Thomas Wacker, CFA, analyst, thomas.wacker@ubs.

com, UBS AG

Wealth Management Research

16 September 2010

Corporate bonds
Subordinated bank bonds shine in light of Basel 3
s This report is the latest update of our series on subordinated

Related WMR publications
Basel 3 or when the regulatory curtains go up Subordinated bank bonds regain appeal Banks review and outlook Understanding Bonds, Part 10: Subordinated Bonds 14.09.2010 03.08.2010 06.07.2010 24.09.2009

bank bonds. In this report, we explain the consequences of the Basel Committee's recent release of further details on bank capital regulation, and we update our recommendations.
s The phase-in process for stricter capital standards supports our

recommended positioning, and we believe institutional Tier 1 and Tier 2 securities of stronger banks are now highly likely to be called at their first call date.
s We affirm our preference for stronger issuers and institutional step-

Preferred Financials
Americas Europe Goldman Sachs, J.P. Morgan Allianz, BNP Paribas, Credit Suisse, Deutsche Bank, DnB Nor, Intesa SanPaolo, Nordea, Rabobank, SEB, Unicredit, Zurich Financial Barclays, HSBC Holdings Bank of Montreal, Bank of Nova Scotia, Royal Bank of Canada, Toronto Dominion Australia & New Zealand Banking Group, Commonwealth Bank of Australia, National Australia Bank, Westpac Banking

up bond structures, and we recommend switching out of weaker structures and issuers. This report covers subordinated bank bonds, which are subject to higher credit risk than senior bonds. We emphasize that these bonds should only be held in a diversified manner, and we believe deeply subordinated perpetual securities should be considered more like stocks than bonds from a portfolio risk perspective.
s We assess the latest news on the Basel 3 regulations and the

UK Canada Australia

Source: UBS WMR

consequences for subordinated bank securities (pages 2-3)
s We also discuss common structures of perpetual bonds and offer our

Bank Capital Securities A simplified overview
Senior bonds Fixed maturity bonds, coupons to be paid
Senior to Outranked only by preferential or secured claims

view on their relative appeal for investors (pages 4-5)
s We update our list of recommended securities, and we list bonds that

we would use as sources of funds for switches. (pages 6-10)
s For reference, we also reprint our discussion of valuation and

important features of perpetual securities.

Lower Tier -2 Fixed maturity bonds, coupons to be paid, subordinated to senior debt
Senior to

Only loss-absorbing in the event of insolvency; only subordinated to senior debt Loss-absorbing, i.e. coupon and principal can be written down to remain solvent; can also be fixed maturity bonds Core Capital: no obligation to pay share dividends; Tier-1 coupons can be cancelled if Tier-1 ratio would fall below the regulatory minimum (defined in the prospectus); lossabsorbing, i.e. nominal amount may be written down to remain solvent

Upper Tier -2 Usually perpetual bonds, coupons deferrable and cumulative
Senior to

Tier-1 Perpetual bonds, coupons deferrable and non -cumulative (Preferred shares)
Senior to

Shareholders equity Common shares

Source: UBS WMR

This report has been prepared by UBS AG.

Please see important disclaimers and disclosures that begin on page 14.
Past performance is no indication of future performance. The market prices provided are closing prices on the respective principal stock exchange. This applies to all performance charts and tables in this publication.

instruments meeting the following three conditions will be phased out over the same horizon described in the previous bullet point: (1) they are issued by a non-joint stock company. but most likely a niche product Lower Tier-2 Upper Tier-2 Innovative Tier-1 Non-step Tier-1 ECN. respectively. However. savings banks and co-operative banks that hold much of their current core Tier 1 capital in the form of silent participations. with the cap reducing by 10 percentage points in each subsequent year. In addition. unless they meet the new standard. Two Basel statements are key for subordinated bank bonds Statement 1: "Capital instruments that no longer qualify as non-common equity Tier 1 capital or Tier 2 capital will be phased out over a 10-year horizon beginning 1 January 2013." for a detailed review of the new guidelines. starting on 1 January 2013. "Basel 3 or when the regulatory curtains go up. but will continue to exist.2 . Potential restrictions on allowed structures Will disappear Will disappear More restrictive structures to emerge New. their recognition will be capped at 90% from 1 January 2013. Therefore. subject to annual reductions of 10%. which are joint-stock companies. Please refer to our 14 September report. We maintain our negative stance on Landesbank Tier 1 securities. and. this allows the Landesbanks to keep their existing silent participations as part of their core Tier 1. we think Landesbanks will find it hard to replace those with common equity to meet the increasing minimum common equity Tier 1 ratio. starting in 2013. Statement 2 "Capital instruments that no longer qualify as common equity Tier 1 will be excluded from common equity Tier 1 as of 1 January 2013. Until then. Contingent Capital Notes Common shares Source: UBS WMR Corporate bonds .UBS Wealth Management Research 16 September 2010 Corporate bonds Basel provides details on minimum capital and transition phase The Basel Committee's update on 12 September provided the future set of minimum capital ratios and clear guidance on the phase-in period and transition rules for existing hybrid securities (see page 3). Changes to bank capital securities According to Basel 3 proposal Tier 3 Will disappear Less important. The exact structure of new Tier 1 securities is currently not clear and we expect Basel to provide the missing details by December 2010. the last sentence above tells us that those will stop qualifying as Tier 1 or Tier 2 capital. unless there is a regulatory call option available to enforce an early redemption. instruments with an incentive to be redeemed will be phased out at their effective maturity date. raising common equity and replacing existing hybrid capital securities with new structures that qualify as Tier 1 capital. With the exception of WestLB. Conclusions and recommendations We think the transition period provides banks with sufficient time to adjust their capital bases by retaining earnings. the capital recognition will be reduced by 10% each year. In this report. (2) they are treated as equity under the prevailing accounting standards. Fixing the base at the nominal amount of such instruments outstanding on 1 January 2013. it makes little sense for banks to issue "old-style" Tier 1 securities as the transition rules only apply to securities issued until 12 September 2010 and later new issues would not qualify for Tier 1 as of January 2013. and (3) they receive unlimited recognition as part of Tier 1 capital under current national banking law. Despite this Germany-specific exception. as a consequence." The second statement is tailormade for some German Landesbanks. HSH Nordbank and LB Berlin. there is a strong incentive for the issuer to redeem those bonds. at the first call date. we concentrate on the impact for subordinated bank bonds. We think this provides an incentive for issuers to tender for bonds with long-dated first calls." The bonds we recommended in this series contained an incentive to be redeemed. For bonds with first call dates later than end-2012 and those an issuer decided not to call until then.

we think both the larger common equity buffer and their potential scarcity value should contribute to a stronger performance of existing subordinated bank bonds compared to instruments of similar risk.0% 6. 12 September 2010 As a consequence.0% 8. and we already excluded a number of hybrid securities from fundamentally strong banks from our list as we viewed them as too expensive. with prices dropping in magnitudes exceeding 10%. Summary of our relative preferences s Prefer step-up to non-step structures s Prefer institutional to retail issues s Within step-up's. we may see enhanced volatility again in subordinated bonds. Our best guess is that already by 1 January 2013.5% 4. the existing Tier 1 bond market is now a closed universe without supply and any future new Tier 1 issue will have a less investorfriendly structure. we think investors should monitor their positions closely and consider taking profits as valuations become stretched.0% 6.0% 8. It is yet unclear when an issuer would be legally in a position to claim a change in regulation.0% 8.875% 3. like high-yield bonds for example.0% 6.0% 8.5% 2016 4.0% 8. While we continue to recommend investing in subordinated bank bonds.125% 9.5% 8.0% 2015 4.5% 8.5% 2019 4. We highlight that investing in Tier 1 securities continues to require an individual assessment of each instrument. which better protects existing Tier 1 bonds from losses. Risk of a bubble? Based on the initial market reaction and our outlook above.0% 8.0% 5.0% 8.3 .625% 1. high coupon step-up structures should be preferred.5% 2014 4. We think investors should keep in mind the equity-like risk when looking at decreasing yields to call and remember that higher future capital requirements do not already make banks safer investments as of today. Also. Retail or non-step Tier 1 securities may not be redeemed early and banks may choose to consider their call options from an economic perspective. based on our negative stance towards some peripherial European countries. we think there is a risk that the asset class may attract too much interest in an environment of low yields.0% 8.750% 6. we think investors should switch into other Tier 1 structures instead of taking the additional risk.5% 6.0% 10. We maintain our view that high cash price securities with regulatory par call language should be sold (see list below).0% 4. unless they contain regulatory par calls s Any subordinated bond trading above par should be sold if there is a regulatory par call available to the issuer Corporate bonds .0% 8.250% 1. Except for those banks with material event risk. At the same time.875% Phased out over 10 year horizon beginning 2013 Source: BIS "Group of Governors and Heads of Supervision announces higher global minimum capital standards".5% 2017 4.5% 2. to redeem those immediately at par.125% 5. banks need to build up a larger common equity position.UBS Wealth Management Research 16 September 2010 Corporate bonds Basel 3 Phase-in arrangements (shading indicates transition periods) All dates as of 1 January 2012 Minimum Common Equity Capital Ratio Capital Conservation Buffer Minimum common equity plus capital conservation buffer Minimum Tier 1 Capital Minimum Total Capital Minimum Total Capital plus conservation buffer Capital instruments that no longer qualify as non-core Tier 1 capital or Tier 2 capital 2013 3.375% 6.5% 0. we prefer lower coupon structures of stronger issuers s For issuers with unclear call policy.0% 5.625% 9.5% 7.0% 4. and we think the Basel annoucement supports our preference for institutional step-up structures as those are now highly likely to be redeemed at their first call date. but in the absence of a significant valuation discount for those bonds. regulatory par calls may be executed.5% 2018 4.

