Financial businesses results

2007

Results

Last year was one of the most difficult in UBS's history. While most UBS businesses, in particular the wealth management businesses, continued their strong revenue and profit growth momentum and finished the year with record results, this performance was overshadowed by the developments in the Investment Bank's positions related to the US residential mortgage market. The sudden and serious deterioration in the US housing market, in combination with a large exposure in sub-prime mortgage related securities and derivatives, has deeply impacted UBS.

Attributable net loss in 2007 was CHF 4,970 million. Discontinued operations contributed a profit of CHF 265 million, compared with CHF 4 million in 2006. Net loss from continuing operations was CHF 5,235 million, down from a profit of CHF 11,249 million in 2006.

Operating income

Total operating income was CHF 31,032 million in 2007, down 34% from CHF 47,171 million in 2006. Net interest income at CHF 5,337 million was down 18% compared with CHF 6,521 million a year earlier. Net trading income was negative CHF 8,353 million, sharply down from positive CHF 13,743 million in 2006.

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, UBS analyzes 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 businesses was down significantly from a positive CHF 13,730 million in 2006 to a negative CHF 10,658 million in 2007. The second half of 2007 was severely impacted by losses on positions related to the US mortgage market (see Note 3 in Financial statements 2007 for further details). Fixed income, currencies and commodities (FICC) results were very weak. As credit markets continued to worsen towards the end of 2007, the credit business in FICC delivered negative revenues, especially in proprietary strategies. Structured products results were down, especially in Europe and the US, reflecting the decrease in customer demand for complex derivatives transactions. Markdowns on highly leveraged underwriting commitments also had a negative impact. The result for emerging markets was helped by gains from the sale of UBS's stake in Brazil Mercantile & Futures Exchange after demutualization. In addition, UBS had a gain of CHF 397 million on credit default swaps (CDS) hedging loan exposures, compared with a loss of CHF 245 million the previous year.

Revenues from the equities business were up, mainly as a result of very strong gains in the derivatives business in China. Equity capital markets and equity prime brokerage revenues were up in Latin America following the acquisition of Banco Pactual at the end of 2006. Exchange-traded derivatives profited from the acquisition of ABN AMRO's global futures and options business towards the end of 2006. Mark-to-market gains of UBS's stake in Bovespa, the Brazilian stock exchange, helped the equities result. These positive performances were partially offset by losses recorded in proprietary trading as all regions were impacted by the market dislocation.

As a result of observed market widening of UBS's credit spread, both equities and FICC recorded gains in net trading income on structured liabilities for which the fair value option was elected. In full year 2007, the Investment Bank recorded a gain of CHF 659 million.

Net income from interest margin businesses was CHF 6,230 million, up 9% from CHF 5,718 million in 2006, reflecting an increase in spreads for Swiss franc, euro and US dollar deposits and growth in wealth management's collateralized lending business. The US wealth management business also benefited from increased levels of deposits.

At CHF 1,412 million, net income from treasury activities and other in 2007 was CHF 596 million, 73% higher than CHF 816 million in 2006. The accounting treatment of interest rate swaps, which hedge the economic interest rate risk of accrual-accounted balance sheet items (for example, loans or money market and retail banking products), positively affected income. They are carried on the balance sheet at fair value and, if they qualify for cash flow hedge accounting under IAS 39, changes in fair value are recorded in equity, thereby avoiding volatility in the group income statement. In 2007, these hedges were not fully effective, leading to a gain that was booked to UBS's income statement. Higher interest income was also recorded as a result of increased yield on a slightly higher average capital base.

In 2007, UBS experienced a net credit loss expense of CHF 238 million, compared to a net credit loss recovery of CHF 156 million in 2006. The market dislocations stemming from the US sub-prime mortgage market during the second half of 2007 were the main reasons for the significant increase, mainly in the Investment Bank.

Net credit loss recovery at Global Wealth Management & Business Banking amounted to CHF 28 million in 2007 compared with a net credit loss recovery of CHF 109 million in 2006. The reduced level of credit loss recovery was a consequence of the continued reduction in the impaired lending portfolio and related allowances to a level such that recoveries realized from work-outs continue to trend lower and no longer compensate for the ongoing need to establish new allowances. The US mortgage market dislocation had no impact on these figures.

The Investment Bank realized a net credit loss expense of CHF 266 million in 2007, compared with a net credit loss recovery of CHF 47 million in 2006. This mainly relates to valuation adjustments taken in connection with the securitization of certain US commercial real estate assets.

