Changes in 2008

Update on the transaction with the Swiss National Bank

Transaction structure

As announced on 16 October 2008, the Swiss National Bank (SNB) and UBS reached an agreement to transfer in one or more sales up to USD 60 billion of illiquid securities and other positions from UBS's balance sheet to a fund owned and controlled by the SNB. The size of the transaction has since been reduced (see below).

The SNB will finance the fund with a loan in the amount of 90% of the purchase price to be paid by the fund, secured by the assets of the fund. The remaining 10% will take the form of an equity contribution by the SNB. At the closing of each asset transfer, UBS will purchase, for an amount equal to the SNB's equity contribution on that date, an option to acquire the fund's equity once the loan has been fully repaid. The option exercise price will be USD 1 billion plus 50% of the amount by which the equity value exceeds USD 1 billion at the time of exercise. While economically unchanged, this differs from the initially announced structure, under which UBS would have made equity contributions equal to 10% of the purchase price to be paid by the fund at each closing and immediately sold the equity to the SNB for USD 1 plus an option to repurchase the equity in the fund.

If, upon the fund's termination, the SNB incurs a loss on the loan it has made to the fund, the SNB will be entitled to receive 100 million UBS ordinary shares against payment of the par value of those shares (currently CHF 0.10 per share).

Governance

In fourth quarter 2008, the fund was established under the name SNB StabFund as a Swiss limited partnership for collective investments. Its objective is to manage the acquired positions based on fundamental value considerations. The SNB StabFund is owned by a general partner and a limited partner, both of which are wholly owned by the SNB. The general partner has a board of directors with five members, of which three are designated by the SNB and two by UBS.

UBS acts as the investment manager of the SNB StabFund, subject to the oversight of the board of directors of the general partner which must approve certain types of decisions. The board also retains the right to remove UBS as the investment manager of the SNB StabFund.

First asset sale

On 16 December 2008, the SNB StabFund acquired a first tranche of 2,042 securities positions from UBS for USD 16.4 billion.

The assets purchased were primarily US and European residential and commercial mortgage-backed securities, as well as other asset-backed securities. The purchase price of USD 16.4 billion was the value of these securities as of 30 September 2008 as determined by the SNB based on a valuation conducted by third-party valuation experts. The purchase price was USD 0.3 billion lower than the value UBS assigned to these securities on 30 September 2008.

The remaining positions identified for sale to the fund are planned to be transferred over the course of first quarter 2009 in one or more additional transfers.

Change in portfolio composition and size

UBS and SNB have agreed that UBS's student loan auction rate securities (ARS) positions and securities currently insured by monolines will not be sold to the fund (refer to the discussion of risk concentrations in the "Risk management and control" section of this report for more information on these positions). As a result, the overall amount of positions already transferred or still expected to be transferred to the SNB StabFund has been reduced to USD 39.1 billion, as shown in the table below.

Implications for UBS's income statement in fourth quarter 2008

The overall impact on UBS's income statement in fourth quarter 2008 of the SNB transaction and the placement of the mandatory convertible notes (MCNs) with the Swiss Confederation was a net charge of CHF 4.2 billion. This reflects the costs of the equity purchase option, partially offset by the year-end value on that option, the loss referred to above arising from valuation differences on securities sold to the SNB StabFund, losses on hedges that were subject to trading restrictions as a result of the SNB transaction, and the impact of the contingent issuance of UBS shares in connection with the transaction. The fair valuation impact of the issuance of the MCNs, as described in note 14 of this report, is also included in this total.

Reclassification of financial assets

The markets for many financial instruments began to dry up in 2007 and many instruments that previously traded in active and liquid markets ceased actively trading by mid-2008. In an effort to address accounting concerns arising from the global credit crisis, the International Accounting Standards Board published an amendment to International Accounting Standard 39 (IAS 39 Financial Instruments: Recognition and Measurement) on 13 October 2008.

Although the amendment could have been applied retrospectively from 1 July 2008, UBS decided at the end of October 2008 to apply the amendment with effect from 1 October 2008 following an assessment of the implications on its financial statements.

Subject to certain conditions being met, the amendments to IAS 39 permit financial assets to be reclassified out of the "held for trading" category if the firm has the intent and ability to hold them for the foreseeable future or until maturity. Eligible assets may be reclassified to the "loans and receivables" category, carried at amortized cost less impairment, or the "available-for-sale" category, carried at fair value through equity with impairment recognized in profit or loss. Assets designated at fair value through profit or loss ("fair value option") and derivatives may not be reclassified.

Assets reclassified in fourth quarter 2008

Effective 1 October 2008, UBS reclassified eligible assets which it intends to hold for the foreseeable future with a fair value of CHF 17.2 billion on that date from "held for trading" to the "loans and receivables" category. In addition, student loan auction rate securities (ARS) with a fair value of CHF 8.4 billion have been reclassified as of 31 December 2008.

In fourth quarter 2008, an impairment charge of CHF 1.3 billion was recognized as credit loss expense on reclassified financial instruments. If reclassification had not occurred, the impairment charge would not have been recognized but a trading loss of CHF 4.2 billion would have been recorded in UBS's fourth quarter income statement. Net interest income after reclassification amounted to CHF 0.3 billion. In the fourth quarter, the operating profit before taxes would have been CHF 3.4 billion lower if the reclassification would not have occured.

Impact of accounting for reclassified assets on an accrual basis

The assets have been reclassified from "held for trading" to "loans and receivables" on the basis of their fair value at the reclassification date. The carrying amount of reclassified assets will accrete back to the value of their discounted expected future cash flows by applying the effective interest rate method. Under this method, those assets will yield a return in excess of the asset's contractual interest rate.

In the event a reclassified asset is determined to be impaired subsequent to reclassification, the impairment will be recognized as credit loss expense. Reclassified assets are subject to the same impairment testing methodologies as financial instruments which have been classified as loans and receivables at origination or acquisition. Any further improvement in expected future cash flows will be recognized as an adjustment to the effective interest rate on a prospective basis.

Refer to note 11 and the "Exposure to auction rate securities" sidebar in the "Risk management and control" section of this report for more information.

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