UBS Wealth Management Research / 19 May 2008 a b Preferred Securities Update USD Lead analyst An abundance of financial supply Barry McAlinden, CFA

At a glance Preferred price changes since January 2008 „ Non-cumulative perpetual preferreds are awarded unrestricted Supply has influenced the performance of each sector. Tier 1 capital treatment by the Federal Reserve and they have 20.0 % played a key role in the capital-raising toolkit of financial institu- 15.0

tions, a trend that is likely to continue. 10.0 „ We believe the historically high spread levels being offered in the 5.0 marketplace make preferreds an attractive means of expressing a view on the financial sector. We prefer to add exposure to non- 0.0 financial sectors in the corporate bond market, where the dura- -5.0 REIT Preferreds Trust Preferreds tion risk is not as high. -10.0 Non-US QDI „ Despite the recently improved tone in the credit markets, we con- DRD-Eligible -15.0 Floating-Rate tinue to focus our Outperform preferred security ratings among -20.0 better-positioned financial companies, according to the views of WMR analysts. We believe these companies should continue to Jan-08 Jun-08 Feb-08 Apr-08 Mar-08 experience lesser credit spread volatility and are likely to be less May-08 Source: UBS WMR, as of 16 May 2008 prone to supply-related price pressure.

Preferred spreads versus Treasuries

Financial preferred spreads peaked in mid-March. Market Overview 500 REIT Preferreds It has been a roller coaster ride for the preferred security market as the Trust Preferreds Sr Note Preferreds 450 interplay between sentiment in the credit markets and new supply Subordianted Note Preferreds Non-US QDI Preferreds have had an influence on prices. After posting exceptional perform- 400

ance in January, prices turned weaker in March as events surrounding 350 the Bear Stearns collapse caused financial stress to peak. Prices again 300 rebounded in April as the Fed’s actions helped to calm widespread credit fears, which caused spreads on risk assets to improve. However, 250 preferreds have since treaded water as an exceptionally active new is- 200

sue calendar continues to take place. This record amount of supply has 150 been the primary factor influencing the preferred market recently as 100 above-average coupons and the massive size of new deals adds pres- Jul- Aug- Sep- Oct- Nov- Dec- Jan- Feb- Mar- Apr- May- Jun- 07 07 07 07 07 07 08 08 08 08 08 08 sure to secondary prices. The areas of the preferred market with lim- ited supply have performed best this year (e.g., REITs, +15 YTD), while Source: UBS WMR, as of 16 May 2008 supply-focused areas have not fared as well (e.g., DRD-eligible preferreds, +2%). 2008 Preferred issuance by structure Type Amount (bn) # Securities What’s fueling the pipeline? Foreign QDI 9.615 5 The hefty pace of preferred issuance comes as a result of the asset Trust 6.310 8 write-downs and de-leveraging that has swept through the entire fi- DRD Eligible 10.936 6 nancial sector. According to Bloomberg, there has been USD 379bn in Subordinated Notes 0.965 3 write-downs worldwide by financial companies, and as a result, USD REIT 0.300 1 262bn in capital has been raised. Financial companies have utilized a Total 28.126 23 variety of methods to help replenish the lost equity capital from the Source: UBS WMR, as of 16 May 2008

balance sheets. This has included both non-convertible and convertible 2008 Preferred issuance by sector perpetual preferred securities and hybrid securities, as well as common equity shares and sovereign wealth funds. Preferred securities have Type Amount (bn) # Securities therefore played a key role in the capital-raising toolkit, a trend that is US banks & brokers 17.496 15 likely to continue. In a Fed speech in Chicago, Fed Chairman Bernanke Non-US banks 9.615 5 Utilities 0.715 2 recently commented that he has been "encouraged by financial insti- REITs 0.300 1 tutions' ability to raise capital and they must be proactive in building Total 28.126 23 up generous cushions.” Source: UBS WMR, as of 16 May 2008

This report has been prepared by UBS Financial Services Inc. (UBS FS). ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 4. UBS Wealth Management Research / 19 May 2008

