Shares and capital instruments

Shares

UBS shares and Tier 1 capital

The majority of Tier 1 capital comprises retained earnings attributed to UBS shareholders. As per 31 December 2007, total International Financial Reporting Standard (IFRS) equity attributable to UBS amounted to CHF 35,585 million and was represented by a total of 2,073,547,344 issued UBS shares, of which 158,105,524 shares (7.6 %) 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 receive a proportionate share of the dividend that is distributed. There are no preferential rights for individual shareholders and no other classes of shares are issued by the parent bank (UBS AG) directly.

In 2007, the outstanding shares were reduced by a net total of 31,725,942 million shares, reflecting the cancellation of shares bought back under the 2006 / 2007 share buyback program.

Additional future issuance of shares for mandatory convertible notes and stock dividend

As part of the measures to strengthen its capital base following the substantial writedowns related to the US residential sub-prime mortgage market, on 10 December 2007 UBS announced the issuance of mandatory convertible notes (MCNs) and the distribution of a stock dividend for 2007 instead of a cash dividend – see the "Capital management" section and pages 64, 65 and 67 of this report.

To allow for the delivery of shares upon conversion of the MCNs, the extraordinary general meeting of shareholders on 27 February 2008 approved the creation of the conditional capital in a maximum amount of CHF 27,775,000. The conditional capital is to be used exclusively for sourcing the shares for the conversion of the MCNs, which is to occur in March 2010 at the latest. Based on the conditional capital, the share capital of UBS AG upon conversion of the MCNs will be increased through the issuance of a maximum of 277,750,000 fully paid registered shares of UBS AG with a par value of CHF 0.10.

For the stock dividend, shareholders approved the creation of authorized capital at the extraordinary general meeting of shareholders on 27 February 2008. The stock dividend will not exceed 5% of the share capital at year-end 2007 or a ratio of one free new share for a minimum of every 20 shares already owned. This corresponds to a maximum amount of authorized capital of CHF 10,370,000 or 103,700,000 shares. The final exchange ratio will be determined by the Board of Directors (BoD) and the shareholders will be informed on the day of the annual general meeting (AGM) on 23 April 2008.

Furthermore, conditional capital is available to issue an additional 150,138,634 shares against the exercise of employee options.

Capital dilution

Whether earnings per share will be higher or lower as a result of these measures depends on the effect they have in maintaining the strength, and therefore profits, of UBS in general and the wealth management business in particular. When there is excess capital available, UBS expects to also return to its normal policy, subject to regulatory requirements, of returning excess capital – that is, capital that exceeds the level that UBS believes to be reasonably appropriate in the context of its portfolio and business growth – to shareholders, through buyback and cash dividends.

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Holding of UBS shares

UBS holds its own shares for three main purposes. Treasury repurchases shares on a second trading line, where they are earmarked for cancellation purposes. Shares are bought back by Treasury to cover employee share and option programs; and the Investment Bank holds shares, to a limited extent, for trading purposes where it engages in market-making activities in UBS shares and its related derivative products.

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Share buyback programs

Under Swiss regulations, a company wishing to cancel shares must purchase them on the stock exchange under a special security code that clearly identifies to the market the time and quantity of shares repurchased for that specific purpose (the so-called second trading line). For each buyback program to date, UBS has announced a maximum Swiss franc amount to be used for share purchases. The level of actual repurchases is determined by the capital management plan, which is adjusted throughout the year to reflect changes in business plans or acquisition opportunities. UBS publishes the number of shares repurchased and the average price paid on a weekly basis on the internet at www.ubs.com/investors.

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Treasury shares earmarked for cancellation (share buyback program 2006 / 2007)

As part of the 2006 / 2007 share buyback program ending on 7 March 2007, 33,020,000 shares representing a total value of CHF 2.4 billion were cancelled on 29 June 2007.