In 2007, net fee and commission income was CHF 30,634 million, up 20% or CHF 5,178 million from CHF 25,456 million in 2006. Asset-based revenues showed particular strength, reflecting higher average invested asset levels, following strong inflows into the wealth management businesses. Underwriting fees, at their highest level ever, were CHF 3,742 million, up 20% from CHF 3,113 million in 2006. Equity underwriting fees, at CHF 2,564 million, increased by CHF 730 million, or 40%, with double-digit growth in the Americas and Europe. Fixed income underwriting fees were CHF 1,178 million, down 8% or CHF 101 million from CHF 1,279 million, reflecting the adverse conditions in credit markets and a decline in investor sentiment affecting volume and pricing of debt issuance. At CHF 2,768 million, mergers and acquisitions and corporate finance fees in 2007 were up significantly by 49% from CHF 1,852 million a year earlier. Advisory gross revenues increased during 2007, as clients took advantage of strategic opportunities in the brisk merger and acquisition environment and UBS's growing franchises across all regions. Net brokerage fees were CHF 7,671 million in 2007, up 25% or CHF 1,522 million from CHF 6,149 million in 2006, mainly driven by higher revenues in Europe, the US and Asia, due to additional services from a new equities trading platform, and a considerable increase in client activity in all client segments. Additionally, the equity derivatives business also posted higher revenues due to increased business volume. Investment fund fees, at their highest level ever, were CHF 7,422 million in 2007, up 27% from CHF 5,858 million in 2006, mainly reflecting higher asset-based fees for the wealth management businesses, driven by strong client money inflows. Global Asset Management also increased management and performance fees globally. Fiduciary fees were slightly higher in 2007, increasing from CHF 252 million in 2006 to CHF 297 million, reflecting an increase in business volume. At CHF 1,367 million, custodian fees in 2007 were up 8% from CHF 1,266 million in 2006. This increase was due to an enlarged asset base. Portfolio and other management and advisory fees increased by 18% to CHF 7,790 million in 2007 from CHF 6,622 million in 2006. The increase is again the result of rising invested asset levels driven by strong net new money inflows and to a lesser extent due to higher management fees. Insurance-related and other fees, at CHF 423 million in 2007, decreased by 6% from a year earlier. Lower insurance fees paid in Global Asset Management were only partially offset by increased sales and asset-based fees from the wealth management businesses. Credit-related fees and commissions increased slightly by 4% to CHF 279 million in 2007 from CHF 269 million in 2006. Commission income from other services decreased by 4% from CHF 1,064 million in 2006 to CHF 1,017 million in 2007, mainly driven by equity derivative products, partially offset by higher fees for account keeping.

Other income was up considerably in 2007 by CHF 2,357 million or 182% from last year's CHF 1,295 million. This was mainly relating to the sale of a 20.7% stake in Julius Baer in second quarter 2007. The demutualization of UBS's stake in Bovespa, the Brazilian stock exchange, and in the Brazil Mercantile & Futures Exchange positively affected the other income line as well. In 2006 UBS recorded gains on the New York Stock Exchange membership seats, which were exchanged into shares when it went public in March 2006. In the same year UBS sold its stakes in the London Stock Exchange, Babcock & Brown and EBS group.

Operating expenses

Total operating expenses increased by 5% to CHF 34,503 million in 2007 from CHF 32,782 million in 2006.

Personnel expenses increased CHF 1,218 million, or 5%, to CHF 24,687 million in 2007 from CHF 23,469 million in 2006. The rise was driven by higher salaries due to the 7% increase in personnel over the year, mainly in wealth management businesses which added 1,400 client and financial advisors. Performance-related compensation decreased, reflecting the losses incurred in the Investment Bank. Personnel expenses are managed on a full-year basis with final fixing of annual performance-related payments in fourth quarter. Share-based components were up 9%, or CHF 200 million, to CHF 2,387 million from CHF 2,187 million, mainly reflecting accelerated amortization of deferred compensation awarded for senior managers who have left UBS. Contractors' expenses, at CHF 630 million, were CHF 192 million below 2006's, mainly due to the transfer of Perot contractors into permanent staff. Insurance and social security contributions declined by 11% to CHF 1,219 million in 2007 compared with CHF 1,374 million in 2006, reflecting lower bonus payments. Contributions to retirement benefit plans rose 15% or CHF 120 million to CHF 922 million in 2007 as a result of both higher salaries paid and the increased staff levels. At CHF 1,956 million in 2007, other personnel expenses increased by CHF 392 million from 2006, mainly driven by severance payments relating to the reduction in staff levels.

