounting purposes, as explained in Note 1a4). The amounts shown in the table for traded products are based on regulatory capital treatment, as shown in the table in part e). It should be noted that, for regulatory capital pur- poses, netting of positive and negative replacement values on derivatives is permitted for counterparties with whom UBS has a master netting agreement that is enforceable in insolvency, but netting is not permitted for accounting pur- poses unless the cash flows will actually be settled net, which is not generally the case – for details see Note 23. The regu- latory capital treatment of securities borrowing and lending transactions and repo and reverse repo transactions is based on the net positive value of cash or securities given by UBS to the counterparty. These values are included in the table in part e) in Due from banks and other collateralized lendings. They are only a small percentage of the balance sheet amounts which are based on the full value of transactions – for details see Note 11. The amounts shown in the table for traded products do not include any estimate of the potential future exposure which is included in the internal credit risk control view. UBS manages, limits and controls concentrations of cred- it 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 cli- ents are engaged in similar activities, or are located in the same geographic region or have comparable economic char- acteristics such that their ability to meet contractual obliga- tions would be similarly affected by changes in economic, political or other conditions. UBS sets limits on its credit ex- posure to both individual counterparties and counterparty groups. UBS’s credit portfolio is heterogeneous, varying signifi- cantly in terms of client type, sector, geographical diversity and the size of exposures. Limits take a variety of forms such as nominal values, statistical measures and scenario-based stress loss. They are applied to individual portfolios or sectors where appropriate, to restrict credit risk concentrations or areas of higher risk, or to control the rate of portfolio growth. Stress loss limits are applied to exposures to all but the best- rated countries. Note 29 Financial Instruments Risk Position (continued) c) Credit Risk (continued) Aggregate risk across portfolios is measured using a pro- prietary statistical methodology which provides an indication of risk in the portfolio and the way it changes over time. Stress loss measures are applied to all significant portfolios to assess the impact of variations in default rates and asset val- ues, taking into account risk concentrations in each portfo- lio. These measures include an analysis of contribution by industry and geography. The Group's gross lending portfolio of CHF 364 billion is widely diversified across industry sectors with no significant concentrations of credit risk. CHF 153 billion (42% of the total) consists of loans to thousands of private households, predominantly in Switzerland, and mostly secured by mort- gages, financial collateral or other assets. Exposure to banks and financial institutions amounted to CHF 138 billion (38% of the total). This includes cash posted as collateral by UBS against negative replacement values on derivatives or other positions, which, from a risk perspective is not considered lending but is a key component of the measurement of counterparty risk taken in connection with the underlying products. Exposure to banks includes money market depos- its with highly rated institutions. Excluding financial institu- tions, the largest industry sector exposure is CHF 25 billion (7% of the total) to the services sector. 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 inability to meet its commitments (including interest pay- ments, principal repayments or other payments due, for ex- ample on a derivative product or under a guarantee) accord- ing to the contractual terms, and after realization of any available collateral. Loans carried at amortized cost are classified as non-performing where payment of interest, principal or fees is overdue by more than 90 days and there is no firm evidence that they will be made good by later pay- ments or the liquidation of collateral, or where insolvency proceedings have commenced or obligations have been restructured on concessionary terms. The recognition of impairment in the Financial Statements depends on the accounting treatment of the claim. For prod- ucts accounted for on an amortized cost basis or off-balance sheet items, impairment is recognized through the creation of an allowance or a provision respectively which is charged to the income statement as Credit loss expense. 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, impairment is recognized through a credit valuation adjustment, which is charged to the income statement through the Net trading income line. For products carried at amortized cost, UBS also assesses portfolios of claims with similar credit risk characteristics for collective impairment in accordance with IAS 39. A portfolio is considered impaired on a collective basis if there is objective evidence to suggest that it contains impaired obligations but the individual impaired items cannot yet be identified. For further information about accounting policy for al- lowances and provisions for credit losses, see Note 1 a10). For the amounts of allowance and provision for credit losses and amounts of impaired and non-performing loans, see Note 10 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 below, and in Breakdown of credit exposure 1 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 31.12.06 31.12.05 364,110 17,908 97,287 110,732 47,870 (1,332) 636,575 314,482 16,566 72,905 86,950 40,765 (1,776) 529,892 1 Positions in Industrial Holdings are excluded. 2 See Note 10a – Due from Banks and Loans for further information. 3 See Note 26 – Commitments and Contingent Liabilities for further information. 4 Does not include potential future credit exposure arising from changes in value of products with variable value. Potential future credit exposure is, however, included in internal measures of credit exposure for risk management and control purposes. 5 Replacement values are shown net where netting is permitted for regulatory capital purposes. See also Note 29e) – Capital Adequacy. 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 securities borrowing / lending and repo / reverse repo transactions. 7 See Note 11 – Securities Borrowing, Securities Lending, Repurchase and Reverse Repurchase Agreements for further information about these types of transactions. 8 See Note 10b - Allowances and Provisions for Credit Losses for further information. 149 Financial Statements Notes to the Financial Statements Note 29 Financial Instruments Risk Position (continued) c) Credit Risk (continued) Notes 10a) and b), but that portfolios against which collective loan loss provisions have been established are not included in the totals of impaired loans in Note 10c). The occurrence of credit losses is erratic in both timing and amount and those that arise usually relate to trans- actions entered 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 statistically based concept which is used to estimate the annual costs that will arise, on average, from positions in the current portfolio that become impaired. It is derived from the probability of default (given by the counter- party rating), current and likely future exposure to the coun- terparty and the likely severity of the loss should default occur. Note 2a) includes two tables: the first shows Credit loss expense, as recorded in the Financial Statements, for each Business Group; the second reflects an “Adjusted ex- pected credit loss” for each Business Group, which is the expected credit loss on its portfolio, plus the difference be- tween Credit loss expense and expected credit loss, amor- tized over a three-year period. The difference between the total of these Adjusted expected credit loss figures and the Credit loss expense recorded at Group level for financial re- porting is reported in Corporate Center. d) Liquidity Risk UBS’s approach to liquidity management is to ensure, as far as possible, that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking sustained damage to business franchises. Treasury, which is part of Corporate Center, is responsible for the liquidity con- trol framework while the Investment Bank Cash and Collat- eral Trading unit is responsible for day-to-day operations. The approach is based on a comprehensive assessment of all material known and expected cash flows of the Group and the availability of high-grade collateral which could be used to secure additional funding if required. The framework en- tails careful monitoring and control of the daily liquidity posi- tion, and regular liquidity stress testing under a variety of scenarios. Scenarios encompass both normal and stressed market conditions, including general market crises and the possibility that access to markets could be impacted by a stress event affecting some part of UBS’s business 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 2006, which is the starting point for the liquidity analyses, is shown in the table on the next page. 150 Note 29 Financial Instruments Risk Position (continued) d) 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 available-for-sale Accrued income and prepaid expenses Investments in associates Property and equipment Goodwill and other intangible assets Other assets Total 31.12.06 Total 31.12.05 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 31.12.06 Total 31.12.05 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 3.5 27.2 0.0 0.0 627.0 251.5 328.4 5.9 42.9 8.1 10.4 0.0 0.0 0.0 17.4 1,322.3 1084.2 41.4 0.0 0.0 204.8 332.5 0.0 157.0 21.5 0.0 29.6 786.8 732.7 0.0 0.0 239.6 67.1 0.0 0.0 0.0 0.0 44.7 0.0 0.0 0.0 0.0 0.0 0.0 351.4 289.8 4.4 55.5 30.9 0.0 0.0 0.0 130.2 0.0 0.0 33.6 254.6 244.7 0.0 19.5 102.7 278.5 0.0 0.0 0.0 0.0 89.0 0.3 0.0 0.0 0.0 0.0 0.0 490.0 452.6 151.9 7.6 425.1 0.0 0.0 7.8 268.5 0.0 101.1 0.0 962.0 791.5 0.0 1.2 9.3 49.2 0.0 0.0 0.0 0.0 32.2 0.1 0.0 0.0 0.0 0.0 0.0 92.0 98.2 5.2 0.0 81.8 0.0 0.0 28.0 13.7 0.0 21.9 0.0 150.6 90.1 0.0 2.3 0.0 10.9 0.0 0.0 0.0 0.0 79.5 0.2 0.0 0.0 0.0 0.0 0.0 92.9 87.9 0.3 0.0 7.7 0.0 0.0 79.2 1.0 0.0 9.3 0.0 97.5 74.8 0.0 0.2 0.0 0.1 0.0 0.0 0.0 0.0 24.2 0.2 0.0 1.5 6.9 14.8 0.0 47.9 45.6 0.5 0.0 0.0 0.0 0.0 30.7 0.2 0.0 57.9 0.0 89.3 72.9 Total 3.5 50.4 351.6 405.8 627.0 251.5 328.4 5.9 312.5 8.9 10.4 1.5 6.9 14.8 17.4 2,396.5 2,058.3 203.7 63.1 545.5 204.8 332.5 145.7 570.6 21.5 190.1 63.2 2,340.7 2,006.7 1 Deposits without a fixed term, on which notice of withdrawal or termination has not been given (such funds may be withdrawn by the depositor or repaid by the borrower subject to an agreed period of notice). 2 Trading and derivative positions are shown within ‘On demand’ which management believes most accurately reflects the short-term nature of trading activities. The contractual maturity of the instruments may however extend over significantly longer periods. 151 Financial Statements Notes to the Financial Statements Note 29 Financial Instruments Risk Position (continued) e) Capital Adequacy The adequacy of UBS’s capital is monitored using, among other measures, the framework 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 BIS capital ratios, 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 business. On bal- ance, this results in higher RWAs than under the BIS rules and UBS’s ratios are lower when calculated under the SFBC regulations than under the BIS framework. UBS’s capital requirements are based on its consolidated Financial Statements prepared under IFRS. Adjustments are made to exclude IFRS consolidated entities that are not ac- tive in the areas of banking, finance or real estate – mainly securitization and collective investment vehicles and indus- trial holdings (including Motor-Columbus in 2005). Adjust- ments are also made to IFRS-based profit and reserves, in line with BIS recommendations, as prescribed by the SFBC, pri- marily in relation to gains and losses recognized under the fair value option and unrealized gains on available-for-sale financial investments. 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 dif- ferences not recognized in the income statement and hybrid Tier 1 capital (part of Equity attributable to minority inter- ests) less accrued expected dividend, net long positions in own shares, and goodwill. Tier 2 capital includes subordi- nated long-term debt. Additionally certain non-trading ex- posures to other financial institutions are required to be de- ducted from capital. 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, mar- ket risk, and other risk, each of which is described below. The credit risk component consists of on- and off-balance sheet claims, measured according to regulatory formulas outlined below, and weighted according to type of counter- party and collateral. The least risky claims, such as claims on OECD governments and claims collateralized by cash, are weighted at 0%, meaning that no regulatory 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 re- quired. 152 Securities not held for trading are included as claims, based on the net long position in the securities of each is- suer, including both physical holdings and positions derived from other transactions such as options. UBS’s investments in IFRS consolidated industrial holdings (which for 2005 in- cludes Motor-Columbus) are treated for regulatory capital purposes as positions in securities not held for trading. Claims arising from derivatives transactions include two components – the current positive replacement values, and “add-ons” to reflect their potential future exposure. Where UBS has entered into a master netting agreement which is accepted by the SFBC as being legally enforceable in insol- vency, positive and negative replacement values with indi- vidual counterparties can be netted and therefore the on- balance sheet component of RWAs for derivatives trans- actions shown in the table on the next page (Positive replacement values) is less than the balance sheet value of Positive replacement values. The add-ons component of the RWAs is shown in the table under Off-balance sheet expo- sures 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 percentages of nominal value specified by the regulators. Regulatory capital is required to support market risk aris- ing on all foreign exchange, and energy, metals and com- modity positions, and on all positions held for trading, and meeting the regulatory definition of trading book, in interest rate instruments and equities, including risks on individual equities and traded debt obligations such as bonds. For most market risk positions, UBS derives its regulatory capital re- quirement from its internal Value at Risk (VaR) model – see section b)(i) – which is approved by the SFBC. For some small positions market risk regulatory capital is computed using the standardized method defined by the regulators. Unlike the calculations for credit risk and other risks, this produces the capital requirement itself rather than the RWA amount. In order to compute a total capital ratio, the total market risk capital requirement is converted 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 total market risk capital requirement is multiplied by 12.5. Other risks consist of other types of asset, most notably property and equipment, and intangibles (included in the table on the next page within Other assets). These assets are not subject to credit or market risk, but they represent a risk to the Group in respect of their potential for write-down and impairment and therefore require capital underpinning in ac- cordance with regulatory formulas. Note 29 Financial Instruments Risk Position (continued) e) 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 Positive replacement values 3 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 4 Purchased options 4 Market risk positions 5 Total risk-weighted assets Exposure 31.12.06 Risk-weighted   amount 31.12.06 452,821 10,262 110,732 887,694 9,302 8,436 15,976 17,908 98,439 31,522,982 1,913,971 10,438 8,447 24,161 206,359 4,920 8,436 10,827 7,842 23,592 16,599 411 19,860 341,892 Exposure 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 Risk-weighted amount 31.12.05 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 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 the Market risk positions. 2 Includes industrial holdings, which are not consolidated for capital adequacy. Excludes positions in the trading book, which are included in Market risk positions. 3 Represents the mark to market values of Forward and swap contracts and Purchased options, where positive but after netting, where applicable. 4 Represents the add-ons for these contracts. 5 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. BIS capital ratios Tier 1 of which hybrid Tier 1 Tier 2 Total BIS Capital CHF million 31.12.06 40,528 5,633 9,836 50,364 Ratio % 31.12.06 11.9 1.6 2.9 14.7 Capital CHF million 31.12.05 39,834 4,975 3,974 43,808 Ratio % 31.12.05 12.8 1.6 1.3 14.1 The Tier 1 capital includes preferred securities of CHF 5,633 million (USD 3,300 million and EUR 1,000 million) at 31 Decem- ber 2006 and CHF 4,975 million (USD 2,600 million and EUR 1,000 million) at 31 December 2005. 153 Financial Statements Notes to the Financial Statements Note 30 Fair Value of Financial Instruments and Continued Recognition of Transferred Financial Assets a) 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 available-for-sale 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 available-for-sale Derivative instruments designated as cash flow hedges Net unrealized gains and losses recognized directly in equity Carrying   value 31.12.06 Fair value 31.12.06 Unrealized   gain / (loss) 31.12.06 Carrying value 31.12.05 Fair value 31.12.05 Unrealized gain / (loss) 31.12.05 3.5 50.4 351.6 405.8 627.0 251.5 328.4 5.9 312.5 8.9 203.7 63.1 545.5 204.8 332.5 145.7 570.6 190.1 3.5 50.4 351.6 405.7 627.0 251.5 328.4 5.9 311.3 8.9 203.7 63.1 545.5 204.8 332.5 145.7 570.6 191.1 5.4 33.6 288.4 404.4 499.3 154.8 333.8 1.2 279.9 6.6 124.3 59.9 478.5 188.6 337.7 117.4 466.9 160.7 5.4 33.6 288.3 404.5 499.3 154.8 333.8 1.2 280.5 6.6 124.3 59.9 478.5 188.6 337.7 117.4 466.9 162.0 0.0 0.0 0.0 (0.1) 0.0 0.0 0.0 0.0 (1.2) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (1.0) (2.3) 3.7 (0.6) 0.8 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) 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 in- struments 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 evi- dence of the fair value of a financial instrument. Market prices and rates are not, however, available for certain 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 and financial assets and liabilities held for trading and designated at fair value. The most frequently applied pricing 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 significantly 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, dis- count rates, volatility, and credit risk. The following methods and significant assumptions have been applied in determining the fair values of financial in- struments presented in the 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 assets pledged as collateral, financial assets and liabilities designated at fair value through profit or loss, deriva- tives, and other transactions undertaken for trading 154 Note 30 Fair Value of Financial Instruments and Continued Recognition of Transferred Financial Assets (cont.) a) Fair Value of Financial Instruments (continued) purposes are measured at fair value by reference to quot- ed 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; (b) financial investments 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 un- realized gains and losses, excluding impairment write- downs, are recorded in Equity until an asset is sold, col- lected 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 impair- ment is recognized 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 quality of loans within the portfolio are not taken into account in determining gross fair values, as the impact of impairment is recognized separately by deducting the amount of the allowance for credit losses from both carrying and fair values. Where applicable, the interest accrued to date on finan- cial instruments is included in the carrying value of the finan- cial instruments mentioned in the table. These valuation techniques and assumptions provide a consistent measurement of fair value for UBS’s assets and liabilities as shown in the table. However, because other in- stitutions may use different methods and assumptions when estimating fair value using a valuation technique, and when estimating the fair value of financial instruments not carried at fair value, such fair value disclosures cannot necessarily be compared from one financial institution to another. The table does not reflect the fair values of non-financial assets and liabilities such as property, equipment, goodwill, prepayments and non-interest accruals. Fair values of physi- cal commodities are reflected in the table under trading portfolio assets. Substantially all of UBS’s undrawn commitments to ex- tend credit are at variable rates. Accordingly, UBS has no significant exposure to fair value fluctuations resulting from interest rate movements related to these commitments. The fair values of UBS’s fixed-rate loans, long- and medi- um-term notes and bonds issued are predominantly hedged by derivative instruments, mainly interest rate swaps, as ex- plained in Note 23. The interest rate risk inherent in balance sheet positions with no specific maturity is also hedged with derivative instruments based on management’s view of 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 interest rate risk on a fixed-rate financial instrument is hedged with a derivative in a fair value hedge, the fixed-rate financial instrument (or hedged portion 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 des- ignated as cash flow hedges is explained in Note 1 a14). The amount shown in the table as Derivative instruments desig- nated as cash flow hedges is the net change in fair values on such derivatives that is recorded in Equity and not yet trans- ferred to income or expense. 155 Financial Statements Notes to the Financial Statements Note 30 Fair Value of Financial Instruments and Continued Recognition of Transferred Financial Assets (cont.) b) Determination of Fair Values from Quoted Market Prices or Valuation Techniques For trading portfolio assets and liabilities, financial assets and liabilities designated at fair value and financial investments available-for-sale which are listed or otherwise traded in an active market, for exchange traded derivatives, and for other financial instruments for which quoted prices in an active market are available, fair value is determined directly from those quoted market prices. For financial instruments which do not have quoted market prices directly available, fair values are estimated using valua- tion techniques or models, based wherever possible on as- sumptions supported by observable market prices or rates pre- vailing at the balance sheet date. This is the case for the majority 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 cannot be obtained directly from quoted market prices, or indirectly using valuation techniques or models sup- ported by observable market prices or rates. This is gener- ally the case for private equity investments in unlisted secu- rities, and for certain complex or structured financial instruments. In these cases, fair value is estimated indirect- ly using valuation techniques or models for which the in- puts are reasonable assumptions, based on market con- ditions. The following table presents the valuation methods used to determine fair values of financial instruments carried at fair value: CHF billion Trading portfolio assets Trading portfolio assets pledged as collateral Positive replacement values Financial assets designated at fair value Financial investments available-for-sale Total assets Trading portfolio liabilities Negative replacement values Financial liabilities designated at fair value Total liabilities 31.12.06 Valuation  technique –   market-   observable   Valuation   technique –   non-market   observable   inputs 411.8 8.0 285.6 5.1 4.6 715.1 34.9 290.6 80.0 405.5 inputs 0.1 0.0 11.5 0.8 1.8 14.2 0.0 9.2 65.7 74.9 Total 627.0 251.5 328.4 5.9 8.9 1,221.7 204.8 332.5 145.7 683.0 Quoted   market   price 215.1 243.5 31.3 0.0 2.5 492.4 169.9 32.7 0.0 202.6 31.12.05 Valuation technique – market- observable inputs Valuation technique – non-market observable inputs Quoted market 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 Total 499.3 154.8 333.8 1.2 6.6 995.7 188.6 337.7 117.4 643.7 156 Note 30 Fair Value of Financial Instruments and Continued Recognition of Transferred Financial Assets (cont.) c)  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. All models used for valuation undergo an internal validation 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 pa- rameters it employs, and the extent to which inputs are not market observable, or as a result of other elements affecting the valuation. Valuation adjustments are made to reflect such uncertainty and deducted from the fair values produced by the models or other valuation techniques. Based on UBS’s established fair value and model gover- nance policies and the related controls and procedural safe- guards the Group employs, management believes the result- ing 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 alter- native 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 1,038 million using less favorable assumptions and an increase of approximately CHF 955 million using more favor- able assumptions at 31 December 2006; and a reduction of approximately CHF 1,094 million using less favorable assump- tions and an increase of approximately CHF 1,176 million us- ing more favorable assumptions at 31 December 2005. The determination of reasonably possible alternative as- sumptions is itself subject to considerable judgment. For val- uations based on models, reasonably possible alternatives have been estimated using the same techniques as are used to determine model valuation adjustments, by increasing (for less favorable assumptions) and decreasing (for more favorable assumptions) the confidence level applied. In changing the assumptions, it is assumed that the impact of correlation between different financial instruments and models is minimal. A similar approach is used for valuation techniques other than those based on models. d)  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 2006 and 31 December 2005 was CHF 13,318 million and CHF 7,996 million, respectively, which represents the net re- sult from a range of products traded across different busi- ness activities, including the effect of the foreign currency translation of monetary assets and liabilities and including both realized and unrealized income. Unrealized income is determined from changes in fair values, using quoted prices in active markets when available, and otherwise estimated using valuation techniques. Included in the unrealized portion of Net trading income are net losses from changes in fair value of CHF 8,284 mil- lion and CHF 2,286 million for the years ended 31 December 2006 and 31 December 2005, respectively, on financial in- struments for which fair values were estimated using valuation techniques. These valuation techniques include models such as those described in previous sections, which range from relatively simple models with market-observable inputs, to those which are more complex and require the use of assumptions or estimates based on market conditions. Net trading income is often generated from transactions involving several financial instruments or subject to hedging or other risk management techniques. This may result in different portions of the transaction being priced using dif- ferent methods. In many cases, the amounts estimated using valuation techniques were offset by changes in fair value of other financial instruments or transactions, for which quoted market prices or rates were available, or on which the gain or loss has been realized. Consequently, the changes in fair value which were estimated using valuation techniques and have been recognized in profit or loss during the period rep- resent only a portion of Net trading income. The amount of realized income and unrealized income from changes in fair values estimated using quoted market prices, including the effect of foreign currency translation on unrealized gains or losses, was a gain of CHF 21,602 million, CHF 10,282 million and CHF 12,025 million for the years end- ed 31 December 2006, 31 December 2005 and 31 December 2004, respectively. Changes in fair value estimated using valuation techniques are also recognized in net profit in situations of unrealized impairments on financial investments available-for-sale. The total of such impairment amounts recognized in Net profit was CHF 10 million for the year ended 31 December 2006, CHF 3 million for the year ended 31 December 2005 and CHF 218 million for the year ended 31 December 2004. 