Regulatory treatment drives issuance Tier 1 capital Among the USD 25 par preferred securities which are the focus of our Non-restricted Tier 1 capital elements coverage, non-cumulative perpetual preferreds have been the most • Non-cumulative perpetual preferred (includ- prevalent type of new issue structure. The reason for this stems from ing related surplus) with no maturity date the unrestricted Tier 1 capital treatment that these preferreds are • Common stockholder’s equity, net of Treasury awarded from the Federal Reserve. Cumulative preferreds, on the stock • Minority interests related to common equity or other hand, are subject to a 25% maximum limitation of total Tier 1 non-cumulative perpetual capital. At the issuer level, the coupon payments on non-cumulative • Less goodwill, added intangible assets and certain perpetual preferreds are paid on an after-tax basis, and they therefore other items come at a higher than trust preferreds that are paid on • Less net unrealized gains on equity securities and net unrealized gains (losses) on available-for-sale a before-tax basis. Trust preferreds, however, are also subject to Tier 1 debt securities. limitations of 15% for internationally active bank holding companies and 25% for other banks. Banks will generally turn to non-cumulative Restricted Tier 1 capital elements (restricted to 25% of total perpetual preferreds once these trust preferred limitations are reached. Tier 1 capital) Although the coupon levels on perpetual preferreds are at high levels • Cumulative perpetual preferred stock not seen since the early part of the decade, the cost is still generally • -related to cumulative perpetual lower than issuing common equity and comes without the dilutive ef- preferred stock fects of issuing new common shares. • Minority interest-related common equity or per- petual preferred stock issued by a consolidated subsidiary that is neither a US depository institu- Are non-cumulative preferreds riskier? tion nor a foreign bank. We are often asked about our comfort level with non-cumulative • Trust-preferred securities. preferreds relative to cumulative ones. In the case of coupon deferral, an issuer must repay all skipped payments on its cumulative preferreds, Source: UBS Education Note: Understanding Bank Capital, 26 March 2008 while non-cumulative preferred coupons do not have to be paid in ar- rears. We consider it very unlikely that a solvent financial institution would voluntarily defer payments on its preferred securities as a means Average coupon level for new issue preferreds of conserving capital. Stopping preferred dividends requires elimination New issue coupon levels are at multi-year highs. of common dividends and would cause the company’s funding costs 10.00 and counterparty risks to substantially rise. This would cause operating conditions to deteriorate rapidly and, as a result, it’s only been cases of 9.50 bankruptcy where financials have deferred their preferred dividends. 9.00 Moreover, the credit ratings agencies do not differentiate between 8.50 cumulative and non-cumulative preferreds when assigning ratings to 8.00 preferred securities. In late 2006, Moody’s decided against rating non- 7.50 cumulative preferreds an additional notch lower on the basis that this option is rarely voluntarily exercised by issuers. Rather than basing the 7.00 investment decision solely on the cumulative or non-cumulative feature 6.50 of a preferred, we instead consider the credit quality of the issuer and 6.00 tax status of the security as higher priority inputs into the investment Nov-00 Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 decision process. May-01 May-02 May-03 May-04 May-05 May-06 May-07 May-08 Source: Bloomberg, UBS WMR, as of 16 May 2008 Historical supply has caused dislocations to exist The need for financial institutions to recapitalize has caused various dislocations to occur in the preferred market. First, on a structural ba- sis, the large supply of tax-advantaged preferreds has caused instances where their yields are higher than fully taxable preferreds. This has helped to reduce the legislative risk stemming from change to the divi- dend tax code. Secondly, there are instances where newly preferreds of the same issuer yield close to 100 bps more than issuers’ equal- ranking secondary preferreds. This is due to both the sheer size of many new issues and the above-average coupons that are necessary to clear the market. These dislocations have given investors the opportu- nity to evaluate current holdings relative to other preferred securities that are available with higher coupons and more favorable tax status.

