Credit risk

The table below provides an overview of the aggregate credit exposure of UBS in gross terms, i.e. without recognition of credit hedges, collateral or other risk mitigation.

UBS's total 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 mortgages, financial collateral or other assets. Exposure to banks and financial institutions amounts 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 is not considered lending from a risk perspective but is a key component of our measurement of the counterparty risk we take in connection with the underlying products. Exposure to banks includes money market deposits with highly rated institutions. Excluding financial institutions, the largest industry exposure is CHF 25 billion (7% of the total) to the services sector.

Global Wealth Management & Business Banking

Global Wealth Management & Business Banking's gross lending portfolio on 31 December 2006 amounted to CHF 229 billion, of which CHF 140 billion (61%) was secured by real estate and CHF 63 billion (27%) by marketable securities. The pie chart below shows that exposure to real estate is well diversified with 40% of the gross lending portfolio being secured on single-family homes and apartments, which, historically, have exhibited a low risk profile. The 12% of exposure secured by residential multi-family homes consists of rented apartment buildings. Loans and other credit engagements with individual clients, excluding mortgages, amounted to CHF 83 billion and are predominantly extended against the pledge of marketable securities. The volume of collateralized lending to private individuals rose by CHF 6.6 billion or 12% from the previous year. The increasing demand for this product, as in 2005, reflects the continuing low interest rate environment.

Unsecured lending consists predominantly of exposures to public authorities, banks and financial institutions. The remainder is to corporate clients in Switzerland, widely spread across rating categories and industry sectors, reflecting our position as a market-leading lender to this segment of mostly small- to medium-sized enterprises. During 2006 we have continued to focus on improving the quality of this portfolio.

The table above shows credit exposure across counterparty ratings and loss given default (LGD) buckets. As part of the ongoing validation of our risk parameters, we have adjusted LGDs to reflect the positive development of our credit losses in recent years. As a result, exposures in the table have shifted to lower LGDs, in particular the 26-50% bucket. We have also improved rating differentiation in the residential mortgage business, so that the previous concentration of exposures in rating class 5 is now more widely dispersed across ratings. The average rating of the portfolio is unchanged.

Investment Bank

A substantial majority of the Investment Bank's credit exposure falls into the investment grade category (internal counterparty rating classes 0 to 5), both for gross banking products (62%) and for traded products (94%). The counterparties are primarily sovereigns, financial institutions, multinational corporate clients and investment funds.

Banking products exposure

The Investment Bank's total banking products exposure on 31 December 2006, reported in accordance with IFRS, was CHF 234 billion of which CHF 91 billion was loans, compared with CHF 70 billion on 31 December 2005. Part of the CHF 21 billion increase over the course of 2006 was the result of our expanding prime brokerage and equity finance businesses, and part reflects increased underwriting activity as we capitalized on our strengthened business franchise in advising corporate clients.

Disclosures in the remainder of this section present the credit exposure from a risk management and control perspective, which differs from disclosure under IFRS. In particular, gross banking products exposure in risk terms amounts to CHF 161 billion (excluding loans designated at fair value), a difference of CHF 73 billion from the CHF 234 billion reported for the Investment Bank in the table on page 66 / 67. This difference is mainly made up of cash collateral posted by UBS against negative replacement values and other positions which, as noted above, are not considered loans from a risk perspective. On the other hand, in our internal risk control view we consider certain US residential mortgage financing conducted under repo- / reverse repo-like agreements to be banking product exposures. The table on the next page shows a reconciliation between the IFRS and risk views.

As described under "Risk mitigation", the Investment Bank has engaged in a substantial credit risk hedging program. On  31 December 2006 we had a total of CHF 33 billion in credit hedges in place against our banking products exposure.

To illustrate the effects of credit hedging and other risk mitigation, we show in the graph opposite the exposures by counterparty ratings before and after application of risk mitigation. Additionally, the matrix on page 69 shows the distribution of the Investment Bank's take and hold banking products exposure after application of risk mitigants across rating classes and LGD buckets. LGDs in this portfolio are assigned based on benchmark LGDs, which are 40% for senior secured claims, 50% for senior unsecured claims and 70% for subordinated claims. There is thus a concentration in the 26–50% bucket. The significant sub-investment grade exposure in the 0–25% LGD bucket is mainly comprised of short-term loans to US mortgage originators, both prime and sub-prime, secured on their mortgage portfolios, pending securitization or sale. The low LGD assigned reflects our assessment of both the quality of the collateral held and the structure of the financing agreements. Note that exposure distribution across counterparty ratings shown elsewhere in this section refers only to gross exposure and probability of default, without reference to the likely severity of loss or loss mitigation from collateral or credit hedges.

Banking products exposure after application of credit hedges continues to be widely diversified across industry sectors. At 31 December 2006, the largest exposure (31%) was to financial institutions.

Traded products exposure

A significant proportion of the Investment Bank's credit risk arises from its trading and risk management activities and from the provision of risk management solutions to clients, which includes the use of derivative products.

The graph opposite shows the Investment Bank's traded products exposure by counterparty rating on 31 December 2006. Further details of derivative instruments are provided in note 23 to the financial statements and details of securities borrowing, securities lending, repurchase and reverse repurchase activities can be found in note 11 to the financial statements.