did not call step-up structures at their first call date. Non-step structures are riskier Comparing a structure with a high first-call probability (like step-ups) to one with very low call probability.e. Retail instruments are usually non-innovative (i. this was also the case during the financial crisis. as a consequence. Non-innovative structures may be callable by the issuer. With few exceptions. it is insufficient to select attractive issuers.UBS Wealth Management Research 16 September 2010 Corporate bonds Investment considerations (updated from last note) Within the Tier 1 space. Rather. which leads to higher interest rate sensitivity and thus higher price volatility. except for economical considerations like cheaper refinancing or excess capital. call probabilities depend to a large extent on the distinction between retail and institutional securities. as long as the margin over swap remains identical. Corporate bonds . From a regulatory perspective. In this section. institutional structures are usually called at the first call date. as the issuer may not chose to redeem it for an extended period of time. Those that were issued came at significantly higher coupons than the ones being called.. Due to lower market liquidity in retail structures. Throughout the crisis. leaving investors exposed to its credit risk. Therefore. investors may not be able to exit these securities very easily. as the valuation and expected performance of various bond structures of an issuer can differ substantially. However. the latter are generally riskier. However. we emphasize that investors should never rely on the first call date. but the call must not be combined with any feature that incentivizes the issuer to redeem the security. we explain important differences and provide lists of securities we would consider buying and selling. most calls have to be considered uneconomic calls since markets have been almost closed for new issues of subordinated instruments. Retail versus institutional Tier 1 Usually. Besides those banks that were restricted by their regulator and/or by the EU Commission from making coupon payments and calling capital securities. non-step) structures that provide no incentive to call at the first call date. they should be prepared for extension risk since banks may review their call policy due to capital shortfalls or other considerations. Innovative versus non-innovative Tier 1 The most significant difference between traditional and innovative hybrid capital instruments is that the latter usually include an incentive for early redemption – a coupon step-up after the first call date or an equity settlement feature. innovative Tier 1 is lower quality capital and it will disappear after the transition to full implementation of Basel 3.4 . Retail deals were often sold to a bank's customer base since institutional investors often demand more certainty on the redemption date. even after the Basel 3 announcement. Also. only Deutsche Bank applied economic considerations to institutional issues during the crisis and. those securities are usually priced to perpetuity. coupons of non-innovative securities may also change from fixed to floating at the call date.

calculated by discounting its future cash flows with a predefined discount rate. as of 15 September 2010 Corporate bonds . investors are currently not compensated for this additional risk. These allow the issuer to redeem or exchange the security once the regulatory capital framework changes in a way that would make those securities ineligible. Our best ideas in Tier 1 securities are listed in Table 2. We recommend reviewing any hybrid bond trading significantly above par (i.7 132. Below we update the lists of bonds we would buy and sell. We compare an older GBP 6% issue to the 14% coupon bond issued in the financial crisis. 100%) for potential regulatory par-calls. for example treasury yield + 1%. contain regulatory par calls.5 10. Some securities include regulatory make-whole calls. We suggest switching into lower cash-price alternatives. Bloomberg.5 .e. The transition rules for Basel 3 make our negative stance towards Tier 1 securities with regulatory par calls and prices at or above par even more pronounced.2019 14. However.000 3mL+1340 8. Source: UBS WMR. We are convinced most banks would use this call option and looking at market valuations. This means the bond may be redeemed at the higher value of par or the bond's fair value. In this case. The 14% bond trading at 132. and have their first call dates later than mid 2013.1 87. Fig 1: High versus low coupons Valuation example for high par call risk Name First Call date Coupon current FRN Yield & Price (%) to call mat. whereas the 6% is non-cumulative. We think the market is not yet pricing this risk and there may be large price declines once this issue gains investor attention. Therefore. even before the first call date.0 XS0222208539 8. This regulatory call may apply at any time.000 3mL+142 15. redemption prices may be above par but still significantly below the current market value.UBS Wealth Management Research 16 September 2010 Corporate bonds Beware of regulatory calls Many Tier 1 securities with high coupons include regulatory call features. We think the prospectus of those bonds may be interpreted in a way that already the 10% cut in Tier 1 recognition starting on 1 January 2013 is a trigger event for the regulatory call.06.12.5 XS0397801357 Barclays has a track record of redeeming innovative Tier 1 securities at the first call date. Ask ISIN GBP BARCLAYS BANK PLC GBP BARCLAYS BANK PLC 15. we advise selling Tier 1 securities that are trading at or above par.5% has a regulatory par call. The 14% has cumulative coupons.5 4. we would prefer the 6% bond at currently equal yields-to-call..2017 6.

