Shares and capital instruments

Shares

UBS shares and tier 1 capital

The majority of UBS's tier 1 capital comprises share premium and retained earnings attributed to UBS shareholders. As of 31 December 2008, total IFRS equity attributable to UBS shareholders amounted to CHF 32,531 million and was represented by a total of 2,932,580,549 issued UBS shares, of which 61,903,121 (2.1%) were held by UBS. Each outstanding share has a par value of CHF 0.10 and entitles the holder to one vote at the shareholders' meeting and to a proportionate share of the dividend that is distributed. There are no preferential rights for shareholders and no other classes of shares are issued by the parent bank (UBS AG) directly.

In 2008, as part of UBS's shareholder-approved recapitalization measures, the outstanding shares were increased by a total of 859,033,205 reflecting mainly the issuance of newly created shares for the stock dividend (98,698,754 shares) and for the capital increase by means of a rights offering (760,295,181 shares). For the stock dividend, each share held on 25 April 2008 was allocated one entitlement. Twenty of those entitlements gave the holder the right to receive one UBS share for free on 19 May 2008. For the subsequent capital increase by means of a rights offering, shareholders were allotted one subscription right per share held on 26 May 2008. For every 20 of those rights, shareholders were entitled to buy seven shares at CHF 21.00 on 17 June 2008. As a result of the latter rights offering, a net total of CHF 15.6 billion of new capital was received. At the time of issuance this was equal to an increase of approximately 4.8% in UBS's tier 1 ratio.

Holding of UBS shares

UBS holds its own shares for three main purposes: Group Treasury holds shares to cover employee share and option programs; it repurchases shares on a second trading line, where they are earmarked for cancellation purposes (the latter activity is temporarily suspended); and the Investment Bank holds shares, to a limited extent, for trading purposes where it engages in market-making activities in UBS shares and related derivative products.

The holding of treasury shares on 31 December 2008 -decreased to 61,903,121 or 2.1% of shares issued, from 158,105,524 or 7.6% on the same date one year prior.

In 2008, a total of 3.7 million employee options were exercised and an additional 63.0 million new options were granted. As of 31 December 2008, UBS was holding approximately 48.9 million shares in Group Treasury and an additional 150 million unissued shares in conditional share capital that can be used to cover future employee option exercises, of which a total of 236 million were outstanding on 31 December 2008. At year-end 2008, the shares available covered all exercisable employee options.

The presentation in the table below shows the purchase of UBS shares by Group Treasury under buy-back programs at the stock exchange and does not include activities of the Investment Bank in UBS shares.

Treasury shares held by the Investment Bank

The Investment Bank, acting as liquidity provider to the -equity index futures market and as a market maker in UBS shares and derivatives, has issued derivatives linked to UBS stock. Most of these instruments are classified as cash-settled derivatives and are held for trading purposes only. To hedge the economic exposure, a limited number of UBS shares are held by the Investment Bank.

Capital instruments

Mandatory convertible notes

As part of the measures taken to strengthen its capital base in 2008, UBS issued two mandatory convertible notes (MCNs), with principal amounts of CHF 13 billion (MCN1) and CHF 6 billion (MCN2) respectively, in private placements to large institutional investors and the Swiss Confederation. To allow for the delivery of shares upon conversion of the MCNs, separate extraordinary general meetings of UBS shareholders were held on 27 February and 27 November 2008 to approve the creation of conditional capital for this purpose. The shareholders approved a maximum number of 277.8 million UBS shares to be delivered under the first issued MCN and 365 million UBS shares to be delivered under the second MCN. The initial investors in the MCNs are allowed to sell or transfer the instruments without restrictions to other investors. The share capital will be increased upon voluntary or mandatory conversion of the MCNs. The future mandatory capital increase allows the full proceeds to be counted as tier 1 capital for regulatory capital purposes from the date of issuance.

MCNs are a special type of equity-linked security that will never be redeemed in cash but rather, upon maturity or early conversion, will automatically convert into shares of the note issuer or an affiliated company. The number of shares to be delivered depends on the conversion price, and will vary according to the precise terms (see below). The MCNs issued by UBS contain provisions allowing early conversion at the option either of the holders or of UBS.

