UBS Results

Operating income

Total operating income was CHF 9,484 million in second quarter 2004, up 6% from CHF 8,981 million in the same period a year earlier. Excluding the CHF 161 million pre-tax gain from the sale of CSC in second quarter 2003, operating income increased 8% compared to a year ago. Most of our Business Groups were able to improve revenues, with the biggest gains being seen in our wealth and asset management businesses. They profited from higher market levels and, as a result, rising asset-based revenues, with investment fund fees seeing a record result. Our investment banking business was also strong in second quarter, benefiting from a large increase in advisory revenues as market conditions for M&A improved and we benefited from our market share gains. Private equity made a positive contribution to results for the third consecutive time, reflecting lower writedowns and higher divestment gains. We posted an unusually high level of credit recoveries.

Net interest income was CHF 3,056 million in second quarter 2004, up from CHF 3,026 million in the same period a year earlier. Net trading income was CHF 1,177 million this quarter, down from CHF 1,318 million in second quarter 2003.

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, we analyze the total according to the business activities that give rise to the income, rather than by the type of income generated.

Net income from interest margin products was CHF 1,290 million in second quarter 2004, virtually unchanged from the CHF 1,292 million in the same period a year earlier. Lower income reflecting our shrinking Swiss recovery portfolio (down CHF 1.9 billion), reduced interest margins on client cash and savings accounts, as well as declining revenues from US dollar-denominated accounts, was balanced out by the growth of our domestic mortgages business, higher volumes in saving accounts and loan growth in our wealth management businesses.

At CHF 2,809 million, net income from trading activities in second quarter 2004 was 6% lower than the CHF 2,997 million recorded a year earlier. Equity trading income was CHF 696 million in second quarter 2004, down from CHF 703 million in the same quarter a year ago. The drop was mainly due to the strengthening of the Swiss franc against major currencies. Excluding the currency impact, equity trading revenues rose as increased client activity helped market-making, and we benefited from the acquisition of the ABN AMRO prime brokerage business. Those developments were partially offset by lower proprietary trading revenues. Fixed income trading revenues dropped 9% to CHF 1,619 million in second quarter 2004 from CHF 1,782 million a year ago. Excellent performances in the government bond sector and derivatives businesses were offset by falls in principal finance and fixed income market-making as the environment of rising rates and low volatility drove activity from the market. We recorded positive revenues of CHF 12 million relating to Credit Default Swaps (CDSs) hedging existing credit exposure in the loan book against the mark to market loss of CHF 343 million a year ago. Foreign exchange trading revenues, at CHF 422 million in second quarter 2004, were up 2% from CHF 413 million a year ago, reflecting strong performance in our derivatives business.

Net income from treasury activities was CHF 373 million in second quarter 2004, up 10% from CHF 340 million a year earlier. The increase was mainly due to a small unrealized gain related to cash flow hedging, which we determined was ineffective in offsetting the interest rate risk of various financial products (for example, loans or money market and retail banking products). Hedged items are accounted for on an accrual basis. In contrast, related derivatives used to economically hedge the interest rate risk of the items are carried on the balance sheet at fair value, with changes in fair value recorded in equity, thereby avoiding volatility in the group income statement. If a part of the hedge is deemed to be ineffective, as this quarter, then that portion of the change in fair value must be recorded in earnings. Otherwise, the net income result from treasury activities was affected by reduced returns on invested equity as we continued to repurchase shares. The impact of lower interest rates was partially offset by the diversification of our invested equity into currencies other than the Swiss franc.

In second quarter 2004, other net trading and interest income was negative CHF 239 million compared to negative revenues of CHF 285 million a year earlier. The improvement was mainly due to lower funding costs for goodwill as well as the contraction of our private equity portfolio.

In second quarter 2004, net fee and commission income was CHF 4,841 million, up 12% from CHF 4,313 million a year earlier. The increase was mainly due to higher asset-based and corporate finance fees, reflecting the recovery of financial markets compared to a year ago. At CHF 626 million, underwriting fees in second quarter 2004 were CHF 28 million or 4% lower than CHF 654 million a year earlier. Compared to a year ago, fixed income underwriting increased 13% to CHF 288 million whereas equity underwriting dropped by 15% to CHF 338 million. Corporate finance fees were CHF 273 million in second quarter 2004, up 78% from CHF 153 million in the same quarter a year earlier. The improved market environment led to higher corporate activity levels, resulting in a 12% increase in the M&A global fee pool for the first six months of this year compared to the same period a year earlier (according to Freeman). Net brokerage fees rose by 3% to CHF 1,091 million in second quarter 2004 from CHF 1,063 million in second quarter 2003. The increase was due to higher individual and institutional investor activity levels. Investment fund fees, at their highest level ever, increased 24% to CHF 1,158 million this quarter from CHF 931 million a year earlier. The gain was mainly driven by higher asset-based fees in our wealth management and asset management businesses, reflecting increased asset levels on the recovery in financial markets and an ever-improving mix of asset classes. Portfolio and other management and advisory fees were CHF 1,154 million in second quarter 2004, up 27% from CHF 911 million in the same period a year earlier. The gain was due to higher asset levels in portfolio management mandates and managed accounts in our wealth management businesses as well as higher fees in our asset management business – themselves the result of rising invested asset levels and strong inflows of net new money.