Value for the long term

Despite having a Neutral view on the Financials Services sector overall, we believe the historically high spread levels being offered in the mar- ketplace make preferreds an attractive means of expressing a view on the sector. Under more normal credit environments, financial institu-

Preferred Stock Report 2 UBS Wealth Management Research / 19 May 2008

tions would not be eager to pay up to 400 bps over 30-year Treasuries Issuers with preferreds we rate Outperform in order to issue preferred securities. Instead, these companies have Issuer WMR Credit done so in order to help repair their capital bases during this historical Rating/Trend financial period. The above-average coupon rates would allow the se- curities to perform better than lower-coupon preferreds should interest Bank of America Corp. Low AA (Deteriorating) rates move higher over time.

Due to the large give-up in yields for preferreds issued by companies in HSBC Holdings plc. Mid AA (Stable) the Utility and Industrial sectors, we recommend gaining exposure to these sectors in the corporate bond market where the duration risk is JP Morgan Chase & Co. Low AA (Stable) not as high. The interest rate sensitivity of corporate bonds with short- to-intermediate maturities is considerably lower than preferreds. Lehman Brothers Holdings, Inc. High A (Stable)

Security selection process MetLife, Inc. Mid A (Stable) Last year we shifted our preferred securities recommendations to place Selective Insurance Group, Inc. N/A a primary emphasis on the credit quality of issuers in our universe. That US Bancorp Low AA (Stable) is, our Outperform-rated securities have been centered on those finan- cial institutions that our WMR analysts consider better positioned than & Co. Mid AA (Stable) their peers in terms of the effect the housing crisis has had on their businesses and earnings. This group includes preferreds issued by the W. R. Berkley Corp. N/A diversified financial companies Bank of America, HSBC, JPMorgan, Source: UBS WMR, as of 19 May 2008. Lehman Brothers, US Bancorp and Wells Fargo. With the exception of Lehman Brothers, preferreds by these issuers currently yield in the Preferred security discontinuations 6.25% to 7.25% area. On the other hand, financial preferreds that we WMR Strip YTW Symbol Coupon Maturity rate Marketperform include those issued by Citigroup, Merrill Lynch, Price (%) Preferred and Wachovia, and yield in the 7.25 to 8.5% area. Rating JSM 6.00% 12/15/43 18.08 8.30% N/A Despite the improved tone in the credit markets following the numer- Source: UBS WMR, strip price as of 16 May 2008, rating as of 19 May 2008. ous actions taken by the Fed to restore liquidity, we continue to posi- tion our Outperform security ratings with an emphasis on these better- positioned companies. We look for their credit spreads to experience greater stability in the near term, particularly since this group is less susceptible to additional large capital raises in the preferred market. Also, any new issues by these companies are likely to be well received by investors given large new issue concessions occurring throughout the entire sector. That said, however, we are comfortable with the coupon-paying ability of those preferreds in our universe that are rated both Marketperform and Underperform. When adding exposure to preferreds, we therefore recommend that investors take into account their own risk tolerance as well as their current exposure to each spe- cific company. Those that wish to pick up yield may look toward the preferreds in our Marketperform category, while those looking for less credit volatility may want to focus on the Outperform list.

At this time we are discontinuing the coverage of the JSM senior note preferreds issued by SLM Corp. due to the suspension of credit cover- age of this company. For a complete listing of our preferred security recommendations, see the Preferred Securities Universe.

Preferred Stock Report 3 UBS Wealth Management Research / 19 May 2008

Back to "At a glance"

Statement of Risk Prospective investors should consult their tax advisors concerning the federal, state, local, and non-U.S. tax consequences of own- ing preferred .

Preferred stocks are subject to market value fluctuations, given changes in the level of interest rates. For example, if interest rates rise, the value of these securities could decline. If preferred stocks are sold prior to maturity, price and yield may vary. Adverse changes in the credit quality of the issuer may negatively affect the market value of the securities. Most preferred securities may be redeemed at par after five years. If this occurs, holders of the securities may be faced with a reinvestment decision at lower future rates. Preferred stocks are also subject to other risks, including illiquidity and certain special redemption provisions.