0 94.868 5.7 6.2 3.6 3.6 6.04.8 3.5 108.396 5.922 5.0 94.0 94.09.2 Ask 101.4 7.2 6.5 98.250 8.11.04.5 93.5 3.5 7.2 7.03.375 7.1 3mE+642.3 6.2017 var 15.330 4.06.2012 var 26.5 90.6 2.5 2.8 7.5 129.0 106.2013 var 26.2014 var 23.6 8.2019 var 13.3 3.4 3.419 4.047 5.3 7. yield & price (%) to call 5.02.136 5.1 7.8 8.2015 fix Coupon current 8.2015 var 24.5 102.2 8.3 6.375 5.028 4. Bloomberg.79 7y UST+494 3mL+698.4 6.875 FRN 3mE+405 3yS+640 3mE+480 3mE+375 3mE+890. Please refer to the appendix section for explanations on the table.2017 var Fix 6.047 8.5 132.3 5.4 3.0 93.4 5yT+465 3mL+1340 3mL+646.12.208 14.V.019 6. Corporate bonds .2017 var 13.2018 var 02.8 2.9 7.2016 var 27.06.5 94.04.0 96.01.342 7.2016 var 05.05.12.10.3 3.6 7.4 6.2016 var 17.10.375 9.6 .1 7.610 4.4 6.130 5.8 8.2018 fix 24.0 104.926 5.6 6.0 103.75 make-whole AA-/AA-/A2 1+1 DE000A1ALVC5 1+1 2+2 2+2 2+2 DE000A0TU305 XS0387971152 FR0010772244 XS0531067659 Source: UBS WMR.1 make-whole BBB+/A/Baa1 3mL+176 3mL+181 3mL+395 3mL+170 6mL+185 3mL+198.2019 var 26.4 5.06.12.0 88.03.2018 var 04.2015 fix 15.03.7 2.862 5.9 3.730 4.5 Bid 108.5 101.471 5.2019 var 27.2 6.9 3.781 9.7 4.500 8.2016 var 30.10.4 7.2012 var 16.5 7.2016 var 13.3 6.2017 var 21.092 8.5 3.2 Regulatory Call par call par call* make-whole par call par call par call make-whole par call par call par call par call par call par call par call par call par call Ratings A/A/Baa1 BBB-/A-/Ba2 A-/A/A3 A/A/Baa1 BBB+//Baa2 A-/A/A3 A-/A+/A3 A-/A/Baa2 A-/A/A3 A+/A/A3 A-/A/A3 BBB/A/Baa2 BBB/A/AA-/AA-/A2 A-/A/A3 BBB+/A/Ind.5 108.7 8.2 10.5 7.6 5.2 5.6 7.0 97.1 5.186 5.6 79.10.196 4.5 7.5 make-whole BBB/BBB/Baa3 A-/A/A3 A/A/Baa1 A-/A/Baa2 A-/A/Baa2 par call par call par call 3mL+157.6 4.000 8.04.9 7.2016 var 12.12.7 6.0 5.2015 var 20.5 93.5 96.5 make-whole make-whole BBB/BBB/Baa3 make-whole A/A+/Baa1 3mL+199.5 make-whole A-/A+/A3 3mL+182.3 6.10.0 6.2017 var 20.860 Coupon FRN 3mE+233 3mE+261 3mE+248 3mE+195 3mE+153 3mE+176 3mE+165 3mE+190 3mE+169 3mE+173 3mE+172 3mE+335 3mE+340 3mE+410 par call Regulatory Call make-whole make-whole make-whole Ratings A/A/Baa1 A-/A/A3 A/A/Baa1 Ind.04.000 7.8 2. as of 16 September 2010.375 5. Table 2: Tier 1 securities with an attractive risk / return profile First Name EUR BNP PARIBAS CAP TRST IV EUR CL CAPITAL TRUST 1 EUR BNP PARIBAS CAP TRST VI EUR SG CAPITAL TRUST III EUR SOCIETE GENERALE EUR UNICREDITO ITAL CAP TRST EUR CREDIT AGRICOLE SA EUR HSBC CAPITAL FUNDING LP EUR BNP PARIBAS EUR ALLIANZ FINANCE II B.4 6.375 9.999 7.8 6.2036 var 27.954 8.05.000 8.2020 var 15.6 mat.06.6 7.2015 var 29.0 91.000 3mL+1086.04.2019 var 24.750 7.369 5.12.0 109.2014 fix 26.0 97. 5.5 111. 3.2 6.4 3.06.9 7.4 4.2019 var 26.2013 var 10.8 3.01.2015 var 09.75 make-whole BBB-/A-/Ba2 3mL+154 3mL+158 3mL+168 3mL+175 3mL+175 3mL+169 make-whole BBB-/A-/Ba2 par call par call par call A-/A/Baa2 A/A/Baa1 A-/A/Baa2 1+1 USG463802037 100+1 USW25381DL07 100+1 USW25381DM89 100+1 USW5816FCM42 1+1 100+1 2+2 USF1058YHV32 XS0269453139 US225448AA76 make-whole BBB+/A-/Baa2 make-whole BBB+/A/A3 100+1 USF8586CAA02 Source: UBS WMR.12.1 6.5 93.593 6.11.5 104.1 6.2019 var 31.9 7.07.667 9.2017 var 19.0 7.06.2013 var 25.03.2019 var 07.4 3. yield & price (%) to call 5.06.5 6.0 98. as of 16 September 2010.0 106.424 5.2 Piece 50+50 1+1 50+50 50+50 50+50 50+50 1+1 50+1 50+50 100+1 75+1 100+1 ISIN FR0010661314 XS0454821462 FR0010603159 FR0010638338 XS0449487619 FR0010814434 XS0110560165 XS0397801357 FR0010814418 XS0347918723 XS0431744282 USF22797FK97 11.10.5 7.958 5.5 90.4 3.01.0 110.1 6.125 8.7 3.2015 var 29.5 94.2014 fix 12.2 9.07.9 mat.9 7.0 92.8 6.5 86.4 8.6 108.0 Piece 1+1 1+1 1+1 1+1 1+1 50+1 50+50 1+1 50+50 1+1 50+50 50+50 50+1 50+50 50+50 50+1 50+50 50+50 50+1 50+1 1+1 50+1 ISIN XS0141843689 XS0146942189 XS0160850227 XS0179207583 FR0010136382 XS0231436238 FR0010248641 XS0188853526 FR0010306738 XS0211637839 FR0010456764 XS0336598064 XS0337453202 XS0371711663 XS0456541506 XS0231436667 FR0010291997 FR0010348557 XS0372556299 XS0305103482 XS0189704140 XS0248675364 make-whole BBB+/A-/Baa2 make-whole BBB+/A-/Baa2 make-whole BBB/BBB/Baa3 make-whole make-whole par call A-/A/A3 A-/A+/A3 A/A/Baa1 A+/A/A2 A/A/Baa1 make-whole BBB+//Baa2 make-whole BBB-/A-/Ba2 make-whole BBB+/A/Baa1 3mE+687.2015 var 27. Bloomberg.6 6.12.5 85. Please refer to the appendix section for explanations on the table.2018 var 15.2019 var 30.5 107.2 6.200 7.03.09.2015 var 15.5 99. EUR BNP PARIBAS EUR SOCIETE GENERALE EUR SKANDINAVISKA ENSKILDA EUR INTESA SANPAOLO SPA EUR INTESA SANPAOLO SPA GBP UNICREDITO ITAL CAP TRST GBP CREDIT AGRICOLE SA GBP BNP PARIBAS GBP UNICREDIT INTL BANK GBP BARCLAYS BANK PLC GBP HSBC BANK FUNDING STER GBP BARCLAYS BANK PLC USD HSBC CAPITAL FUNDING LP USD SKANDINAVISKA ENSKILDA USD SKANDINAVISKA ENSKILDA USD NORDEA BANK AB USD BNP PARIBAS USD BARCLAYS BANK PLC USD SOCIETE GENERALE USD CREDIT SUISSE GUERNSEY Maturity perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual Call date 24.2018 var 14.5 7.3 5.5 107.02.130 4.2013 var 31.03.0 100.7 7.6 6.UBS Wealth Management Research 16 September 2010 Corporate bonds Table 1: Tier 1 securities we recommend to sell to switch into stronger structures (Table 2) First Name EUR BNP PARIBAS EUR SKANDINAVISKA ENSKILDA EUR CREDIT AGRICOLE SA EUR BNP PARIBAS EUR SOCIETE GENERALE EUR CREDIT AGRICOLE SA GBP HSBC CAPITAL FUNDING LP GBP BARCLAYS BANK PLC GBP CREDIT AGRICOLE SA USD NATIONAL AUSTRALIA BK-NY USD RABOBANK NEDERLAND USD CREDIT AGRICOLE SA EUR DB CAPITAL FUNDING XI EUR DB CONT CAP TRUST IV USD RABOBANK NEDERLAND USD CREDIT AGRICOLE SA USD CLAUDIUS (CREDIT SUISSE) Maturity perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual perpetual Call date 11.0 101.875 8.2015 var 15.0 7.7 7.03.0 102.1 6.2015 var 31.6 107.09.

We have a preference for floating-to-floating structures. For some banks that received substantial state aid. Risk premium for Lower Tier 2 bonds (in bps) 1'000 900 800 700 600 500 400 300 200 100 07/07 01/08 Banks Senior 07/08 01/09 Banks LT2 07/09 01/10 07/10 Non-Financials BBB Source: UBS WMR. we think investors need to be more careful in selecting LT2 issuers than with senior bonds. However. there are a few risk aspects to consider even in the absence of a default. because the issuer would be deemed in default on all its obligations if a coupon payment on LT2 were not be paid on time. yield-to-worst (maturity) should be used. BNP Paribas. we also believe that more issuer credit risk can be taken compared to perpetual bonds. rating agencies incorporate a rating uplift for expected support in their senior bond ratings. based on their relative valuation. which are subject to a twoyear call restriction. as individual investment targets and cash flow plans for a portfolio may require certain income streams and diversification. Once the remaining life of the bond is less than five years. This leads to LT2 bonds being rated several notches lower than senior bonds in some cases. This is reflected in our recommendations. Fixed-to-floating (variable) bonds. its capital recognition is reduced by 20% annually. likelihood of being called and our interest rate call for floating rate notes. Three common LT2 structures Fixed-for-life. If the issuer is likely to call them at the first call date. A step-up by 30-60 bps is usual. LT2 securities need to be issued with long maturities. which include several banks that are not part of our preferred financials list. which most issuers execute. which is the most common risk premium measure for floating rate notes. As a consequence. For RBS and Lloyds. Given their enhanced risk. However. Floating-to-floating. Subordinated bonds may be transferred to a different entity than senior bonds if a bank is split up or a bad-bank structure is created to facilitate the rescue of a struggling bank. However. which they do not apply to LT2. but higher stepups of 120 bps or even 150 bps exist. if they are either able to issue new LT2 at reasonable costs or no longer need as much Tier 2 capital. Relative preferences Relative valuations between the three types shown on the top right require a number of assumptions. Credit ratings LT2 bonds are usually rated one notch below senior bonds. with a step-up of the floating margin at the first call date. The subordination to senior claims would only matter in liquidation.UBS Wealth Management Research 16 September 2010 Corporate bonds Lower Tier 2 (updated from last note) Subordinated LT2 bonds have a fixed maturity date and "must-pay" coupons. we provide longer lists of attractively valued securities for all three strategies and leave it to investors to choose an appropriate structure. and some that are even currently subject to coupons suspensions on their perpetual securities. reflecting the expectation that this capital will not be available in a few years time. no coupon step-up and no issuer call. we use the discount margin.7 . offering a higher call incentive for the issuer. when LT2 bondholders may incur a total loss. For relative valuation. Capital conventions for Tier 2 To be eligible as regulatory Tier-2 capital. If the issuer is unwilling to or restricted from calling its LT2 bonds. the yield to the first call after the restriction period may be used. This structure can be valued like a regular fixed-rate senior bond and we use spread-to-treasury as a measure of relative value. spread-to-treasury or yield-to-call are appropriate valuation measures. which change to a floating coupon after the first call date. many LT2 securities have a first call five years prior to maturity. as of 03 August 2010 Corporate bonds .