157 Financial Statements Notes to the Financial Statements Note 30 Fair Value of Financial Instruments and Continued Recognition of Transferred Financial Assets (cont.) e) Transferred Financial Assets which do not Qualify for Derecognition The following table presents details of financial assets which have been sold or otherwise transferred, but which do not qualify for derecognition. Criteria for derecognition are discussed in Note 1 a4). CHF billion Nature of transaction Securities lending agreements Repurchase agreements Other financial asset transfers Total Continued asset recognition in full – Total assets 31.12.06 31.12.05 98.9 146.5 69.8 315.2 50.5 100.0 85.0 235.5 The transactions are mostly conducted under standard agreements employed by financial market participants and are undertaken with counterparties subject to UBS’s normal credit risk control processes. The resulting credit exposures are controlled by daily monitoring and collateralization of the positions. The financial assets which continue to be rec- ognized are typically transferred in exchange for cash or oth- er financial assets. The associated liabilities can therefore be assumed to be approximately the carrying amount of the transferred financial assets. UBS retains substantially all risks and rewards of the trans- ferred assets in each situation of continued recognition in full. These include credit risk, settlement risk, country risk and market risk. Repurchase agreements and securities lending agree- ments are discussed in Notes 1 a12) and 1 a13). Other financial asset transfers include sales of financial assets while concurrently entering into a total rate of return swap with the same counterparty and sales of financial assets involving guarantees. Transferred financial assets which are subject to partial continued recognition were immaterial in 2006 and 2005. The carrying amounts of the partially recognized transferred financial assets are included in the table. 158 Note 31  Pension and Other Post-Retirement Benefit Plans a) Defined benefit plans The Group has established various pension plans inside and outside of Switzerland. The major plans are located in 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 companies in Switzerland and Germany are included in the disclosure up to 31 December 2005 but are not included in the 31 December 2006 disclosure since these companies were sold on 23 March 2006. 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 contributions paid, is sufficient to maintain reasonable con- trol over the various funding risks of the plans. The invest- ment 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 allocation is determined by a variety of current economic and market 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 actuarial advisors. Swiss pension plans The pension plan of UBS covers practically all UBS em- ployees in Switzerland and exceeds the minimum benefit requirements under Swiss law. The Swiss plan was amended on 1 January 2007 to change the definition of retirement benefits from a final covered salary to a retirement savings approach. The pension plan provides benefits which are based on annual contributions as a percentage of salary and accrue at an interest rate that is defined annually by the plan trustees. Contributions to the pension plan of UBS are paid by em- ployees and the employer. The employee contributions are calculated as a percentage of covered salary and are deduct- ed monthly. The percentages deducted from salary for full benefit coverage (including risk benefits) depend on age and vary between 1% and 10% of covered base salary and 3% and 8% of covered bonus. The employer pays a contribution that ranges between 100% and 350%, or approximately 230%, on average, of the sum of employees’ contributions. The benefits covered include retirement benefits, disability, death and survivor pensions, and employment termination benefits. The employer contributions expected to be made in 2007 to the Swiss pension plan are CHF 520 million. The accumu- lated benefit obligation (which is the current value of ac- crued benefits without allowance for future salary increases) for the Swiss pension plan was CHF 19,094 million as of 31 December 2006 (2005: CHF 18,863 million, 2004: CHF 18,566 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 benefit plans. The locations with defined benefit plans of a material nature are in the UK, the US and Germany. The UK and the US defined benefit plans are closed to new entrants who are covered by defined contribution plans. 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 2007 to these pension plans are CHF 76 million. The funding policy for these plans is consistent with local government and tax requirements. The assumptions used in foreign plans take into account local economic conditions. The accumulated benefit obli- gation for these pension plans was CHF 5,142 million as of 31 December 2006 (2005: CHF 4,992 million, 2004: CHF 4,118 million). For pension plans with an accumulated ben- efit obligation in excess of plan assets, the aggregate pro- jected benefit obligation and accumulated benefit obligation was CHF 4,710 million and CHF 4,683 million as of 31 De- cember 2006 (2005: CHF 4,521 million and CHF 4,497 mil- lion, 2004: CHF 3,755 million and CHF 3,735 million). The fair value of plan assets for these plans was CHF 4,092 mil- lion as of 31 December 2006 (2005: CHF 3,789 million, 2004: CHF 3,166 million). 159 Financial Statements Notes to the Financial Statements Note 31  Pension and Other Post-Retirement Benefit Plans (continued) a) Defined benefit plans CHF million For the year ended Swiss Foreign 31.12.06 31.12.05 31.12.04 31.12.06 31.12.05 31.12.04 Defined benefit obligation at the beginning of the year (20,972) (20,225) (18,216) (5,020) (4,142) (3,663) (347) (611) (221) (125) (265) 723 (17) 329 (21,506) 20,229 998 447 492 221 (723) (328) 21,336 (170) 2,123 (353) (660) (219) (345) (672) (203) (713) (1,392) 866 (37) 369 (20,972) 18,575 925 1,284 468 219 (866) (376) 20,229 (743) 2,334 910 (35) (272) (20,225) 17,619 878 102 411 203 (910) 272 18,575 (1,650) 3,006 (76) (242) (120) (84) 149 186 (5,207) 4,288 283 40 74 66 (82) (236) (416) (280) 144 (2) (6) (5,020) 3,580 263 247 253 89 (83) (212) (296) 146 125 (159) (4,142) 3,402 248 122 (132) 65 (149) (144) (125) 4,602 (605) 1,237 1 4,288 (732) 1,222 1 3,580 (562) 1,046 1 (1,953) (1,591) (1,356) 0 0 0 633 491 485 (492) 492 (468) 468 (411) 411 0 0 0 0 0 0 491 (103) 66 170 9 633 815 (182) 633 485 (125) 89 (6) 48 491 832 (341) 491 710 (105) 65 (159) (26) 485 805 (320) 485 Service cost Interest cost Plan participant contributions Amendments 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 past 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 Settlement Foreign currency translation (Accrued) / prepaid pension cost Amounts recognized in the balance sheet Prepaid pension cost Accrued pension liability (Accrued) / prepaid pension cost 160 Note 31  Pension and Other Post-Retirement Benefit Plans (continued) a) Defined benefit plans (continued) CHF million For the year ended Components of net periodic pension cost Service cost Interest cost Expected return on plan assets 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 Defined benefit obligation from funded plans 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 Swiss Foreign 31.12.06 31.12.05 31.12.04 31.12.06 31.12.05 31.12.04 347 611 (998) 125 25 17 365 492 353 660 (925) (3) 101 37 10 235 468 345 672 (878) 35 237 411 Swiss 76 242 (283) 68 82 236 (263) 68 2 83 212 (248) 58 103 125 105 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 (20,225) 18,575 (1,650) (18,216) 17,619 (597) (19,204) 16,566 (2,638) (21,506) 21,336 (170) (265) 447 (20,972) 20,229 (743) (77) 1,284 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 Foreign (5,002) (205) 4,602 (605) (11) 40 (4,635) (385) 4,288 (732) 7 247 Swiss (3,815) (327) 3,580 (562) (3,509) (154) 3,402 (261) (3,295) (141) 2,382 (1,054) Foreign 31.12.06 31.12.05 31.12.04 31.12.06 31.12.05 31.12.04 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 3.0 5.0 2.5 0.8 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 5.2 4.6 2.1 5.0 6.7 4.4 1.9 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 1.9 161 Financial Statements Notes to the Financial Statements Note 31  Pension and Other Post-Retirement Benefit Plans (continued) a) Defined benefit plans (continued) CHF million, exept where indicated Expected future benefit payments 2007 2008 2009 2010 2011 2012–2016 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 31.12.06 31.12.05 31.12.04 31.12.06 31.12.05 31.12.04 157 150 160 171 183 1197 53 38 4 5 100 49–53 37–44 4–6 1–5 7.8 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 10.8 976 992 1,013 1,008 1,022 5,307 41 45 11 3 100 33–51 31–50 10–19 0 7.2 684 193 7,169 69 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 1 The number of UBS AG shares was 2,600,417; 3,589,152; and 4,986,346 as of 31 December 2006, 31 December 2005 and 31 December 2004, respectively. 162 Note 31  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 ben- efits that contribute to the health care coverage of employ- ees and beneficiaries after retirement. In addition to retiree medical benefits, the Group in the US also provides retiree life insurance benefits. The UK plan is closed to new en- trants. The benefit obligation in excess of fair value of plan assets for those plans amounts to CHF 219 million as of 31 Decem- ber 2006 (2005: CHF 216 million, 2004: CHF 166 million) and the total accrued post-retirement cost amounts to CHF 176 million as of 31 December 2006 (2005: CHF 168 million, 2004: CHF 136 million). The net periodic post-retirement costs for the years ended 31 December 2006, 31 December 2005 and 31 December 2004 were CHF 24 million, CHF 21 million and CHF 16 million, respectively. The employer contributions expected to be made in 2007 to the post-retirement medical and life plans are CHF 9 mil- lion. The expected future benefit payments are CHF 9 mil- lion for the years 2007 and 2008, CHF 10 million for the years 2009 and 2010, CHF 11 million for the year 2011, CHF 64 million in total for the years 2012 to 2016. b) Post-retirement medical and life plans CHF million Post-retirement benefit obligation at the beginning of the year 31.12.06 (216) 31.12.05 (166) 31.12.04 (179) Service cost Interest cost Plan participant contribution Actuarial gain / (loss) Foreign currency translation Amendments Benefits paid (10) (11) (1) 1 10 (1) 9 (8) (11) 0 (17) (22) 0 8 (6) (9) 0 8 12 0 8 Post-retirement benefit obligation at the end of the year (219) (216) (166) Fair value of plan assets at the beginning of the year Employer contributions Plan participant contribution Benefits paid Fair value of plan assets at the end of the year 0 8 1 (9) 0 0 8 0 (8) 0 0 8 0 (8) 0 Defined benefit obligation Plan asset Surplus / (deficit) Experience gains / (losses) on plan liabilities 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 (219) 0 (219) 1 (216) 0 (216) (3) (166) 0 (166) 0 (179) 0 (179) 0 (166) 2 (164) 0 The assumed average health care cost trend rate used in determining post-retirement benefit expense is assumed to be 11% for 2006 and to decrease to an ultimate trend rate of 5% in 2013. On a country-by-country basis, the same discount rate is used for the calculation of the post-retire- ment benefit obligation from medical and life plans as for the defined benefit obligations arising from pension plans. Assumed health care cost trend rates have a significant ef- fect on the amounts reported for health care plans. 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) (19) 163 Financial Statements Notes to the Financial Statements Note 31  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 em- ployees to make contributions and earn matching or other contributions from the Group. The contributions to these plans recognized as expense for the years ended 31 December 2006, 31 December 2005 and 31 December 2004 were CHF 229 million, CHF 184 million and CHF 187 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 borrowing. All transactions have been executed at arm’s length conditions. 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 following fees and interest have been received or paid by UBS: CHF million Received by UBS Fees Paid by UBS Interest Dividends and capital repayments The transaction volumes in UBS shares and other UBS securities are as follows: 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 31.12.06 31.12.05 31.12.04 53 2 33 48 4 7 42 4 7 For the year ended 31.12.06 31.12.05 31.12.04 1,793 8 2,752 14 2,774 0 4,526 45 5,644 47 7,426 18 UBS has also leased buildings from its pension funds. The rent paid by UBS under these leases amounted to CHF 4 mil- lion in 2006, CHF 4 million in 2005 and CHF 5 million in 2004. There were financial instruments in the amount of CHF 120 million due from UBS pension plans outstanding as of 31 December 2006 (2005: CHF 163 million, 2004: 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 14,158,961 UBS shares with a market value of CHF 1,043 million as of 31 December 2006 (2005: 14,128,558 shares with a market value of CHF 885 million, 2004: 14,460,628 shares with a market value of CHF 691 million). 164 Note 32  Equity Participation and Other Compensation Plans  a) Plans offered UBS has established several equity participation plans to further align the long-term interests of executives, managers and staff with the interests of shareholders. The plans are offered to eligible employees in approximately 50 countries and are designed to meet the complex legal, tax and regula- tory requirements of each country in which they are offered. The explanations below describe the most significant plans in general, but specific plan rules may vary by country. Equity Plus Plan (Equity Plus): This voluntary plan gives eligible employees the opportunity to purchase UBS shares at fair market value on the purchase date and generally re- ceive 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 shares on the date the option is granted and are forfeitable in certain circumstances. Share purchases can be made annually from bonus compensation and/or quarterly based on regular de- ductions 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 period and generally expire ten years from the date of grant. Discounted purchase plan: Up to and including 2005, selected employees in Switzerland were entitled to purchase a specified number of UBS shares, which must be held for a specified period of time, at a predetermined discounted price each year. No new awards are made under this plan. Equity Ownership Plan (EOP): Selected employees 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, cer- tain employees were eligible to receive a portion of their EOP award in Alternative Investment Vehicles (AIVs) or UBS op- tions. Since 2005, options are not granted as part of EOP and awards are generally made in UBS shares, with less than 5% being made in AIVs to selected employee groups. EOP awards vest in one-third increments over a three-year vesting period. In certain circumstances, these awards are forfeit- able. Key Employee Stock Option Plan (KESOP): 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. One option gives the right to ac- quire one registered UBS share at the option’s strike price. Options generally vest in one-third increments over a three- year vesting period and generally expire ten years from the grant date. In certain circumstances, these awards are for- feitable. 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 (generally money market funds, UBS and non-UBS mutual funds and other UBS sponsored funds). No additional company match is granted, and the awards are generally not forfeitable. In ad- dition, 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 trea- sury or newly issued shares are delivered to the employee against receipt of the strike price. As of 31 December 2006, UBS was holding approximately 115 million shares in trea- sury and an additional 150 million unissued shares in condi- tional share capital which are available and can be used for future employee option exercises. The shares available cover all vested (i.e. exercisable) employee options. 165 Financial Statements Notes to the Financial Statements Note 32  Equity Participation and Other Compensation Plans (Continued) b) UBS share awards Movements in shares granted under various equity participation plans described in Note 32a) are as follows: 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  31.12.06 53,725,186 26,652,070 (22,712,566) (1,523,588) 56,141,102 Weighted   average   grant date   fair value   (CHF) 46 69 43 56 58 Number of shares 31.12.05 49,273,638 27,252,100 (21,991,760) (808,792) 53,725,186 Weighted average grant date fair value (CHF) 40 51 39 45 46 Number of shares 31.12.04 62,767,780 23,426,812 (35,992,996) (927,958) 49,273,638 Weighted average grant date fair value (CHF) 38 48 40 39 40 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 1,587 million, CHF 1,083 million and CHF 1,922 million for the years ended 31 December 2006, 31 December 2005 and 31 December 2004, respectively. c) UBS option awards Movements in options granted under various equity participation plans described in Note 32a) are as follows: 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   31.12.06 181,765,090 45,517,013 (47,179,386) (3,303,002) (20,628) 176,779,087 80,312,503 Weighted 1   average1   exercise price1   (CHF) 1 42 71 36 55 40 50 36 Number of options 31.12.05 201,814,708 45,202,854 (61,303,418) (3,810,106) (138,948) 181,765,090 74,788,838 Weighted1 average1 exercise price1 (CHF) 1 35 55 34 45 34 42 35 Number of options 31.12.04 218,080,052 48,226,504 (58,793,918) (5,385,648) (312,282) 201,814,708 75,882,560 Weighted1 average1 exercise price1 (CHF) 1 32 46 29 33 38 35 33 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 rate for the purposes of this table. The weighted average share price at the time when the op- tions were exercised during the year was CHF 71, CHF 53 and CHF 46 for the years ended 31 December 2006, 31 De- cember 2005 and 31 December 2004, 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) 31.12.06 31.12.05 31.12.04 1,660 12 1,224 8 960 13 In addition, UBS received cash of CHF 1,698 million and CHF 2,018 million and an income tax benefit of CHF 153 million and CHF 217 million from the exercise of share options for the years ended 31 December 2006 and 31 December 2005, respectively. The intrinsic value of share-based liabilities (shares and options) paid for the years ended 31 December 2006, 31 December 2005 and 31 December 2004 was CHF 177 million, CHF 87 million and CHF 669 million, respectively. 166 Note 32  Equity Participation and Other Compensation Plans (continued) c) UBS option awards (continued) The following table summarizes additional information about options outstanding and options exercisable at 31 Decem- ber 2006: Range of exercise price per share Options outstanding Weighted average exercise price (CHF / USD) Aggregate intrinsic value (CHF / USD million) Weighted average remaining contractual term (years) Options exercisable Weighted average exercise price (CHF / USD) Aggregate intrinsic value (CHF / USD million) Weighted average remaining contractual term (years) Number of options exercisable Number of options outstanding 22,771,326 18,173,910 25,666,234 3,100,770 41,726,240 111,438,480 1,196,068 28,759,581 14,070,241 21,314,717 65,340,607 34.56 46.86 51.96 65.95 71.56 55.30 13.75 23.32 36.38 43.76 32.63 899 494 567 25 127 5.7 6.5 8.1 9.4 9.2 22,446,861 11,928,252 3,412,867 5,812 0 34.56 46.74 50.72 63.23 886 326 80 0 2,112 7.8 37,793,792 39.87 1,292 56 1,064 337 353 1,810 0.6 4.6 7.3 8.1 1,196,068 28,759,581 9,199,687 3,363,375 6.2 42,518,711 13.75 23.32 35.89 42.72 27.31 56 1,064 225 59 1,404 5.7 6.1 8.2 8.9 6.1 0.6 4.6 7.2 8.1 5.3 CHF 26.69–40.00 40.01–50.00 50.01–60.00 60.01–70.00 70.01–77.33 26.69–77.33 USD 2.25–20.00 20.01–30.00 30.01–40.00 40.01–53.50 2.25–53.50 d) Valuation The fair value of options granted from 1 January 2005 has been determined by means of a Monte Carlo simulation. The simulation technique uses a mix of implied and historic vola- tility and specific employee exercise behavior patterns based on statistical data, taking into account the specific terms and conditions under which the 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 option is calculated as the probability-weighted average period of the time between grant and exercise. The term structure of volatility is derived from the implied vola- tilities of traded UBS options in combination with the ob- served 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 2006 and 2005 was determined using the following assumptions: Expected volatility (%) Risk-free interest rate (%) Expected dividend (CHF) Strike price (CHF) Share price (CHF) 1 Less than 1% of awards in 2006 were granted in USD. These have been combined with CHF awards for purposes of this disclosure. CHF awards 1 25.38 2.15 2.26 71.19 70.16 31.12.06 range low range high 22.51 1.96 1.76 65.13 65.13 27.18 2.68 2.83 77.33 76.25 167 Financial Statements Notes to the Financial Statements Note 32  Equity Participation and Other Compensation Plans (Continued) d) Valuation (continued) 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 2.30 52.08 51.33 12.39 0.62 1.50 48.23 48.23 27.03 2.34 3.89 63.23 63.23 23.36 4.11 1.89 44.11 43.40 15.21 1.91 1.22 39.25 39.25 27.21 4.63 4.12 48.26 48.26 The fair value of options granted during 2004 was determined using a proprietary option pricing model, similar to an American-style binomial model, using the following assumptions: 31.12.04 Expected volatility (%) Risk-free interest rate (%) Expected dividend rate (%) Strike price (CHF/USD) Share price (CHF/USD) Expected life (years) CHF awards USD awards 33.66 2.03 3.86 47.80 47.09 5.6 33.45 3.70 3.88 37.56 37.03 5.6 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 recog- nizes compensation expense over the requisite service period which is generally equal to the vesting period. Share and op- tion awards typically have a three-year tiered vesting struc- ture which means awards vest in one-third increments over that period. The total share-based compensation expense recognized for the years ended 31 December 2006, 31 De- cember 2005 and 31 December 2004 was CHF 2,188 mil- lion, CHF 1,662 million and CHF 1,406 million, respectively. The total income taxes recognized in the income statement in relation to these expenses were a benefit of CHF 491 mil- lion, CHF 431 million and CHF 64 million for the years ended 31 December 2006, 31 December 2005 and 31 December 2004, respectively. For the years ended 31 December 2006, 31 December 2005 and 31 December 2004, the compensa- tion expense recognized for share-based payments was pri- marily related to equity settled plans. At 31 December 2006, total compensation expense re- lated to nonvested awards not yet recognized in the income statement is CHF 1,679 million, which is expected to be rec- ognized in Personnel expenses over a weighted average pe- riod of 1.7 years. 