Other income was CHF 279 million in second quarter 2004, down 14% from CHF 323 million in the same quarter a year ago. The decrease was mainly due to the sale of CSC in second quarter 2003, as well as fewer gains from the disposal of financial investments (down CHF 77 million). This was partially offset by higher disposal gains from private equity investments (up CHF 146 million), and lower impairment charges (down CHF 43 million).

Operating expenses

Managing costs closely remains a key focus and we continue to look for ways to improve the efficiency and profitability of our businesses. Total operating expenses increased by 2% or CHF 104 million to CHF 6,889 million in second quarter 2004 from CHF 6,785 million in the same period a year earlier. The increase was driven by higher general and administrative expenses from the USD 100 million (CHF 128 million) penalty levied by the Fed related to our banknote trading business, and increased operational provisions. Excluding the fine and the higher provisions, underlying general and administrative expenses were actually down, reflecting our ongoing tight cost controls. Personnel expenses, depreciation and amortization expenses all dropped slightly, with the decline also helped by the weakening of major currencies against the Swiss franc.

Personnel expenses declined CHF 20 million to CHF 4,599 million in second quarter 2004 from CHF 4,619 million a year earlier despite revenue growth, as the Investment Bank continues to accrue performance-related compensation at a lower rate than in 2003. This was accompanied by lower severance expenses at the Investment Bank, a drop in early retirement expenses in Switzerland and lower retention expenses for the Wealth Management USA business (which ended this quarter). Personnel expenses are managed on a full-year basis with final fixing of annual performance-related payments in fourth quarter.

General and administrative expenses, at CHF 1,743 million in second quarter 2004, increased 9% from CHF 1,600 million a year earlier. Underlying running expenses were down, and the reported increase was mainly due to the USD 100 million (CHF 128 million) civil penalty levied by the Fed related to our banknote trading business, as well as increased operational provisions, among them potential additional US withholding tax costs (refer to page 38 for more detail). Other increases were seen in IT project costs, travel and entertainment (where second quarter 2003 expenses were particularly low due to the SARS crisis) as well as legal fees. They were offset by decreases in other categories, with major drops in occupancy, administration (which was at its lowest level ever) and telecommunication and postage expenses. The result was also helped by the weakening of major currencies against the Swiss franc.

Depreciation dropped by 2% to CHF 322 million in second quarter 2004 from CHF 328 million a year earlier. The decline reflected lower charges for IT equipment.

At CHF 225 million, amortization of goodwill and other intangible assets was down 5% from CHF 238 million in second quarter 2003, reflecting the strengthening of the Swiss franc against major currencies, as well as lower amortization charges for the Wealth Management USA business (due to the CSC disposal).

Tax

We incurred a tax expense of CHF 512 million in second quarter 2004, reflecting an effective tax rate of 19.7% for the quarter and 19.2% for the first six months of 2004. In 2003, the full-year rate was 17.9% (before significant financial events). The 2003 tax rate was positively influenced by a favorable regional profit mix. The rate for the first six months of 2004 was primarily driven by the strong profitability of the Swiss operations, with the increase from the 2003 full-year rate reflecting, amongst other effects, slightly higher progressive tax rates. We believe that an underlying tax rate of around 19–20% before significant financial events) is a reasonable indicator for full-year 2004.

Fair value disclosure of options

The fair value of options granted in the first half of 2004 was CHF 468 million (pre-tax: CHF 515 million) compared to CHF 405 million (pre-tax: CHF 505 million) in the same period a year ago. The increase was driven by a higher UBS share price, a lower pro-forma tax benefit, and adjusted assumptions for the valuation of options. In fact, significantly fewer option grants were made in first half 2004 (down nearly 40% from the same period a year earlier), in line with our strategy of granting options more selectively.

While most stock options are granted in the first quarter of the year, the pre-tax increase of CHF 19 million from first quarter 2004 reflects additional grants made primarily under the Equity Plus program, an employee participation program under which voluntary investments in UBS shares are matched with option awards. Aside from the Equity Plus options, which are offered quarterly, we do not expect further significant grants for the remainder of this year.

Our valuation of options may change during the year due to further work we will undertake to implement the new IFRS 2 standard. For further details on the new standard, please refer to page 5.

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