At the AGM on 18 April 2007, shareholders gave the BoD a mandate to set up a repurchase program (2007 / 2010) for a maximum amount of 10 % of shares totaling 210,527,328 shares. Between 14 March 2007 and 25 September 2007, 36.4 million shares in the total amount of CHF 2.6 billion were purchased for cancellation. As part of the capital measures announced on 10 December 2007, the BoD has used its discretion to rededicate for further use the 36.4 million treasury shares previously intended for cancellation. At year-end, no shares were held under the buyback program earmarked for cancellation.

The holding of treasury shares decreased to 158,105,524 or 7.6% of shares issued on 31 December 2007, from 164,475,699 or 7.8% on the same date a year ago. Shares held cover employee share and option programs and, to a limited extent, market-making activities at the Investment Bank.

In 2007, a total of 32.2 million employee options were exercised and an additional 45.5 million new options were granted. As of 31 December 2007, UBS was holding approximately 141 million shares in 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 CHF 186 million were outstanding on 31 December 2007. The shares available cover all exercisable employee options.

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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.

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

Capital Instruments

Mandatory convertible notes

On the 27 February 2008 the extraordinary general meeting (EGM) of shareholders approved the issuance of a maximum of 277,750,000 shares (corresponding approximately to 13.4% of the current share capital) to two long-term financial investors, Government of Singapore Investment Corporation Pte Ltd (GIC) and an investor from the Middle East without future dilutive effects. UBS expects to use a maximum of 252,525,253 shares of the available conditional capital. The share capital will be increased upon voluntary or mandatory conversion of the MCNs due 2010. The future mandatory capital increase allows the full proceeds of CHF 13 billion to be counted as Tier 1 capital for regulatory capital purposes for the first time in first quarter 2008.

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 mature in two years (March 2010) and contain market-standard provisions allowing early conversion at the option either of the holders or of UBS.

Through the lifetime of the MCNs, the holders will receive an annual coupon of 9% of the nominal value of the MCNs. This annual coupon reflects not only the cost of capital but also compensates the noteholders for bearing the risk of share price deterioration before conversion, if the share price falls below the reference price described below, 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, and for the fact that until conversion MCN holders will not receive any dividends on the underlying UBS shares. The MCNs can be converted at the earliest after a period of six months has elapsed after their issuance and they must be converted at the latest by maturity of the notes in March 2010.

If the MCNs are converted at maturity, they will be converted for UBS shares at a price – the "conversion price" – that is linked to the prevailing market price of UBS shares at specific dates. The conversion price is set within a range that is dependent on the UBS share price in relation to the "reference price" of CHF 51.48. (This, in turn, was determined by the average of (i) CHF 57.2 and (ii) the average of the three daily volume-weighted average price on virt-x for the three days prior to the EGM, subject to a minimum of CHF 51.48 and a maximum of CHF 62.92). The total amount of shares that the MCN holders receive is then calculated by dividing CHF 13 billion by the conversion price. There are basically three different scenarios for conversion at maturity. The conversion price will be set at:

– CHF 60.23, corresponding to 117% of the reference price, if at maturity the UBS share price is at or above CHF 60.23. In this case, the MCN holders will receive approximately 215,839,283 shares (CHF 13billion / CHF 60.23), which is the minimum amount of shares;

– the prevailing UBS share price if it is between CHF 51.48 and CHF 60.23 (corresponding respectively to 100% and 117% of the reference price) at maturity; and

– CHF 51.48, corresponding to 100% of the reference price, if the prevailing UBS share price is at or below CHF 51.48 at maturity. In this case, the MCN holders will receive approximately 252,525,253 shares (CHF 13billion / CHF 51.48), which is the maximum amount of shares;

– If either UBS or the MCN holders choose to convert the MCNs prior to maturity, the maximum conversion price (and hence minimum amount of shares) is applied in case the early conversion occurs at the request of the MCN holders, while the minimum conversion price (and hence maximum amount of shares) is applied if converted at the request of UBS.

The two graphs below illustrate the payout profile of the MCNs at maturity as a function of the underlying UBS share price.