01.2013 05.2017 23.000 5.4 107.3 4.875 6.2011 04.01.8 4.07.0 106.4 6.875 4.8 99.750 9.5 5.7 101.5 2.6 1.2014 15.6 4. Please refer to the appendix section for explanations on the table.06.125 5.04.9 4. Ask 2.6 4.09.09.03.2018 21.625 6.02.2013 01.8 105.6 105.000 4.000 6.2015 23.2015 15.500 5.150 5.01.2011 30.05.2 95.12.750 6.2013 20.4 3.3 105.750 5.2020 17.7 106.625 6.0 5.400 Spread to Treasury 201 162 194 310 183 369 168 266 378 270 329 236 255 236 341 215 272 344 189 218 359 305 301 169 260 307 294 270 170 91 123 335 153 150 350 361 398 181 278 229 463 212 Ratings BBB/A+/Baa2 -/A/A1 A/A/A1 BBB/A+/Baa2 A/A/A1 BBB/A+/Baa2 A/A+/Baa1 BBB/A+/Baa3 BBB-/A+/Baa3 BBB/A+/Baa3 BBB/A+/Baa3 A-/A-/A1 -/A /*-/A2 A/A+/Baa1 BBB/A+/Baa3 A/A+/Aa3 -/A+/A2 BBB/A+/Baa2 A/A+/NR A/A+/Aa3 BBB+/A/Baa3 -/A+/Baa3 BBB/A+/Baa2 A+/A+/Aa2 A-/A/A2 A-/A/A1 BBB/A+/Baa3 A-/A/A2 A/AA-/A1 A/A+/A1 A/AA-/A1 -/A/Ba2 AA-/AA-/A1 A/A+/A1 BBB-/A/Ba2 BBB-/A/Ba2 BBB+/A/Baa3 A/A+/A1 A-/A/A2 A/A+/Aa2 BBB-/A+/Baa3 A/A+/Aa2 Ind.4 5.875 4.000 6.3 98.2012 12.2021 12.2020 fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix fix Coupon 4.2027 15.7 95.UBS Wealth Management Research 16 September 2010 Corporate bonds Table 4: Lower Tier 2 fixed rate bonds Name EUR LLOYDS TSB BANK PLC EUR COMMERZBANK AG EUR ING BANK NV EUR BANK OF SCOTLAND PLC EUR ING BANK NV EUR BANK OF SCOTLAND PLC EUR BARCLAYS BANK PLC EUR ROYAL BK OF SCOTLAND PLC EUR HBOS PLC EUR ROYAL BK OF SCOTLAND PLC EUR ROYAL BK OF SCOTLAND PLC EUR UNICREDIT SPA EUR BAYERISCHE LANDESBANK EUR BARCLAYS BANK PLC EUR ROYAL BK OF SCOTLAND PLC EUR INTESA SANPAOLO SPA EUR LANDESBANK BERLIN AG EUR LLOYDS TSB BANK PLC EUR DEUTSCHE BANK AG EUR INTESA SANPAOLO SPA EUR NATIONWIDE BLDG SOCIETY GBP LLOYDS BANKING GROUP PLC GBP LLOYDS TSB BANK PLC GBP JP MORGAN CHASE BANK NA GBP GOLDMAN SACHS GROUP INC GBP COMMERZBANK AG GBP NATL WESTMINSTER BANK GBP GOLDMAN SACHS GROUP INC GBP HSBC HOLDINGS PLC USD JPMORGAN CHASE & CO USD HSBC HOLDINGS PLC USD ROYAL BK SCOTLND GRP PLC USD HSBC BANK USA USD JPMORGAN CHASE & CO USD ROYAL BK SCOTLND GRP PLC USD ROYAL BK SCOTLND GRP PLC USD NATIONWIDE BUILDING SOC USD JPMORGAN CHASE & CO USD GOLDMAN SACHS GROUP INC USD CREDIT SUISSE NEW YORK USD HBOS PLC USD CREDIT SUISSE Maturity 18.2 101.6 3.6 101.01.10.2015 01.2020 24.000 5.6 4.2012 29.01.050 5.750 6.2013 31.6 6.03.1 103.2012 12.000 4.04.3 1.03.2017 26.3 4.5 2.5 3.10.1 105.500 5.2014 08.934 5.2017 30.2017 15.6 102.6 4.05.2019 07.5 106.2012 04.2016 14.625 5.2018 09.08.5 Piece 1+1 1+1 1+1 1+1 1+1 1+1 1+1 1+1 1+1 1+1 50+50 50+1 50+50 50+1 50+1 50+50 50+50 50+1 50+50 50+1 1+1 1+1 50+50 1+1 10+10 10+10 1+1 1+1 ISIN XS0095501606 DE0006288921 NL0000119592 XS0156924051 NL0000113140 XS0124047431 XS0165867226 XS0128842571 XS0165449736 XS0167127447 XS0271858606 XS0322918565 XS0326869665 XS0342289575 XS0356705219 XS0452166324 XS0468940068 XS0497187640 XS0526326334 XS0527239221 XS0069909751 XS0109722990 XS0269436472 XS0300096491 XS0101360161 XS0090254722 XS0270349003 XS0159497162 50+50 DE000DB5DCW6 1+1 US46625HAN08 1+1 1+1 100+1 1+1 1+1 1+1 1+1 US404280AB51 US780097AN12 US40428EJQ35 US46625HBV15 US780097AL55 US780097AP69 US46625HDF47 1+1 US63859XAA54 2+1 US38141GEU40 2+1 US22541HCC43 100+1 US4041A3AH52 2+1 US22546QAD97 Source: UBS WMR.2 4.05.0 105.07.1 5.875 6.2019 25.3 109.2017 23.0 6.1 2.08.8 4.375 6.350 5.09.5 4.2014 01.5 4.8 5.3 6.750 6.2015 22.0 98.7 104.01.5 105.4 109.11.8 101.7 104.1 102.09.2018 14.03.2015 01.1 6.1 2.500 5.0 5.125 5.8 108.10.000 5.05.125 4.8 103.10.2 109.04.6 4.500 5.8 108.9 107.2020 22.8 .2015 28.000 5.2020 16.6 103.250 5.8 2.2011 02.2021 20.10.2013 10. as of 15 September 2010.500 5.03.1 4.2019 24.125 6.02.9 107.8 4.9 103.6 105.10.5 5.11.5 108.5 2.0 5.01. yield & price (%) to call mat.0 3.5 107. Corporate bonds .625 5.09.03.250 6.5 101.8 106.2018 23.750 5. Bloomberg.12.1 4.625 5.150 6.125 6.9 107.4 103.5 105.