168 Note 33 Related Parties The Group defines related parties as associated companies, post-employment benefit plans for the benefit of UBS em- ployees, key management personnel, close family members of key management personnel and 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. Key management personnel is defined as members of the Board of Directors (BoD) and Group Execu- tive Board (GEB). This definition is based on the requirements of IAS 24 Related Party Disclosures and the “Directive on Information Relating to Corporate Governance” issued by the SWX Swiss Exchange. 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) For the year ended 31.12.06 31.12.05 31.12.04 16 107 1 2 15 90 1 3 15 70 1 2 The non-executive members of the BoD do not have employment 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 5.9 million in 2006, CHF 6.1 million in 2005 and CHF 5.7 million in 2004. 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 31.12.06 10,886,798 7,974,724 31.12.05 10,862,250 8,713,984 31.12.04 12,009,994 7,013,220 Of the share totals above, at 31 December 2006 and 31 De- cember 2005, respectively, 7,146 shares and 6,538 shares were held by close family members of key management per- sonnel and 2,200,000 shares and 2,486,060 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 manage- ment personnel or their close family members. Further infor- mation about UBS’s equity participation plans can be found in Note 32. No member of the BoD or GEB is the beneficial owner of more than 1% of the Group’s shares at 31 Decem- ber 2006. 169 Financial Statements Notes to the Financial Statements Note 33 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 reduced 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 31.12.06 31.12.06 21 1 (3) 19 16 7 (2) 21 No unsecured loans were granted to key management personnel as of 31 December 2006 and 31 December 2005. 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 Foreign currency translation Balance at the end of the year 31.12.06 31.12.05 321 116 (48) 1 (15) 375 83 267 (26) (3) 0 321 All loans to associated companies are transacted at arm’s length. Of the balances above, the amount of unsecured loans amounted to CHF 177 million and CHF 82 million at 31 December 2006 and 31 December 2005, 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 Note 35 provides a list of significant associates. For the year ended or as of 31.12.06 31.12.05 31.12.04 58 79 32 397 258 39 248 180 170 Note 33 Related Parties (continued) e) Other related party transactions During 2006 and 2005, 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 management personnel or their close family members. In 2006 and 2005 these companies included BMW Group (Germany), Kedge Capital Funds Ltd. (Jersey), Löwenfeld AG (Switzerland), Royal Dutch Shell plc (UK), Seromer Biotech SA (Switzerland, previously Ber- tarelli Biotech SA), Serono Group (Switzerland), Stadler Rail Group (Switzerland), Team Alinghi (Switzerland), and Unisys Cor- poration (USA). Related parties in 2006 also included Aebi + Co. AG (Switzerland), Bertarelli Family (Switzerland), DKSH Hold- ing AG (Switzerland), Kedge Capital Selected Funds Ltd. (Jersey), Lista AG (Switzerland), Martown Trading Ltd. (Isle of Man) and Team Alinghi (Spain). Movements in loans to other related parties are as follows: CHF million Balance at the beginning of the year Additions Reductions Loan at the end of the year 1 31.12.06 31.12.05 919 34 81 872 294 628 3 919 1 In 2006 includes loans, guarantees and contingent liabilities of CHF 128 million and unused committed facilities of CHF 744 million but excludes unused uncommitted working capital facilities and unused guarantees of CHF 173 million. In 2005 includes loans, guarantees and contingent liabilities of CHF 116 million and unused committed facilities of CHF 804 million but excludes unused uncom- mitted working capital facilities and unused guarantees of CHF 52 million. 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 31.12.06 31.12.05 31.12.04 8 8 15 1 34 10 As part of its sponsorship of Team Alinghi, defender for the “America’s Cup 2007”, UBS paid CHF 8.7 million (EUR 5.4 mil- lion) in sponsoring fees for 2006. 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. Note 34 Post-Balance Sheet Events There have been no material post-balance sheet events which would require disclosure or adjustment to the 31 Decem- ber 2006 Financial Statements. The closing of the acquisition of McDonald Investments’ Branch Network and the announcement of the acquisition of Standard Chartered’s mutual funds management business in 2007 are discussed in Note 37. On 8 March 2007, 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 18 April 2007 for approval. 171 Financial Statements Notes to the Financial Statements 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, regula- tory and funding framework. Neither the Business Groups of UBS (namely Investment Bank, Global Wealth Manage- ment & 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 capital, 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 acquisition, 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 compa- nies in the Group are listed below: Significant subsidiaries Company Banco UBS Pactual S.A. Banco UBS S.A. Crédit Industriel Société Anonyme in Liquidation Jurisdiction of incorporation Rio de Janeiro, Brazil Rio de Janeiro, Brazil Zurich, Switzerland Dillon Read Capital Management (Singapore) Pte. Ltd. Singapore, Singapore Dillon Read Capital Management (UK) Ltd Dillon Read Capital Management LLC Dillon Read Solutions Pte. Ltd. Noriba Bank BSC OOO UBS Bank PT UBS Securities Indonesia Thesaurus Continentale Effekten UBS (Bahamas) Ltd. UBS (France) S.A. London, Great Britain Delaware, USA Singapore, Singapore Manama, Bahrain Moscow, Russia Jakarta, Indonesia Zurich, Switzerland Nassau, Bahamas Paris, France Business Group 1 IB IB Global WM&BB Global AM Global AM Global AM Global AM 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) S.p.A. UBS (Luxembourg) S.A. UBS (Monaco) S.A. UBS Advisory and Capital Markets Australia Ltd UBS Alternative and Quantitative Investments LLC UBS Americas Inc UBS Asesores SA UBS Bank (Canada) UBS Bank USA UBS Belgium SA/NV UBS Capital (Jersey) Ltd UBS Capital AG UBS Capital B.V. UBS Card Center AG Milan, Italy Luxembourg, Luxembourg Monte Carlo, Monaco Sydney, Australia Delaware, USA Delaware, USA Panama, Panama Toronto, Canada Utah, USA Brussels, Belgium St. Helier, Jersey Zurich, Switzerland Amsterdam, the Netherlands Global WM&BB Global WM&BB Global WM&BB IB Global AM IB Global WM&BB Global WM&BB Global WM&BB Global WM&BB IB IB IB Glattbrugg, Switzerland Global WM&BB UBS Clearing and Execution Services Limited London, Great Britain UBS Commodities Canada Ltd. UBS Corporate Finance Italia SpA UBS Derivatives Hong Kong Limited UBS Deutschland AG UBS Employee Benefits Trust Limited UBS Energy LLC UBS España, S.A. UBS Factoring AG Toronto, Canada Milan, Italy Hong Kong, China IB IB IB IB Frankfurt am Main, Germany Global WM&BB St. Helier, Jersey Delaware, USA Madrid, Spain Zurich, Switzerland CC IB Global WM&BB Global WM&BB Share capital in millions Equity interest accumulated in % BRL BRL CHF USD GBP USD USD USD RUB IDR CHF USD EUR USD EUR CHF EUR AUD USD USD USD CAD USD EUR GBP CHF EUR CHF USD USD EUR HKD EUR GBP USD EUR CHF 296.7 52.9 0.1 8.6 18.0 12.5 1.1 10.0 1,250.0 100,000.0 0.1 4.0 25.7 25.0 60.0 150.0 9.2 580.8 2 0.1 0.0 0.0 8.5 1,700.0 23.0 181.0 5.0 78.8 2 0.1 50.0 11.3 1.9 60.0 176.0 0.0 0.0 72.2 5.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 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 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. 172 Share capital in millions Equity interest accumulated in % Note 35  Significant Subsidiaries and Associates (continued) Significant subsidiaries (continued) Company UBS Fiduciaria S.p.A. UBS Fiduciary Trust Company UBS Finance (Cayman Islands) Ltd. UBS Finance (Curação) N.V. UBS Finance (Delaware) LLC UBS Financial Services Inc. Jurisdiction of incorporation 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, L.L.C. UBS Fund Holding (Luxembourg) S.A. UBS Fund Holding (Switzerland) AG UBS Fund Management (Switzerland) AG UBS Fund Services (Cayman) Ltd UBS Fund Services (Ireland) Limited UBS Fund Services (Luxembourg) SA UBS Futures Singapore Ltd. Delaware, USA Luxembourg, Luxembourg Basel, Switzerland Basel, Switzerland George Town, Cayman Islands Dublin, Ireland Luxembourg, Luxembourg Singapore, Singapore 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 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 IB Global AM Global AM Global AM Global AM UBS Global Asset Management (France) S.A. 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 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 B.V. UBS International Inc. UBS International Life Limited 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 Menkul Degerler AS UBS Mortgage Holdings LLC UBS New Zealand Limited UBS O’Connor LLC UBS Pactual Asset Management S.A. DTVM UBS Portfolio LLC UBS Preferred Funding Company LLC I UBS Preferred Funding Company LLC II UBS Preferred Funding Company LLC IV 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 Toronto, Canada Milan, Italy Zurich, Switzerland Zurich, Switzerland California, USA London, Great Britain Delaware, USA Istanbul, Turkey Delaware, USA Global WM&BB Global WM&BB Global WM&BB IB Global WM&BB Global WM&BB Global WM&BB IB IB IB Global WM&BB Auckland, New Zealand IB Delaware, USA Rio de Janeiro, Brazil Global AM Global AM Delaware, USA Delaware, USA Delaware, USA Delaware, USA IB CC CC CC EUR USD USD USD USD USD USD USD CHF CHF CHF USD EUR CHF USD USD AUD CAD EUR EUR HKD EUR JPY SGD TWD USD GBP CHF CAD EUR USD EUR CAD EUR CHF CHF USD GBP USD TRY USD NZD USD BRL USD USD USD USD 0.2 4.4 2 0.5 0.1 37.3 2 2,005.8 2 31.0 2 0.0 42.0 18.0 1.0 5.6 1.3 2.5 39.8 2 0.0 8.0 117.0 7.7 2.1 25.0 2.0 2,200.0 4.0 340.0 35.2 2 48.0 5.0 0.1 6.8 44.3 2 1.0 0.0 15.1 10.0 25.0 39.3 2 29.4 16.7 0.4 0.0 7.5 1.0 53.9 0.1 0.0 0.0 0.0 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. 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 173 Financial Statements Notes to the Financial Statements Note 35  Significant Subsidiaries and Associates (continued) Significant subsidiaries (continued) Company UBS Principal Finance LLC UBS Real Estate Investments Inc UBS Real Estate Kapitalanlagegesellschaft mbH UBS Real Estate Securities Inc UBS Realty Investors LLC Jurisdiction of incorporation Delaware, USA Delaware, USA Munich, Germany Delaware, USA Massachusetts, USA UBS Sauerborn Private Equity Komplementär GmbH Bad Homburg, Germany Business Group 1 IB Global AM Global AM IB Global AM Global WM&BB 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 S.A. UBS Securities Hong Kong Limited UBS Securities India Private Limited UBS Securities International Limited UBS Securities Japan Ltd UBS Securities Limited UBS Securities LLC UBS Securities Malaysia Sdn. Bhd. UBS Securities Philippines Inc UBS Securities Pte. Ltd. UBS Securities Pte. Ltd. Seoul Branch UBS Services USA LLC 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 Delaware, USA Kuala Lumpur, Malaysia Makati City, Philippines Singapore, Singapore Seoul, South Korea Delaware, USA 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 UBS Wealth Management Australia Ltd 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 Melbourne, Australia Global WM&BB Global WM&BB IB IB Global WM&BB Global WM&BB Share capital in millions Equity interest accumulated in % USD USD EUR USD USD EUR THB HKD AUD CAD EUR EUR HKD INR GBP JPY GBP USD MYR PHP SGD KRW USD ZAR CHF USD USD USD GBP SGD GBP GBP GBP AUD 0.1 0.0 7.5 0.4 2 9.3 0.0 400.0 20.0 209.8 2 10.0 15.0 22.9 230.0 237.8 18.0 60,000.0 140.0 2,455.6 2 75.0 190.0 311.5 150,000.0 0.0 87.1 2 1.5 5.0 2 2.0 2.0 0.0 3.3 5.0 100.0 2.5 53.9 100.0 100.0 51.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 75.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 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. 174 Note 35  Significant Subsidiaries and Associates (continued) Consolidated companies: changes in 2006 Significant new companies Banco UBS Pactual S.A. – Rio de Janeiro, Brazil Dillon Read Capital Management (Singapore) Pte. Ltd. – Singapore, Singapore Dillon Read Capital Management (UK) Ltd – London, Great Britain Dillon Read Capital Management LLC – Delaware, USA Dillon Read Solutions Pte. Ltd. – Singapore, Singapore OOO UBS Bank – Moscow, Russia UBS Clearing and Execution Services Limited – London Great Britain UBS Futures Singapore Ltd. – Singapore, Singapore UBS Menkul Degerler AS – Instanbul, Turkey UBS Pactual Asset Management S.A. DTVM – Rio de Janeiro, Brazil UBS Sauerborn Private Equity Komplementär GmbH – Bad Homburg, Germany Deconsolidated companies Significant deconsolidated companies Aare-Tessin AG für Elektrizität – Olten, Switzerland Atel Energia S.r.l. – Milan, Italy Atel Installationstechnik AG – Olten, Switzerland Entrade GmbH – Schaffhausen, Switzerland Etra SIM SpA – Milan, Italy GAH Beteiligungs AG – Heidelberg, Germany Motor-Columbus AG – Baden, Switzerland Società Elettrica Sopracenerina SA – Locarno, Switzerland UBS (Trust and Banking) Limited – Tokyo, Japan UBS Capital II LLC – Delaware, USA UBS Preferred Funding Company LLC III – Delaware, USA Significant associates Company 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 ATR Acquisition LLC – Texas, USA Waterside Plaza Holdings LLC – Delaware, USA Industry Financial Financial Private Investment Company Private Investment Company Private Investment Company Manufacturing Real Estate A&Q Select Funds – Euro Limited – George Town, Cayman Islands Private Investment Company Williamsburg Edge LLC – Delaware, USA Real Estate Dillon Read Financial Products Trading Ltd – George Town, Cayman Islands Private Investment Company 1 For hedge funds net asset value instead of share capital. 2 UBS has significant influence even though it holds less than 20% of the voting power of the entity. Reason for deconsolidation Sold Sold Sold Sold Merged Sold Sold Sold Liquidated Liquidated Liquidated Equity interest in % Share capital in millions 32.9 33.3 37.4 21.8 29.9 24.2 50.0 22.0 50.0 7.1 2 CHF 26 CHF 45 USD 896 1 USD 427 1 USD 517 1 USD 314 USD 119 USD 3161 USD 78 USD 542 175 Financial Statements Notes to the Financial Statements Note 36 Invested Assets and Net New Money Invested assets include all client assets managed by or de- posited with UBS for investment purposes. Invested assets include, for example, managed fund assets, managed insti- tutional assets, discretionary and advisory wealth manage- ment portfolios, fiduciary deposits, time deposits, savings accounts and wealth management securities or brokerage accounts. All assets held for purely transactional purposes and custody-only assets, including corporate client assets held for cash management and transactional purposes, are excluded from invested assets as the Group only administers the assets and does not offer advice 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 UBS de- cides how a client’s assets are invested. Other invested assets are those where the client ultimately decides how the assets are invested. When a single product is created in one Busi- ness Group and sold in another, it is counted in both the Business Group that manages the investment 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 in a period is the net amount of invested assets that are entrusted to UBS by new and existing clients less those withdrawn by existing clients and clients who ter- minate their relationship with UBS. Net new money is calcu- lated using the direct method, by which in and outflows to/from invested assets are determined at the client level based on transactions. Interest expenses paid by clients on their loans are treated as net new money outflows. Interest and dividend income from invested assets is not counted as net new money inflow. Market and currency movements as well as fees and commissions are excluded from net new money, as are the effects resulting from any acquisition or divestment of a UBS subsidiary or business. Reclassifications between invested assets and client assets as a result of a change in the service level delivered are treated as net new money flows. CHF billion Fund assets managed by UBS Discretionary assets Other invested assets Total invested assets (double counts included) thereof double count thereof acquisitions (divestments) Net new money (double counts included) As of or for the year ended 31.12.06 31.12.05 439 849 1,701 2,989 371 81.1 151.7 390 716 1,546 2,652 332 (93.9) 148.5 176 Note 37 Business Combinations Business combinations completed in 2006 During 2006, UBS completed several acquisitions that were accounted for as business combinations. The acquisition of Banco Pactual S.A. was individually significant to the Finan- cial Statements and is therefore presented separately in this note. The other acquisitions are presented in aggregate per business group. Banco Pactual S.A. On 1 December 2006, UBS completed the acquisition of Bra- zilian bank Banco Pactual S.A. The bank was merged with UBS's Brazilian business, and both are now operating under the name UBS Pactual. The cost of the business combination is estimated at USD 2,194 million (CHF 2,677 million) but is still subject to final determination. Of the total consideration, USD 971 million (CHF 1,164 million) was paid on 1 Decem- ber 2006 in cash. The residual payment of up to USD 1.6 billion (CHF 1.9 billion) is subject to certain performance conditions and is due on 30 June 2011. The purchase price allocation is preliminary and will be finalized in 2007. The preliminary allocation shows the booking of net assets of USD 376 million (CHF 459 million), intangible assets of USD 830 million (CHF 1,013 million) and goodwill of USD 988 million (CHF 1,205 million). Identified intangible assets in- clude client relationships, non-compete agreements, favor- able contracts, investment banking pipeline, proprietary software, trademarks and trade names, with an economic useful life from 1 to 20 years. UBS Pactual offers a broad range of services in investment banking, asset management and wealth management. It has offices in São Paolo, Rio de Janeiro, Belo Horizonte and Recife. The residual payment obligation is reflected on UBS’s bal- ance sheet in Other liabilities and is measured at its present value (USD 1,223 million on acquisition date). It had no ef- fect on the Statement of Cash Flows for the year ended 31 December 2006. Book value Step-up to fair value Fair value CHF million Assets Intangible 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 0 9 16 0 11,877 11,902 52 28 11,363 11,443 459 11,902 1,013 0 0 1,205 0 2,218 0 0 0 0 2,218 2,218 1,013 9 16 1,205 11,877 14,120 52 28 11,363 11,443 2,677 14,120 Total 1,013 1,205 On the acquisition date, intangible assets and goodwill were allocated to the Business Groups as follows: CHF million Assets Intangible assets Goodwill Global Wealth Management & Business Banking Investment Bank Global Asset Management 176 50 349 962 488 193 Since the acquisition date, UBS Pactual contributed revenues of CHF 102 million to UBS’s results, and an after-tax profit of CHF 28 million after acquisition costs (retention payments and amortization of intangible assets) but excluding finance costs. 177 Financial Statements Notes to the Financial Statements Note 37 Business Combinations (continued) Investment Bank ABN AMRO’s Global Futures and Options Business On 30 September 2006, UBS acquired the global futures and options business of ABN AMRO for USD 704 million (CHF 880 million) in cash. The ABN AMRO futures and options business provides clearing and execution services on a global basis. The acquired business has been integrated into the Prime Services business within the Equities business of the Investment Bank. The purchase price was allocated to net assets of USD 362 million (CHF 452 million) and intangible assets of USD 108 million (CHF 134 million). The difference of USD 234 million (CHF 294 million) from the purchase price was recognized as goodwill. The acquired business contributed CHF 7 million to UBS’s net profit since the date of acquisition. Book value Step-up to fair value Fair value 0 13 26 0 11,942 11,981 0 11,574 11,574 407 11,981 134 0 54 294 0 482 9 0 9 473 482 134 13 80 294 11,942 12,463 9 11,574 11,583 880 12,463 CHF million Assets Intangible assets Property and equipment Financial investments available-for-sale Goodwill All other assets Total assets Liabilities Provisions All other liabilities Total liabilities Net assets Total liabilities and equity 178 Note 37 Business Combinations (continued) Global Wealth Management & Business Banking Piper Jaffray Companies’ Private Client Services Branch Network On 11 August 2006, UBS completed the acquisition of Pip- er Jaffray Companies’ Private Client Services branch net- work. The cost of the business combination consisted of USD 500 million (CHF 616 million) for the business opera- tions and of USD 227 million (CHF 280 million) for the loans to customers portfolio, resulting in a total cash con- sideration paid of USD 727 million (CHF 896 million). The purchase price was allocated to net assets of USD 236 mil- lion (CHF 291 million) and intangible assets of USD 120 million (CHF 148 million) representing client relationships. The difference of USD 371 million (CHF 457 million) from the purchase price was recognized as goodwill. The pur- chase price allocation and cost of the business combination is in the process of being finalized. Approximately 90 Piper CHF million Assets Intangible assets Property and equipment Financial investments available-for-sale Goodwill All other assets Total assets Liabilities Provisions Deferred tax liabilities All other liabilities Total liabilities Net assets Total liabilities and equity Jaffray wealth management offices, mainly located in the Midwest and Western United States, serving 190,000 households, will be renamed and integrated into Wealth Management US. UBS has retained approximately 700 of Piper Jaffray’s financial advisors, which corresponds to ap- proximately 80% of the advisors before the acquisition. The acquisition is expected to benefit Wealth Management US’s existing business by expanding the presence in the re- gions where the acquired branches are located. Dolfi On 2 March 2006, UBS acquired Dolfi Finance SAS, a small wealth management firm based in Strasbourg, France, as well as certain assets from Mr Dolfi. The company, estab- lished 18 years ago, serves clients in the North Eastern part of France and had more than EUR 600 million of invested assets on the acquisition date. The acquisition complements UBS’s existing wealth management business in France. Book value Step-up to fair value Fair value 0 16 1 0 291 308 0 0 2 2 306 308 158 (4) 0 479 0 633 8 3 4 15 618 633 158 12 1 479 291 941 8 3 6 17 924 941 179 Financial Statements Notes to the Financial Statements Note 37 Business Combinations (continued) Acquisitions of minority interests of subsidiaries in 2006 UBS Bunting Limited On 28 March 2006, UBS acquired the 50% minority interest in its Canadian institutional securities subsidiary, UBS Bun- ting Limited. The purchase price consists of a combination of cash and UBS shares and has been estimated at CAD 163 million (approximately CHF 182 million). Approximately CAD 23 million (CHF 26 million) of the consideration is linked to the performance of the acquired business in 2006 and 2007 and may be reduced if agreed revenue targets are not achieved. The difference between the purchase price and the carrying value of the acquired minority interest of CAD 116 million (CHF 129 million) was reflected in Equity. Through this transaction UBS now wholly owns the Investment Bank’s operations in Canada, which continue to operate under the same leadership team as before this transaction. Business combinations announced but not yet completed Beijing Securities Ltd. In April 2006 UBS entered into a commitment to acquire the restructured activities of Beijing Securities, a Chinese broker- age and securities firm. Under the terms of the transaction, a new company, UBS Securities Co. Limited emerges, in which UBS is expected to have a 20% capital stake and ob- tain management and operational control. The cost of the business combination including capital contributions and transaction costs is expected to be approximately CHF 278 million (RMB 1.8 billion). UBS Securities Co. Limited will operate in China on the basis of a comprehensive set of domestic securities licences offering corporate finance, equities, fixed income, wealth management and asset management service. On 11 December 2006, UBS Securities Co. Limited was of- ficially established following the registration of the business. The closing of the transaction, which is subject to final regula- tory approval, is expected during first half 2007. Business combinations completed in 2005 During 2005, UBS completed several acquisitions that were accounted for as business combinations. None of the acqui- sitions was individually significant to the Financial State- ments, and therefore they are presented in aggregate by Business Group for 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 Dresd- ner Bank Lateinamerika (DBLA). 