At CHF 8,421 million in 2007, general and administrative expenses increased by 6% from CHF 7,929 million a year ago. Administration costs increased due to elevated business volumes in Latin America related to the acquisition of Banco Pactual in 2006 and higher levels of UBS staff. The increased number of employees pushed occupancy costs, as well as travel and entertainment expenditures, higher. Professional fees were up on higher legal fees and IT and other outsourcing expenses were higher in all UBS businesses. This increase was only partially offset by lower provisions.

Depreciation was CHF 1,243 million in 2007, almost unchanged from CHF 1,245 million in 2006. Lower depreciation on IT and communication equipment was offset by higher real estate charges.

At CHF 276 million, amortization of intangible assets was up 86% from CHF 148 million a year earlier, related to acquisitions made at the end of 2006, mainly Banco Pactual.

Tax

Tax expense from continuing operations for 2007 was CHF 1,275 million, compared with a tax expense for 2006 of CHF 2,751 million. The tax charge for 2007 reflects tax expenses on profits earned outside the US during the year, partially offset by US and Swiss tax benefits on the writedowns incurred related to the US sub-prime crisis. The US tax benefits recognized have arisen mainly as a result of the ability to carry back losses against US profits earned in the two prior years. The remainder of the losses are carried forward to offset against future US taxable earnings. Only a portion of these losses have been recognized as deferred tax assets on the balance sheet in line with the requirements of IAS 12, which limits the ability to recognize such assets when losses have been incurred.

Business group tax rates

Indicative business group and business unit tax rates are calculated on an annual basis based on the results and statutory tax rates of the financial year. These rates are approximate 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, therefore, give guidance on the tax cost of each business group doing business during 2007 on a stand-alone basis, without the benefit of tax losses brought forward from earlier years.

No tax rate has been presented for the Investment Bank, since the combination of applying statutory tax rates to losses related to the US sub-prime crisis and profits in other locations would not result in a meaningful overall tax rate for the Investment Bank. The indicative tax rate for Global Asset Management of 20% takes into account tax benefits related to closure costs of Dillon Read Capital Management. Excluding these tax benefits, the indicative tax rate for Global Asset Management would have been 24%, at the same level as in the last two years.

Please note that these tax rates are not necessarily indicative 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 2007 rose to CHF 2,116 million. This is 258 million, or 14%, more than the CHF 1,858 million granted in 2006, with the increase largely due to a rise in the proportion of bonuses being delivered in restricted shares.

The fair value of options granted as of 31 December 2007 was CHF 501 million, down CHF 63 million, or 11%, from CHF 564 million in 2006. The decrease reflects a lower fair value per option, related to changes in market parameters. Additionally, the number of options granted in 2007 was lower.

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 recognized 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.

2006

Results

Attributable net profit in 2006 was CHF 11,253 million, of which discontinued operations contributed CHF 4 million, compared with CHF 4,075 million in 2005 following the sale of Private Banks & GAM. Net profit from continuing operations was CHF 11,249 million, up 19% from CHF 9,442 million in 2005. Higher revenues in practically all businesses drove the increase, outpacing growth in costs. Asset-based revenues showed particular strength, a reflection of rising market levels as well as strong inflows into the wealth and asset management businesses. UBS saw a strong increase in brokerage, corporate finance and underwriting fees. Income from trading activities was driven by higher gains from equity derivatives, prime brokerage and equity proprietary trading. Fixed income activities saw stronger results driven by positive market conditions and improved performances in derivatives, mortgage-backed securities and commodities. Revenues from interest margin products increased, a reflection of the success and growth of lending activities to wealthy private clients worldwide. UBS also reported credit loss recoveries. Expenses continued to increase (+18%) in the context of strategic expansion. Personnel expenses were up 18% from 2005, performance-related payments rose with revenues and there was a 12% increase in staff numbers. For 2006, 53% of personnel expenses took the form of bonus or other variable compensation, up from 50% in 2005. General and administrative expenses were up 23% from 2005. Provision expenses rose, mainly as a result of the settlement agreement with Sumitomo Corporation and the sublease of unused office space in New Jersey, US. The rise in costs was outpaced by the improvement in revenues, driving the 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.

Net interest income was CHF 6,521 million in 2006, down from CHF 9,528 million in 2005. Net trading income was CHF 13,743 million, up from CHF 8,248 million in 2005.

Net income from trading businesses increased by 16%, or CHF 1,935 million, from CHF 11,795 million in 2005 to CHF 13,730 million in 2006. Equities trading income in 2006 was up as it saw a large increase in derivatives trading, as well as in prime brokerage. Additionally, the proprietary business recorded higher results. These gains were partially offset by lower revenues in the cash equity business, partly due to increased client facilitation requirements by clients in the US and Europe. Fixed income trading revenues were up. The rates business recorded significant increases with business expansion in energy trading and in mortgage backed securities driven by higher client activity and favorable market conditions. This was partially offset by lower derivatives income due to declining customer flows. The metals business was positively affected by active markets. Revenues from the credit fixed income business were up slightly compared with 2005, while a loss of CHF 245 million was recorded in relation to credit default swaps (CDSs) hedging existing credit exposure in the loan book, against a gain of CHF 103 million in 2005.

