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  • The table above reflects a HYBRID View, currently also used in our Handbook. for Banking products: ACCOUNTING VIEW for Traded products: RISK VIEW The numbers reported refer to the "Financial Businesses" only and therefore exclude the "Industrial Holdings" (CHF 710 million gross loans at Q3-05, mostly due from banks.) Commentary on the historical development of this credit risk metric: Over the past 12 months, the "Banking Products" increased materially, essentially driven by the Investment Bank where "gross loans" increased by 35% or +25 bn and "undrawn commitments" by 30% or +15bn. This reflects the expansion mode in our loan underwriting business, lending to US residential mortgage originators as well as higher secured financing by our prime brokerage business. The Global WM&BB banking products exposure growth was essentially driven by WM "lombard" loans (loans with pledged securities collateral).
  • RISK VIEW Overall IB Nominal Credit Protection amounts to CHF 37.8 billion, representing ~13% of the current IB "reported credit exposure" of CHF 290.3 billion. [37.8/290.3] To reconcile with the numbers shown on slide Nr.8 "Credit exposure by business groups" of CHF 290.6 billion we must factor in various accounting nominal values, mainly reverse collateral, other receivables and traded loans (see details on previous slide #19) Banking products+ Money Market: Prior Year (Sept 04) Reported Table: (at that time, only "regulatory" hedges were reported)
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    1. 1. Credit Risk Control at UBS Group January 25, 2006 Presentation to NYU
    2. 2. Who we are … <ul><li>UBS is one of the world's leading financial firms. We are </li></ul><ul><ul><li>one of the world's leading wealth management businesses </li></ul></ul><ul><ul><li>a global investment banking and securities firm </li></ul></ul><ul><ul><li>a leading asset manager </li></ul></ul><ul><ul><li>the market leader in Swiss retail and commercial banking . </li></ul></ul><ul><li>Our first priority is our clients' success. As an integrated firm, UBS creates added value for clients by drawing on the combined resources and expertise of all its businesses. As an organization, UBS combines financial strength with a global culture that embraces change. </li></ul>
    3. 3. Gross Credit Exposure by Business Group Global Wealth Management & Business Banking Investment Bank Other TOTAL UBS
    4. 4. Impaired loans and loan loss provisions Problem loans are low in the Investment Bank ... … and UBS reduced its recovery portfolio in Business Banking
    5. 5. <ul><li>Swiss bankruptcy rates increased dramatically, … </li></ul><ul><li>… real estate prices tumbled … </li></ul><ul><li>… and loan losses surged </li></ul>Credit Risk Quantification  where we came from … <ul><li>The mandate was to upgrade our risk control tools with a view to </li></ul><ul><ul><li>detecting weak customers and ensure proactive &quot;work out&quot; measures </li></ul></ul><ul><ul><li>implementing a risk grading system for the &quot;good portfolio&quot; </li></ul></ul><ul><ul><li>ensuring implementation of risk adjusted pricing across the portfolio </li></ul></ul>(from a 1997 presentation to the BIS [FSI])
    6. 6. <ul><li>Set-up of a framework </li></ul><ul><li>to estimate the credit losses and introduce a comprehensive rating system for all portfolios </li></ul><ul><li>to &quot;allocate&quot; the risk costs including a return on risk adjusted capital to individual transactions </li></ul><ul><li>to anchor credit policies to ratings and Expected Loss </li></ul>What we concentrated on … Rapid implementation of behavioral change ... … through pragmatic use of modeling techniques
    7. 7. What we have achieved … Profitable lending activities, ... … and very low credit loss expenses New business originated in 4Q99 Rating Real Estate Loans <ul><li>Margin on new loans </li></ul><ul><li>&quot;Fully loaded&quot; target margin </li></ul><ul><li>Originated loan volumes </li></ul>1 2 3 4 5 6 7 8 9 10 11 12 Real Estate Loans Rating Corporate Loans Credit Loss Expenses in CHF million 1997 1998 1999 2000 2001 2002 2003 2004 Q3-05 -1,278 -951 -956 130 - 498 -115 -72 241 243
    8. 8. What has changed in the industry… <ul><li>Traditional Model </li></ul><ul><li>balance sheet focus </li></ul><ul><li>&quot;yes/no&quot; decision </li></ul><ul><li>loss avoidance </li></ul><ul><li>no portfolio view </li></ul><ul><li>&quot;one price for all&quot; </li></ul><ul><li>no liquidity </li></ul><ul><li>Gut Feel, expert knowledge </li></ul>Degree of Specialization Degree of Sophistication <ul><li>Risk Quantification </li></ul><ul><li>transaction focus </li></ul><ul><li>credit rating </li></ul><ul><li>expected loss concept </li></ul><ul><li>portfolio analysis </li></ul><ul><li>price differentiation </li></ul><ul><li>some liquidity </li></ul><ul><li>Use of actuarial and </li></ul><ul><li>statistical tools : </li></ul><ul><li>probability of default </li></ul><ul><li>loss severity </li></ul><ul><li>exposure at default </li></ul><ul><li>default correlation </li></ul><ul><li>Active Portfolio Mgmt </li></ul><ul><li>portfolio focus </li></ul><ul><li>risk/return optimization </li></ul><ul><li>credit risk models </li></ul><ul><li>profit center of its own </li></ul><ul><li>increasing liquidity allowing </li></ul><ul><li>for active portfolio mgmt </li></ul><ul><li>(buy, sell, hedge) </li></ul><ul><li>New organization, possibility of specialization of individual institutions : </li></ul><ul><li>origination </li></ul><ul><li>servicing </li></ul><ul><li>portfolio management </li></ul>Paradigm shift in credit risk management
