Measurement and analysis of performance

UBS's performance is reported in accordance with International Financial Reporting Standards (IFRS). This discussion and analysis of the UBS results comments on the underlying operational performance of the business, with a focus on continuing operations. As discontinued activities are no longer relevant to the management of the company, UBS does not consider them to be indicative of its future potential performance. They are therefore not included in UBS's business planning decisions. This helps to better assess UBS's performance against that of its peers and to estimate future growth potential.

In the last three years, two such items had a significant impact on UBS's consolidated financial statements:

– in fourth quarter 2005, UBS's Private Banks & GAM unit was sold to Julius Baer at a gain of CHF 3,705 million after tax (pre-tax CHF 4,095 million) – the unit comprised the Banco di Lugano, Ehinger & Armand von Ernst and Ferrier Lullin private banks as well as specialist asset manager GAM. After the sale, UBS retained a stake of 20.7% in the new Julius Baer; and

– on 23 March 2006, UBS sold its 55.6% stake in Motor-Columbus to a consortium representing Atel's Swiss minority shareholders, EOS Holding and Atel, as well as French utility Electricité de France (EDF) for a sale price of approximately CHF 1,295 million, which led to an after-tax gain on sale of CHF 387 million.

Up to and including 2005, UBS provided comments and analysis on an adjusted basis that also excluded the amortization of goodwill and other acquired intangible assets. With the introduction of IFRS 3 Business Combinations at the beginning of 2005, UBS ceased amortizing goodwill, which was by far the largest adjustment made to its results.

Factors affecting UBS's financial positions and results of operations in 2007

– In second quarter 2007, UBS sold its 20.7% stake in Julius Baer which was held as a financial investment available-for-sale. The post-tax gain of CHF 1,926 million was therefore included in performance from continuing operations.

– In the same quarter, the closure of Dillon Read Capital Management (DRCM), an alternative investment venture launched in 2006, led to a charge against profits of CHF 384 million pre-tax (CHF 229 million after-tax).

– In the second half of 2007, UBS was severely affected by the progressive market dislocation. This led to total losses of approximately USD 18.7 billion (CHF 21.3 billion) on UBS's positions related to the US residential sub-prime and Alt-A real estate market, representing a combination of writedowns, hedge gains and losses, realized losses from the scale of position and credit valuation adjustments on credit default swaps (CDSs) purchased from monoline insurers. Losses on securities related to US sub-prime residential mortgages totaled USD 14.6 billion, of which USD 9.2 billion were recorded on super senior tranches of collateralized debt obligations (CDOs). Positions related to Alt-A mortgages lost USD 2 billion due to spread widening towards the end of the year. Losses of USD 1.3 billion were incurred on US structured credit programs (reference-linked notes) in the US. Total credit valuation adjustments on protection bought from monoline insurers were USD 0.8 billion in 2007, reflecting the degree to which UBS considers its claims against these counterparties to be impaired.

Seasonal characteristics

The main businesses of UBS do not generally show significant seasonal patterns, except for the Investment Bank, where revenues are impacted by the seasonal characteristics of general financial market activity and deal flows in investment banking.

Accordingly, when discussing quarterly performance, the Investment Bank's financial results of the reported quarter are compared with those achieved in the same period of the previous year. Similarly, when considering the impact of the Investment Bank's performance on UBS's financial statements, the overall quarterly performance is discussed 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 the Investment Bank are compared on a present-quarter to previous-quarter basis. For all other business groups and business 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 eight years, UBS has consistently assessed its performance against a set of four measures that were designed to measure the delivery of continuously improving returns to its shareholders.

On average, through periods of varying market conditions, UBS will:

– seek to increase the value of its firm by achieving a sustainable, after-tax return on equity of a minimum of 20%;

– aim to achieve a clear growth trend in net new money for all financial businesses, including Global Wealth Management & Business Banking as well as Global Asset Management;

– target a double-digit percentage growth for diluted earnings per share (EPS); and

– continue to manage business group and business unit cost / income ratios at levels that compare well with competitors. The cost / income ratio target is limited to the financial businesses.

Business group key performance indicators

At the business group or business unit level, performance is measured by carefully chosen key performance indicators (KPIs). They indicate the business group's or business unit's success in creating value for shareholders but UBS does not disclose explicit targets for these KPIs. 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.

These business group KPIs are used for internal performance measurement and planning as well as external reporting. This ensures management accountability for performance by senior executives and consistency in external and internal performance measurement.

Client / invested assets reporting

Since 2001, UBS has 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; and

– invested assets is a more restrictive term and includes all client assets managed by or deposited with UBS for investment purposes.

Invested assets is the central measure for UBS 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 UBS has a minimal advisory role for such clients and as asset flows are driven more by liquidity requirements than investment needs. The same holds true for the corporate cash management business of the Wealth Management US unit, which UBS has excluded from its invested assets since the end of 2005. Non-bankable assets (for example, art collections) 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 paid to UBS on clients' loans out of invested assets is treated as net new money outflow. From 2008 onwards, these interest payments will be deducted from the performance of invested assets and no longer impact net new money. Interest and dividend income from invested assets is not counted as net new money inflow. Market and currency movements and 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 both finance industry practices and UBS's open architecture strategy and allows the firm to accurately reflect the performance of each individual business. Overall, CHF 392 billion of invested assets were double counted in 2007 (CHF 371 billion in 2006).