Net income from interest margin businesses increased by 8% to CHF 5,718 million in 2006, a reflection of 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 the shrinking Swiss recovery portfolio, which dropped by CHF 0.7 billion compared to year-end 2005.

At CHF 816 million, net income from treasury activities and other in 2006 was CHF 127 million or 18% higher than CHF 689 million in 2005. Interest income increased due to a higher consolidated capital base. Compared with 2005, income benefited from mark-to-market gains on US dollar foreign exchange 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, treasury revenues were negatively affected by the accounting treatment of interest rate swaps, as these hedges were not fully effective.

In 2006, UBS experienced a net credit loss recovery of CHF 156 million, compared to a net credit loss recovery of CHF 375 million in 2005. The positive macro-economic environment in key emerging markets allowed the release of CHF 48 million 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 the credit portfolio has again resulted in a low level of new defaults. The management of the impaired portfolio, which continues to shrink, has also contributed to this result.

The Investment Bank realized a net credit loss recovery of CHF 47 million in 2006, compared with a net credit loss recovery of CHF 152 million in 2005. This continued strong performance was the result of further recoveries of previously established allowances and provisions from the workout of the impaired portfolio, and no new defaults in 2006.

In 2006, net fee and commission income was CHF 25,456 million, up 20% from CHF 21,184 million in 2005. Underwriting fees were CHF 3,113 million in 2006, up 20% from CHF 2,605 million in 2005. Equity underwriting fees, at CHF 1,834 million, increased by CHF 493 million, or 37%, in all geographical regions. This was partially due to UBS's role in the initial public offering of the Bank of China during second quarter 2006, where the firm acted as joint coordinator and bookrunner. Fixed income underwriting fees, at CHF 1,279 million, were slightly up by CHF 15 million. At CHF 1,852 million, mergers and acquisitions and corporate finance fees in 2006 were up 27% from CHF 1,460 million in 2005. Advisory gross revenues increased during 2006, as clients took advantage of strategic opportunities in the brisk merger and acquisition environment and UBS's growing 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, a reflection of the improved markets and the resulting higher confidence of institutional and individual clients. Additionally, higher income from exchange-traded derivatives was driven by the acquisition of ABN AMRO's global futures and options business. Investment fund fees were CHF 5,858 million in 2006, up 23% from CHF 4,750 million in 2005, mainly a reflection of higher asset-based fees for the wealth and asset management businesses, driven by strong client money inflows and favorable market conditions. Fiduciary fees were slightly higher in 2006, increasing from CHF 212 million in 2005 to CHF 252 million, reflecting 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 increased by 25% to CHF 6,622 million in 2006 from CHF 5,310 million in 2005. The increase was 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 449 million in 2006, increased by 21% from 2005, 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, a reflection of declining 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 UBS's New York Stock Exchange membership seats, which were exchanged into shares when it went public in March 2006. In addition, UBS sold its 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.

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 which reflected the better performance in all UBS businesses. Salary expenses rose due to the 12% increase in personnel over 2006, reflecting the expansion of UBS's 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 a reflection of more share awards being 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 compared with CHF 1,256 million in 2005. 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 levels of staff.

At CHF 7,929 million in 2006, general and administrative expenses increased CHF 1,481 million from CHF 6,448 million in 2005. The increase was driven by a number of provisions, mainly for the Sumitomo settlement and the long-term lease on an office building in New Jersey, US. Professional fees rose for projects that support UBS's 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 unchanged from CHF 1,240 million in 2005. Higher depreciation on real estate was partially offset by falling IT-related charges.

At CHF 148 million, amortization of intangible assets was up 17% from CHF 127 million in 2005, related to acquisitions made during 2006.

Tax

The 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 was positively influenced by the release of deferred tax valuation allowances, mainly reflecting improved forecast earnings in certain group companies and branches.

Fair value disclosure of shares and options

The fair value of shares granted in 2006 rose to CHF 1,858 million, 35% higher than CHF 1,381 million in 2005. The increase compared with 2005 was primarily driven by higher performance-based compensation and a rise in the proportion of bonuses being delivered in restricted shares.

The fair value of options granted as of 31 December 2006 was CHF 564 million, up 56% from CHF 362 million in 2005. The increase reflected a higher fair value per option, primarily due to a higher UBS share price.