UBS - Risk concentrations

Risk concentrations Identified risk concentrations Previously disclosed risk concentrations

Risk concentrations

A concentration of risk exists where: (i) a position or group of positions in financial instruments is affected by changes in the same risk factor or group of correlated factors; and (ii) the exposure could, in the event of large but plausible adverse developments, result in significant losses.

The identification of risk concentrations requires judgment because potential future developments cannot be predicted with certainty and may vary from period to period. In determining whether a risk concentration exists, UBS considers a number of elements, both individually and in combination. These elements include: the shared characteristics of the instruments; the size of the position or group of positions; the sensitivity of the position or group of positions to changes in risk factors and the volatility and correlations of those factors. Also important in this assessment is the liquidity of the markets where the instruments are traded and the availability and effectiveness of hedges, as the value of a hedge instrument may not always move in line with the position being hedged. This is referred to as basis risk.

UBS is exposed to price risk, basis risk, credit spread risk and default risk, other idiosyncratic and correlation risks on both equities and fixed income inventories, and to country risk in many of its lending and trading activities. Refer to the "Market risk", "Credit risk" and "Operational risk" sections of this report for more information on the risk categories to which UBS is exposed. UBS has also bought and may be required to buy securities and units from funds that UBS has sold to clients. Such purchases, especially of illiquid assets such as interests in hedge funds, could create a significant risk exposure for UBS.

If a risk concentration is identified, it is assessed to determine whether it should be reduced or mitigated, and the available means to do so are also evaluated. Identified risk concentrations are subject to increased monitoring.

Identified risk concentrations

Based on UBS's assessment of its portfolios and asset classes with potential for material loss in a stress scenario relevant to the current environment, the firm believes the various exposures shown below can be considered risk concentrations according to the abovementioned definition.

UBS has significant lending, counterparty and country risk exposures that could sustain significant losses if the current economic conditions were to persist. Refer to the "Credit risk" section of this report for more information.

It is possible that material losses could occur on asset classes, positions and hedges other than those disclosed in this section of this report, particularly if the correlations that emerge in a stressed environment differ markedly from those anticipated by UBS.

Exposure to monoline insurers, by rating ¹
USD million, unless otherwise stated	31.12.08
	Notional amount ³	Fair value of underlying CDOs ⁴	Fair value of CDSs prior to credit valuation adjustment ⁵	Credit valuation adjustment on 31.12.08	Fair value of CDSs after credit valuation adjustment
	Column 1	Column 2	Column 3 (=1-2)	Column 4	Column 5 (=3-4)
Credit protection on US RMBS CDOs ²	9,111	1,695	7,415	4,659	2,756
of which: from monolines rated AAA to A	23	12	11	4	6
on US sub-prime residential mortgage-backed securities (RMBS) CDOs high grade	0	0	0	0	0
on US sub-prime RMBS CDOs mezzanine	0	0	0	0	0
on other US RMBS CDOs	23	12	11	4	6
of which: from monolines rated BBB and below	9,088	1,683	7,404	4,655	2,750
on US sub-prime residential mortgage-backed securities (RMBS) CDOs high grade	6,222	952	5,269	2,961	2,308
on US sub-prime RMBS CDOs mezzanine	1,092	28	1,064	897	167
on other US RMBS CDOs	1,774	703	1,071	797	275
Credit protection on other assets ²	12,424	7,509	4,914	2,335	2,579
of which: from monolines rated AAA to A	2,399	1,568	830	334	496
of which: from monolines rated BBB and below	10,025	5,941	4,084	2,001	2,083
Total 31.12.08	21,535	9,204	12,329	6,994	5,335
Total 31.12.07 (USD billion)	24.2	19.7	4.5	0.9	3.6
1 Excludes the benefit of credit protection purchased from unrelated third parties. 2 Categorization based on the lowest insurance financial strength rating assigned by external rating agencies. 3 Represents gross notional amount of credit default swaps (CDSs) purchased as credit protection. 4 Collateralized debt obligations (CDOs). 5 Credit default swaps.