180 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 ag- gregate consideration of approximately CHF 76 million. The business manages over USD 4 billion of client assets, in- cluding custodial assets, and employs approximately 50 staff in four locations. These operations have been inte- grated 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 private and institutional clients in Italy and manages approx- imately EUR 400 million of client assets with 20 staff. The operations were subsequently 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. On 31 December 2005, the cost of the acquisition was approximately CHF 136 million, and re- sulted in the recognition of goodwill of approximately CHF 133 million. In 2006, additional goodwill of CHF 39 mil- lion resulted from an adjustment to the purchase price. The acquired business covers all important Latin American mar- kets and strengthens UBS’s position 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 manage- ment activities in Germany by acquiring a 51% stake in the real estate investment management business of Siemens Kapitalanlagegesellschaft mbH (SKAG), a subsidiary of Sie- mens 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 approximately CHF 57 million. The busi- ness comprises three open-end real estate funds with a total fund volume of approximately EUR 2 billion (as of 31 December 2004) and has been integrated into the global real estate business, giving it access to Global Asset Management’s established distribution network. The business was renamed UBS Real Estate Kapitalanlagege- sellschaft mbH. Note 37 Business Combinations (continued) Investment Bank – Prediction On 11 November 2005, UBS acquired the remaining 68.3% of Prediction LLC (Prediction), a financial engineering and trading 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 tech- nology and allows continuous operation and development of Prediction’s automated trading systems. Furthermore, UBS secures the know-how available at Prediction and the oppor- tunity to leverage it across UBS. The purchase price of ap- proximately CHF 84 million was primarily allocated to intan- gible assets valued at approximately CHF 26 million and goodwill of approximately CHF 51 million. Details of assets and liabilities recognized from the acquisitions made by the Financial Businesses in 2005 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 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. On 20 December 2005, Motor-Columbus also acquired Moravske Teplarny a.s., a power generator in the Czech Re- public, for approximately CHF 108 million. The purchase price was predominantly allocated to the power station and fair value of net assets acquired was equal to the purchase price. No goodwill was recognized in this acquisition. Motor- Columbus was sold on 23 March 2006. See Note 38 Discon- tinued Operations for details. Details of assets and liabilities recognized from these two acquisitions in 2005 are as follows (on the next page): 181 Financial Statements Notes to the Financial Statements Note 37 Business Combinations (continued) 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 Pro-forma information (unaudited) The following pro-forma information shows UBS’s total op- erating income, net profit and basic earnings per share as if all of the acquisitions completed in 2006 had been made as of 1 January 2005 and all acquisitions completed in 2005, had been made as of 1 January 2004. Adjustments have been made to reflect additional amortization and deprecia- tion 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) For the year ended 31.12.06 31.12.05 49,408 12,556 6.35 42,021 14,070 6.99 31.12.04 37,341 8,006 7.77 Business combinations completed in 2007 McDonald Investments’ Branch Network On 9 February 2007, UBS announced the completion of the acquisition of the branch network of McDonald Investments, a unit of KeyCorp. The cost of the business combination consisted of USD 219 million (CHF 267 million) for the busi- ness operations and of USD 57 million (CHF 70 million) for certain assets of McDonald investments, resulting in a total cash consideration paid of USD 276 million (CHF 337 mil- lion). The total consideration paid remains subject to adjust- ment. Based in Cleveland, Ohio, US, McDonald Investments comprised 51 branch offices throughout the Northeast, Mid- west, Rocky Mountain and Northwest states, including the offices of Gradison and Gradison Asset Management, which will be integrated into Wealth Management US. The unit provides comprehensive wealth management services to af- fluent and high net worth individuals, including estate plan- ning, retirement planning and asset management. Business combinations announced in 2007 Standard Chartered’s mutual funds management business in India On 26 January 2007, UBS announced the acquisition of Standard Chartered’s mutual funds management business in India. The cost of the business combination is estimated to be USD 126 million, and the business will be integrated into Global Asset Management. The transaction is expected to close in third quarter 2007. 182 Note 38 Discontinued Operations 2006 2005 Motor-Columbus On 23 March 2006, UBS sold its 55.6% stake in Motor-Co- lumbus to a consortium representing Atel’s Swiss minority shareholders (EBM, EBL, the Canton of Solothurn, IB Aarau, AIL Lugano and WWZ Zug), EOS Holding and Atel, as well as to the French utility Electricité de France (EDF) following the receipt of relevant regulatory approvals by the Swiss and in- ternational authorities. Motor-Columbus is presented as a discontinued operation in these Financial Statements. The income statements for the comparative prior periods have been restated to reflect that presentation. In total, UBS sold 281,535 Motor-Columbus shares, at a price of CHF 4,600 per share, resulting in a sale price of approximately CHF 1,295 million, which was fully paid in cash. A pre-tax gain on sale of CHF 364 million is reported in the Industrial Holdings segment. From 1 January to 23 March 2006, Motor-Colum- bus had a Net profit from operations of CHF 71 million. To- gether with the after-tax gain on sale of CHF 387 million, the Net profit from discontinued operations is CHF 458 million in 2006. For the years ended 31 December 2005 and 31 De- cember 2004, Motor-Columbus had a Net profit from opera- tions of CHF 323 million and CHF 159 million, respectively. Industrial Holdings In 2006, private equity investments contributed CHF 407 mil- lion to UBS´s Net profit from discontinued operations, which includes after-tax gains on sale of CHF 425 million and an after-tax operating loss of CHF 18 million. In 2005, UBS sold four of its consolidated private equity investments for an ag- gregate cash consideration of CHF 179 million, and the sales of these investments had a positive impact on Net profit from discontinued operations of CHF 86 million. In 2004, five con- solidated private equity investments were sold for an aggre- gate cash consideration of CHF 141 million, and the sales of these investments had a positive impact on Net profit from discontinued operations of CHF 125 million. These private equity investments were all held within the Industrial Hold- ings 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. 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 million, of which CHF 3,375 million was received in cash, CHF 225 million in the form of hybrid Tier 1 instruments, and the remaining CHF 2,083 million representing a 21.5% stake in the enlarged Julius Baer. As part of the sales agree- ment, CHF 200 million of cash was retained within UBS. The gain on sale after taxes from this transaction amounts to CHF 3,705 million on 31 December 2005. In 2006, UBS re- ported an additional after-tax gain on sale of CHF 4 million due to an adjustment to the purchase price. 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 strat- egy or on its operational business decisions, and has no right to register its shares with voting rights for a period of 3 years, unless specifically defined events occur that could materially dilute or otherwise affect UBS’s position as an in- vestor 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 operation 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 pre- sented as a separate business segment. 183 Financial Statements Notes to the Financial Statements Note 38 Discontinued Operations (continued) CHF million Operating income Operating expenses Operating profit / (loss) from discontinued operations before tax Pre-tax gain / (loss) on sale Profit from discontinued operations before tax Tax expense / (benefit) on operating profit from discontinued operations before tax Tax expense / (benefit) on gain on sale Tax expense / (benefit) from discontinued operations Net profit / (loss) from discontinued operations Net cash flows from operating activities investing activities financing activities 1 Pre-tax gain on sale includes CHF 4 million related to Private Banks & GAM, which is included in Corporate Center in Note 2a. For the year ended 31.12.06 Motor-Columbus 2,494 2,412 82 364 446 11 (23) (12) 458 1 (52) (22) Other 1 Industrial Holdings 1 312 331 (19) 429 410 (1) 0 (1) 411 (7) 76 (88) CHF million Operating income Operating expenses Operating profit / (loss) from discontinued operations before tax Pre-tax gain / (loss) on sale Profit from discontinued operations before tax Tax expense on operating profit from discontinued operations before tax Tax expense on gain on sale Tax expense / (benefit) from discontinued operations Net profit / (loss) from discontinued operations Net cash flows from operating activities investing activities financing activities CHF million Operating income Operating expenses Operating profit / (loss) from discontinued operations before tax Pre-tax gain / (loss) on sale Profit from discontinued operations before tax Tax expense on operating profit from discontinued operations before tax Tax expense on gain on sale Tax expense / (benefit) from discontinued operations Net profit / (loss) from discontinued operations Net cash flows from operating activities investing activities financing activities 184 For the year ended 31.12.05 Private Banks & GAM Motor-Columbus Other Industrial Holdings 1,102 633 469 4,095 4,564 99 390 489 4,075 (143) (22) 0 8,711 8,323 388 0 388 65 0 65 323 252 (326) 163 2,111 2,116 (5) 113 108 22 0 22 86 68 (43) 28 For the year ended 31.12.04 Private Banks & GAM Motor-Columbus Other Industrial Holdings 1,086 690 396 0 396 97 0 97 299 (725) 30 3 3,668 3,460 208 0 208 49 0 49 159 75 (71) 112 3,748 3,639 109 68 177 52 0 52 125 (288) 124 34 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 of Average rate Year ended 31.12.06 31.12.05 31.12.06 31.12.05 31.12.04 1.22 1.61 2.39 1.02 1.31 1.56 2.26 1.11 1.25 1.58 2.31 1.08 1.25 1.55 2.27 1.13 1.24 1.54 2.27 1.15 185 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 Stan- dards. Included in this note are the significant differences in regard to recognition and measurement between IFRS and the provisions of the Banking Ordinance and the Guidelines of the Swiss Banking Commission governing financial state- ment reporting pursuant to Article 23 through Article 27 of the Banking Ordinance. 1. Consolidation Under IFRS, all entities which are controlled by the Group are consolidated. Under Swiss law, only entities that are active in the field of banking and finance and real estate entities are subject to consolidation. Entities which are held temporarily are gener- ally recorded as Financial investments available-for-sale. 2. Financial investments available-for-sale Under IFRS, Financial investments available-for-sale are car- ried at fair value. Changes in fair value are recorded directly in Equity until an investment is sold, collected or otherwise disposed of, or until an investment is determined to be im- paired. At the time an available-for-sale investment is deter- mined to be impaired, the cumulative unrealized loss previ- ously recognized in Equity is included in net profit or loss for the period. On disposal of a financial investment available- for-sale, the cumulative gain or loss previously recognized in Equity is recognized in the income statement. 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 up to original cost as well as gains and losses on disposal are included in Other income. 3. Cash flow hedges The Group uses derivative instruments to hedge the expo- sure from varying cash flows. Under IFRS, when hedge ac- counting is applied the unrealized gain or loss on the effec- tive portion of the derivatives is recorded in Equity until the hedged cash flows occur, at which time the accumulated gain or loss is realized and released to income. Under Swiss law, the unrealized gains or losses on the ef- fective portion of the derivative instruments used to hedge cash flow exposures are deferred on the balance sheet as as- sets or liabilities. The deferred amounts are released to in- come when the hedged cash flows occur. 186 4. Investment property Under IFRS, investment properties are carried at fair value, with fair value changes reflected in profit or loss. Under Swiss law, investment properties are carried at am- ortized cost less impairment unless the investment proper- ties are held for sale. Investment properties held for sale are recorded at the lower of cost or market value. 5. Fair value option Under IFRS, the Group applies the fair value option to cer- tain financial assets and financial liabilities, mainly to hybrid debt instruments. As a result the entire hybrid instrument is accounted for at fair value with changes in fair value re- flected in net trading income. Furthermore, UBS designated certain loans, loan commitments and fund investments as financial investments designated at fair value through profit and loss. Under Swiss law, the fair value option is not available. Hybrid instruments are bifurcated: while the embedded de- rivative is marked to market through net trading income, the host contract is accounted for on an accrued cost basis. Gen- erally, loans are accounted for at amortized cost less impair- ment, loan commitments stay off-balance sheet and fund investments are accounted for as financial investments. 6. Goodwill and intangible assets Under IFRS, goodwill acquired in business combinations is not amortized, but tested annually for impairment. Intangi- ble assets acquired in business combinations with an indefi- nite useful life are also 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. Dis- posal groups that meet the criteria of discontinued opera- tions are presented in the income statement in a single line as net income from discontinued operations. Under Swiss law, no such reclassifications take place. 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 differences between IFRS and US GAAP. 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 am- ortized over periods ranging from two years to 20 years. 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 adjust- ments were made to the carrying values of the assets and liabilities. Under US GAAP, the business combination creat- ing UBS AG is accounted for under the purchase method with Union Bank of Switzerland being considered the ac- quirer. Under the purchase method, the cost of acquisition is measured at fair value and the acquirer’s interests in identifi- able tangible assets and liabilities of the acquiree are restat- ed to fair values at the date of acquisition. Any excess con- sideration paid over the fair value of net tangible assets acquired is allocated, first to identifiable intangible assets based on their fair values, if determinable, with the remain- der 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. 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 amor- tized but be tested annually for impairment. Identifiable in- tangible assets with finite lives continue to be amortized. Upon adoption, the amortization charges related to the 1998 business combination of Union Bank of Switzerland and Swiss Bank Corporation ceased to be recorded under US GAAP. In 2006 and 2005, goodwill recorded under US GAAP was reduced by CHF 18 million and CHF 67 million respec- tively, due to recognition of deferred tax assets of Swiss Bank Corporation which had previously been subject to valuation reserves. b. Goodwill With the adoption of IFRS 3 Business Combinations on 31 March 2004, UBS ceased amortizing goodwill on 1 Janu- ary 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 standards. 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 31 December 2001 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 recognized separately from goodwill if they meet defined recognition criteria. Existing intangible assets that do not meet the recognition criteria have to be reclassified to good- will. On 1 January 2005, UBS reclassified the trained work- force intangible asset recognized in connection with the acquisition of PaineWebber with a book value of CHF 1.0 billion to Goodwill. Under US GAAP, this asset was re- classified from Intangible assets to Goodwill on 1 January 2002 with the adoption of SFAS 142 Goodwill and Other Intangible Assets. Under IFRS, the cost of the business combination of Banco Pactual is estimated at USD 2,194 million (CHF 2,677 million) on 31 December 2006 but is still subject to final determi- nation. Of the total consideration, USD 971 million (CHF 1,164 million) was paid on 1 December 2006 in cash. The residual payment of up to USD 1.6 billion (CHF 1.9 billion) is subject to certain performance conditions and is due on 30 June 2011. 50% (USD 800 million) of the deferred re- sidual payment is contingent upon achieving a specified cumulative net income before tax of the acquired business during the period from 1 December 2006 to 30 June 2011. Under US GAAP, contingent consideration which depends on the achievement of a specified earnings level in future periods is not recognized as a cost of the business combina- tion at its present value until the contingency is resolved. For 187 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) that reason, Goodwill and Other liabilities recognized under US GAAP are reduced by the present value of the contingent consideration of CHF 746 million to CHF 459 million. Ac- cordingly, the addition of accrued interest on the present value of the contingent consideration recognized under IFRS is reversed under US GAAP, which resulted in a decrease of Interest expense and Other liabilities of CHF 3 million. c. Purchase accounting under IFRS 3 and FAS 141 With the adoption of IFRS 3 on 31 March 2004, the ac- counting for business combinations generally converged with US GAAP except for the differences described below. 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 recog- nized at the percentage of book value of identifiable net as- sets acquired at the acquisition date. In most cases, minority interests would tend to have a higher measurement value under IFRS than under US GAAP. The accounting treatment of purchased minority interests of a subsidiary differs between IFRS and US GAAP. Under IFRS, UBS records the difference between the purchase price and the carrying value of the acquired minority interest di- rectly in Equity whereas the acquisition of the minority inter- ests is treated as a business combination under US GAAP. In 2006, goodwill of CAD 35 million (CHF 40 million) and in- tangible assets of CAD 71 million (CHF 79 million) under US GAAP resulted from the purchase of the then outstanding 50% minority interest in a consolidated subsidiary, UBS Bun- ting. See Note 37 Business Combinations for the IFRS treat- ment of this acquisition. Furthermore, IFRS requires that in a step acquisition the existing ownership interest in an entity be revalued to the new valuation basis established at the time of acquisition. The increase in value is recorded directly in equity as a re- valuation reserve. Under US GAAP, the existing ownership interest remains at its original valuation. d. Hedge accounting Under IAS 39, UBS hedges interest rate risk based on fore- cast 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 fu- ture 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. Accord- ingly, for US GAAP such hedging instruments continue to be carried at fair value with changes in fair value recognized in Net trading income. In addition, a new hedging methodology, fair value hedge of portfolio interest rate risk, was implemented in 2005 for a specific portfolio of mortgage loans. This new hedging method is not recognized under US GAAP and therefore, the fair value change of hedged items recognized 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 qual- ify as hedges under current requirements under IFRS are am- ortized to income over the remaining life of the hedging re- lationship. Such amounts have been reversed for US GAAP as they have never been treated as hedges. e. Financial investments available-for-sale For UBS, the following differences exist between IFRS and US GAAP in accounting for financial investments available-for- sale: 1) Under US GAAP, instruments which are not securities or equity securities with no readily determinable fair value (excluding private equity investments discussed in the next part) are not classified as available-for-sale investments. They are classified as Other assets and measured at cost less im- pairment. Under IFRS, these instruments are measured at fair value with changes in fair value reflected directly in equity. 2) Under IFRS, restricted stock is classified as a financial in- vestment available-for-sale. Under US GAAP, restricted stock (with a restriction period of more than one year) is classified as Other assets and measured at cost less impairment. f. Private equity investments On 1 January 2005, UBS adopted revised IAS 27 Consoli- dated and Separate Financial Statements and revised IAS 28 Investments 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 invest- ments. Previously under IFRS, such investments were classi- fied as Financial investments available-for-sale with changes in fair value recorded directly in Equity. The effect of adopt- ing 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 account- ed for as associated companies using the equity method of accounting. The remaining private equity investments con- tinue to be accounted for as Financial investments available- for-sale. 188 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) 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 accounted for at fair val- ue with changes in fair value recorded in other income. The remaining private equity investments held by UBS are ac- counted for at cost less “other than temporary” impairment. All private equity investments are presented in the balance sheet line Private equity investments under US GAAP. line basis as those amounts are recognized in the income statement. Under IFRS, the amount recognized on the balance sheet as a net pension asset or liability is comprised of the funded status of the plans as adjusted for unrecognized actuarial gains and losses and prior service costs and the unrecog- nized prepaid pension asset. Unrecognized net actuarial gains and losses and prior service costs are subsequently rec- ognized in the income statement on a straight line basis. g. Pension and other post-retirement benefit plans h. Equity participation plans Under IFRS, UBS recognizes post-retirement benefit expense based on a specific method of actuarial valuation used to determine the projected plan liabilities for accrued service, including future expected salary increases, and expected re- turn on plan assets. Plan assets are recorded at fair value and are held in a separate trust to satisfy plan liabilities. Under IFRS, the recognition of a prepaid asset is subject to certain limitations, and any unrecognized prepaid asset is recorded as pension expense. US GAAP does not allow a limitation on the recognition of prepaid assets recorded in the balance sheet. Under US GAAP, post-retirement benefit expense is based on the same actuarial 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 transi- tion date rules, stricter provisions for recognition of prepaid assets under IFRS, 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 li- ability 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 intan- gible asset is reported in other comprehensive income (OCI). This amount was removed from OCI when SFAS 158 Em- ployers’ Accounting for Defined Benefit Pension and Other Postretirement Plans was first applied at 31 December 2006. See Note 41.2 for details. In accordance with SFAS 158, the US GAAP balance sheet at 31 December 2006 shows the funded status of all post- retirement benefit plans under Other liabilities. All amounts not recognized in US GAAP Net profit are recognized in Oth- er comprehensive income (OCI) as an adjustment to the end- ing balance as of 31 December 2006. The recorded amounts in OCI are subsequently reclassified from OCI on a straight- On 1 January 2005, UBS adopted IFRS 2 Share-based pay- ment which requires that the fair value of all share-based payments made to employees be recognized as compensa- tion expense from the date of grant over the service period, which is generally equal to the vesting period. UBS applied IFRS 2 on a retrospective application basis and restated its 2003 and 2004 comparative prior periods for all awards that impact income statements commencing 2003. UBS recorded an opening retained earnings adjustment on 1 January 2003 to reflect the cumulative income statement effects of prior periods. See Note 1b) for details. Previously under IFRS, op- tion 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 ex- pense in full in the performance 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 employees be recognized in the income statement over the requisite ser- vice period based on their fair values at the date of grant. The requisite service period is defined as the period that the em- ployee is required to provide active employment in order to earn their award. This may be different from the service peri- od 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 op- tions has been previously recognized in the income state- ment 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 189 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) the revenue produced. For disclosure purposes, UBS recog- nized the fair value of option awards on the date of grant. Thus, for recognition and disclosure purposes, expense for share and option awards issued prior to but outstanding at the date of adoption 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 prof- it. 