Appendix

Terms and Abbreviations Abbreviation Description / Definition Symbol The preferred security’s trading symbol. UBS ID The UBS security identification number. Next Call Date The next date that the issuer has the option to redeem the security. Once a preferred security’s first call date has passed, the issuer can redeem the security at anytime within 30 days notice. Strip Price The strip price removes the accrued dividend from a preferred’s exchange-traded price to get a better reflection of the underlying value of the security. CY/YTM (Current Yield/ Yield to Maturity). In the case of perpetual preferreds, the displayed yield will be the security’s current yield as calculated by the annual dividend divided by the strip price. For preferreds with a finite maturity date, the YTM is the internal rate of return that equates the security’s strip price with the sum of its total discounted cash flows to the maturity date. YTC (Yield to Call). The YTC is the internal rate of return that equates the security’s strip price with the sum of its total discounted cash flows to the next call date. UBS WMR Parent Credit Rating/Trend The WMR Credit Rating provides an indication of the risk of investing in the senior unsecured debt of the preferred’s parent company. The WMR Credit Trend (Improving, Stable, Deteriorat- ing) provides an indication of the direction of credit quality defined in terms of the WMR Credit Rating, which is assessed over a 12-month period. Moody’s / S&P Credit Rating The credit rating that Moody’s and S&P assign to the specific preferred security. OAS (Option Adjusted Spread). A measure of a preferred’s spread relative to a benchmark curve that adjusts for the security’s embedded call option. To determine whether a security is rich or cheap on a relative value basis, we compare the OAS on an individual preferred security with the aver- age OAS of the peer group, adjusting for differences in credit quality and duration. Dur. (Effective Duration.) Duration is calculated as the weighted average maturity of a security’s total cash flows and is used a measure of the security’s price sensitivity to changes in yields. Effective duration takes into account how the preferred’s embedded call option will affect the security’s future cash flows. Spread Volatility (Low, Average, High). A measure of the volatility of an individual preferred’s OAS relative to the median OAS volatility of our preferred full coverage universe. Safety of Income (Low, Average, High). An assessment of the preferred security’s dividend safety. For accounts that are willing to accept the high degree of interest rate risk inherent in preferred securities but that are focused on generating long-term income distributions, our income return classification may be an important, and ultimately overriding, factor in the decision-making process. UBS WMR Rating (Buy, Neutral, Reduce).The preferred rating is based on the security’s expected total returns rela- tive to its peer group over a three-month time horizon. Securities rated Buy have potential to outperform their peer group, and the company is likely to meet dividend payment. Securities rated Neutral are likely to perform in line with peer group, and the company is likely to meet dividend payment. Securities rated Reduce have the potential to underperform the peer group, or the company is increasingly likely to defer or miss dividend payment. Liquidity (Primary or Secondary). Our coverage universe is dividend into primary and secondary groups, according to the volume of shares traded. Although the securities in both groups will be subject to the same process and ratings system, the securities on the primary list are likely ac- cessible to a broader investor base, whereas the securities on the secondary list are more illiquid. Sector The preferred security’s industry sector.

Preferred Stock Report 4 UBS Wealth Management Research / 19 May 2008

Appendix

Required Disclosures

Analyst Certification Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers; and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report.

If the date of this report is not current, the investment opinion and contents may not reflect the analyst's current thinking.

Disclosures (19 May 2008)

SLM Corporation 6% due 12/15/2043

1 UBS Securities LLC makes a market in the securities and/or ADRs of this company. 2 UBS AG, 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).

UBS Securities LLC is a subsidiary of UBS AG and an affiliate of UBS Financial Services Inc. UBS Financial Services Inc. is a subsidiary of UBS AG.

