Measurement and analysis of performance

Key factors affecting UBS's financial position and results of operations in 2008

- In 2008, UBS continued to be severely affected by negative revenues in the Investment Bank due to trading losses on risk positions. Refer to the "Risk concentrations" section and "Note 3 Net interest and trading income" in the financial statements of this report for more information on risk positions and associated losses.

- UBS recorded a significant increase in credit losses from CHF 238 million in the prior year to CHF 2,996 million. This reflects the deteriorating economic environment and impairment charges taken on reclassified financial assets in fourth quarter 2008. Refer to the "Credit risk" section of this report for more information.

- On 5 March 2008, UBS issued mandatory convertible notes (MCNs) with a face value of CHF 13 billion to two investors. This transaction resulted in an accounting gain of CHF 3,860 million in first quarter 2008 and in an increase in share premium of CHF 7.0 billion. Refer to "Note 26 Capital increases and mandatory convertible notes" in the financial statements of this report for more information.

- On 23 April 2008, the annual general meeting of shareholders approved a proposal that UBS strengthen its shareholders' equity by way of an ordinary capital increase. The capital increase was completed in June 2008 by means of a rights offering and resulted in the issue of 760,295,181 new fully paid registered shares with a par value of CHF 0.10 each. Net proceeds from the capital increase were approximately CHF 15.6 billion. Refer to "Note 26 Capital increases and mandatory convertible notes" in the financial statements of this report for more information.

- On 20 May 2008, UBS completed the sale of a portfolio of US residential mortgage-backed securities (RMBSs) for proceeds of USD 15 billion to the RMBS Opportunities Master Fund, LP, a third-party entity managed by BlackRock, Inc. The portfolio had a notional value of approximately USD 22 billion and comprised primarily Alt-A and sub-prime related assets. The fund was capitalized with approximately USD 3.75 billion in equity raised by BlackRock from third-party investors and an eight-year amortizing USD 11.25 billion senior secured loan provided by UBS (balance at year-end 2008 was USD 9.2 billion).

- As announced on 16 October 2008, the Swiss National Bank (SNB) and UBS have reached an agreement to transfer, in one or more sales, up to USD 60 billion of illiquid and other positions from UBS's balance sheet to a separate fund entity controlled and owned by the SNB. The size of the transaction has since been reduced to USD 38.6 billion. This transaction allowed UBS to reduce its exposure to certain asset classes and potential associated losses. In parallel, UBS placed CHF 6 billion of MCNs with the Swiss Confederation on 9 December 2008. The overall impact on UBS's income statement of the SNB transaction and the placement of the MCNs with the Swiss Confederation was a net charge of CHF 4.5 billion. This reflects a net loss arising from the acquisition of the equity purchase option, a loss arising from valuation differences determined to date on securities sold or to be sold to the SNB StabFund, losses on hedges that were subject to trading restrictions as a result of the SNB transaction, and the impact of the contingent issuance of UBS shares in connection with the transaction. The fair valuation impact of the issuance of the MCNs, as described in "Note 26 Capital increases and mandatory convertible notes" in the financial statements of this report, is also included in this total.

- In 2008, the Investment Bank recorded a gain on own credit from financial liabilities designated at fair value of CHF 2,032 million, resulting from the widening of UBS's credit spread, which was partly offset by the effects of redemptions and repurchases of such liabilities. The cumulative own credit balance for such debt held at 31 December 2008 amounts to CHF 2,953 million. Refer to "Note 27 Fair value of financial instruments" in the financial statements of this report for more information. Financial liabilities designated at fair value are liabilities for which UBS applied the option granted by IFRS to fair value them through profit or loss, predominately issued structured products. The gain reflects an increase in the difference between the market value of UBS's debt accounted for under the fair value option (which is presented on the balance sheet line "Financial liabilities designated at fair value") and the amount it would cost UBS to issue this debt at current market terms. As a general rule, the market value of UBS's outstanding debt decreases if UBS's own credit spread widens and increases if UBS's credit spread tightens. Therefore, if UBS's credit spread were to tighten again in the future, the market value of UBS's outstanding fair valued debt would increase accordingly, resulting in the reversal of some or all of the gains on own credit recorded so far, unless UBS redeems own debt before maturity.