UBS Wealth Management Research 16 September 2010 Corporate bonds Table 5: Lower Tier 2 floating-to-floating rate bonds Name EUR JPMORGAN CHASE & CO EUR INTESA SANPAOLO SPA EUR ING BANK NV EUR HBOS PLC EUR HSBC BANK PLC EUR INTESA SANPAOLO SPA EUR BARCLAYS BANK PLC EUR INTESA SANPAOLO SPA EUR LLOYDS TSB BANK PLC EUR HBOS PLC EUR ABN AMRO BANK NV EUR UNICREDIT SPA EUR FORTIS BANK SA/NV EUR BNP PARIBAS EUR DNB NOR BANK ASA EUR UNICREDIT SPA EUR NATIONWIDE BLDG SOCIETY EUR FORTIS BANK SA/NV EUR ROYAL BK OF SCOTLAND PLC EUR HBOS PLC EUR DNB NOR BANK ASA EUR SOCIETE GENERALE EUR DEXIA CREDIT LOCAL EUR SKANDINAVISKA ENSKILDA EUR SVENSKA HANDELSBANKEN AB EUR ABN AMRO BANK NV GBP BNP PARIBAS SA GBP LLOYDS TSB BANK PLC USD CREDIT AGRICOLE (LONDON) USD SVENSKA HANDELSBANKEN AB USD ROYAL BK OF SCOTLAND PLC USD ING BANK NV USD BARCLAYS BANK PLC USD DNB NOR BANK ASA USD COMMONWEALTH BANK AUST USD HBOS PLC USD HSBC HOLDINGS PLC USD ROYAL BK OF SCOTLAND PLC USD WESTPAC BANKING CORP USD COMMONWEALTH BANK AUST USD ABN AMRO BANK NV USD BARCLAYS BANK PLC USD BNP PARIBAS USD ING BANK NV USD WESTPAC BANKING CORP USD ROYAL BK OF SCOTLAND PLC USD HBOS PLC USD BARCLAYS BANK PLC Maturity 12.2 10.5 29.10.05.9 .2015 05.036 3mE+17.2012 31.5 0.5 93.2012 30.3 98.2017 11.2011 11.2011 29.058 3mE+17.923 3mE+17.2015 First Call date frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn frn Coupon current FRN 1.713 3mL+17.5/67.2011 13.0 2.3 97.3 89.8 25.2016 08.2011 18. Please refer to the appendix section for explanations on the table.7 1. as of 15 September 2010.09.320 0.2012 27.6 3.01.03.0 96.09.5 Piece 50+50 50+50 1+1 1+1 50+1 50+1 50+50 1+1 1+1 1+1 1+1 50+1 50+1 50+1 1+1 1+1 50+1 50+1 50+50 50+1 50+1 50+50 50+50 50+1 50+1 1+1 1+1 1+1 ISIN XS0231555672 XS0242832599 XS0240868793 XS0249026682 XS0248366576 XS0249938175 XS0240949791 XS0194783352 XS0195810717 XS0192560653 XS0267063435 XS0267703352 BE0932051759 XS0270531147 XS0202707567 XS0203450555 XS0279585169 BE0932317507 XS0259579547 XS0292269544 XS0255264656 XS0303483621 XS0307581883 XS0230339847 XS0232843671 XS0256778464 XS0230888439 XS0218023447 XS0237452320 XS0246446859 XS0250214797 XS0255306671 US06738CKJ70 XS0265516335 XS0269363577 XS0269136163 XS0269733258 XS0202629407 XS0272075705 XS0278417596 XS0282833184 XS0292937165 XS0296895047 XS0306992545 XS0313165374 XS0302127625 XS0304201790 XS0229313696 08.03.2016 01.2018 31.725 3mL+23/73 3mL+20/70 3mL+15/165 3mL+20/70 3mL+20/70 3mL+23/98 3mL+20/70 3mL+20/70 3mL+20/70 3mL+28/78 3mL+21/71 3mL+22/72 3mL+20/70 97.6 3.01.2016 01.737 0.2011 30.138 3mE+20/70 3mE+20/80 3mE+30/90 3mE+30/80 3mE+30/80 3mE+20/70 3mE+30/90 3mE+25/75 3mE+22/72 3mE+30/105 3mE+45/105 3mE+22/72 3mE+25/75 3mE+25/75 3mE+20/70 3mE+20/95 3mE+15/65 3mE+25/175 3mE+20/170 3mE+25/75 1.03.2017 03.0 98.2016 13.9 3.952 1.2016 20.723 0.2 0.0 3.8 1.2017 07.3 1.734 0.07.2016 28.5 95.731 0.2012 23.0 0.0 97.9 15.09.05.176 1.668 3mL+17.03.0 94.10.2016 18.146 0.154 3mE+40 3mE+25/85 FRN disc.0 84.2016 27.2017 27.3 3.6 1.06.10.09.10.0 0.0 4.09.0 1.5 15.5/67.2011 15.096 1.5 1.527 0.03.2011 18.2016 15.2011 28.08.5 93.499 0.2011 22.10.051 3mE+17.05.5 97.2012 07.806 0.2017 30.2016 14.5/67.2011 06.2016 29.0 86.3 5. Large step-ups marked in blue.10.6 98.6 3.06.5 0.6 98.2 3.4 2.0 4.4 2.042 1.2 9.2017 17.1 2.09.907 3mE+17.5 100+100 99.9 9.2016 29.2017 06.8 93.09.03.2016 17.2011 01.04.10.1 3.2012 1.2011 29.10.8 2.5 98.188 1.5 85.2011 20.2017 17.3 1.2011 01.102 1.6 1. yield & price (%) to call mat.5 98.0 85.5 0.0 88.078 1.2 3.0 10.2012 30.5 1.12.5 0.8 0.2017 19.046 1.06.2011 14.2011 28.1 10.10.2016 19.4 1.01.0 100+100 83.0 86.4 2.2011 17. margin* 5 14 34 3 5 5 4 19 22 11 5 5 3 3 5 8 5 17 14 3 3 10 3 2 6 4 24 7 5 32 13 6 3 3 20 3 19 4 3 11 6 4 7 3 13 12 5 Ratings A/-/A1 A/A+/Aa3 -/-/A1 BBB-/A+/Baa3 A+/AA-/A2 A/A+/Aa3 A/A+/Baa1 A/A+/Aa3 BBB/-/Baa2 BBB-/A+/Baa3 A-/A/A1 A-/A-/A1 AA-/A/A2 AA-/A+/Aa3 A/-/A1 -/A-/A1 BBB+/A/Baa3 AA-/A/A2 BBB/A+/Baa3 BBB-/A+/Baa3 A/-/A1 A/A/Aa3 A-/A/A2 A-/A/A2 A+/A+/Aa3 A-/A/A1 -/-/Aa3 -/-/Baa2 A+/-/Aa2 A+/-/Aa3 BBB/A+/Baa3 -/-/A1 A/-/Baa1 A/-/A1 AA-/-/Aa2 BBB-/A+/Baa3 A/AA-/A1 BBB/A+/Baa3 AA-/-/Aa2 AA-/-/Aa2 A-/-/A1 A/-/Baa1 AA-/-/Aa3 A/-/A1 AA-/-/Aa2 BBB/A+/Baa3 BBB-/A+/Baa3 A/-/Baa1 Ind.8 0.2012 29.2011 21.2011 23.2 1.6 1.210 1.7 3.2016 18.12.2016 15.5 100+100 84.03.2012 27.3 1.09.0 100+1 100+1 75+1 100+1 50+50 50+50 75+1 100+1 1+1 0.0 2.02.1 21.10.12.5/67.493 3mL+20/70 3mL+23/73 3mL+20/70 3mL+20/70 3mL+20/70 97.5/67.2016 22.2016 11. Bloomberg.7 3.0 92.2012 19.493 0.1 2.2017 21.0 100+100 88.2 4.512 0.10.2011 09.4 6.948 1.06.5 91.1 3.2016 06.2012 11.2012 03.7 2.07.03.5 100+100 98.0 1.0 99.734 0.2012 06.04.2013 05.04.01.03.2011 20.3 1.2011 13.09.0 99.10.09.1 2.2011 19.6 2.5 98.09.01.2012 09.952 0.6 1.2011 27.3 88.0 3.04.4 2.5/67.6 1.09. Corporate bonds .9 1.12.01.1 10.2 2.3 1.088 0.04.03. Ask 5.0 15.04.10.04.2016 09.5/67.10.03.5 3.3 1.9 2.2011 17.8 4.2012 21.05.3 1.07.5 8.2016 20.0 2.10.2016 29.0 97.07.09.09.2017 30.992 1.0 99.03.02.2016 14.6 2.929 1.5 100.09.2011 15.0 1.7 4.4 0.08.7 2.0 98.514 3mL+17.146 1.5 96.2016 23.2017 09.2016 13.2017 28.2012 28.2017 29.2 2.6 5.10.03.5/67.03.728 0.2010 29.3 13.2016 21.974 0.5 3.6 1.04.5 1.2 1.493 0.0 97.10.09.04. Yield to call marked in red means that the issuer is currently restricted from redeeming subordinated instruments at this date.5 1.2016 20.2011 17.2017 23.072 1.2017 27.0 88.07.0 98.06.733 0.05.5 3.5 2.0 97.05.7 5.2016 28.10.0 2.5 86.07.2011 14.5 89.10.09.8 13.3 1.066 1.046 1.2016 30.3 100+1 1+1 Source: UBS WMR.8 9.07.0 1.07.5 0.737 0.04.09.3 50+50 100+1 50+50 75+1 0.8 97.442 0.06.2011 20.5 0.5 93.