Preferred Stock Report 5 UBS Wealth Management Research / 19 May 2008

Appendix

Stock Recommendation System Analysts provide two ratings: an absolute rating and a relative rating. The absolute rating is based on the current Estimated Fair Value Range (EFVR) for the stock and the stock's recent trading price. The relative rating is based on the stock’s total return potential against the total esti- mated return of the appropriate sector benchmark over the next year. The EFVR is the price range within which the analyst estimates the stock to be fairly valued. The estimation of the EFVR is based on methods such as a valuation or a valuation multiples comparison. In the definition of the EFVR, analysts take into account the risk profile (predictability) of the stock. Absolute Stock Rating System Buy We believe the stock is undervalued relative to current market prices. Hold We believe the stock's current market valuation is within a fair range. Sell We believe the stock is overvalued relative to current market prices. Under review Upon special events that require further analysis, the stock rating may be flagged as "Under review" by the analyst. Suspended If data is not valid anymore, the stock rating may be flagged as "Suspended" by the analyst. Restricted Issuing of research on a company by WMR can be restricted due to legal, regulatory, contractual or best business-practice obligations which are normally caused by UBS Investment Bank's involvement in an transaction in regard to the concerned company. Industry Sector Relative Stock View Outperform (OUT) Expected to outperform the benchmark Marketperform (MKT) Expected performance in line with the benchmark Underperform (UND) Expected to underperform the benchmark Current WMR Global Rating Distribution (as of last month-end) Buy 28%** (49%*) Outperform 32%*** (52%*) Hold 58%** (53%*) Marketperform 44%*** (46%*) Sell 2%** (33%*) Underperform 11%*** (41%*) * 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. Source: UBS WMR, as of 1 May 2008 ** At present, not all securities in WMR's global coverage universe have been assigned an Absolute Stock Rating in a Corporate Report. The Absolute Stock Rating distribution calculation includes only securities that have been assigned an Absolute Stock Rating as of the last month-end. *** Under our Industry Sector Relative Stock View system, "Outperform" most closely corresponds with a "Buy" recommendation, "Marketperform" most closely corresponds with a "Hold" recommendation, and "Underperform" most closely corresponds with a "Sell" recommendation

UBS Prefered Stock Ratings: Definitions and Distributions Corresponding % of companies % for which IB UBS Financial Definiton and Criteria Services Rating Rating under coverage services have been Category with this rating provided Outperform Securities have potential for outperformance relative to peer Buy 27 79 group, and the company is likely to meet dividend payment. Market Perform Securities are likely to perform in line with peer group, and Hold 72 71 the company is likely to meet dividend payment. Securities have the potential for underperformance relative Underperform to peer group, and the company is likely to meet dividend Sell 1 100 payment. Investors should sell their preferreds in light of substantial Sell downside credit or default risk that raises the likelihood of a Sell 0.0 n.m. deferral or missed dividend payment. Source: UBS Financial Services Inc., as of 1 May 2008

Preferred Stock Report 6 UBS Wealth Management Research / 19 May 2008

Appendix

Global Rating History Preferred Security JSM (USD)

30

24

18

12

6 22/05/0 22/06/0 22/07/0 22/08/0 22/09/0 22/02/0 22/03/0 22/04/0 22/05/0 22/06/0 22/07/0 22/08/0 22/09/0 22/02/0 22/03/0 22/04/0 22/05/0 22/06/0 22/07/0 22/08/0 22/09/0 22/02/0 22/03/0 22/04/0 22/11/05 22/11/06 22/11/07 22/10/05 22/12/05 22/01/06 22/10/06 22/12/06 22/01/07 22/10/07 22/12/07 22/01/08