- Following the auction rate securities (ARS) settlement in August 2008, Wealth Management US recorded losses of CHF 1,636 million, of which CHF 1,464 million were included in general and administrative expenses, and CHF 172 million were recognized as trading losses. Under the ARS settlement, Wealth Management US agreed to purchase ARS from clients at their par value. Up to fourth quarter 2008, the ARS settlement liability represented a provision. The liability was reclassified from provisions to negative replacement values in fourth quarter 2008, when ARS settlement rights, which are treated as derivative instruments, were issued to and accepted by clients. Losses incurred post-reclassification represented trading losses.

- As announced on 18 February 2009, UBS settled the US cross-border case with the US Department of Justice (DOJ) and the US Securities and Exchange Commission (SEC), by entering into a deferred prosecution agreement with the DOJ and a consent order with the SEC. As part of these settlement agreements, UBS agreed to pay an amount of CHF 917 million (USD 780 million) to the United States. Refer to the "Settlement regarding the US cross-border case" sidebar in the "Wealth Management International & Switzerland" section of this report for more information.

- UBS recognized an income tax benefit of CHF 6,837 million in 2008, which mainly reflects the CHF 6,126 million impact from the recognition of incremental deferred tax assets on available tax losses. The incremental deferred tax assets relate mainly to Swiss tax losses incurred during 2008 (primarily due to the writedown of investments in US subsidiaries) but was reduced by a decrease in the deferred tax assets recognized for US tax losses. Refer to "Note 22 Income taxes" in the financial statements of this report for more information.

Discontinued 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 and they are therefore not included in its business planning decisions. This assists in comparing UBS’s performance against that of its peers, and in the estimation of future results. In the last three years, one such item had a significant impact on UBS’s consolidated financial statements: On 23 March 2006, UBS sold its 55.6% stake in Motor-Columbus to a consortium representing Atel’s Swiss minority shareholders, EOS Holding, Atel and French utility Electricité de France (EDF) for a sale price of approximately CHF 1,295 million, leading to an after-tax gain on sale of CHF 387 million.

Seasonal characteristics

The main businesses of UBS do not generally show significant seasonal patterns, although the Investment Bank's revenues have been affected in some years by the seasonal characteristics of general financial market activity and deal flows in investment banking. Other business divisions are only slightly impacted by seasonal components, such as asset withdrawals that tend to occur in fourth quarter and lower client activity levels related to the end-of-year holiday season.

Performance measures

Key performance indicators (2008)

Until the end of 2008, UBS consistently assessed its performance against indicators designed to measure the delivery (on average and through periods of varying market conditions) of returns to its shareholders. At the Group level, these indicators were: after-tax return on equity; net new money; diluted earnings per share (EPS); and cost / income ratio. Business division key performance indicators (KPIs) were also used for internal performance measurement and planning as well as external reporting.

A new key performance indicator framework was introduced in first quarter 2009 and will be used to measure performance in 2009 and forward. Refer to the "Key performance indicators: 2009 and beyond" sidebar in the "Strategy and structure" section of this report for more information

Client / invested assets reporting

UBS reports 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.

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

Of the two, 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. 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 UBS by new and existing clients less those withdrawn by existing clients and clients who terminate their relationship with UBS. Negative net new money means that there are more outflows than inflows. Interest and dividend income from invested assets is not counted as net new money inflow. Market and currency movements as well as fees, commissions and interest on loans charged 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 inflow or outflow.

When products are managed in one business division and sold in another, they are counted in both the investment management unit and the distribution unit. This results in double counting within 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 division 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 273 billion of invested assets were double counted in 2008 (CHF 392 billion in 2007).