375 7.2011 20.6 1.2018 05.2014 22.1 104.250 4.2019 30.12.500 4.625 4.0 2. Bloomberg.7 4.500 4.2018 07.6 109.0 3.4 7.12.570 5.2018 19.06.04.8 7.7 103.2012 12.11.05.3 91.2016 19.5 3.2019 07.2017 12.10.8 6.3 2.03.1 4.04. as of 15 September 2010.3 100.12.10.5 4.03.2022 18.06.2 111.2019 12.10.3 4.8 100.750 4.09.09.2020 16.2020 29.2015 29.2011 09.500 4.01.03.6 3.625 5.5 3.6 96.11.2013 26.2012 29.06.2011 08.4 106.8 105.03.03.2012 05.8 4.2017 18.2014 12.10.2017 16.2017 07.500 4.2017 29.09.2015 08.625 5.750 5.2011 20.09.2013 29.2015 29.06.02.2 108.2014 12.2018 29.7 100.12.12.2023 29.2020 29.1 105.12.375 4.01.09.2023 29.375 3.625 3.375 5.11.06.5 95.05.2016 20.2 3.1 3.9 98.5 4.4 104.125 4.3 9.3 2.0 3.2013 26.750 6.2 102.2011 18.03.04.6 100.8 4.05.2015 22.7 4.742 6.0 101.2010 07.3 3.09.11.4 4.06.09.2014 30.9 5.3 2.2018 26.375 4.8 8.06.03.7 7.8 3.750 3.0 3. yield & price (%) to call mat.0 5.500 6.8 102.2013 13.6 104.7 3.750 6.12.2012 29.2016 13.9 2.03.1 2.10 .9 Piece 1+1 1+1 50+1 10+10 50+50 50+1 50+50 1+1 50+1 50+1 50+50 50+1 50+1 50+50 1+1 1+1 1+1 50+1 1+1 50+50 50+50 1+1 50+1 1+1 50+1 1+1 1+1 50+1 50+1 50+1 50+50 10+10 50+1 1+1 50+1 50+1 50+50 50+1 50+1 10+10 ISIN XS0180946906 XS0164883992 XS0250873642 XS0170248503 DE000CB07899 XS0267704087 XS0278214563 DE0003933941 XS0322614420 XS0350487400 XS0258143477 XS0372124403 XS0283256062 XS0285330717 XS0187033864 XS0187584312 NL0000113892 XS0200676160 XS0203871651 XS0205436040 XS0213101230 XS0222053315 XS0229593529 XS0201065496 XS0366066149 XS0221178584 XS0237036370 XS0260456065 XS0320304164 XS0325811296 XS0324790657 XS0156885302 XS0326211801 XS0171431660 XS0366686284 XS0230339417 XS0326347373 XS0336248082 XS0366066222 XS0170398068 28.963 4.3 5.2016 28.7 102.2013 22.06.2019 22.2 3.7 3.9 5.875 3mE+85 3mE+105 3mE+172 3mE+205 3mE+90 3mE+94 3mE+83 3mE+76 3mE+260 3mE+185 3mE+203 3mE+100 3mE+380 3mE+71 3mE+81 3mE+139 3mE+92 3mE+144 3mE+95 3mE+136 3mE+150 3mE+89 3mE+93 3mE+136 3mE+130 3mE+255 3mL+72 3mL+68 3mL+99 3mL+118 3mL+120 3mL+135 3mL+173 3mL+138 3mL+143 3mL+195 3mL+82 3mL+130 3mL+255 3mL+255 3mL+100 Spread to Treasury 2327 216 216 244 841 322 733 429 264 354 457 328 275 170 661 298 197 297 264 551 249 269 174 278 466 271 381 289 636 292 709 472 214 398 203 369 260 228 225 279 170 Ratings BBB/A+/Baa3 A+/AA-/A2 A+/A+/Aa3 BBB/A-/Baa2 A-/A/A1 A-/A-/A1 -/A/Aa3 A/A+/A1 -/-/A3 A-/A/A1 BBB/A+/Baa2 A/A+/Aa3 A-/-/A3 AA-/A+/Aa3 -/-/A2 A/A+/Baa1 A/A/Aa3 -/A/A1 A-/A-/A1 BBB-/A+/Baa3 A/A+/A1 A/A+/Aa3 A/AA-/A1 A/A/A1 BBB/A/Ba2 A/A/A1 AA-/A+/Aa3 AA-/A+/Aa2 A/A+/Aa3 AA-/A+/Aa3 BBB-/A+/Baa3 A/A+/Aa3 AA-/AA-/Aa2 A-/A-/A1 AA-/A+/Aa2 BBB/-/Baa2 A+/AA-/A2 A/AA-/A1 A/A+/Aa2 A/A/A1 AA-/AA-/Aa2 Ind.1 100.8 2.03.2016 29.2011 20.01.03.2018 26.750 6.1 2.8 100.0 2.7 93.2011 19.375 4.03.2018 29.1 3.1 3.09.01.2017 27.02.2020 29.2013 16.6 2.9 102. Ask 23.2016 20. Corporate bonds .3 5.2023 19.2 5.09.2016 20.2014 15.0 101.4 4.2015 16.6 3.6 2.2023 16.2018 50+50 DE000CB8AUX7 Currently.2017 09.2019 12.12.3 3.1 3.500 4.375 6.10.125 3.875 4.01.9 96.4 91.05.4 2.10.125 4.2 108.2016 07.6 4.2021 22.7 98.2012 18.09.2015 18.2 4.2018 08.5 100.3 3. Please refer to the appendix section for explanations on the table.9 101.03.500 4.4 98.6 4.03.05.06.06.375 4.7 4.0 4.0 2.2016 08.2016 18.4 3.4 3.4 105.05.09.UBS Wealth Management Research 16 September 2010 Corporate bonds Table 6: Lower Tier 2 fixed-to-floating rate bonds Name EUR ROYAL BK OF SCOTLAND PLC EUR HSBC BANK PLC EUR SVENSKA HANDELSBANKEN AB EUR DANSKE BANK A/S EUR COMMERZBANK AG EUR UNICREDIT SPA EUR LANDBK HESSEN-THUERINGEN EUR DEUTSCHE BANK AG EUR SWEDBANK AB EUR COMMERZBANK AG EUR LLOYDS TSB BANK PLC EUR INTESA SANPAOLO SPA EUR SWEDBANK AB EUR BNP PARIBAS EUR BAYERISCHE LANDESBANK EUR BARCLAYS BANK PLC EUR SOCIETE GENERALE EUR ING BANK NV EUR UNICREDIT SPA EUR HBOS PLC EUR JPMORGAN CHASE & CO EUR INTESA SANPAOLO SPA EUR HSBC HOLDINGS PLC EUR ING BANK NV EUR ROYAL BK OF SCOTLAND PLC EUR ING BANK NV GBP BNP PARIBAS GBP AUST & NZ BANKING GROUP GBP INTESA SANPAOLO SPA GBP BNP PARIBAS GBP HBOS PLC GBP INTESA SANPAOLO SPA GBP WESTPAC BANKING CORP GBP UNICREDIT SPA GBP AUST & NZ BANKING GROUP GBP LLOYDS TSB BANK PLC GBP HSBC BANK PLC GBP HSBC HOLDINGS PLC GBP CREDIT SUISSE LONDON GBP ING BANK NV GBP COMMONWEALTH BANK AUST Maturity First / Next Call date var var var var var var var var var var var var var var var var var var var var var var var var var var var var var var var var var var var var var var var var var Coupon current FRN 4.625 4.10.125 4.5 91.3 95.2 3.5 3.0 2.2014 02.2013 07.10.7 109.12.8 3.4 4.3 4.4 1.2014 07.03.9 2.0 3.7 2.6 100.2019 04.12.8 101.250 4.2014 04.2019 15.6 4.000 4.0 3.625 6.305 6.6 3. there are no USD LT2 fixed-to-floating rate recommendations available Source: UBS WMR.11.09.6 2.8 4.6 3.09.2020 02.01.8 4.09.11.2018 16. Yield to call marked in red means that the issuer is currently restricted from redeeming subordinated instruments at this date.2012 27.09.0 102.3 3.2019 22.09.2011 07.875 6.04.3 6.

In terms of risk. investors may be unable to sell positions if news flow turns negative. estimates for early redemption are difficult. which should not exceed prudent limits. the bond would trade close to par. in a worst case. perpetual bonds trade "Need to knows" before buying perpetual (hybrid) bank securities 1) Investors buying perpetual securities should have a long investment horizon. s Binary outcomes . whereas their prices behave more like the company's stock in a crisis. 2) Risk tolerance must be high to accept potential coupon nonpayments and principal losses.540% 11. However. In many cases.012% 7.50% 90 Yield 19. Alternatively. s Perpetual bonds generally have lower secondary market liquidity than stocks.640% 10.740% 7.150% 9.061% 8. a bank has different types of bond structures outstanding. which is not necessarily the case at the first call date. the two measures should be used to derive a best-case and a worst-case yield assumption. Yield measures Perpetual bonds with call options have two common yield measures. assuming all coupon payments are made and the bond is repaid at 100% at a date far in the future. Stop-loss orders.730% 8.700% 10. Yield-to-call assumes the issuer would call the bond at the next call date. deeply subordinated bond could be seen as part of the high-yield bond allocation. vice versa. On the other hand. whereas senior bonds usually recover some value in liquidation. In the current market environment. This would lead to a low yield-to-maturity value if the current coupon is low and. whereas yield-to-maturity approximates the perpetual nature of the instrument with a very long assumed remaining life. 3) Be aware of concentration risks: all stocks and hybrid bonds of a single issuer should be seen as one risky position.425% Corporate bonds . as many banks are no longer in a position to call perpetual bonds at the first call date. Source: UBS WMR close to regular bonds. As a consequence.all or nothing: In good times. However. a consideration that is also often overlooked in good times. investors should consider perpetual bank bonds comparable to the equity allocation of their portfolios.50% 105 Yield 4. pricing in a longer remaining life. Both values may differ significantly. as they are traded over-the-counter and often turn illiquid once an issuer is in difficulties. Ideally.560% 8. as the assumed remaining life of the bond is very different if the call date is close. This may lead to extremely high yield-to-call values if market participants think that the bond may not be redeemed at this date. which are frequently used for stocks. Hybrid bonds often turn illiquid and investors may need to wait until the issuing bank calls the bond. Yield example for callable perpetual bonds Different assumed redemption dates Bond 1 Fixed coupon Bond price (%) Redemption (Call) in 1 year in 2 years in 3 years in 4 years in 5 years in 10 years in 20 years in 30 years Source: UBS WMR Bond 2 9. it is difficult to estimate how much additional yield should be required to compensate for liquidity risk.UBS Wealth Management Research 16 September 2010 Corporate bonds Reference Section on subordinated bonds It is very difficult to derive fair values for deeply subordinated bonds due to the following challenges: s Contractual terms differ: conditions for canceling or deferring coupons and using the principal to absorb losses are defined individually for each bond and may be enforced to a different extent by national regulators. As a consequence.578% 7.990% 8. The recovery value of perpetual bonds in case of an issuer default is most likely zero.290% 6. investors should form an opinion on the expected remaining life and calculate the yield to this date (see yield example).450% 13. a high current coupon would result in an inflated yield-to-maturity. if market participants firmly believe in the next call being executed by the issuer. We caution against using these yield measures for bonds that may not pay coupons or principal.240% 8.11 . would not work for such bonds.955% 9. yieldto-call and yield-to-maturity. yield-to-call usually shows the best-case yield that may be achieved and yield-to-maturity shows the lowest annual yield.

In this case. but coupons on hybrids can still be paid. s The recovery value of defaulted high-yield bonds averaged at 45% over the last 27 years.UBS Wealth Management Research 16 September 2010 Corporate bonds Comparing perpetuals to high-yield bonds As many perpetual bank bonds are now rated below investment-grade. Downside scenario If a bank fails. There are. a bank's hybrid securities may suffer in similar proportion to the losses absorbed by common shares. In good times.12 . Upside scenario In good times. some differences to keep in mind: s Hybrids may lose coupon and principal payments without the issuer defaulting. this is now reflected in their lower ratings compared to a bank's senior unsecured rating. whereas deeply subordinated bonds usually have zero recovery value in case of a bank default. whereas shareholders may earn higher dividends and price increases. whereas hybrid bonds are traded overthe-counter and may turn illiquid. Even if it survives but needs to be recapitalized. stocks outperform hybrid bonds and in bad times there is little bond-like protection. However. preventing a stop-loss trade. hybrid bonds almost always underperform stocks. There is even an advantage for stock investors in a period of market disruption. as stocks tend to remain liquid due to market makers on stock exchanges. as their redemption value is limited to 100% and their coupon terms are fixed. high-yield securities may allow a reasonable relative return comparison. Only if losses remain manageable. hybrids profit from their seniority to common shares. Conclusion Deeply subordinated bonds are more attractive than stocks in a stock market that is trading in a narrow range or in a moderate cyclical downturn. Comparing perpetuals to stocks s Yield stock: dividend yield + expected price performance s Yield perpetual bond: discount rate that returns the current market value of the security assuming all coupon payments are made and the principal value is repaid at 100% at the next call date (yield-to-call) or an assumed maturity date far in the future. however. share dividends may be suspended. Corporate bonds . both its stock and its hybrids are most likely worthless.

