Critical accounting policies

The ongoing crisis in the financial markets dramatically changed industry dynamics and the related decrease in market capitalization of UBS made it necessary to monitor closely whether there was indication that goodwill allocated to its cash-generating units was impaired. At 31 December 2008, equity attributable to UBS shareholders stood at CHF 33 billion. UBS’s market capitalization, excluding the shares to be issued upon conversion of the MCNs, amounted to CHF 44 billion at 31 December 2008. On the basis of the impairment testing methodology described in Note 16, UBS concluded that the year-end 2008 balances of goodwill allocated to all its segments remain recoverable. Goodwill allocated to the Investment Bank at 31 December 2008 amounted to CHF 4.3 billion (CHF 5.2 billion at 31 December 2007), to Wealth Management US CHF 3.7 billion, Wealth Management International & Switzerland CHF 1.6 billion and Global Asset Management CHF 2.0 billion. The assessment of the goodwill in the Investment Bank, which is most affected by the financial market crises, was a key focus.

In its review of the year-end 2008 goodwill balance, UBS considered the performance outlook of its Investment Bank division and the underlying business operations to resolve whether the recoverable amount for this unit covers its carrying amount. Based on the estimated cash flows the Investment Bank will generate from its businesses, discounted back to their present value using a discount rate that reflects the risk profile of the Investment Bank’s activities, UBS concluded that goodwill allocated to the Investment Bank remained recoverable on 31 December 2008. The conclusion was reached on the basis of the forecast results of those activities which management expects to generate positive cash flows in future years. The forecasts are based on an expectation that the economic environment will gradually improve over the next three years and reach an average growth level thereafter. The fair value obtained from the model calculation was subject to a stress test by decreasing forecast cash flows by one third and at the same time increasing the discount rate by 3.5 percentage points to 16.5%. The stress value covered the book value of the Investment Bank. However, if the conditions in the financial markets and banking industry further deteriorate and turn out to be worse than anticipated in UBS’s performance forecasts, the goodwill carried in the Investment Bank business division may need to be impaired in future periods.

The same model is applied to all segments carrying goodwill. It is most sensitive to changes in the forecast earnings available to shareholders in year one to five, 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. Valuation parameters used within the Group’s impairment test model are linked to external market information, where applicable. Management believes that reasonable changes in key assumptions used to determine the recoverable amounts of all segments will not result in an impairment situation.

Source: Annual report 2008, section Financial information