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Hybrid Tier 1 capital

Hybrid Tier 1 instruments represent innovative and non-innovative perpetual instruments and accounted for approximately 19.5 % of eligible Tier 1 capital on 31 December 2007. They are accounted for under minority interest in the bank's equity. In 2007 UBS raised EUR 600 million in the form of preferred securities issued by UBS Capital Securities (Jersey) Ltd. The instrument bears a 7.152 % coupon and is callable in 2017. As per December 31, 2007 UBS had issued in various currencies a total of CHF 6,387 million of such instruments. 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 the adherence to minimal capital ratios by UBS. Any payment missed is non-cumulative.

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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 account for CHF 13,770 million in total capital as per year-end 2007, representing 3.7 percentage points of the total capital ratio of 12.0 %. Tier 2 instruments rank senior to both UBS shares and to hybrid Tier 1 instruments but are subordinated with respect to all senior obligations of UBS. In 2007 UBS raised GBP 250 million with a coupon of 6.375% maturing in 2024 callable by the issuer in 2019 and CHF 350 million with a 4.125% coupon maturing in 2017.

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Distributions to shareholders

UBS normally pays an annual dividend to shareholders registered as of the date of the AGM (the record date). Payment is usually scheduled three business days thereafter.

The level of the dividend is dependent on UBS's targeted capital ratios and the cash flow generation of the company. The dividend policy takes into account the fact that shareholders have different preferences for receiving shareholder returns: some prefer cash dividends, some prefer share buybacks. By pursuing both avenues, UBS aims to attract and retain the widest, most diverse global shareholder base.

The decision on dividend payments falls under the AGM's authority and is subject to shareholder approval.

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Total distributions in 2007

From the results of ordinary business, UBS transferred a total of CHF 5.1 billion in equity to its shareholders in 2007. This included CHF 0.8 billion in shares the bank repurchased during 2007 for purposes of cancellation and a total payout to shareholders for the 2006 financial year of CHF 4.3 billion or CHF 2.20 per share with payment on 23 April 2007.

Shareholders in the US received a net dividend payment of USD 1.19 (rounded) per share on 23 April 2007. This excludes the 35% Swiss withholding tax that can partly be reclaimed by US investors.

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Distributions to shareholders in 2008

Stock dividend

At the extraordinary shareholders' meeting held on 27 February 2008, the shareholders approved distribution of a stock dividend to shareholders. The stock dividend is designed to provide shareholders with the opportunity to obtain proceeds comparable to the cash dividend paid in previous years. There will be one entitlement allocated to each share outstanding on the record date on 25 April 2008 after close of business. A certain number of entitlements will give the holder the right to receive one additional UBS share for free. The entitlements are expected to be tradable for nine business days and will then be exchanged into UBS shares. For the stock dividend shareholders approved the creation of authorized capital at the EGM on 27 February 2008. The stock dividend will not exceed 5% of the share capital at year-end 2007 or a ratio of one free new share for a minimum of every 20 shares already owned. This corresponds to a maximum amount of authorized capital of CHF 10,370,000 or 103,700,000 shares. The final exchange ratio will be determined by the BoD and the shareholders will be informed on or by the day of the AGM on 23 April 2008. After expiration of the entitlement trading period on 9 May 2008, all entitlements will automatically be exchanged into new shares, which will settle on 19 May 2008. Fractions that have not been sold or aggregated during the entitlement trading period will not be compensated by UBS in its capacity as issuer.

This stock dividend is 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 will be allocated to shareholders without deduction of Swiss withholding tax. For Swiss income tax purposes, the taxable value of the stock dividend will approximately be equal to the par value of CHF 0.10 per share of the shares distributed as a stock dividend proportionately allocated to the entitlement distributed. For Swiss shareholders, this is a very small fraction of the taxable value of an equivalent cash dividend. The taxation of shareholders not resident in Switzerland depends on the laws in their tax jurisdiction. In many cases, the distribution of entitlements and the exercise thereof should be tax-free. Shareholders should consult with their own tax advisors to determine the tax treatment applicable to them.

Compared with the cash dividend, a stock dividend is beneficial for UBS's (Tier 1) capital base. Cash dividend payments are deducted from the bank's net profits and retained earnings, which are some of the major components of the bank's 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.