"3mL+20/70. it may do so at any coupon date thereafter. Credit ratings for each instrument Ratings for each security are shown as S&P / Fitch / Moody's and may differ due to subordination levels and the agencies' different rating approaches for these bonds. the issuer and the regulator usually have ample discretion in this matter. For bonds denominated in currencies other than EUR.5%. Floating rate bonds with a coupon step-up at the first call date show two margins. the one paid at the next coupon date. Coupons Coupons may be fixed for life (fix). we show the coupon formula in the column "FRN". Under certain conditions.25. may default without the parent company defaulting. according to conditions defined in the prospectus of each bond. Variable (var) rate bonds usually start with a fixed coupon for a defined period. floating (frn) or a combination of both (var). Corporate bonds . We only include bonds that currently appear to be liquid.).g. This is indicated in the "payment" column. Most Tier 1 bonds have non-cumulative (non-cum. that is. We also include the minimum piece in our tables. Some securities may be subject to withholding taxes or sales restrictions.13 . An issuer may only call a perpetual bond after obtaining approval from the regulator. which can be canceled entirely. for example. "3mE+200" means that a quarterly coupon is paid that is calculated as one-fourth of 3-month Euribor plus a margin of 200 bps. indicating the minimum investment size and increment. For Lower Tier 2 (LT2) securities. we show the next call date in blue italics. Those entities may be subsidiaries of a parent company that are not guaranteed and. 5yT means the 5-year Treasury bond yield. If the first call date has already passed. If the issuer does not call a bond at the first call date. We include the next call date for each bond in the tables. "100+1" means a minimum investment of 100.) coupons.UBS Wealth Management Research 16 September 2010 Corporate bonds Notes to the bond tables All of the securities shown are subordinated Tier 1 or Tier 2 capital instruments and investors should carefully read the following notes before investing. At the first call date.000 followed by pieces of 1. in most cases. the issuer may chose to redeem the bond at defined call dates. Floating rates linked to longer-term interest rates are usually linked to treasury rates." meaning the margin above Libor increases from 20 bps to 70 bps after the first call date. As an example. as a consequence.5% + 2%) / 4 x EUR 1000 = EUR 11. but investors should obtain updated pricing information and use limit orders. that is. This means that the issuer is not obliged to redeem the bond and repay the principal. Call dates Most instruments have no fixed maturity date. The tables include the currency and the legal entity issuing the bond. with the obligation to pay them before any payments can be made to shareholders. they are perpetual. as this reduces the amount of available regulatory capital. Some subordinated bonds allow coupon payments to be deferred. Many securities have lower secondary market liquidity and may be difficult to trade. Price data Pricing information in the tables is only indicative. We show the current coupon. However. those are usually Upper Tier 2 (UT2) bonds and the coupon is called cumulative (cumul. coupons must be paid. Libor (L) is used instead of Euribor. coupon payments on subordinated bonds may not be made by the issuer. unless the bond is redeemed by the issuer. For floating rate coupons. Assuming 3-month Euribor is 2. the coupon switches to an FRN formula. during which the bond is not callable by the issuer. However. rounded to three digits. the quarterly payout of a bond with a principal value of EUR 1000 is (2.000 for any additional amount. e.

Nordea 7. 17. UBS AG. 12. UBS Securities (Hong Kong) Limited is a market maker in the HK-listed securities of this company. 22. or you require general information on UBS Wealth Management Research including research policies and statistics regarding past recommendations. and non-investment banking securities-related services are being. Dexia 5. 12. or within the past 12 months has been. Rabobank 12. 23. 12. 23. a client of UBS Financial Services Inc. 22. 7. its affiliates or subsidiaries beneficially owned 1% or more of a class of this company's common equity securities as of last month's end (or the prior month's end if this report is dated less than 10 days after the most recent month's end). its affiliates or subsidiaries beneficially owned more than 3% of the total issued share capital of this company. 16. SEB Group 12. 15. This company/entity is. HSBC Holdings Ord 5. 11. 23. 17. UBS Securities LLC has received compensation for products and services other than investment banking services from this company/entity. 23. 22. 16. 23. 12. UBS Limited is acting as advisor to Royal Bank of Scotland Group on the sale of part of its UK banking business comprising certain branches. 22. 17. 16. 23. 5. 22. its affiliates or subsidiaries held other significant financial interests in this company/entity as of last month's end (or the prior month's end if this report is dated less than 10 working days after the most recent month's end). 17. 22. Svenska Handelsbanken 17. Lloyds Banking Grp 1. 23. 17. Australia Branch or an affiliate expect to receive or intend to seek compensation for investment banking services from this company/entity within the next three months. or within the past 12 months has been. NordLB 22. Within the past 12 months. 17. 23. Commonwealth Bank 4. 17. 8. Credit Suisse Group 3. 23. 12. or have been. 19. 7. 14. 7. 22. 15. 12. 20. 23. 15. 23. 23. Commerzbank 1. 12. Goldman Sachs 6. Danske Bank 12. provided. 23. UBS AG. ING 5. Australia Branch has been appointed as CBA's broker in respect of the DRP neutralisation in connection with its FY2010 final dividend and may receive fees for acting in that capacity 5. 23. Directors or employees of UBS AG. 19. placement or sales agent in regard to an offering of securities of this company/entity or one of its affiliates. 12. its affiliates or subsidiaries has issued a warrant the value of which is based on one or more of the financial instruments of this company. 17. 4. This company/entity is. 13. 23. Helaba 22. 9. 22. Intesa Sanpaolo 5. 21. 22. WestLB 22. underwriter. 17. 2. 23. 16. 15. 6. 17. 16. 17. and non-securities services are being. 21. 16. 8. 23. 22. 23. provided. 15.14 . Deutsche Bank 3. 23. 15. or have been. 3. UBS AG. 23. 12. UBS Limited acts as broker to this company. 20. DNB NOR 12. 23. Allianz 3. or within the past 12 months has been. 7. 9. 17. 23. 17. SME customers and supporting infrastructure 10. 18. 22. UBS Limited is acting as manager/co-manager. 17. 7. 17. 10. 5. 22. 7. its affiliates or subsidiaries has acted as manager/co-manager in the underwriting or placement of securities of this company/entity or one of its affiliates within the past 12 months. 15. 10. 16. 16. UBS Securities LLC is acting as advisor to Royal Bank of Scotland on its announced agreement to sell its Argentina wholesale banking operation to Banco Comafi SA. UBS AG. UBS AG. Fortis Bank SA/NV 13.UBS Wealth Management Research 16 September 2010 Corporate bonds Appendix If you require further information on the instruments or issuers mentioned in this publication. 22. UBS AG. its affiliates or subsidiaries are directors of this company. Within the past 12 months. 17. 15. BayernLB 12. 15. 17. 22. 16. 12. 22. a client of UBS Securities LLC. 12. Swedbank 17. 22. 22. 16. 2. 12. 7. 7. 7. UBS Securities LLC makes a market in the securities and/or ADRs of this company. Barclays 5. JP Morgan Chase & Co 7. UBS AG. and investment banking services are being. Société Générale 12. a client of UBS Securities LLC. 15. 5. and non-investment banking securities-related services are being. 19. 12. 15. 22. 22. or within the past 12 months has been. This company/entity is. 23. 22. RBS 1. 16. 17. BNP Paribas 15. 23. or have been. UBS AG. 23. 15. 15. 6. 12. 1. 22. 18. UBS Financial Services Inc has received compensation for products and services other than investment banking services from this company. 22. its affiliates or subsidiaries has received compensation for investment banking services from this company/entity. 22. a client of UBS Securities LLC. 18. provided. 6. Crédit Agricole 5. Corporate bonds . 12. provided. 22. 17. 16. 8. please contact either your Client Advisor or the mailbox UBS-research@ubs. ANZ Bank 6. 19. 5. 16. or have been. This company/entity is. 22. 11. Within the past 12 months. 7.com giving your country of residence. Westpac Bank 7. 17. 14. its affiliates or subsidiaries expect to receive or intend to seek compensation for investment banking services from this company/entity within the next three months. 16. 12. 22. 22. Disclosures (16 September 2010) ABN-Amro 5. 7. Nationwide Building 12. 23. 12. UBS AG. 22. UBS Limited is acting as advisor to Royal Bank of Scotland on the sale of its Global Merchant Services (GMS) division. 23.