Exposure to monoline insurers

The vast majority of UBS's direct exposure to monoline insurers arises from over-the-counter (OTC) derivative contracts, mainly credit default swaps (CDSs), purchased to hedge specific positions. On 31 December 2008, the total fair value of CDS protection purchased from monoline insurers against these positions was USD 5.3 billion after cumulative credit valuation adjustments (CVAs) of USD 7.0 billion. The level of CVAs increased significantly in 2008 from USD 0.9 billion on 31 December 2007 reflecting the progressive deterioration in both the fair value of the underlying CDOs and the credit quality of the monoline insurers during the year.

Exposure under CDS contracts with monoline insurers is calculated as the sum of the fair values of individual CDSs after credit valuation adjustments. This, in turn, depends on the valuation of the instruments against which protection has been bought. A positive fair value, or a valuation gain, on the CDS is recognized if the fair value of the instrument it is intended to hedge decreases.

The table on the previous page shows the CDS protection bought from monoline insurers to hedge specific positions. It illustrates the notional amounts of the protection originally bought, the fair value of the underlying instruments and the fair value of the CDSs both prior to and after credit valuation adjustments taken for these contracts. Refer to "Note 27 Fair value of financial instruments" in the financial statements of this report for more information on CVA valuation and sensitivities. The CVA as at 31 December 2008 was adjusted to take into account the anticipated economic impact of commuting trades with certain monolines.

Other than credit protection bought on the positions detailed in the table on the previous page, UBS held direct derivative exposure to monolines of USD 437 million after CVAs of USD 499 million on 31 December 2008. In its trading portfolio, UBS also had indirect exposure to monoline insurers through securities which they have guaranteed ("wrapped") and which were issued primarily by US states and municipalities and US student loan programs. These had a net market value of approximately USD 5.5 billion on 31 December 2008.

Exposure to leveraged finance deals

UBS defines leveraged finance deals according to internal credit ratings, which correspond with external corporate credit ratings of BB- or worse at the point of reporting and included underwritten positions that experienced a rating downgrade in 2008. The net exposure to leveraged finance commitments held by UBS was reduced significantly in 2008 to USD 4,009 million at 31 December 2008, of which USD 3,161 million was funded. Leveraged finance exposures on 31 December 2008 are shown net of cumulative gross writedowns and impairment charges, as well as effective hedges. Exposure to leveraged finance commitments, net of effective hedges, at 31 December 2007 was USD 11.4 billion, of which USD 7.4 billion was funded. The net exposure at this date, after deductions of cumulative gross markdowns, was USD 11 billion.

Exposure to auction rate securities

Auction rate securities held by UBS

Auction rate securities (ARS) are long-term securities structured to allow frequent reset of their coupon and, at the same time, the possibility for holders to sell their investment in a periodic auction, giving the securities some of the characteristics of a short-term instrument in normal market conditions. These are typically issued by municipal entities and student loan trusts, and may be wrapped by monoline insurers.

Coupons paid on ARS are determined by an auction at the beginning of each interest reset period, the intention being to allow investors to earn a market rate of interest. In the past UBS acted as broker-dealer for certain ARS programs. Although it is not obligated to do so, UBS has in the past provided liquidity, from time to time, to these markets by submitting bids to ARS auctions and acquired ARS inventory in the first half of 2008 as a result.

As described in the "Changes in 2008" section of UBS's fourth quarter report, UBS and the Swiss National Bank (SNB) agreed that UBS's student loan ARS positions will not be sold to the SNB fund. UBS's inventory of student loan ARS was reclassified from "held for trading" to "loans and receivables" on 31 December 2008 and the student loan ARS repurchased from clients in fourth quarter 2008 were also classified as loans and receivables. Under their new classification, all student loan ARS positions held by UBS are subject to an impairment test which includes a detailed review of the quality of the underlying collateral.

In fourth quarter 2008 UBS carried out a fundamental analysis of its student loan ARS inventory as well as client positions included in the buy-back program (refer to "Maximum exposure to client auction rate securities" on the next page for more information). The majority of the collateral backing the securities is backed by Federal Family Education Loan Program (FFELP) which is reinsured by the US Department of Education.

