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UBS AG (UBS - Analyst Report) – Switzerland's largest bank in term of assets – is set to end an embarrassing episode in its history. UBS plans to repurchase the remainder of the Swiss National Bank’s bailout fund. During the 2008 financial crisis, the fund set up by the central bank helped the company to shed its toxic assets.

UBS declared its intention to acquire the fund in the fourth quarter, as a connected loan would be paid back to the central bank. The aforementioned move will likely strengthen UBS’s capital base and make it competent to counter an economic downturn in the future.

The Background Story

After the bankruptcy of Lehman Brothers Holdings Inc. in 2008, UBS was on the verge of collapse. The bank’s venture into the U.S. housing market led it to incur losses of about $57 billion during the economic crisis.

As part of the bailout, the Swiss National Bank took over 9% stake in UBS and  offloaded risky assets of $38.7 billion into a fund, while the government provided CHF 6 billion ($6.4 billion) as bailout money. Switzerland’s government sold its investment in UBS within a year, for a profit of CHF 1.2 billion.

In consistence with the bailout, UBS was granted an alternative to buy back the fund once the loan to the central bank was repaid. Hence, it required UBS to shell out $1.0 billion and an additional 50% of its gains in order to repurchase the fund. UBS will, at present, buy back the bailout fund from the central bank after paying off the residual CHF 1.2 billion of the CHF 24.0 billion loan.

This will result in adding CHF 1-2 billion to the bank’s balance sheet, apart from an increment of up to 70–90 basis points to UBS's common equity ratio in the fourth quarter. The bank’s common equity ratio under Basel III rules was 11.2% as of Jun 30, 2013.

Strong Capital Ratios

Europe’s major banks seem to be keen on maintaining a healthy capital buffer.

Barclays PLC (BCS - Analyst Report) plans to raise £5.8 billion from shareholders to bolster its capital ratios.

Deutsche Bank AG (DB - Analyst Report), Germany’s biggest bank, intends to shrink its balance sheet by € 250 billion, apart from continuing the reduction of risky assets.

Our Viewpoint

We believe that the aforementioned repurchase by UBS is encouraging. It indicates the bank’s successful tackling of the challenging times.  

UBS’ restructuring initiatives such as job cuts and scaling down of the investment banking unit, will likely stimulate the bank’s capital ratio to reach the target of 13%. We believe that such efforts will help improve the company’s operating competence in the future. Moreover, prudent business model changes can further improve the company’s efficiency and bolster its competitive edge.

UBS AG currently carries a Zacks Rank #4 (Sell). Well-placed foreign banks that are worth considering include Mitsubishi UFJ Financial Group, Inc. (MTU - Analyst Report), which carries a Zacks Rank #1 (Strong Buy).

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