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 retained earnings adjustment on 1 January 2003 and subsequent IFRS 2 restatement adjustments were reversed and only the awards required to be expensed were recorded in the 2005 US GAAP Financial Statements. Subsequent awards have been recognized over the requisite service peri- ods, which are determined 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 recogni- tion of estimated forfeitures of share-based compensation awards under SFAS 123-R. The standard requires that ex- pense be recognized only for those instruments where the requisite service is performed. During the service period, compensation cost recognized is based on the estimated number of instruments for which the requisite service is ex- pected to be rendered. That estimate is revised if subsequent information indicates that the actual number is likely to dif- fer from previous estimates. Under SFAS 123-R, entities are required to continue to provide pro-forma disclosures for the periods in which the fair value method of accounting for share-based compensa- tion was not applied. See Note 42.7 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 provisions. Under SFAS 123-R, awards with non- compete provisions generally do not impose a requisite ser- vice period, and therefore expense should not be recognized over a future period. UBS has determined that the appropri- ate expense recognition period for such awards is the perfor- mance year, which is generally the period prior to grant. This is consistent with the approach applied under APB 25. Com- pensation expense for awards with non-compete provisions is generally recognized over the vesting period under IFRS. Certain UBS awards contain provisions that permit the em- ployee to retire, provided they meet certain eligibility condi- tions 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 con- nection with share-based payment arrangements and de- ferred 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 required to consolidate that trust. UBS consolidated such employee benefit trusts retrospectively to 1 January 2003. For further details on the restatement, see Note 1b). Under US GAAP prior to 1 January 2004, certain equity compensa- tion trusts were already consolidated under US GAAP under the provisions of EITF-97-14, Accounting for Deferred Com- pensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested. With the adoption of FASB Interpretation No. 46 Consolidation of Variable Interest Enti- ties (revised December 2003), an interpretation of Account- ing Research Bulletin No. 51 (FIN 46-R), on 1 January 2004, the remaining unconsolidated employee equity compensa- tion trusts formed before 1 February 2003 were consolidat- ed 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. With the consolidation of the additional trusts under FIN 46-R from 1 January 2004, UBS re-evaluated its accounting for share-based compensation plans under APB 25 by taking into consideration the settlement methods and activities of the trusts. Based on this review, most share plans issued 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 authority is triggered. This is generally the distribution date for share awards and the exercise date of options. 190 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) In addition, CHF 1,450 million has been reclassified from Other liabilities to Shareholders' equity in the 31 December 2005 US GAAP balance sheet. The reclassification relates to equity-settled awards which were recorded in Other liabilities. i. Variable interest entities (VIEs), limited partnerships  and entities issuing preferred securities IFRS and US GAAP generally require consolidation of entities on the basis of controlling a majority of voting rights. How- ever, in certain situations, there are no voting rights, or con- trol of a majority of voting rights is not a reliable indicator of the need to consolidate, such as when voting rights are sig- nificantly disproportionate to risks and rewards. There are differences in the approach of IFRS and US GAAP to those situations. Under IFRS, when control is exercised through means oth- er than controlling a majority of voting rights, the consolida- tion assessment is based on the substance of the relation- ship. Indicators of control in these situations include: predetermination of the entity’s activities; the entity’s activi- ties being conducted 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 activities of the entity; or retaining the major- ity of the residual or ownership risks related to the entity’s assets in order to obtain benefits from its activities. In most other cases, US GAAP requires that control over an entity be assessed first based on voting interests. If voting interests do not exist, or differ significantly from economic interests, the entity is considered a variable interest entity (VIE) under FASB interpretation No. 46 (revised December 2003) Consolidation of Variable Interest Entities, an interpre- tation of Accounting Research Bulletin No. 51 (FIN 46-R), and control is assessed based on its variable interests. A dis- cussion of FIN 46-R requirements is set out in Note 42.1. In most instances, limited partnerships are not consoli- dated under IFRS because UBS`s legal and contractual rights and obligations do not indicate that UBS has the power to govern the financial and operating policies of these entities and concurrently has the objective to obtain benefits form its activities through this power. Under US GAAP, UBS applies EITF 04-05, 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), provided an entity is not considered a VIE under FIN 46-R. As a result, UBS consolidates some limited partnerships which are not consolidated under IFRS. Under EITF 04-05, a general partner in a limited partnership is pre- sumed to control that limited partnership regardless of the extent of the general partners' ownership interest in the lim- ited partnership. The assessment of whether the rights of the limited partners should overcome the presumption of control by the general partner is a matter of judgment that depends on facts and circumstances. If the limited partners have either (a) the substantive ability to dissolve (liquidate) the limited partnership or otherwise remove the general partner without cause or (b) substantive participating rights, the general partner does not control the limited partnership and therefore does not consolidate the entity. The entities consolidated for US GAAP purposes at 31 December 2006, 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 2006, which UBS consolidates under IFRS, are certain entities which have issued preferred securities. Under IFRS such securities are equity instruments held by third par- ties 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 Group Financial State- ments. Under US GAAP, these entities are not consolidated, and the UBS-issued debt is recognized as a liability in the 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 or loss IFRS provides, under certain circumstances, the option to designate at initial recognition a financial asset or financial liability at fair value through profit or loss (see Notes 1, 9 and 19). This option is not available under US GAAP as UBS did not early adopt SFAS 155 Accounting for Certain Hybrid In- struments, an amendment of FASB Statements No. 133 and 140 (see Note 41.2). SFAS 155 will allow a fair value designa- tion for certain hybrid instruments from 1 January 2007 on- wards. Additionally, beginning 1 January 2008, Statement of Financial Accounting Standards No. 159, The Fair Value Op- tion for Financial Assets and Liabilities (Statement 159) will become effective. Statement 159 provides a fair value op- tion that is broader than that provided in Statement 155 and is similar to the fair value option provided by IFRS. In 2006, as in prior periods, UBS reversed all IFRS fair value desig- nations of financial assets and financial liabilities under US GAAP. 191 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) UBS applies the fair value option to a significant portion of its issued debt under IFRS. Many debt issues are in the form of hybrid instruments, consisting of a debt host with an embedded derivative. These hybrid instruments are carried in their entirety at fair value with all changes in fair value recorded in Net trading income. Under US GAAP, the debt host contracts of these hybrid instruments are recognized at amortized cost while the embedded derivatives are recog- nized at fair value with changes in fair value recognized in Net profit. Although separately measured, the positive and negative replacement values of the embedded derivatives are classified with the debt host contract. k. Physically settled written puts on UBS shares Under IFRS, the accounting for physically settled written put options on UBS shares is as follows: the present value of the contractual amount is recorded as a financial liability, while the premium received is credited to equity. Subsequently, the liability is accreted over the life of the put option to its con- tractual amount recognizing interest expense in accordance with the effective interest method. Under US GAAP, physi- cally settled written put options on UBS shares are account- ed for as derivative instruments. All other outstanding de- rivative contracts, except written put options with the UBS share as underlying, are treated as derivative instruments un- der both sets of accounting standards. l. Investment properties In the IFRS Financial Statements, investment properties are accounted for under the fair value method. Under this meth- od, changes in fair value are recognized in the income state- ment, and depreciation is no longer recognized. Under US GAAP, investment properties continue to be carried at cost less accumulated depreciation. 192 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 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 stipulates that the general partner in a limited part- nership is presumed to control that limited partnership un- less the limited partners have either substantive kick-out rights or substantive participating rights. EITF 04-5 is effec- tive after 29 June 2005 for new limited partnership agree- ments and for pre-existing limited partnership agreements that are modified; otherwise, the guidance was effective as of 1 January 2006 for existing unmodified partnerships. Adoption of EITF 04-05 did not have a material impact on UBS’s Financial Statements. As part of its convergence efforts with the IASB, 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) in May 2005. State- ment 154 changes the requirements for the accounting and reporting of a change in accounting principle and 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’ finan- cial statements of a voluntary change in accounting principle unless it is impracticable, whereas Opinion 20 previously re- quired that the cumulative effect of most voluntary changes in accounting principle be recognized in the net income of the period of the change. Statement 154 was effective for accounting changes and corrections of errors made in fiscal years beginning after 15 December 2005. Adoption of State- ment 154 did not have a material impact on UBS’s Financial Statements. In April 2006, the FASB issued FASB Staff Position FIN 46(R)-6, Determining the Variability to Be Considered in Ap- plying FASB Interpretation No. 46(R) (FSP FIN 46(R)-6). FSP FIN 46(R)-6 addresses the application of FIN 46(R), Consoli- dation of Variable Interest Entities, in determining whether certain contracts or arrangements with a variable interest entity (VIE) are variable interests by requiring companies to base its evaluation on an analysis of the VIE’s purpose and design, rather than on its legal form or accounting classifica- tion. FSP FIN 46(R)-6 was effective for all newly created VIEs or for those that must be re-analyzed under FIN 46(R) as of 1 July 2006. Adoption of FSP FIN 46(R)-6 did not have a ma- terial impact on UBS’s Financial Statements. In September 2006, the FASB issued Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Oth- er Postretirement Plans (Statement 158). Statement 158 re- quires: (1) recognition of the over- or under-funded status of a defined benefit post-retirement plan as an asset or liability in the balance sheet; (2) recognition within shareholders eq- uity (net of tax) of gains or losses and prior service costs or credits arising during the period that are not recognized as components of the period's net periodic benefit cost; and (3) measurement of the defined benefit plan assets and obliga- tions as of the date of the employer’s fiscal year-end balance sheet. The recognition requirements of Statement 158 (re- quirements (1) and (2), above) are effective as of the end of the fiscal year ending after 15 December 2006. See Note 42.5 for the incremental effect of the first time application of these requirements. The requirement to measure plan as- sets and benefit obligations as of the date of the employer’s fiscal year end is effective for fiscal years ending after 15 De- cember 2008. Adoption of this requirement will not have an impact on UBS's Financial Statements as plan assets and benefit obligations are currently measured as of the balance sheet date. Recently issued US accounting standards not yet adopted In February 2006, the FASB issued Statement of Financial Ac- counting Standard No. 155, Accounting for Certain Hybrid Instruments, an amendment of FASB Statements No. 133 and 140 (Statement 155). Statement 155 permits UBS to elect to measure any hybrid financial instrument at fair val- ue, with changes in fair value recognized in net profit, if the hybrid instrument contains an embedded derivative that would otherwise require bifurcation under Statement 133. The election to measure the hybrid instrument at fair value is made on an instrument-by-instrument basis and is irrevers- ible. Statement 155 is effective after the beginning of an entity’s first fiscal year that begins after 15 September 2006, with early adoption permitted in certain circumstances. At adoption of Statement 155, any difference between the to- tal carrying amount of the individual components of an ex- isting hybrid instrument and the fair value of the combined hybrid financial instrument is recognized as a cumulative-ef- fect adjustment to beginning retained earnings. UBS did not elect to early adopt Statement 155 and, therefore, will adopt the new standard as of 1 January 2007. On a US GAAP basis, it is anticipated that the cumulative-effect adjustment to be- ginning retained earnings resulting from the adoption of Statement 155 will be a decrease to retained earnings of ap- proximately CHF 414 million (before tax). Financial assets designated at fair value and Financial liabilities designated at fair value are estimated to be approximately CHF 4,125 mil- lion and CHF 151,440 million on a US GAAP basis on 1 Janu- ary 2007. 193 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 (continued) In March 2006, the FASB issued Statement of Financial Accounting Standard No. 156, Accounting for Servicing of Financial Assets, (Statement 156). Statement 156 addresses the accounting for recognized servicing assets and servicing liabilities related to certain transfers of the servicer’s financial assets and for acquisitions or assumptions of obligations to service financial assets that do not relate to the financial as- sets of the servicer and its related parties. Statement 156 requires that all recognized servicing assets and servicing li- abilities are initially measured at fair value and subsequently measured at either fair value or by applying an amortization method for each class of recognized servicing assets and ser- vicing liabilities. Statement 156 is effective in fiscal years be- ginning after 15 September 2006. The adoption of SFAS 156 is not expected to have a material impact on UBS's Financial Statements. In June 2006, the FASB issued FIN 48, Accounting for Un- certainty in Income Taxes – an interpretation of SFAS 109, which prescribes a recognition threshold and measurement attribute for financial statement recognition and measure- ment of a tax position. FIN 48 is effective for years com- mencing after 15 December 2006. UBS is continuing to evaluate the impact of FIN 48 on its Financial Statements. However, UBS does not expect FIN 48 to have a material ef- fect on its financial position or results of operations. On 15 September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Mea- surements (Statement 157). Statement 157 defines fair val- ue, establishes a framework for measuring fair value, and expands the required disclosures about an entity's fair value measurements. Additionally, Statement 157 eliminates the requirement to defer calculated profit or loss on transaction values that include unobservable inputs (“Day 1 profit and loss”) and eliminates the use of block discounts for securities traded in an active market. Statement 157 is effective for fi- nancial statements issued for fiscal years beginning after 15 November 2007. The provisions of Statement 157 should be applied prospectively upon initial adoption, except for the provisions that eliminate prior measurement guidance re- garding block discounts and Day 1 profit or loss. Those changes should be applied retrospectively as an adjustment to the opening balance of retained earnings in the period of adoption. UBS is still assessing the impact Statement 157 will have on its Financial Statements. In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Liabilities (Statement 159). This new standard permits entities to irrevocably choose to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected are recognized in net profit at each subsequent reporting date. The election in Statement 159 is similar, but not identical, to the fair value option in IAS 39. The fair value option in IAS 39 is subject to certain quali- fying criteria not included in this standard, and it applies to a slightly different set of instruments. Statement 159 is effec- tive for fiscal years beginning after 15 November 2007. Early adoption is permitted only if the provisions of Statement 157 are also applied. UBS is currently assessing the impact Statement 159 will have on its Financial Statements. 194 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 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 Hedge accounting Financial investments available-for-sale Private equity investments Pension and other post-retirement benefit plans Equity participation plans Variable interest entities (VIEs), limited partnerships and entities issuing preferred securities Financial assets and liabilities designated at fair value through profit or loss Physically settled written puts on UBS shares Investment properties Other adjustments Tax adjustments Total adjustments Amounts determined in accordance with US GAAP Equity attributable to UBS shareholders (IFRS) / Shareholders’ equity (US GAAP) as of Net profit attributable to UBS shareholders (IFRS) / Net profit (US GAAP) for the year ended 31.12.06 31.12.05 31.12.06 31.12.05 31.12.04 49,686 44,015 12,257 14,029 8,016 Note 41.1 Reference a b c d e f g h i j k l 15,091 2,366 85 (5) (1,670) 337 (1,452) 815 (1) (994) 184 (12) 317 (224) 15,116 2,373 (86) (40) (384) 709 229 658 (98) (197) 131 (8) 74 (876) 14,837 64,523 17,601 61,616 (25) 3 (6) 372 171 (278) 165 (475) (2) (682) 6 (4) 130 (146) (771) 11,486 (36) 0 35 (455) 0 (486) (18) 358 0 (436) 8 0 (118) (529) (1,677) 12,352 (44) 778 3 (217) 0 217 (110) 62 18 100 9 14 (50) 22 802 8,818 195 Financial Statements Notes to the Financial Statements Note 41.4  Earnings per share Under both IFRS and US GAAP, basic earnings per share (“EPS”) is computed by dividing income available to com- mon shareholders by the weighted-average number of com- mon shares outstanding. Diluted EPS includes the determi- nants 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 2006, 31 December 2005 and 31 De- cember 2004 are presented in the following table. For the year ended US GAAP IFRS US GAAP IFRS US GAAP 31.12.06 31.12.05 31.12.04 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 11,486 11,082 404 11,478 11,074 404 12,257 11,491 766 12,249 11,483 766 12,352 8,376 3,976 12,330 8,377 3,953 14,029 9,776 4,253 14,007 9,777 4,230 8,818 8,398 420 8,813 8,401 412 IFRS 8,016 7,547 469 8,011 7,550 461 Weighted average shares outstanding 1,975,933,228 1,976,405,800 2,013,859,982 2,013,987,754 2,059,791,220 2,059,836,926 Diluted weighted average shares outstanding 2,058,834,812 2,058,834,812 2,097,191,540 2,097,191,540 2,163,922,720 2,163,922,720 Basic earnings per share (CHF) from continuing operations from discontinued operations Diluted earnings per share (CHF) from continuing operations from discontinued operations 5.81 5.61 0.20 5.57 5.38 0.19 6.20 5.81 0.39 5.95 5.58 0.37 6.13 4.16 1.97 5.88 3.99 1.89 6.97 4.85 2.12 6.68 4.66 2.02 4.28 4.08 0.20 4.07 3.88 0.19 3.89 3.66 0.23 3.70 3.49 0.21 196 Note 41.5 Presentation Differences between IFRS and US GAAP In addition to the differences in valuation and income recog- nition, other differences exist between IFRS and US GAAP which generally have an impact solely on balance sheet and/ or Income statement presentation, although in certain cases, these presentation differences may result in an immaterial impact on US GAAP Shareholders’ equity and Net profit. In such cases, these differences are aggregated in the Other differences line in the table in Note 41.3. The following is a summary of these differences. 1. Settlement date vs. trade date accounting UBS’s transactions from securities activities are recorded un- der IFRS on the settlement date. This results in recording a forward transaction during the period between the trade date and the settlement date. Forward positions relating to trading activities are revalued to fair value, presented as re- placement value on balance sheet and any unrealized profits and losses are recognized in Net profit. Under US GAAP, trade date accounting is required for spot purchases and spot sales of securities. Therefore, all such transactions with a trade date on or before the balance sheet date and with a settlement date after the balance sheet date have been recorded at trade date for US GAAP. This has resulted in receivables and payables to broker-deal- ers and clearing organizations recorded in Other assets and Other liabilities in the US GAAP balance sheet. 2. Securities received as collateral in a securities-for- securities lending transaction When UBS acts as the lender in a securities lending agree- ment and receives securities as collateral that can be pledged or sold, it recognizes the securities received and a correspond- ing obligation to return them. These securities are reflected on the US GAAP balance sheet in the asset line Securities re- ceived as collateral. The offsetting liability is presented in the line Obligation to return securities received as collateral. 3. Reverse repurchase, repurchase, securities borrowing and securities lending transactions UBS enters into certain types of reverse repurchase, repur- chase, securities borrowing and securities lending transac- tions 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 as- sets or derecognition of the financial assets lent. The cash collateral received or delivered in such transactions is reflect- ed in the balance sheet with a corresponding receivable or obligation to return it. Under US GAAP, however, certain transactions are considered purchase and sale transactions due to the fact that the contracts do not meet specific re- quirements, including those related to collateral or margin- ing or the repurchase of the transferred securities is not be- fore maturity of these securities. Due to the different treatment of these transactions under IFRS and US GAAP, interest income and expense recorded under IFRS is reclassi- fied to Net trading income for US GAAP. Additionally under US GAAP, the securities received are recognized on the bal- ance sheet as a spot purchase (Trading portfolio assets or Trading portfolio assets pledged as collateral) with a corre- sponding forward sale transaction (Replacement values) and a receivable (Cash collateral on securities borrowed) is reclas- sified, as applicable. The securities delivered are recorded as a spot sale, which means that the securities are derecog- nized if they are on-balance sheet securities or recorded as a short sale if the delivered securities are off-balance sheet se- curities (Trading portfolio liabilities). Additionally, a corre- sponding forward repurchase transaction (Replacement val- ues) and a liability (Cash collateral on securities lent) is reclassified, as applicable. Securities borrowing transactions with the clients' pool are generally done without providing collateral. UBS pays a fee to the client in such transactions. Under IFRS, the bor- rowed securities are not recognized on balance sheet but disclosed in a separate line in Note 24 Pledgeable Off-Bal- ance Sheet Securities. Under US GAAP, the borrowed securi- ties are recognized in Trading portfolio assets and Trading portfolio assets pledged as collateral, as applicable, and the obligation to return the securities, which represents a hybrid instrument, is included in Negative replacement values. Ef- fects on net profit which arise from derecognition/ recogni- tion of financial assets and related recognition of forward transactions are reflected in the Net trading income. 