Throughout the lifetime of the MCNs, the holders will receive an annual coupon based on the nominal value of the MCNs. This annual coupon not only reflects the cost of capital but also compensates the noteholders for the value of options embedded in the structure, for instance for bearing the risk of a share price deterioration before conversion if the share price falls below the reference price described below, and for the fact that MCN holders only participate in the benefit of an increasing share price once the share price exceeds 117% of the reference price. The MCNs can be converted at the earliest after a period of six months has elapsed following their issuance and they must be converted at the latest by maturity of the notes.

As of year end, holders of the March 2008 MCNs (or MCN1) are expected to receive in aggregate a fixed number of 270.4 million UBS shares at conversion or settlement independently of the UBS share price development, whereas under the terms of the second issuance (the December 2008 MCNs or MCN2) holders will receive a variable number of shares. At or below a UBS share price of CHF 18.21, the December 2008 MCNs will be converted into a maximum of 329.4 million UBS shares. Should the UBS share price rise above this level, the holders would receive a lower number of shares and the minimum would be reached with a share price of CHF 21.31. Thereafter, a further increase in price leads to an incremental increase in shares delivered, provided however that the total number of shares to be issued will not exceed the maximum number of shares (see the graphs on the next page).

Hybrid tier 1 capital

Hybrid tier 1 instruments represent innovative and non-innovative perpetual instruments and made up approximately 21.4% of adjusted core capital on 31 December 2008. They are accounted for under minority interests in the IFRS equity. In 2008, UBS raised EUR 1 billion of capital preferred securities issued by UBS Capital Securities (Jersey) Ltd. The instrument bears an 8.836% coupon and is callable in 2013. As of 31 December 2008, UBS had issued a total of CHF 7,393 million of such instruments in various currencies. Hybrid tier 1 instruments are perpetual instruments which can only be redeemed if they are called by the issuer. If such a call is not exercised at the respective call date, the terms might include a change from fixed to floating coupon payments and, in the case of innovative instruments only, a limited step-up of the interest rate. Non-innovative instruments do not have a step-up of the interest rate and are therefore viewed as having a higher equity characteristic for regulatory capital purposes. The instruments are issued either through trusts or subsidiaries of UBS and rank senior to UBS shares in dissolution. Payments under the instruments are subject to adherence to minimum capital ratios by UBS. Any payment missed is non-cumulative.

Tier 2 capital

The major element in tier 2 capital consists of subordinated long-term debt. Tier 2 instruments have been issued in various currencies and with a range of maturities across capital markets globally. They accounted for CHF 12,290 million in total capital as of year-end 2008. Tier 2 instruments rank senior to both UBS shares and to hybrid tier 1 instruments but are subordinated to all senior obligations of UBS.

Distributions to shareholders

The decision whether to pay a dividend and the level of the dividend are dependent on UBS's targeted capital ratios and its cash flow generation. The decision on dividend payments is proposed by the Board of Directors (BoD) to the shareholders and is subject to their approval at the annual general meeting. The BoD has decided not to propose any dividend for the financial year 2008.

Distribution to shareholders in 2008 - stock dividend

At the extraordinary general meeting of 27 February 2008, the shareholders approved distribution of a stock dividend offering the opportunity to obtain sale proceeds comparable with the cash dividend paid in previous years. One entitlement was allocated to each share outstanding after the close of business on the record date of 25 April 2008. Twenty entitlements gave the holder the right to receive one additional UBS share for free.

This stock dividend was tax-efficient for many shareholders resident in Switzerland and those in many other countries. Unlike a cash dividend, where the Swiss withholding tax of 35% is deducted from the gross amount payable, the stock dividend was allocated to shareholders without deduction of Swiss withholding tax.

Compared with the cash dividend, a stock dividend is also more beneficial for UBS's (tier 1) capital base. Cash dividend payments are deducted from the firm's net profits and retained earnings, which are major components of its core (tier 1) capital. In contrast, by issuing new shares in lieu of a dividend cash payment, the level of UBS's (tier 1) capital base is maintained.

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