Auction preferred stocks (APS) are issued by closed-end mutual funds with an underlying portfolio of tax-exempt municipal bonds, common stock, preferred stock, or taxable debt. A closed-end fund is a publicly traded investment company registered under the Investment Company Act of 1940. The Investment Company Act of 1940 requires significant over-collateralization which benefits the APS holders.

On 31 December 2008, UBS had student loan ARS positions with a carrying value totaling USD 8.4 billion, of which approximately 66% of the securities in the portfolio was backed by FFELP guaranteed collateral. On the same date, UBS had exposures to US auction preferred securities of USD 4.0 billion.

Maximum exposure to client auction rate securities

UBS has committed to restore liquidity to client holdings of ARS. This commitment is in line with previously announced agreements in principle with various US regulatory agencies, and the final settlements entered into Audited with the Massachusetts Securities Division, the US Securities and Exchange Commission, and the New York Attorney General. On 7 October 2008, UBS filed a registration statement with the US Securities and Exchange Commission for Auction Rate Securities Rights necessary to offer clients the right to sell their ARS to UBS at par value during their buy-back period. The table below shows the maximum required repurchase amount at par of ARS, which would occur over various time periods between 31 October 2008 and 2 July 2012 according to client type and security. UBS anticipates that the maximum required repurchase amount is likely to decline over time as issuers refinance their debt obligations and UBS works with issuers, industry peers and US government officials on restructuring initiatives and redemption opportunities.

Approximately 88% of the USD 11.8 billion student loan ARS held by clients are backed by FFELP guaranteed collateral. Following the start of the buy-back program in fourth quarter 2008, UBS repurchased approximately USD 0.5 billion of US student loan ARS, USD 0.2 billion of US municipal ARS, USD 0.6 billion of US taxable auction preferred securities (APS) and USD 3.2 billion of US tax exempt APS from clients.

Auction rate securities exposure
	Net exposures on 31.12.08 ^1,2 (USD million)	Net exposures on 31.12.07 ¹ (USD billion)
US student loan auction rate securities	8,362	4.5
US municipal auction rate securities	451	1.4
US taxable auction preferred securities	782
US tax-exempt auction preferred securities	3,167
Total	12,763	5.9
1 Net exposure represents market value of gross exposure net of short positions and hedges considered effective. 2 On 31 December 2008, USD 4.6 billion of the US student loan auction rate securities were monoline wrapped.

Client holdings: auction rate securities
			Buy-back period
	Par value of maximum required purchase on 31.12.08	Private clients		Institutional clients
USD million	Par value of maximum required purchase on 31.12.08	31.10.08-4.1.11	2.1.09-4.1.11	30.6.10-2.7.12
US student loan auction rate securities	11,775	41	3,196	8,538
US municipal auction rate securities	2,041	144	1,589	308
US taxable auction preferred securities	1,659	161	1,202	296
US tax-exempt auction preferred securities	64	64	-	-
Total	15,539	410	5,987	9,142

Previously disclosed risk concentrations

In 2008, UBS significantly reduced its exposures to US resi dential and commercial real estate-related positions and the US reference-linked note (RLN) program. These reductions were achieved both through sales and writedowns as well as UBS's agreement with the Swiss National Bank (SNB) in October 2008, which allows for the transfer of illiquid securities and other positions from UBS to a fund owned and controlled by the SNB. As a result of this agreement, UBS's residual positions in these asset classes were no longer considered as concentrations of risk. Refer to the "Strategy and structure" section of this report for more information on the SNB transaction. UBS previously reported net exposures on 31 December 2007 to US sub-prime residential mortgages of USD 27.6 billion and to US Alt-A residential mortgages of USD 26.6 billion. At the same date UBS had net exposures to US commercial real estate of USD 7.7 billion and to US RLN of USD 11.2 billion. UBS also reported in third quarter 2008 net exposures of USD 6.1 billion on 30 June 2008 and USD 2.3 billion on 30 September 2008 to US prime residential mortgages.

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