4. Recognition / derecognition of financial assets The guidance governing recognition and derecognition of a financial asset requires a multi-step decision process to de- termine whether recognition or derecognition of transferred financial assets is appropriate. UBS derecognizes financial as- sets for which it transfers the contractual rights to the cash flows and no longer retains any risk or reward coming from them nor maintains control over the financial assets. As a result of these requirements, certain transactions are ac- counted for as secured financing transactions instead of pur- chases or sales of trading portfolio assets with an accompa- nying swap derivative. Under US GAAP, these transactions typically continue to be shown as purchases and sales of trading portfolio assets and were reclassified accordingly. Ef- fects on net profit which arise from derecognition / recogni- tion of financial assets and related recognition of forward transactions are reflected in Net trading income. 197 Financial Statements Notes to the Financial Statements Note 41.6 Consolidated Income Statement The following is a Consolidated Income Statement of the Group, for the years ended 31 December 2006, 31 December 2005 and 31 December 2004, 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 31.12.06 31.12.05 31.12.04 Reference US GAAP IFRS US GAAP IFRS US GAAP IFRS Operating income Interest income Interest expense Net interest income Credit loss (expense) / recovery f 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 / (benefit) Minority interests (US GAAP) Net profit/(loss) from continuing operations Net profit / (loss) from discontinued operations Net profit (IFRS) Net profit attributable to minority interests (IFRS) Cumulative adjustment due to the adoption of SFAS 123 (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, f, i, j, 3, 4 87,380 87,401 a, b, d, f, i, j, k,3, 4 (80,463) (80,880) 58,791 (49,488) 59,286 (49,758) 6,917 156 7,073 25,881 12,548 1,742 0 47,244 23,771 7,944 1,277 0 143 0 6,521 156 6,677 25,881 13,318 1,596 693 48,165 23,671 8,116 1,263 0 153 295 d, e, f, h, i, j, k,3, 4 c, e, f, i, j, l f f, g, h f, i a, f, i b c, f f 9,303 375 9,678 21,436 7,012 747 0 9,528 375 9,903 21,436 7,996 1,122 675 38,991 (27,245) 11,746 334 12,080 18,435 4,795 1,158 0 39,228 (27,484) 11,744 241 11,985 18,506 4,902 853 640 38,873 41,132 36,468 36,886 19,542 6,469 1,272 0 119 0 20,148 6,632 1,261 0 131 283 17,970 6,420 1,295 0 103 0 17,891 6,563 1,284 673 170 263 33,135 33,498 27,402 28,455 25,788 26,844 14,109 2,932 14,667 2,786 11,881 869 12,750 (493) f, i (95) 11,082 404 c, f, i h h 12,677 2,471 10,206 4,484 14,690 (661) 11,471 2,995 (138) 8,338 3,976 38 10,042 2,155 7,887 583 8,470 (454) 10,680 1,966 (322) 8,392 420 6 11,486 12,257 12,352 14,029 8,818 8,016 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. 198 Note 41.7 Condensed Consolidated Balance Sheet The following is a Condensed Consolidated Balance Sheet of the Group, as of 31 December 2006 and 31 December 2005, 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 available-for-sale 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) Total liabilities, minority interests and   shareholders’ equity Reference US GAAP IFRS US GAAP IFRS 31.12.06 31.12.05 f, i, j,1,3, 4 3 j, 3 44 44 f, h, i, j,1, 4 3, 4 i, j,1, 3, 4 j a, f, i, j,1, 4 e, f, i, j,1, 4 2 f, j c, e, f a, c, f, l a, b, c, f b, c, f f c, d, e, f, g, h, i, j, k, l,1 f, i, j,1, 4 3 i, j, 3 i, j,1, 3, 4 2 i, j, k,1, 3, 4 i, j,1 f, i, j,1, 4 f, i, j a, c, f, i, j, 1 b, c, d, f, g, h, i, j, k, l,1 c, f, i 3,495 51,416 351,461 361,571 627,160 401,176 332,128 316,141 4,535 49,088 10,335 1,823 7,207 28,530 2,340 2,195 84,027 3,495 50,426 351,590 405,834 627,036 251,478 328,445 5,930 312,521 8,937 10,361 1,523 6,913 12,464 2,309 17,249 5,359 33,427 288,304 359,883 505,717 272,494 337,105 277,471 3,407 67,430 8,853 2,554 9,282 28,104 1,665 2,210 75,992 2,634,628 2,396,511 2,279,257 206,985 60,878 520,351 236,929 49,088 439,495 597,139 22,131 306,994 129,239 203,689 63,088 545,480 204,773 332,533 145,687 570,565 21,527 190,143 63,251 2,569,229 2,340,736 876 64,523 6,089 49,686 55,775 127,252 59,897 464,957 201,212 67,430 432,290 481,784 19,106 240,212 121,493 2,215,633 2,008 61,616 5,359 33,644 288,435 404,432 499,297 154,759 333,782 1,153 279,910 6,551 8,918 2,956 9,423 11,313 2,173 16,243 2,058,348 124,328 59,938 478,508 188,631 337,663 117,401 466,907 18,791 160,710 53,837 2,006,714 7,619 44,015 51,634 2,634,628 2,396,511 2,279,257 2,058,348 Note: References above coincide with the discussions in Note 41.1 and Note 41.5. These references indicate which IFRS to US GAAP differences affect an individual financial statement caption. Certain prior year US GAAP amounts have been reclas- sified to conform to the current year’s presentation. 199 Financial Statements Notes to the Financial Statements Note 41.8 Comprehensive Income Comprehensive income under US GAAP is defined as the change in shareholders’ equity excluding transactions with shareholders. Comprehensive income has two major com- ponents: Net profit, as reported in the income statement, and Other comprehensive income (OCI). OCI includes for- eign currency translation adjustments and changes in unre- alized gains / losses on available-for-sale securities. In addi- tion, up to 31 December 2006, OCI included adjustments to the additional minimum pension liability, which as of 31 December 2006 has been eliminated to reflect that a minimum pension liability is no longer recognized under US GAAP. However, as a result of the adoption of SFAS 158 as discussed in Note 41.1.g, OCI now includes changes in gains or losses and prior service costs or credits relating to post-retirement benefit plans that have not been recog- nized as components of net periodic pension costs. The components and Accumulated other comprehensive in- come amounts on a US GAAP basis for the years ended 31 December 2006, 31 December 2005 and 31 December 2004 are as follows: CHF million Balance at 1 January 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 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 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 Pension and other post-retirement benefit plans – initial adoption of SFAS 158 1 Balance at 31 December 2006 Unrealized   gains /   (losses) on   available-   for-sale   investments 175 Pension and Other Post- Retirement Benefit Plans (306) Deferred income taxes 211 Accumulated other compre-  hensive income /   (loss) (1,735) Comprehen- sive income /   (loss) 8,818 Foreign currency translation (1,815) (1,062) (1,062) 32 10 (5) 37 (819) (819) (2,877) 212 (1,125) 236 (15) (2) 1 21 241 452 (826) (826) 17 8 (4) (798) (1,603) (3,338) 17 8 (4) (798) (1,603) 7,215 12,352 2,380 (292) 2,088 2,088 2,380 (497) (1,269) 130 19 (19) 130 342 1,506 5 (460) (1,269) 1,051 (1,766) 1,393 (127) (127) (1,252) (38) (38) (1,815) (3,105) (6) (3) 3 18 (280) 172 83 (323) (1) 97 4 (140) 475 507 124 16 (16) (109) 2,103 (1,235) 124 16 (16) (109) 2,103 14,455 11,486 (1,186) (1,186) 1,183 4 (363) (34) (396) 11,090 1,183 4 (363) (34) (396) (1,340) (2,971) 1 Represents the incremental effect of transferring amounts not recognized in the income statement to Accumulated other comprehensive income. 200 Note 42  Additional Disclosures Required under US GAAP and SEC Rules In addition to the differences in valuation, income recogni- tion and presentation, disclosure differences exist between IFRS and US GAAP. The following are additional disclosures that relate to the basic Financial Statements required under US GAAP. Unless otherwise indicated in the note, all amounts are shown on an IFRS basis. Note 42.1  Variable Interest Entities Introduction Since 1 January 2004, UBS has applied FASB Interpretation No. 46, Consolidation of Variable Interest Entities (revised December 2003), an interpretation of Accounting Research Bulletin No. 51 (FIN 46-R). Until 31 December 2003, the pre- decessor standard, FIN 46, had application to UBS only with respect to transitional disclosure requirements, and consoli- dation requirements for certain variable interest entities (VIEs) created after 31 January 2003. All amounts in Note 42.1 are reported on a US GAAP basis. Identification of variable interest entities (VIEs) and mea- surement of variable interests Qualifying special purpose entities (QSPEs) per FASB State- ment No. 140 Accounting for Transfers and Servicing of Fi- nancial Assets and Extinguishments of Liabilities are exclud- ed 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 interests do not exist, or differ sig- nificantly from economic interests, the entity is considered a VIE under FIN 46-R, and control is assessed based on its vari- able interests. Specifically, VIEs are legal entities in which no equity investors exist, or the equity investors: – do not have sufficient equity at risk for the entity to fi- nance its activities without additional subordinated finan- cial support from other parties; or and provide certain disclosures. The holder of a significant variable interest in a VIE is required to make disclosures only. UBS treats variable interests of more than 20% of a VIE’s expected losses, expected residual returns, or both, as sig- nificant. 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, based on variability in the fair value of the net assets in the VIE, exclusive of variable interests. Under this approach, 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 creator (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, equity, 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 models are based on internally approved valuation models and in some cases require the use of Monte Carlo simulation techniques. They are applied when UBS first becomes involved with a – do not have the characteristics of a controlling financial VIE, or after a major restructuring. interest; 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. VIEs are evaluated for consolidation based on all contrac- tual, ownership, or other interests that expose their holders to the risks and rewards of the entity. These interests are termed variable interests and include only investments or contractual interests whose value changes with changes in the fair value of a VIE’s net assets, exclusive of variable inter- ests. Interests of related parties (including management, em- ployees, affiliates and agents) are included in the evaluation as if owned directly by the enterprise. The holder of a variable interest that receives a majority of a VIE’s expected losses, expected residual returns, or both, is the VIE's primary beneficiary and must consolidate the VIE 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 guaran- tees 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 expos- ing 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 in- volves the hedging of risk exposures for VIEs, on the same 201 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) basis as for non-VIE counterparties. See Note 29 for a further discussion of UBS’s risk mitigation strategies. purposes, have combined assets of approximately CHF 3.4 billion and are included in the table below. 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 result 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 beneficiary. Significant groups of these include CHF 2.5 bil- lion of investment fund products, and CHF 1.1 billion of se- curitization VIEs, which includes some third-party VIEs men- tioned below. 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 this population is approximately CHF 7.5 billion, mostly comprising investment funds managed by UBS, other invest- ment fund products, employee equity compensation trusts mentioned previously, and private equity investments. 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. 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 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 Passive intermediary to a derivative transaction Trust vehicles for awards to UBS employees Private equity investments Other miscellaneous structures Total 31.12.06 1,085 3,898 1,027 1,260 1,829 397 1,600 11,096 Consolidated assets that are collateral   for the VIEs’ obligations Classification Loan receivables, government debt securities, corporate debt securities Investment funds Debt, Equity Loan receivables, corporate debt securities UBS shares and derivatives thereon Private equity investments Equity, derivatives, investment funds Amount 1,085 3,898 984 1,260 1,829 272 615 9,943 Entities which are de-consolidated for US GAAP purposes In certain cases, an entity consolidated under IFRS is not con- solidated under FIN 46-R. UBS consolidates under IFRS sev- eral entities that have issued preferred securities amounting to CHF 4.5 billion, which are de-consolidated for US GAAP purposes. Under IFRS the preferred securities are equity in- struments held by third parties and are treated as minority interests, with dividends paid also reported in minority inter- ests; the UBS issued debt held by these entities and the re- spective 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. 202 Note 42  Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.1  Variable Interest Entities (continued) VIEs in which UBS holds a significant variable interest VIEs in which UBS holds a significant variable interest but does not consolidate the VIE are mostly used in securitiza- tions, or as investment fund products, including funds man- aged by UBS. UBS has reviewed the population of potential third-party VIEs it is involved with. Those identified in which UBS holds a significant variable interest have combined assets of ap- proximately CHF 4.6 billion, for which UBS has a maximum exposure to loss of approximately CHF 2.4 billion. Disclo- sures 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 31.12.06 Total assets Nature of involvement 61 5,707 23,870 1,200 1,181 32,019 UBS holds beneficial interests 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 Maximum exposure   to loss 0 1,975 17,772 894 301 20,942 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 81 third party VIEs that in some cases could result in UBS being considered the primary beneficiary, but the information nec- essary to make this determination, or perform the account- ing required to consolidate the VIE was held by third parties, and was not available to UBS. Additional disclosures for these VIEs are provided in the table below. VIEs not originated by UBS – information determining VIE status unavailable from third parties CHF million Nature, purpose and activities of VIEs Investment fund products Total 31.12.06 Total assets Nature of involvement 5,204 5,204 UBS acts as swap counterparty Net income from VIE in current period 441 441 Maximum exposure   to loss 4,483 4,483 203 Financial Statements Notes to the Financial Statements Note 42  Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.2 Securitizations UBS records a securitization of financial assets when the transfer of financial assets to the special purpose entity meets the accounting criteria to be accounted for as a sale. These criteria include: (1) the assets are legally isolated from UBS’s creditors; (2) the entity can pledge or exchange the fi- nancial assets, or if the entity is a qualifying special purpose entity, its investors can pledge or exchange their beneficial interests; and (3) UBS does not maintain effective control over the transferred assets through an agreement to repur- chase the assets before their maturity or have the ability to unilaterally cause the holder to return the assets. Proceeds received at the time of securitization were as follows: CHF billion Residential mortgage securitizations Commercial mortgage securitizations Other financial asset securitizations During the years ended 31 December 2006, 2005 and 2004, UBS securitized residential mortgage loans and securi- ties, 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. All amounts are shown on a US GAAP basis. Prior period amounts have been ad- justed to conform to the current year’s presentation. Proceeds Received 31.12.06 31.12.05 31.12.04 38 6 18 58 5 9 91 3 9 Related pre-tax gains (losses) recognized, including unrealized gains (losses) on retained interests, at the time of securitiza- tion were as follows: CHF million Residential mortgage securitizations Commercial mortgage securitizations Other financial asset securitizations Pre-tax gains / (losses) recognized 31.12.06 31.12.05 31.12.04 128 143 (49) 102 125 17 197 141 21 At 31 December 2006 and 2005, UBS retained CHF 3.5 bil- lion and CHF 1.7 billion, respectively, in agency residential mortgage securities, backed by the Government National Mortgage Association (GNMA), the Federal National Mort- gage Association (FNMA) and the Federal Home Loan Mort- gage Corporation (FHLMC). The retained interests in invest- ment-grade non-residential and other asset-backed securities amounted to CHF 1,618 million at 31 December 2006 and CHF 713 million at 31 December 2005. The fair value of in- vestment-grade retained interests is generally determined using observable market prices. Retained interests in non- investment-grade securities were not material at 31 Decem- ber 2006 and 2005. 204 Note 42  Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.3  Industrial Holdings’ Income Statement After 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 held a majority ownership interest in the company, and as a result, consolidated Motor-Columbus in its Financial Statements since 1 July 2004. The investment in Motor-Columbus is presented as a discontinued operation in the income statements for the years ended 31 December 2006, 31 December 2005 and 31 December 2004 due to its sale on 23 March 2006 (refer to Note 38 Discontinued Op- erations). In addition, due to the adoption of IAS 27 Con- solidated and Separate Financial Statements which is further described in Note 1b), 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. 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 Tax expense 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 receivable trade, gross Allowance for doubtful receivables Accounts receivables trade, net As of or for the year ended 31.12.06 31.12.05 31.12.04 693 469 52 135 0 5 55 716 (23) 0 (44) 334 290 267 35 11 243 865 1,108 104 1,004 103 (7) 96 675 457 61 124 0 4 105 751 (76) 5 (54) 585 536 460 175 25 310 409 719 207 512 2,068 (62) 2,006 640 425 64 111 27 2 66 695 (55) 37 (101) 334 270 215 51 5 169 284 453 93 360 205 Financial Statements Notes to the Financial Statements Note 42  Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.4  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 con- tracts 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. Indemnifications 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 gen- erally represents that certain securitized assets meet specific requirements, for example documentary attributes. UBS may be required to repurchase the assets and/or indemnify the 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 of 31 December 2006, 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 diligence UBS performs to ensure that the assets comply with the requirements set forth in the representations and warranties. UBS receives no compensation for representa- tions and warranties, and it is not possible to determine their fair value because they rarely, if ever, result in a pay- ment. Historically, losses incurred on such repurchases and / or indemnifications have been insignificant. Management expects the risk of material loss to be remote. No liabilities related to such representations, warranties, and indemnifi- cations are included in the balance sheet at 31 December 2006 and 2005. 206 Note 42.5  Pension and Other Post-Retirement Benefit Plans All amounts in Note 42.5 are on a US GAAP basis. The additional minimum liability required amounts to CHF 1,290 million, CHF 1,252 million and CHF 1,125 million as of 31 December 2006, 2005 and 2004, respectively. Incremental Effect of First Time Application of SFAS 158 The incremental effects on individual line items in the 31 December 2006 Financial Statements due to the adoption of SFAS 158 Employers’ Accounting for Defined Benefit Pension and Other Post-Retirement Plans (see Note 41.2 for details) are as follows: CHF million Other assets Total assets Other liabilities Total liabilities Total shareholder’ equity Amounts Included in Accumulated Other Comprehensive Income (AOCI) Before application of SFAS 158 31.12.06 Adjustment After  application of SFAS 158 86,008 86,008 129,880 129,880 65,863 (1,981) (1,981) (641) (641) (1,340) 84,027 84,027 129,239 129,239 64,523 CHF million Net gains or losses Net prior service costs or credits Transition assets Ending balance in AOCI 31.12.06 Swiss plans Foreign plans Post-retirement medical and   life plans (564) (1,153) 0 (1,717) (1,386) 41 0 (1,345) 73 (7) 0 66 (25) (15) (3) (43) 0 1 0 1 Amounts in AOCI expected to be recognized as components of net periodic benefit cost in 2007 Net gains or losses Net prior service costs or credits Transition assets Total 0 347 0 347 No plan assets are expected to be returned to the Group during 2007. For more details on the pension and other post-retirement benefit plans on an IFRS basis, see Note 31. Total (1,975) (1,127) (3) (3,105) 73 341 0 414 207 Financial Statements Notes to the Financial Statements Note 42  Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.6 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 Securities”) of PaineWebber. Prior to the acquisition, PaineWebber was an SEC Registrant. Upon the acquisition, PaineWebber was merged into UBS Americas Inc., a wholly owned subsidiary of UBS. Under the guarantee, if UBS Americas Inc. fails to make any timely payment under the Debt Securities agreements, the holders of the Debt Securities or the Debt Securities trustee may demand payment from UBS without first pro- ceeding against UBS Americas Inc. UBS’s obligations under the subordinated note guarantee are subordinated to the prior payment in full of the deposit liabilities of UBS and all other liabilities of UBS. At 31 December 2006, the amount of senior liabilities of UBS to which the holders of the subor- dinated debt securities would be subordinated is approxi- mately CHF 2,324 billion. The information presented in this note is prepared in ac- cordance with IFRS and should be read in conjunction with the Consolidated Financial Statements of UBS of which this information is a part. At the bottom of each column, Net prof- it and Shareholders’ equity have 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. Supplemental Guarantor Consolidating Income Statement CHF million For the year ended 31 December 2006 UBS AG 1 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 60,057 (56,020) 4,037 167 4,204 11,646 10,306 3,760 (450) 0 29,466 12,208 2,805 979 14 0 16,006 13,460 1,715 11,745 512 12,257 0 12,257 8,748 42,667 (41,049) 1,618 (6) 1,612 8,590 1,634 0 1,637 0 13,473 8,040 3,362 133 83 0 11,618 1,855 585 1,270 0 1,270 527 743 259 39,269 (38,403) 866 (5) 861 5,645 1,378 0 409 693 8,986 3,423 1,949 151 56 295 5,874 3,112 486 2,626 357 2,983 (34) 3,017 2,479 (54,592) 54,592 87,401 (80,880) 0 0 0 0 0 (3,760) 0 0 (3,760) 0 0 0 0 0 0 (3,760) 0 (3,760) 0 (3,760) 0 (3,760) 0 6,521 156 6,677 25,881 13,318 0 1,596 693 48,165 23,671 8,116 1,263 153 295 33,498 14,667 2,786 11,881 869 12,750 493 12,257 11,486 1 UBS AG Parent Bank prepares its financial statements in accordance with Swiss banking law requirements. For the purpose of this disclosure, the accounts have been adjusted to IFRS. 2 Refer to Note 41 for a description of the differences between IFRS and US GAAP. 208 Note 42  Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.6 Supplemental Guarantor Information (continued) Supplemental Guarantor Consolidating Balance Sheet UBS AG 1 Parent Bank 1 UBS Americas Inc. Subsidiaries Consolidating entries UBS Group CHF million As of 31 December 2006 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 available-for-sale 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 Minority interests Total equity Total liabilities and equity Total shareholders’ equity – US GAAP 2 2,660 121,404 99,829 270,814 294,590 162,722 318,936 2,902 414,031 5,843 6,598 34,887 5,432 258 10,709 1,751,615 228,992 106,019 167,166 107,747 326,216 121,074 504,502 12,336 110,020 16,488 1,700,560 51,055 0 51,055 1,751,615 29,738 78 16,884 303,607 167,222 188,710 51,834 13,168 4,147 40,279 862 4,029 179 637 11,128 5,524 808,288 114,782 57,937 419,427 71,165 13,629 49 80,936 8,406 29,149 4,284 757 182,850 156,083 300,862 143,736 36,922 173,243 7,146 38,644 2,232 4,809 237 844 3,387 5,587 0 (270,712) (207,929) (333,064) 0 0 (176,902) (8,265) (180,433) 0 (5,075) (33,780) 0 0 (4,571) 3,495 50,426 351,590 405,834 627,036 251,478 328,445 5,930 312,521 8,937 10,361 1,523 6,913 14,773 17,249 1,057,339 (1,220,731) 2,396,511 130,627 107,061 291,951 25,861 169,590 32,829 165,560 5,860 50,974 47,050 (270,712) (207,929) (333,064) 0 (176,902) (8,265) (180,433) (5,075) 0 (4,571) (1,186,951) (33,780) 0 (33,780) (1,220,731) 0 203,689 63,088 545,480 204,773 332,533 145,687 570,565 21,527 190,143 63,251 2,340,736 49,686 6,089 55,775 2,396,511 64,523 799,764 1,027,363 5,539 2,985 8,524 808,288 7,287 26,872 3,104 29,976 1,057,339 27,498 1 UBS AG Parent Bank prepares its financial statements in accordance with Swiss banking law requirements. For the purpose of this disclosure, the accounts have been adjusted to IFRS. 2 Refer to Note 41 for a description of the differences between IFRS and US GAAP. 209 Financial Statements Notes to the Financial Statements Note 42  Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.6 Supplemental Guarantor Information (continued) Note 42.6 Supplemental Guarantor Consolidating Cash Flow Statement CHF million For the year ended 31 December 2006 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 available-for-sale Net cash flow from / (used in) investing activities Cash flow from / (used in) financing activities Net money market paper issued / (repaid) Net movements in treasury shares and own equity derivative activity Capital issuance Capital repayment by par value reduction Dividends paid Issuance of long-term debt, 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 1 Parent Bank 1 (1,705) UBS Americas Inc. Subsidiaries UBS Group (14,810) 11,805 (4,710) 2,856 1,154 (1,292) 298 90 3,106 17,526 (3,624) 1 (631) (3,214) 79,358 (48,959) 0 0 (8,246) 32,211 388 34,000 68,548 102,548 2,660 73,431 26,457 102,548 0 0 (255) 47 433 225 0 0 (246) 154 1,200 1,108 1,039 (1,644) 0 0 0 0 10,881 (447) 85 2,441 3,055 17,054 (1,871) 598 13,531 14,129 78 11,488 2,563 14,129 0 0 0 0 7,436 (10,545) 1,246 (3,513) 5,191 (1,829) (634) 10,450 8,963 19,413 757 2,225 16,431 19,413 2,856 1,154 (1,793) 499 1,723 4,439 16,921 (3,624) 1 (631) (3,214) 97,675 (59,951) 1,331 (1,072) 0 47,436 (2,117) 45,048 91,042 136,090 3,495 87,144 45,451 136,090 1 UBS AG Parent Bank prepares its financial statements in accordance with Swiss banking law requirements. For the purpose of this disclosure, the accounts have been adjusted to IFRS. 2 Money market paper is included in the Balance sheet under Trading portfolio assets and Financial investments available-for-sale. CHF 7,183 million was pledged at 31 December 2006. 