    9. 9. Credit Risk Control  The key factors to success Credit Risk Culture &quot;One strategy - one goal&quot; Risk Organization &quot;Checks and balances&quot; Risk Quantification &quot;Transparent risk assessment&quot; Risk Limitation &quot;Focus on risk diversification&quot;
    10. 10. Credit Risk Culture Risk policy must be aligned with corporate objectives ... … and be adopted &quot;top down&quot; by the Bank's origination and risk management functions
    11. 11. Corporate Governance and responsibilities Board of Directors Chairman's Office Group Internal Audit Group Executive Board GEB Risk Sub-Committee Group Chief Risk Officer Market Risk Control Credit Risk Control Wealth Management & Business Banking Global Asset Management Investment Bank Corporate Center Risk Policy Risk Management Independent Risk Control Wealth Management USA Group Chief Credit Officer Group Head Operational Risk Operational Risk Control Functional Leadership for Credit Risk Control Units within each Business Group
    12. 12. Credit risk control at UBS ... … is functionally independent from the business line, ... … but an integrated partner of the business groups Group Chief Credit Officer CCO WM&BB CCO Global WM&BB CCO Investment Bank CCO Investment Bank Corporate Center Business groups 102 417 321 Risk methods Risk reporting Risk systems Risk review Risk education Credit authority Functional mgmt
    13. 13. Business Management and Risk Control Clients / Market Risk Management Risk Control &quot;Separation of power&quot; is key to successful ... … optimization of risk and reward Operations Origination  Client Management  Business Origination  Loan Book Management  Risk/return Optimization  Transaction Execution  Loan Disbursement  Model Certification  Risk Limits and Control
    14. 14. Statistical Loss: &quot;Value-at-risk&quot; Credit Risk Market Risk ... Convention of measurement Significant Loss Events Availability of data <ul><li>10 days - 99% </li></ul><ul><li>Higher losses are expected more than twice per year! </li></ul><ul><li>Mainly factor driven </li></ul><ul><li>Immediate occurrence </li></ul><ul><li>Mostly not a problem </li></ul><ul><li>1 year - e.g. 99.98% </li></ul><ul><li>Higher losses in out of 5,000 years? … </li></ul><ul><li>Mean value is not zero! </li></ul><ul><li>Often firm-specific </li></ul><ul><li>Large time lag, if economy swings </li></ul><ul><li>In many segments very difficult </li></ul>Characteristics of the distribution Market risk and credit risk measures are different
    15. 15. Expected Loss Three key variables determine the outcome but their estimation is often difficult PD x LGD x EXP = Expected Loss Terminology: PD = Probability of Default LGD = Loss Severity (given default) EXP (or EAD) = Exposure (at default)
    16. 16. Rating methods are key Risk quantification begins with a &quot;correct&quot; stratification of clients by means of … … high quality rating methods
    17. 17. Risk concentrations drive portfolio risk single loan no default default several loans common default no default single default the individual Unexpected Loss of each loan = Concentration risk the common default behaviour of several loans = Loss Correlation
    18. 18. Credit Risk Modeling <ul><li>All transactions with their attributes are entered </li></ul><ul><li>into a simulation model that causes clients to default ... </li></ul>… and produces a distribution of possible portfolio losses
    19. 19. Extreme events and stress testing Stress testing and limit setting are based on several analytical methods Loss   Frequency   Earnings capacity <ul><li>Scenario analysis </li></ul><ul><li>&quot;What, if&quot; portfolio assessment, e.g. </li></ul><ul><li>Bankruptcy rates </li></ul><ul><li>Asset values </li></ul><ul><li>Statistical analysis </li></ul><ul><li>&quot;Tail Risk&quot; </li></ul><ul><li>Limit setting to avoid undue risk concentrations: </li></ul><ul><li>Counterparty </li></ul><ul><li>Sector </li></ul><ul><li>Country </li></ul><ul><li>and to protect earnings </li></ul>
    20. 20. Credit exposure hedging
    21. 21. Credit risk control measures Credit events have many causes, are difficult to predict ... … and can create substantial losses
    22. 22. Credit risk mitigation <ul><li>Credit derivative transactions to reduce economic exposure </li></ul><ul><li>Collateralization and netting agreements for OTC derivatives </li></ul>Risk taking capacity with many clients would be limited, ... … if risk mitigation could not be effectively used
    23. 23. Active credit portfolio management <ul><li>Markets for retail portfolios have existed for a very long time: individual names are irrelevant </li></ul><ul><li>Rapid growth of sophisticated risk management tools for large corporates: individual names are known </li></ul><ul><li>The challenge is for the middle market segment where individual names matter but are not really known </li></ul>Active portfolio management is not equally available ... … for all customer and product classes
    24. 24. Contact Information <ul><li>Philip J. Lofts </li></ul><ul><li>Group Chief Credit Officer </li></ul><ul><li>Stamford </li></ul><ul><li>Tel. 203-719-3320 </li></ul><ul><li>e-mail: philip.lofts@ubs.com </li></ul>

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