96%*) (64. the stock rating may be flagged as “Under review” by the analyst. . . .67% (50. . . Least preferred: We expect the stock to both underperform the relevant benchmark and depreciate in absolute terms.53% 17. Suspended If data is not valid anymore.30% 0.15 . .33%*) . Equity preference: Most preferred: We expect the stock to both outperform the relevant benchmark and appreciate in absolute terms. contractual or best business practice obligations which are normally caused by UBS Investment Bank’s involvement in an investment banking transaction in regard to the concerned company. Under review Upon special events that require further analysis.57%*) (100. the stock rating may be flagged as “Suspended” by the analyst. Corporate bonds . . . *Percentage of companies within this rating for which investment banking services were provided by UBS AG or UBS Securities LLC or its affiliates within the past 12 months. .34% 16. Stocks relevant for UBS WM clients but not selected as neither "Most preferred" nor "Least preferred" are implicitly defined as "Neutral View". Restricted Issuing of research on a company by WMR can be restricted due to legal. .71%*) (45. . .17% 13. Current UBS WMR global rating distribution (as of last month-end) Most Preferred Neutral View Least Preferred Suspended Discontinued 52.UBS Wealth Management Research 16 September 2010 Corporate bonds Appendix Stock recommendation system: Analysts provide three ratings (Most Preferred. Neutral view: We expect the stock neither to out.or underperform the relevant benchmark nor significantly appreciate or depreciate in absolute terms. Least Preferred or Neutral view). . regulatory. .00%*) (33.

and the expectation of Marketperform (MKT) Bond recommendation Underperform (UND) Sell (Sell) a lower total return than a liquid bond benchmark representing a comparable risk. Issuer / Bonds have very weak credit quality. investors should sell their bonds. The bond is expected to earn a lower total return than a liquid bond benchmark representing a comparable level of risk. and therefore a different rating than the issuer. This may result in the bond having a different risk profile. This is the lowest quality of the speculative grade category. In light of substantial downside credit or default risk. Increased likelihood of UBS WMR credit rating upgrade(s). S p e c u l a t i v e g r a d e Low BB High B Mid B Low B High CCC Mid CCC Low CCC CC Issuer / Bonds have a very high risk of default.UBS Wealth Management Research 16 September 2010 Corporate bonds Appendix Credit issuer/bond recommendation definitions Recommendation Time horizon WMR terminology AAA Definition Issuer / Bonds have exceptionally strong credit quality. Recommendation WMR terminology Outperform (OUT) Definition The bond is expected to earn a higher total return than a liquid bond benchmark representing a comparable level of risk. AAA is the best credit quality. as well as other bonds of the issuer. D Improving Stable Deteriorating WMR credit trend Review within a couple of months Watch + Review within a couple of months Watch Increased likelihood of UBS WMR credit rating change(s). The WMR bond rating is derived by adjusting the WMR credit rating of the issuer for any collateral-type and capital structure considerations specific to that bond. WMR credit/bond* rating Longer term Mid BB Issuer / Bonds have weak credit quality. C Obligor failed to make payment on one or more of its financial commitments. Issuer / Bonds have very strong credit quality. This is the highest speculative grade category. Reflects the analyst's expectation that the credit issuer's fundamentals will deteriorate. Issuer / Bonds have high credit quality. Corporate bonds .16 . Review within a couple of months Watch - Increased likelihood of UBS WMR credit rating downgrade(s). *The WMR bond rating reflects WMR's opinion of the credit quality of a bond. Reflects the analyst's expectation that the credit issuer's fundamentals will improve. Issuer / Bonds have extremely weak credit quality. I n v e s t m e n t g r a d e High AA Mid AA Low AA High A Mid A Low A High BBB Mid BBB Low BBB High BB Issuer / Bonds have adequate credit quality. This is the lowest investment grade category. The bond is expected to earn a total return in line with a liquid bond benchmark representing a comparable level of risk. Reflects the analyst's expectation that the credit issuer's fundamentals will remain stable.

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In Canada. units. a regulated bank under the supervision of the "Commission de Surveillance du Secteur Financier" (CSSF). its subsidiaries and affiliates. Luxembourg: This publication is not intended to constitute a public offer under Luxembourg law. and are subject to change without notice. as a result of using different assumptions and/or criteria. Corporate bonds .. in light of submissions made by various parties. a public offering. Jersey: UBS AG.A. this publication is distributed to clients of UBS Wealth Management Canada by UBS Investment Management Canada Inc. UBS Financial Services Inc. or (iii) in limited circumstances. an Italian bank duly authorized by Bank of Italy to the provision of financial services and supervised by "Consob" and Bank of Italy. Hong Kong: This publication is distributed to clients of UBS AG Hong Kong Branch by UBS AG Hong Kong Branch. in relevant securities or provide advisory or other services to the issuer of relevant securities or to a company connected with an issuer.. The compensation of the analyst(s) who prepared this report is determined exclusively by research management and senior management (not including investment banking). For structured financial instruments and funds the sales prospectus is legally binding. pursuant to an exemption from the dealer registration requirement in the relevant province or territory of Canada in which such offer or sale is made. before proceeding with such measures. UBS will not be liable for any claims or lawsuits from any third parties arising from the use or distribution of this document. Opinions expressed herein may differ or be contrary to those expressed by other business areas or divisions of UBS. the analysis or report. the Dubai Financial Market. Bahamas: This publication is distributed to private clients of UBS (Bahamas) Ltd and is not intended for distribution to persons designated as a Bahamian citizen or resident under the Bahamas Exchange Control Regulations. 231127). Singapore: Please contact UBS AG Singapore branch. is a subsidiary of UBS AG. If you are interested you may attain a copy via UBS or a subsidiary of UBS. in respect of any matters arising from. boulevard Haussmann F-75008 Paris. if the Proposed Amendments apply to an investor. UBS (France) S. formed or created under the laws of Canada or a province or territory of Canada. © UBS 2010. French "société anonyme" with share capital of € 125. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. UBS relies on information barriers to control the flow of information contained in one or more areas within UBS. to its clients and prospects.A. is intended for professional clients only and is not for onward distribution within the United Arab Emirates. its proportionate share of the FIE’s income (or loss) calculated using Canadian tax rules. Investors are urged to consult their own tax advisors regarding the application and impact of the Proposed Amendments in their particular circumstances. Bockenheimer Landstrasse 2-4. We are of necessity unable to take into account the particular investment objectives. a licensed bank under the Hong Kong Banking Ordinance and a registered institution under the Securities and Futures Ordinance. Some investments may not be readily realizable since the market in the securities is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. a bank registered with the Bank of Spain. USA: This document is not intended for distribution into the US and / or to US persons.Version as per January 2010. they will not be covered by the UK regulatory regime or the Financial Services Compensation Scheme. to include in income for income tax purposes each year (i) an amount equal to a prescribed percentage of the designated cost of its participating interest in the FIE. alternatively. the Abu Dhabi Securities market or any other UAE exchange. and should not be construed as advice to any particular investor regarding the implications of the Proposed Amendments in the investor’s particular circumstances. is made as to its accuracy or completeness (other than disclosures relating to UBS AG. funds and investment business. Dubai: Research is issued by UBS AG Dubai Branch within the DIFC. divisions or affiliates of UBS. is a provider of investment services duly authorized according to the terms of the "Code Monétaire et Financier". Additional information will be made available upon request. Australia: Distributed by UBS Wealth Management Australia Ltd (Holder of Australian Financial Services Licence No. To the extent that the information contained herein references securities of an issuer incorporated.. France: This publication is distributed by UBS (France) S. At any time UBS and other companies in the UBS group (or its employees) may have a long or short position. In the Federal Budget tabled on January 27. sale or delivery of shares or other securities under the laws of the United Arab Emirates (UAE). 110) and a wholesale bank licensed under the Singapore Banking Act (Cap. alternatively. A member of the London Stock Exchange. Under no circumstances is the information contained herein to be construed as investment advice in any province or territory of Canada and is not tailored to the needs of the recipient. as currently released. The document may only be used by the direct recipient of this information and may under no circumstances be passed on to any other investor. via del vecchio politecnico 3. (ii) in limited circumstances. A Canadian investor in the Fund must promptly notify UBS if that investor acquires or holds more than 10% of any class of shares of a particular Fund. Different assumptions could result in materially different results. however. but might be made available for information purposes to clients of UBS (Luxembourg) S. sales and trading services. or deal as principal or agent.UBS Wealth Management Research 16 September 2010 Corporate bonds Appendix Disclaimer Wealth Management Research is published by Wealth Management & Swiss Bank and Wealth Management Americas. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis and/or may not be eligible for sale to all investors. Where products or services are provided from outside the UK. Paris B 421 255 670. the investor may be required to include in taxable income amounts that the investor has not earned or received.p. express or implied. the Emirates Securities and Commodities Authority. which includes investment banking. but no representation or warranty. value or income of an investment. Austria: This publication is not intended to constitute a public offer or a comparable solicitation under Austrian law and will only be used under circumstances which will not be equivalent to a public offering of securities in Austria. and will not be. Securities mentioned in this material have not been. the information contained herein or the merits of the securities described herein and any representation to the contrary is an offence. Business Divisions of UBS AG (UBS) or an affiliate thereof. The contents of this report have not been and will not be approved by any authority in the United Arab Emirates including the UAE Central Bank or Dubai Financial Authorities.A. is regulated and authorized by the Jersey Financial Services Commission for the conduct of banking. 2009. UBS expressly prohibits the distribution and transfer of this document to third parties for any reason. R. to which this publication has not been submitted for approval. Any offer or sale of the securities described herein in Canada will be made only under an exemption from the requirements to file a prospectus with the relevant Canadian securities regulators and only by a dealer properly registered under applicable securities laws or. its gain on its participating interest in FIEs.. solicitation of an offer to buy securities described herein. 2 Chifley Square.944.726. Accordingly. it was stated that the government will review the Proposed Amendments.A. Germany: The issuer under German Law is UBS Deutschland AG. In certain countries UBS AG is referred to as UBS SA. 60306 Frankfurt am Main. No securities commission or similar regulatory authority in Canada has reviewed or in any way passed upon these materials. Jersey Branch.

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