210 Note 42  Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.6 Supplemental Guarantor Information (continued) 42.6 Supplemental Guarantor Consolidating Income Statement CHF million For the year ended 31 December 2005 UBS AG Parent Bank 1 UBS Americas Inc. 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 27,782 (24,803) 2,979 (3) 2,976 7,420 (123) 0 476 0 25,340 10,749 9,962 2,330 988 24 0 13,304 12,036 1,712 10,324 3,705 14,029 0 14,029 14,490 6,587 2,667 140 70 0 9,464 1,285 1,079 206 0 206 122 84 (891) Subsidiaries Consolidating entries UBS Group 20,729 (20,067) (29,004) 29,004 59,286 (49,758) 662 8 670 4,346 666 0 (1,989) 675 4,368 3,599 1,635 133 37 283 5,687 (1,319) (320) (999) 779 (220) 539 (759) (1,247) 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 1,122 675 41,132 20,148 6,632 1,261 131 283 28,455 12,677 2,471 10,206 4,484 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. 2 Refer to Note 41 for a description of the differences between IFRS and US GAAP. 211 Financial Statements Notes to the Financial Statements Note 42  Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.6 Supplemental Guarantor Information (continued) Supplemental Guarantor Consolidating Balance Sheet CHF million As of 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 available-for-sale 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 Minority interests Total equity Total liabilities and equity Total shareholders’ equity – US GAAP 2 UBS AG 1 Parent Bank 1 UBS Americas Inc. Subsidiaries Consolidating entries UBS Group 2,712 127,321 98,105 240,762 299,750 79,333 330,894 2,186 299,518 3,198 5,720 31,250 5,462 641 7,509 1,534,361 181,592 85,369 132,073 113,171 337,172 93,207 434,675 10,439 87,267 10,409 1,485,374 48,987 0 48,987 1,534,361 33,028 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 8,415 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 33,644 288,435 404,432 499,297 154,759 333,782 1,153 279,910 6,551 8,918 2,956 9,423 13,486 16,243 838,338 (1,029,672) 2,058,348 81,262 110,202 268,262 6,000 155,499 24,194 64,485 5,672 53,947 42,326 811,849 18,984 7,505 26,489 838,338 20,173 (265,360) (186,028) (282,759) 0 (162,282) 0 (95,496) (4,814) 0 (2,492) (999,231) (30,441) 0 (30,441) (1,029,672) 0 124,328 59,938 478,508 188,631 337,663 117,401 466,907 18,791 160,710 53,837 2,006,714 44,015 7,619 51,634 2,058,348 61,616 1 UBS AG Parent Bank prepares its financial statements in accordance with Swiss banking law requirements. For the purpose of this disclosure, the accounts have been adjusted to IFRS. 2 Refer to Note 41 for a description of the differences between IFRS and US GAAP. 212 Note 42  Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.6 Supplemental Guarantor Information (continued) Note 42.6 Supplemental Guarantor Consolidating Cash Flow Statement CHF million For the year ended 31 December 2005 UBS AG Parent Bank 1 (29,118) 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 available-for-sale 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 Americas Inc. (15,771) Subsidiaries (18,318) UBS Group (63,207) 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 (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 1 UBS AG Parent Bank prepares its financial statements in accordance with Swiss banking law requirements. For the purpose of this disclosure, the accounts have been adjusted to IFRS. 2 Money market paper is included in the Balance sheet under Trading portfolio assets and Financial investments available-for-sale. CHF 4,744 million was pledged at 31 December 2005. Guarantee of other securities UBS AG, acting through a wholly owned finance subsidiaries, issued the following trust preferred securities: USD billion, unless otherwise indicated Issuing entity UBS Preferred Funding Trust I UBS Preferred Funding Trust II UBS Preferred Funding Trust IV UBS Preferred Funding Trust V Type of security Trust preferred securities Trust preferred securities 1 Floating rate noncumulative trust preferred securities Trust preferred securities 1 In June 2006, USD 300 million (at 7.25%) of Trust preferred securities also issued in June 2001 were redeemed. Outstanding as of 31.12.06 Date issued Interest (%) Amount October 2000 June 2001 8.622 7.247 May 2003 May 2006 one-month LIBOR + 0.7% 6.243 1.5 0.5 0.3 1.0 UBS AG has fully and unconditionally guaranteed these se- curities. 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 2006, the amount of senior liabilities of UBS to which the holders of the subordinated debt securities would be subordinated is approximately CHF 2,324 billion. 213 Financial Statements Notes to the Financial Statements Note 42  Additional Disclosures Required under US GAAP and SEC Rules (continued) Note 42.7  Pro-Forma Effect of the Fair Value Method of Accounting on US GAAP Net Profit The following table presents US GAAP Net profit and earn- ings per share for the year ended 31 December 2004 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 com- pensation plans using the modified prospective method. See Note 41.1h) 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 8,818 1,209 (1,717) 8,310 4.28 4.03 4.07 3.84 214 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 Auditors of the Conditional Capital Increase 216 217 218 218 219 220 221 222 222 222 223 223 223 223 224 224 224 224 225 225 225 226 227 UBS AG (Parent Bank) Table of Contents Parent Bank Review Income Statement Balance Sheet The Parent Bank UBS AG Net profit decreased by CHF 6,939 million from CHF 13,497 million to CHF 6,558 million. In- come from investments in associated companies decreased to CHF 1,910 million from CHF 3,943 million in 2005 mainly due to lower dividend distributions received. The decrease in Extraordinary income and increase in Extraordinary expenses are explained on page 222. Total assets increased by CHF 226 billion to CHF 1,586 billion at 31 December 2006. This movement is mainly caused by increased positions in Money market paper of CHF 26 billi- on, Due from banks of CHF 8 billion and Due from custo- mers of CHF 131 billion (of which CHF 88 billion relates to Dillon Read Capital Management and the remaining amount mainly relates to current and margin accounts). A consider- able increase resulted as well in Trading balances in securities and precious metals of CHF 53 billion (thereof debt instru- ments CHF 12 billion, equities CHF 33 billion and precious metals CHF 8 billion). The investments in associated compa- nies expanded by CHF 5 billion which is mainly due to new investments or additional financing of subsidiaries abroad of Banco Pactual S.A., UBS VIII Wilmington (as “funding unit”), Dillon Read Capital Management and Global Futures and Options Business of ABN AMRO but also includes the reduc- tion of investments in associated companies due to the sale of Motor-Columbus. 217 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 218 For the year ended 31.12.06 31.12.05 % change from 31.12.05 45,978 15,324 32 (57,507) 3,827 199 12,288 840 (1,820) 11,507 9,467 333 1,910 21 2,982 (3,059) 2,187 26,988 12,886 4,736 17,622 9,366 1,352 342 7,672 1,095 239 1,970 6,558 27,320 12,482 36 (33,972) 5,866 244 9,751 773 (1,349) 9,419 7,289 95 3,943 38 2,164 (2,352) 3,888 26,462 10,999 4,113 15,112 11,350 1,265 27 10,058 5,274 0 1,835 13,497 68 23 (11) 69 (35) (18) 26 9 35 22 30 251 (52) (45) 38 30 (44) 2 17 15 17 (17) 7 (24) (79) 7 (51) Balance She et 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 31.12.06 31.12.05 % change from 31.12.05 2,660 73,430 439,098 316,241 153,114 411,981 2,844 27,076 4,527 6,573 138,222 9,975 2,712 47,840 431,071 185,331 153,387 358,600 4,216 22,016 4,527 5,359 136,503 7,980 1,585,741 1,359,542 5,852 657,919 69,861 556,136 80,883 508,609 2,238 143,779 16,672 149,879 10,471 2,305 211 8,295 9,114 20,730 6,558 6,094 557,355 52,335 482,134 86,997 406,724 1,464 102,386 13,543 160,002 5,648 2,157 871 7,927 10,562 13,295 13,497 1,585,741 1,359,542 21,907 450,093 16,022 404,108 (2) 53 2 71 0 15 (33) 23 0 23 1 25 17 (4) 18 33 15 (7) 25 53 40 23 (6) 85 7 (76) 5 (14) 56 (51) 17 37 11 219 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 2006 as per the Parent Bank’s Income Statement Appropriation to general statutory reserve Appropriation to other reserves Proposed dividends Total appropriation Dividend Distribution 6,558 457 1,519 4,582 6,558 The Board of Directors will recommend to the Annual General Meeting on 18 April 2007 that UBS should pay a dividend of CHF 2.20 per share of CHF 0.10 par value. If the dividend is approved, the payment of CHF 2.20 per share, after deduction of 35% Swiss withholding tax, would be made on 23 April 2007 for shareholders who hold UBS shares on 18 April 2007. 220 UBS AG (Parent Bank) Notes to the Financial Statements Notes to the Financial Statements Accounting Principles The Parent Bank’s accounting policies are in compliance with Swiss banking law. The accounting policies are principally the same as for the Group Financial Statements outlined in Note 1, Summary of Significant Accounting Policies. Major differences 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 ba- lance sheet as trading balances or as financial investments. 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 treasury shares in the trading portfolio to market value are included in the income statement. Treasury shares included in financial investments are carried at the lower of cost and 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 average rates for the period. Exchange differences arising on the trans- lation of each of these foreign branches are credited to a pro- vision account (other liabilities) in case of a gain, while any losses are debited first 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 impairment, if applicable. 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 extraordina- ry within the Parent Bank Financial Statements, whereas in the Group Financial Statements they are considered to be operating income or expenses and appear within the ap- propriate income or expense category, or they are included in net profit from discontinued operations, if required. Equity participation plans Under IFRS, UBS recognizes the fair value of stock and stock option awards determined at the grant date as compensati- on expense over the required service period. Equity-settled awards are classified as equity instruments and are generally not re-measured subsequently. Cash settled awards are clas- sified as liabilities and re-measured to fair value at each ba- lance sheet date. Under Swiss law, employee stock awards are accrued over the performance period, while employee stock option awards are recognized in the year of grant. Equity- and cash- settled awards are classified as liabilities. Stock option awards are re-measured at their intrinsic value. Comparability For 2005, current income taxes of CHF 2,092 million have been reclassified from Allowances and provisions to Accruals and deferred income and CHF 2,118 million of intra-group revenue transfers has been reclassified from Sundry income from ordinary activities to Sundry ordinary expenses to con- cur with the current year‘s gross presentation of revenue transfers within subsidiaries. UBS holds investments in financial assets in order to economically hedge fair value movements on certain liabi- lities. These financial assets are included in Trading balan- ces in securities and precious metals. Where such invest- ments were consolidated entities under IFRS, they were measured at the lower of cost or market until 2005. Net trading income includes gains of CHF 346 million related to prior years‘ fair value movements on those invest- ments. 221 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 31.12.06 31.12.05 31.12.05 5,761 1,629 2,077 9,467 3,068 1,540 2,681 7,289 88 6 (23) 30 Extraordinary income includes a CHF 678 million gain on the sale of Motor-Columbus compared to a gain on the sale of Private Banks & GAM of CHF 3,183 million in 2005. In addi- tion, amounts in 2006 include a write-up of investments in associated companies of CHF 223 million (2005: CHF 1,263 million), releases of provisions of CHF 167 million (2005: CHF 452 million). Amounts in 2005 include a gain of CHF 370 million resulting from a merger with a subsidiary. Extraordinary expenses include CHF 202 million related to the under-accrual of unused vacation, sabbatical leave and service anniversary awards in prior years and a CHF 37 milli- on loss related to the merger with a subsidiary. 222 Additional Balance Sheet Information Balance at 31.12.05 1,836 3,880 328 1,662 19 7,725 5,568 2,157 Share capital 901 (32) 2 871 (631) (30) 1 Allowances and Provisions CHF million Default risks (credit and country risk) Trading portfolio risks Litigation risks Operational risks Deferred taxes Total allowances and provisions Allowances deducted from assets Total provisions as per balance sheet Statement of Shareholders’ Equity CHF million As of 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 As of 31.12.05 and 1.1.06 Par value reduction Cancellation of own shares Capital increase Increase in reserves Prior year dividend Profit for the period Changes in reserves for own shares As of 31.12.06 Share Capital As of 31.12.06 Issued and paid up Conditional share capital As of 31.12.05 Issued and paid up Conditional share capital Provisions applied in accordance with their specified purpose Recoveries, doubtful interest, currency translation differences (439) (135) (47) (621) 67 (225) (124) 97 (17) (202) Provisions released to income (513) (811) (32) (348) New provisions charged to income 347 256 537 32 (1,704) 1,172 Balance at 31.12.06 1,298 2,844 293 1,901 34 6,370 4,065 2,305 General statutory reserves: Share premium General statutory reserves: Retained earnings 6,213 1,359 Reserves for own shares 9,056 33 322 6,246 1,681 1,506 10,562 34 334 211 6,280 2,015 (1,448) 9,114 Total shareholders’ equity (before distribution of profit) Other reserves 21,739 (3,511) (322) (3,105) 13,497 (1,506) 26,792 35 (3,997) (334) (3,214) 6,558 1,448 27,288 39,268 (3,543) 35 (3,105) 13,497 46,152 (596) (4,027) 35 (3,214) 6,558 44,908 Par value Ranking for dividends No. of shares Capital in CHF No. of shares Capital in CHF 2,105,273,286 210,527,329 2,082,673,286 208,267,329 151,437,410 15,143,741 2,177,265,044 870,906,018 2,109,495,044 843,798,018 3,647,002 1,458,801 On 31 December 2006, a maximum of 1,437,410 shares 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 table above. In addition, during 2006, shareholders approved the creation of conditional capital of up to a maximum of 150 million shares to fund UBS‘s employee share option programs. As of 31 December 2006, no shares have been issued under this program. 223 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 31.12.06 31.12.05 Change in % Book value Effective liability Book value Effective liability Book value Effective liability 37,471 81 89,869 127,421 9,035 38 41,306 50,379 26,513 64 102,330 128,907 6,120 38 48,580 54,738 41 27 (12) (1) 48 (15) (8) Financial assets are pledged in securities borrowing and lending transactions, in repurchase and reverse repurchase trans- actions, under collateralized credit lines with central banks, against loans from mortgage institutions and for security deposits relating to stock exchange and clearinghouse memberships. Commitments and Contingent Liabilities CHF million Contingent liabilities Irrevocable commitments Liabilities for calls on shares and other equities Confirmed credits Derivative Instruments CHF million Interest rate contracts Credit derivative contracts Foreign exchange contracts Precious metal contracts Equity / Index contracts Commodities contracts, excluding precious metals contracts Total derivative instruments Replacement value netting Replacement values after netting 1 PRV: Positive replacement value. 2 NRV: Negative replacement value. 31.12.06 189,627 115,364 125 2,133 31.12.05 184,665 68,071 130 2,004 % change from 31.12.05 3 69 (4) 6 31.12.06 31.12.05 PRV 1 176,765 NRV 2 175,394 29,026 76,459 4,472 22,437 11,459 320,618 182,396 138,222 31,781 70,899 4,168 39,016 11,017 332,275 182,396 149,879 Notional amount CHF bn PRV NRV 29,558 222,508 221,437 2,824 6,134 121 745 359 39,741 15,811 57,705 3,616 25,663 10,677 335,980 199,477 136,503 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 27,952 224 Fiduciary Transactions CHF million Deposits: with other banks with Group banks Total 31.12.06 31.12.05 % change from 31.12.05 41,075 1,650 42,725 37,171 1,382 38,553 11 19 11 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 31.12.06 31.12.05 % change from 31.12.05 790 7,169 19 719 2,222 21 10 223 (10) 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. Personnel Parent Bank personnel was 42,443 on 31 December 2006 and 38,189 on 31 December 2005. 225 UBS AG (Parent Bank) Report of the Statutory Auditors 226 UBS AG (Parent Bank) Report of the Auditors of the Conditional Capital Increase 227 228 Additional Disclosure Required under SEC Regulations Additional Disclosure Required under SEC Regulations Table of Contents Additional Disclosure Required under SEC Regulations Table of Contents A – Introduction B – Selected Financial Data Balance Sheet Data US GAAP Income Statement Data US GAAP Balance Sheet Data Ratio of Earnings to Fixed Charges C – Information on the Company Property, Plant and Equipment D – 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 231 231 233 234 235 235 235 235 236 236 236 238 240 241 242 243 244 245 246 247 249 250 251 230 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 Reporting 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 United States Generally Accepted Accounting Principles (US GAAP). B – Selected Financial Data The tables below set forth, for the periods and dates indica- ted, 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 2007 the noon buying rate was 0.8204 USD per 1 CHF. Year ended 31 December 2002 2003 2004 2005 2006 Month September 2006 October 2006 November 2006 December 2006 January 2007 February 2007 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 0.6453 0.7493 0.8059 0.8039 0.8034 0.7229 0.8069 0.8712 0.7606 0.8200 High 0.7229 0.8189 0.8843 0.8721 0.8396 High 0.8125 0.8049 0.8357 0.8396 0.8247 0.8204 Low 0.5817 0.7048 0.7601 0.7544 0.7575 Low 0.7949 0.7842 0.7958 0.8161 0.7978 0.7980 231 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 (%) 3 Rates of return (%) Return on equity attributable to UBS shareholders 4 Return on average equity Return on average assets 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 For the year ended 87,401 (80,880) 59,286 (49,758) 6,521 156 6,677 25,881 13,318 1,596 693 48,165 33,498 14,667 2,786 11,881 869 12,750 493 12,257 69.7 6.20 5.95 7.42 2.20 35.5 28.2 26.3 0.51 9,528 375 9,903 21,436 7,996 1,122 675 41,132 28,455 12,677 2,471 10,206 4,484 14,690 661 14,029 70.1 6.97 6.68 6.29 1.60 1.26 23.0 39.7 37.2 0.67 39,228 (27,484) 11,744 241 11,985 18,506 4,902 853 640 36,886 26,844 10,042 2,155 7,887 583 8,470 454 8,016 73.2 3.89 3.70 4.88 1.50 1.27 38.6 25.8 23.8 0.44 40,045 (27,784) 12,261 (102) 12,159 16,673 3,670 280 535 33,317 26,000 7,317 1,403 5,914 339 6,253 349 5,904 76.8 2.72 2.59 3.37 1.30 1.00 47.8 18.0 16.9 0.38 39,896 (29,417) 10,479 (112) 10,367 17,481 5,381 13 335 33,577 30,135 3,442 566 2,876 489 3,365 348 3,017 84.7 1.30 1.27 1.48 1.00 0.73 76.9 8.3 7.7 0.20 1 Operating expenses / operating income before credit loss expense for Financial Businesses. 2 For EPS calculation, see Note 8 to the Financial Statements. 3 In July 2006, a par value reduction of CHF 0.60 per share was distributed, after which the UBS share was split 2-for-1. Dividends are normally declared and paid in the year subsequent to the reporting period. On a post-split basis, a dividend of CHF 1.60 per share was paid on 24 April 2006, CHF 1.50 on 26 April 2005, CHF 1.30 on 20 April 2004 and CHF 1.00 on 23 April 2003. A dividend of CHF 2.20 per share will be paid on 23 April 2007, subject to approval by shareholders at the Annual General Meeting. The USD amount per share will be determined on 19 April 2007. 4 Net profit attributable to UBS shareholders / average equity attributable to UBS shareholders less distributions. 232 B – Selected Financial Data (continued) CHF million, except where indicated 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 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 1 See the Handbook 2006/2007 for information about the nature of these ratings. 2,396,511 2,058,348 1,737,171 1,554,032 1,350,905 49,686 1.93 154,222 44,015 1.79 131,949 33,632 1.84 103,638 33,350 2.23 95,401 35,701 2.65 79,448 2,105,273,286 2,177,265,044 2,253,716,354 2,366,093,528 2,512,595,356 164,475,699 208,519,748 249,326,620 273,482,454 282,461,382 11.9 14.7 341,892 2,989 27,018 12,687 30,819 7,616 78,140 AA+ Aa2 AA+ 12.8 14.1 310,409 2,652 26,028 11,007 27,136 5,398 69,569 AA+ Aa2 AA+ 11.8 13.6 264,832 2,217 25,990 10,764 26,232 4,438 67,424 AA+ Aa2 AA+ 11.8 13.4 252,398 2,098 26,662 9,906 25,511 3,850 65,929 AA+ Aa2 AA+ 11.2 13.7 238,790 1,959 27,972 10,009 27,350 3,730 69,061 AAA Aa2 AA+ Balance Sheet Data CHF million Assets Total assets Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Trading portfolio assets pledged as collateral Positive replacement values Loans Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Negative replacement values Financial liabilities designated at fair value Due to customers Debt issued Equity attributable to UBS shareholders 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 2,396,511 2,058,348 1,737,171 1,554,032 1,350,905 50,426 351,590 405,834 627,036 251,478 328,445 312,521 203,689 63,088 545,480 204,773 332,533 145,687 570,565 190,143 49,686 33,644 288,435 404,432 499,297 154,759 333,782 279,910 124,328 59,938 478,508 188,631 337,663 117,401 466,907 160,710 44,015 35,419 210,606 357,164 389,487 159,115 284,577 241,803 120,026 51,301 422,587 171,033 303,712 65,756 386,320 117,856 33,632 31,959 206,519 320,499 354,558 120,759 248,206 220,083 129,084 48,272 415,863 143,957 254,768 35,286 351,583 88,874 33,350 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 35,701 233 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 Total operating income Operating expenses Personnel expenses General and administrative expenses Depreciation of property and equipment Amortization of other intangible assets 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 / (loss) 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 For the year ended 87,380 (80,463) 6,917 156 7,073 25,881 12,548 1,742 47,244 23,771 7,944 1,277 143 33,135 14,109 2,932 (95) 11,082 404 58,791 (49,488) 9,303 375 9,678 21,436 7,012 747 38,873 19,542 6,469 1,272 119 27,402 11,471 2,995 (138) 8,338 3,976 39,802 (27,628) 12,174 (74) 12,100 16,606 3,944 382 33,032 17,234 5,917 1,368 110 24,629 8,403 1,790 (350) 6,263 250 39,612 (29,334) 10,278 (112) 10,166 17,481 5,870 (65) 33,452 18,224 6,953 1,573 1,443 28,193 5,259 456 (331) 4,472 435 639 38,991 (27,245) 11,746 334 12,080 18,435 4,795 1,158 36,468 17,970 6,420 1,295 103 25,788 10,680 1,966 (322) 8,392 420 6 11,486 38 12,352 8,818 6,513 5,546 234 B – Selected Financial Data (continued) US GAAP Balance Sheet Data CHF million Assets Total assets Due from banks Cash collateral on securities borrowed Reverse repurchase agreements Trading portfolio assets Trading portfolio assets pledged as collateral Positive replacement values 1 Loans Goodwill Other intangible assets Other assets Liabilities Due to banks Cash collateral on securities lent Repurchase agreements Trading portfolio liabilities Obligation to return securities received as collateral Negative replacement values 1 Due to customers Accrued expenses and deferred income Debt issued Shareholders’ equity 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 2,634,628 2,279,257 1,903,239 1,699,060 1,296,991 51,416 351,461 361,571 627,160 401,176 332,128 316,141 28,530 2,340 84,027 206,985 60,878 520,351 236,929 49,088 439,495 597,139 22,131 306,994 64,523 33,427 288,304 359,883 505,717 272,494 337,105 277,471 28,104 1,665 75,992 127,252 59,897 464,957 201,212 67,430 432,290 481,784 19,106 240,212 61,616 35,286 208,778 357,164 378,281 230,223 284,468 238,604 26,977 1,722 101,121 119,021 47,548 423,513 190,907 12,950 360,345 397,157 15,229 164,744 52,359 31,758 203,645 320,499 349,023 195,469 248,924 220,142 26,775 1,174 64,434 127,385 46,151 415,863 149,380 13,071 326,136 352,364 14,072 123,259 52,865 32,481 139,073 294,086 268,263 173,582 83,757 211,755 28,127 1,222 21,367 83,178 36,870 366,858 117,721 16,308 132,354 306,872 15,729 129,527 55,267 1 Positive and negative replacement values represent the fair values of derivative instruments. From 2003 onwards they are presented on a gross basis under US GAAP. Certain prior year US GAAP amounts have been reclassified to conform to the current year’s presentation. Ratio of Earnings to Fixed Charges The following table sets forth UBS’s ratio of earnings to fixed charges on a IFRS basis for the periods indicated. The ratios are calculated based on earnings from continuing operations. Ratios of earnings to combined fixed charges and preferred stock dividend requirements are not presented as there were no preferred share dividends in any of the periods indicated. The ratios are calculated on a US GAAP basis and are not materially different from the IFRS ratios for the periods presented. IFRS C – Information on the Company For the year ended 31.12.06 1.17 31.12.05 1.24 31.12.04 1.34 31.12.03 1.24 31.12.02 1.10 Property, Plant and Equipment At 31 December 2006, UBS Financial Businesses operated about 1,135 business and banking locations worldwide, of which about 37% were in Switzerland, 49% in the Americas, 10% in the rest of Europe, Middle East and Africa and 4% in Asia-Pacific. 