Outperform Market Perform Underperform Sell

22/05/05 26/12/05 02/08/06 08/03/07 13/10/07 19/05/08

Source: UBS WMR, as of 19 May 2008

Preferred Stock Report 7 UBS Wealth Management Research / 19 May 2008

Appendix

Disclaimer In certain countries UBS AG is referred to as UBS SA. This publication is for our clients’ information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. It does not constitute a personal rec- ommendation or take into account the particular investment objectives, financial situation and needs of any specific recipient. We recommend that recipients take financial and/or tax advice as to the implications of investing in any of the products mentioned herein. We do not provide tax advice. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. Other than disclosures relating to UBS AG, its subsidiaries and affiliates, all information expressed in this document were obtained from sources believed to be reliable and in good faith, but no representation or war- ranty, express or implied, is made as to its accuracy or completeness. All information and opinions are current only as of the date of this report, and are subject to change without notice. This publication is not intended to be a complete statement or summary of the securities, markets or developments referred to in the report. Opinions may differ or be contrary to those expressed by other business areas or groups of UBS AG, its subsidiaries and affiliates. UBS Wealth Management Research (UBS WMR) is written by, and intended for use by clients of, UBS Global Wealth Man- agement and Business Banking. UBS Investment Research is written by UBS Investment Bank. The research process of UBS WMR is independent of UBS Investment Research. As a consequence research methodologies applied and assumptions made by UBS WMR and UBS Investment Research may differ, for example, in terms of investment horizon, model assumptions, and valuation methods. Therefore investment recommendations independently provided by the two UBS research organizations can be different. The analyst(s) responsible for the preparation of this report may interact with trading desk personnel, sales personnel and other constituencies for the purpose of gathering, synthesizing and interpreting market information. The compensation of the analyst(s) who prepared this report is determined exclusively by research management and senior management (not including investment banking). Analyst compensation is not based on investment banking revenues, however, compensation may relate to the reve- nues of UBS Global Wealth Management and Business Banking as a whole, of which investment banking, sales and trading are a part. At any time UBS AG, its subsidiaries and affiliates (or employees thereof) may make investment decisions that are inconsistent with the opinions expressed in this publication, may have a long or short positions in or act as principal or agent in, the securities (or derivatives thereof) of an issuer identified in this publication, or provide advisory or other services to the issuer or to a com- pany connected with an issuer. Some investments may not be readily realisable 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. UBS relies on in- formation barriers to control the flow of information contained in one or more areas within UBS, into other areas, units, groups or affiliates of UBS. Some investments may be subject to sudden and large falls in value and on realisation you may receive back less than you invested or may be required to pay more. Changes in foreign currency exchange rates may have an adverse effect on the price, value or income of an investment. Past performance of an investment is not a guide to its future performance. Addi- tional information will be made available upon request. All Rights Reserved. This document may not be reproduced or copies circulated without prior written authority of UBS or a sub- sidiary of UBS. UBS expressly prohibits the distribution and transfer of this document to third parties for any reason. UBS will not be liable for any claims or lawsuits from any third parties arising from the use or distribution of this document. This report is for distribution only under such circumstances as may be permitted by applicable law. The securities described herein may not be eli- gible for sale in all jurisdictions or to all categories of investors. UK: Approved by UBS AG, authorised and regulated in the UK by the Financial Services Authority. A member of the London Stock Exchange. This publication is distributed to private clients of UBS London in the UK. Where products or services are provided from outside the UK they will not be covered by the UK regulatory regime or the Financial Services Compensation Scheme. USA: Dis- tributed to US persons by UBS Financial Services Inc., a subsidiary of UBS AG. UBS Financial Services Inc. accepts responsibility for the content of a report prepared by a non-US affiliate when it distributes reports to US persons. All transactions by a US person in the securities mentioned in this report should be effected through a US-registered broker dealer affiliated with UBS, and not through a non-US affiliate. Canada: In Canada, this publication is distributed to clients of UBS Wealth Management Canada by UBS Investment Management Canada Inc.. Germany: Issuer under German Law is UBS Deutschland AG, Stephanstrasse 14 - 16, 60313 Frankfurt am Main. Bahamas: This Publication is distributed to private client 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. Hong Kong: This publication is distributed to clients of UBS AG Hong Kong Branch by UBS AG Hong Kong Branch, a licensed bank un- der the Hong Kong Banking Ordinance and a registered institution under the Securities and Futures Ordinance. Singapore: Dis- tributed by UBS AG Singapore Branch, an exempt Financial Adviser under the Singapore Financial Advisers Act. Australia: Dis- tributed by UBS Wealth Management Australia Ltd (Holder of Australian Financial Services Licence No. 231127), Chifley Tower, 2 Chifley Square, Sydney, New South Wales, NSW 2000. © UBS 1998-2008. The key symbol and UBS are registered and unregistered trademarks of UBS. All rights reserved.

Preferred Stock Report 8