15% 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 2006, the Industrial Holdings segment operated about 42 business locations worldwide, of which 0% were in Switzerland, 55% in the rest of Europe, Middle East and Africa, 43% in the Americas and 2% in Asia-Pacific. 98% 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. 235 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 Selected Statistical Information The tables below set forth selected statistical information re- garding the Group’s banking operations extracted from the Financial Statements. Unless otherwise indicated, average balances for the years ended 31 December 2006, 31 Decem- ber 2005 and 31 December 2004 are calculated from month- ly data. The distinction between domestic and foreign is ge- nerally 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 2006, 2005 and 2004. Average balance 31.12.06 Interest Average rate (%) Average balance 31.12.05 Interest Average rate (%) Average balance 31.12.04 Interest Average rate (%) 5.4 5.0 4.9 4.1 3.6 4.4 2.9 4.4 3.0 3.2 5.9 0.7 3.2 3.2 4.3 15,467 25,497 270 1,334 33,012 776,972 15,545 580,763 3,390 1,079 22,283 457 23,619 58 584,153 23,677 616 691 0 26 174,299 91,290 5,424 3,531 1,036 3,546 0 3,546 1,722,124 3 83 0 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 3.9 0.3 2.3 2.3 3.4 12,463 23,843 154 397 17,969 701,817 10,122 513,922 2,309 457 10,242 336 18,908 27 516,231 18,935 196 0 0 0 168,456 68,393 5,308 2,126 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 3.1 1.5 0.7 0.7 2.5 2,021,523 87,401 4.3 1,722,124 59,286 3.4 1,523,622 39,228 2.6 320,596 7,445 66,362 2,415,926 319,698 9,308 55,178 2,106,308 246,952 8,808 53,140 1,832,522 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 10,800 29,814 587 1,490 27,147 926,575 1,333 38,393 17,976 651 707,432 31,433 4,438 127 711,870 31,560 42 2,325 0 70 181,186 106,491 5,784 6,284 Financial investments available-for-sale Domestic Foreign taxable Foreign non-taxable Foreign total 4,126 3,171 0 3,171 Total interest-earning assets 2,021,523 28 100 0 100 86,280 1,121 Net interest on swaps Interest income and average interest- earning assets Non-interest-earning assets Positive replacement values Fixed assets Other Total average assets 236 D – Information Required by Industry Guide 3 (continued) CHF million, except where indicated Liabilities and Equity Due to banks Domestic Foreign Cash collateral on securities lent and repurchase agreements Domestic Foreign Trading portfolio liabilities Domestic Foreign 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 Total interest-bearing liabilities 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 Average balance 31.12.06 Interest Average rate (%) Average balance 31.12.05 Interest Average rate (%) Average balance 31.12.04 Interest Average rate (%) 46,544 108,885 1,583 5,261 46,224 751,617 1,589 32,432 4,408 283 202,263 14,250 1,864 127,458 58 4,699 70,981 86,631 28,876 186,488 315,917 534 392 639 1,565 11,500 1,973 110,418 115 4,939 3,957 57,899 1,965,915 82 2,524 80,880 320,766 76,270 2,362,951 52,975 2,415,926 3.4 4.8 3.4 4.3 6.4 7.0 3.1 3.7 0.8 0.5 2.2 0.8 3.6 5.8 4.4 2.1 4.4 4.1 35,713 92,431 897 3,321 40,772 647,998 881 19,599 3,632 145 173,394 10,591 638 86,688 67,987 86,373 24,245 178,605 249,561 1,584 96,767 4,250 43,035 5 2,385 292 404 386 1,082 5,906 20 2,905 117 1,904 1,655,068 49,758 335,992 70,654 2,061,714 44,594 2,106,308 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 33,846 606,623 3,717 161,286 385 1,582 489 9,417 180 7,813 85 1 49,234 1,167 67,005 84,112 19,052 170,169 200,664 246 79,902 10,358 28,259 167 414 250 831 2,785 0 1,338 168 1,328 1,471,853 27,484 260,629 60,844 1,793,326 39,196 1,832,522 6,521 9,528 11,744 0.3 0.6 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 1.7 1.6 4.7 1.9 0.8 1 Due to customers in foreign offices consists mainly of time deposits. The percentage of total average interest-earning assets attri- butable to foreign activities was 88% for 2006 (86% for 2005 and 86% for 2004). The percentage of total average interest-bearing liabilities attributable to foreign activities was 85% for 2006 (84% for 2005 and 83% for 2004). All assets and liabilities are translated into CHF at uniform month-end rates. Interest income and expense are transla- ted at monthly average rates. Average rates earned and paid on assets and liabilities can change from period to period based on the changes in interest rates in general, but are also affected by changes in the curren- cy mix included in the assets and liabilities. This is especially true for foreign assets and liabilities. Tax-exempt income is not recorded on a tax-equivalent basis. For all three years presen- ted, tax-exempt income is considered to be insignificant and the impact from such income is therefore negligible. 237 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-ear- ning assets and interest-bearing liabilities, the changes in in- terest income and expense due to changes in volume and interest rates for the year ended 31 December 2006 com- pared with the year ended 31 December 2005, and for the year ended 31 December 2005 compared with the year ended 31 December 2004. Volume and rate variances have been calculated on movements in average balances and changes in interest rates. Changes due to a combination of volume and rates have been allocated proportionally. Refer to page 245 of Industry Guide 3 for a discussion of the treat- ment of impaired, non-performing and restructured loans. 2006 compared with 2005 2005 compared with 2004 Increase / (decrease) due to changes in Increase / (decrease) due to changes in Average volume Average rate Net change Average volume Average rate Net change (79) 224 396 (68) 317 156 (194) 4,338 448 11,772 254 16,110 70 5,193 18 5,211 0 62 213 593 9 (9) 0 (9) 124 2,621 51 2,672 0 (18) 147 2,160 16 26 0 26 19 10,419 10,438 1,131 16,544 17,675 194 7,814 69 7,883 0 44 360 2,753 25 17 0 17 1,150 26,963 28,113 2 28,115 36 28 376 1,127 179 2,473 13 2,486 0 26 187 710 (1) 4 0 4 80 909 116 937 246 10,914 622 12,041 (58) 2,238 18 2,256 0 0 (71) 695 (13) 58 0 58 121 4,711 31 4,742 0 26 116 1,405 (14) 62 0 62 961 19,213 20,174 (116) 20,058 777 4,381 5,158 184 14,832 15,016 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 238 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 2006 compared with 2005 2005 compared with 2004 Increase / (decrease) due to changes in Increase / (decrease) due to changes in Average volume Average rate Net change Average volume Average rate Net change 271 592 120 3,109 31 1,761 10 1,142 12 1 74 87 415 1,348 588 9,724 107 1,898 43 1,172 230 (13) 179 396 686 1,940 708 12,833 138 3,659 53 2,314 242 (12) 253 483 1,593 4,001 5,594 5 410 (8) 654 516 9,261 9,777 90 1,624 (27) (34) 1,612 19,733 21,345 95 2,034 (35) 620 2,128 28,994 31,122 55 (62) 97 662 (4) 581 7 899 2 11 68 81 685 20 287 (98) 694 158 3,746 3,904 457 1,801 295 9,520 (31) 2,197 (3) 319 123 (21) 68 170 512 1,739 392 10,182 (35) 2,778 4 1,218 125 (10) 136 251 2,436 3,121 0 1,280 47 (118) 935 17,435 18,370 20 1,567 (51) 576 1,093 21,181 22,274 239 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 (continued) Deposits The following table analyzes average deposits and the ave- rage rates on each deposit category listed below for the years ended 31 December 2006, 2005 and 2004. The geo- graphic allocation is based on the location of the office or branch where the deposit is made. Deposits by foreign de- positors in domestic offices were CHF 78,234 million, CHF 54,968 million and CHF 49,699 million at 31 December 2006, 31 December 2005 and 31 December 2004, respec- tively. CHF million, except where indicated 31.12.06 31.12.05 31.12.04 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. 2,024 8,776 10,800 29,814 40,614 70,981 86,631 28,876 186,488 315,917 502,405 0.2 4.5 3.7 4.8 4.5 0.8 0.5 2.2 0.8 3.6 2.6 8,491 6,976 15,467 25,497 40,964 67,987 86,373 24,245 178,605 249,561 428,166 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 19,052 170,169 200,664 370,833 0.1 1.7 0.7 1.6 1.3 0.2 0.5 1.3 0.5 1.4 1.0 At 31 December 2006, the maturity of time deposits exceeding CHF 150,000, or an equivalent amount in other currencies, was as follows: Domestic 45,236 5,676 2,764 310 254 Foreign 256,610 4,253 2,224 5,134 90 54,240 268,311 CHF million Within 3 months 3 to 6 months 6 to 12 months 1 to 5 years Over 5 years Total time deposits 240 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 borro- wings, along with the average rates and period-end rates at and for the years ended 31 December 2006, 2005 and 2004. CHF million, except where indicated 31.12.06 31.12.05 31.12.04 31.12.06 31.12.05 31.12.04 Money market paper issued Due to banks Repurchase agreements 1 31.12.06 31.12.05 31.12.04 Period-end balance Average balance Maximum month-end balance Average interest rate during the period (%) Average interest rate at period-end (%) 119,584 102,662 112,391 98,351 123,108 112,217 4.5 4.0 3.0 4.0 79,442 80,148 94,366 1.7 2.1 153,231 90,651 114,815 114,701 84,351 91,158 754,623 667,317 557,892 717,542 628,362 587,988 153,231 101,178 115,880 777,010 719,208 637,594 4.4 4.1 3.3 3.0 1.6 2.0 4.4 5.0 3.0 2.6 1.5 2.0 1 For the purpose of this disclosure, balances are presented on a gross basis. 241 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 2006 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 instruments Total fair value 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 instruments 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 instruments Total fair value Within 1 year 1–5 years 5–10 years Over 10 years Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) 2.22 0.00 0.00 1.48 7.00 0.00 0.00 2 0 0 38 26 0 0 66 0.00 0.00 0.00 1.89 0.00 0.00 9.28 0 0 0 2 0 0 233 235 0.00 0.00 0.00 4.47 0.00 4.48 0.00 0 0 0 57 2 10 0 69 1 0 0 0 0 150 0 151 4.00 0.00 0.00 0.00 0.00 5.10 0.00 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 1 0 12 2 103 129 0 247 4.00 0.00 6.03 6.17 5.66 4.80 0.00 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 1 Money market paper has a contractual maturity of less than one year. 2 Average yields are calculated on an amortized cost basis. 242 D – Information Required by Industry Guide 3 (continued) Due from Banks and Loans (gross) The Group’s lending portfolio is widely diversified across industry sectors with no significant concentrations of credit risk. CHF 152.9 billion (42% of the total) consists of loans to thousands of private households, predominantly in Switzerland, and mostly secured by mortgages, financial collateral or other assets. Exposure to Banks and Financial institutions amounted to CHF 138 billion (38% of the total). This includes cash posted as collateral by UBS against nega- tive replacement values on derivatives or other positions, which, from a risk perspective, is not considered lending but is a key component of the measurement of counterpar- ty risk taken in connection with the underlying products. Exposure to banks includes money market deposits with highly rated institutions. Excluding financial institutions, the largest industry sector exposure is CHF 25 billion (7% of the total) to the Services sector. For further discussion of the lending portfolio, see the Risk Management chapter of the Handbook 2006/2007. The following table illustrates diver- sification of the lending portfolio among industry sectors at 31 December 2006, 2005, 2004, 2003 and 2002. The in- dustry categories presented are consistent with the classifi- cation of loans for reporting to the Swiss Federal Banking Commission and Swiss National Bank. The table below does not include loans designated at fair value. CHF million Domestic Banks 1 Construction Financial institutions Hotels and restaurants Manufacturing 2 Private households Public authorities Real estate and rentals Retail and wholesale Services 3 Other 4 Total domestic Foreign Banks 1 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 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 561 1,535 5,542 1,957 4,439 1,407 1,816 4,213 2,044 5,038 1,406 1,943 4,332 2,269 5,485 619 2,175 4,009 2,440 6,478 117,852 111,549 105,160 102,180 4,972 11,356 4,569 9,159 1,127 5,494 11,792 4,808 9,300 1,004 5,460 11,466 4,908 9,110 591 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 1,722 163,069 158,465 152,130 152,170 151,588 49,895 1,296 483 892 82,064 2,964 2,756 35,029 2,038 4,238 1,750 16,231 1,038 460 32,282 34,269 31,405 31,882 2,716 295 1,637 62,306 3,899 2,694 38,280 1,501 2,707 1,257 5,596 1,419 156 366 122 745 45,095 2,758 1,695 30,237 1,228 940 1,102 8,002 762 318 245 84 249 30,906 2,421 1,114 21,195 1,224 473 1,880 7,983 3,658 432 519 153 1,105 18,378 2,300 868 33,063 2,628 616 1,367 1,654 676 2,314 201,134 364,203 156,745 315,210 127,639 279,769 103,269 255,439 97,523 249,111 1 Includes Due from banks and Loans from Industrial Holdings of CHF 93 million at 31 December 2006, CHF 728 million at 31 December 2005, CHF 909 million at 31 December 2004 and CHF 220 million at 31 December 2003. 2 Includes chemicals, food and beverages. 3 Includes transportation, communication, health and social work, education and other social and personal service activities. 4 Includes mining and electricity, gas and water supply. 5 Includes food and beverages. 6 Includes hotels and restaurants. 243 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 2006, 2005, 2004, 2003 and 2002. Mortgages are included in the industry categories mentioned on the previous page. CHF million Mortgages Domestic Foreign Total gross mortgages Mortgages Residential Commercial Total gross mortgages Due from Banks and Loan Maturities (gross) 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 134,468 10,069 144,537 124,548 19,989 144,537 130,880 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 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 558 54,752 21,068 76,378 47,391 8,451 125,334 181,176 257,554 3 60,051 5,493 65,547 2,323 1,219 13,150 16,692 82,239 0 19,665 1,479 21,144 181 399 2,686 3,266 24,410 561 134,468 28,040 163,069 49,895 10,069 141,170 201,134 364,203 1 Includes Due from banks from Industrial Holdings of CHF 93 million at 31 December 2006. At 31 December 2006, the total amount 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 to 5 years Over 5 years 75,549 6,690 82,239 22,918 1,492 24,410 Total 98,467 8,182 106,649 244 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; or 2) when insolvency proceedings have commenced; or 3) when obligations have been restructured on concessionary terms. CHF million 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 Gross interest income that would have been recorded on non-performing loans: Domestic Foreign Interest income included in net profit for non-performing loans: Domestic Foreign 50 10 56 8 81 8 72 9 107 17 106 8 171 23 163 8 148 53 152 22 The table below provides an analysis of the Group's non-performing loans. For further information, see the Risk Manage- ment chapter of the Handbook 2006 / 2007. CHF million Non-performing loans: Domestic Foreign Total non-performing loans 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 1,744 174 1,918 2,106 257 2,363 2,772 783 3,555 4,012 746 4,758 4,609 1,170 5,779 UBS does not, as a matter of policy, typically restructure loa- ns to accrue interest at rates different from the original con- tractual terms or reduce the principal amount of loans. In- stead, specific loan allowances are established as necessary. Unrecognized interest related to restructured loans was not material to the results of operations in 2006, 2005, 2004, 2003 or 2002. In addition to the non-performing loans shown above, the Group had CHF 710 million, CHF 1,071 million, CHF 1,144 million, CHF 2,241 million and CHF 3,875 million in “other impaired loans” for the years ended 31 December 2006, 2005, 2004, 2003 and 2002, respectively. Other impaired loans are loans where the Group’s credit officers have expressed doubts as to the ability of the bor- rowers to repay the loans. For the years ended 31 December 2006, 2005 and 2004, they are loans not considered “non- performing” in accordance with Swiss regulatory guidelines, and for the years ended 31 December 2003 and 2002, they are loans that were current or less than 90 days in arrears with respect to payment of principal or interest. As of 31 December 2006, 31 December 2005 and 31 December 2004, specific allowances of CHF 106 million, CHF 200 milli- on, CHF 241 million, respectively, had been established against these loans. 245 Additional Disclosure Required under SEC Regulations D – Information Required by Industry Guide 3 (continued) Cross-border Outstandings Cross-border outstandings consist of general banking pro- ducts such as loans and deposits with third parties, credit equivalents of over-the-counter (OTC) derivatives and securi- ties financing, and the market value of the inventory of debt securities. Outstandings are monitored and reported on an ongoing basis by the credit risk control organization with a dedicated country risk information system. With the excepti- on of the 32 most developed economies, these exposures are rigorously limited. The following analysis excludes Due from banks and Loans from Industrial Holdings. Prior periods have been adjusted to conform to the current year’s presen- tation. 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 2006, 2005 and 2004. At 31 December 2006, 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 abi- lity to service its obligations. For more information on cross-border exposure, see the Handbook 2006 / 2007. Banks 7,692 2,283 11,149 15,240 Banks 6,700 16,985 2,044 6,384 3,343 Banks 8,550 18,478 4,362 8,131 31.12.06 Private sector Public sector Total % of total assets 208,200 8,263 16,098 8,080 22,574 30,158 559 1,574 31.12.05 238,466 40,704 27,806 24,894 10.0 1.7 1.2 1.0 Private sector Public sector Total % of total assets 133,561 4,525 7,582 11,423 2,509 23,297 1,265 10,824 555 11,324 31.12.04 163,558 22,775 20,450 18,362 17,176 7.9 1.1 1.0 0.9 0.8 Private sector Public sector Total % of total assets 109,131 2,882 2,207 10,760 8,859 7,348 16,803 259 126,540 28,708 23,372 19,150 7.3 1.7 1.3 1.1 CHF million United States Japan United Kingdom Germany CHF million United States Germany Japan United Kingdom Italy CHF million United States Germany Italy United Kingdom 246 D – Information Required by Industry Guide 3 (continued) Summary of Movements in Allowances and Provisions for Credit Losses The following table provides an analysis of movements in allowances and provisions for credit losses. The following analysis includes Due from banks from Industrial Holdings. UBS writes off loans against allowances only on final settlement of bankruptcy proceedings, the sale of the under- lying assets and / or due to 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 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 31.12.06 1,776 31.12.05 2,802 31.12.04 3,775 31.12.03 5,015 31.12.02 7,992 0 (14) (11) (16) (40) (89) 0 (44) (20) (47) (2) (283) (3) 0 0 0 0 (11) (1) (7) (58) 0 0 0 0 0 (80) (363) 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) (1,772) (49) 0 0 (36) (228) (70) (1) (65) (1) (2) (10) (39) (74) (189) (764) (2,536) 1 Includes chemicals, food and beverages. 2 Includes transportation, communication, health and social work, education and other social and personal service activities. 3 Includes mining and electri- city, gas and water supply. 4 Includes food and beverages. 5 Includes hotels and restaurants. 247 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 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 51 11 62 (301) (108) (48) 13 1,332 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 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 10 3 13 50 (114) (64) 2 63 65 (57) 64 7 (269) (357) (626) 248 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 2006, 2005, 2004, 2003 and 2002. For a description of procedures with respect to allowances and provisions for credit losses, see the Handbook 2006 / 2007. 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 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 10 72 61 27 155 187 3 99 311 113 107 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 1,145 1,425 1,891 2,649 3,484 20 4 2 8 9 37 0 26 21 4 4 7 1 6 35 5 2 16 8 57 1 30 72 3 1 27 0 8 149 38 1,332 265 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 1 Includes chemicals, food and beverages. 2 Includes transportation, communication, health and social work, education and other social and personal service activities. 3 Includes mining, electricity, gas and water supply. 4 Counterparty allowances and provisions only. Country provisions with banking counterparties amounting to CHF 0 million, CHF 37 million and CHF 17 million are disclosed under Collective loan loss provisions for 2006, 2005 and 2004, respectively. 5 Includes food and beverages. 6 Includes hotels and restaurants. 7 The 2006, 2005, 2004, 2003 and 2002 amounts include CHF 0 miilion, CHF 48 million, CHF 161 million, CHF 262 million and CHF 696 million , respectively, of country provisions. 8 The 2006, 2005, 2004, 2003 and 2002 amounts include CHF 76 million, CHF 109 million, CHF 214 million, CHF 290 million and CHF 366 million , respectively, of provisions for unused commitments and contingent liabilities. 249 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 cre- dit losses by industry sectors to evaluate the credit risks in each of the categories. The table below does not include loans designated at fair value. in % Domestic Banks 1 Construction Financial institutions Hotels and restaurants Manufacturing 2 Private households Public authorities Real estate and rentals Retail and wholesale Services 3 Other 4 Total domestic Foreign Banks 1 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 31.12.06 31.12.05 31.12.04 31.12.03 31.12.02 0.2 0.4 1.5 0.5 1.2 32.4 1.4 3.1 1.3 2.5 0.3 44.8 13.7 0.4 0.1 0.2 22.5 0.8 0.8 9.6 0.6 1.2 0.5 4.4 0.3 0.1 0.5 0.6 1.3 0.7 1.6 35.4 1.7 3.7 1.5 3.0 0.3 50.3 10.2 0.9 0.1 0.5 19.8 1.2 0.9 12.1 0.5 0.9 0.4 1.8 0.4 0.0 0.5 0.7 1.5 0.8 2.0 37.6 2.0 4.1 1.7 3.3 0.2 54.4 12.3 0.1 0.0 0.3 16.1 1.0 0.6 10.8 0.4 0.3 0.4 2.9 0.3 0.1 0.2 0.8 1.6 1.0 2.5 40.0 2.1 4.9 2.4 3.7 0.4 59.6 12.3 0.1 0.0 0.1 12.1 1.0 0.4 8.3 0.5 0.2 0.7 3.1 1.4 0.2 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 55.2 100.0 49.7 100.0 45.6 100.0 40.4 100.0 39.1 100.0 1 Includes Due from banks and Loans from Industrial Holdings in the amount of CHF 93 for 2006, CHF 728 million for 2005, CHF 909 million for 2004 and CHF 220 million for 2003. 2 Includes che- micals, food and beverages. 3 Includes transportation, communication, health and social work, education and other social and personal service activities. 4 Includes mining and electricity, gas and water supply. 5 Includes food and beverages. 6 Includes hotels and restaurants. 250 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). The table below does not include loans designated at fair value. CHF million, except where indicated Gross loans 1 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 31.12.06 364,203 2,628 1,918 1,332 301 156 0.7 0.5 0.4 50.7 69.4 46.3 58.0 0.1 0.1 22.6 4.43 31.12.05 315,210 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 31.12.04 279,769 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 31.12.03 255,439 31.12.02 249,111 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 1 Includes Due from banks and Loans from Industrial Holdings in the amount of CHF 93 million 2006, CHF 728 million for 2005, CHF 909 million for 2004 and CHF 220 million for 2003. 2 Includes Collective loan loss provisions. 3 Allowances relating to impaired loans only. 4 Allowances relating to non-performing loans only. 251 252 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 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 and macro-economic trends, (2) legislative developments, governmental and regulatory trends, (3) movements in local and international securities markets, currency exchange rates and interest rates, (4) competitive pressures, (5) technological developments, (6) changes in the financial position or creditworthiness of our customers, obligors and counterparties and developments in the markets in which they operate, (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 2006. UBS is not under any obligation to (and expressly disclaims any such obligation 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-0701 UBS AG P.O. Box, CH-8098 Zurich P.O. Box, CH-4002 Basel www.ubs.com 

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