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Amid an improving economic environment for European banks, Zurich-based UBS AG (UBS - Analyst Report) announced the buyback of the StabFund, a fund created in Oct 2008 by the Swiss government and the Swiss National Bank (SNB) to bail out UBS AG. The bank will pay $3.76 billion to SNB to repurchase the residual value of distressed assets in the fund.

Notably, at the time of financial crisis, UBS AG spun-off its toxic loans, securities and derivatives worth $38.7 billion into the StabFund. Moreover, the government provided $6.5 billion (6 billion francs) of equity and provided a loan to the fund to support the troubled assets as these were run down.

In August, the loan was repaid and UBS AG was supposed to buy back the fund for $1 billion plus 50% of the fund’s equity as of Sep 2013. Therefore, UBS made an announcement of buying back the fund. Along with $3.76 billion, SNB received interest income worth $1.6 billion over the life of the loan.

The Swiss Government aided UBS AG at the time of U.S. housing market meltdown when the bank recorded more than $57 billion in writedowns and losses. The measure was taken to stabilize the Swiss financial system.

UBS has come a long way to strengthen its capital position since the crisis. However, in the last quarter, FINMA imposed a temporary 50% add-on to UBS AG’s advanced measurement approach-based operational risk-related risk-weighted assets (RWA) associated with expected or unexpected litigation, compliance and other operational risk matters.

Therefore, this temporary FINMA add-on is anticipated to record additional operational risk-related RWA of about CHF 28 billion on both a fully applied and a phase-in basis. Currently, UBS AG expects the effect of such an imposition to lower its fully applied Basel III common equity tier 1 ratios by 130 basis points.

However, on a positive note, the application of SNB StabFund option will increase UBS AG’s fully applied and phase-in BIS Basel III common equity tier 1 capital ratios by about 100 basis points. Further, the bank anticipates a 25 basis points surge in Swiss (Systemically Relevant Banks) SRB leverage ratio.

Amid the overall economic volatility and the Eurozone debt crisis, UBS AG is focusing on building its capital level. Restructuring initiatives taken during 2012 are encouraging and we believe that such efforts would help improve the company’s operating competence in the future. Moreover, prudent business model changes can further improve its efficiency and bolster its competitive edge.

UBS AG currently carries a Zacks Rank #3 (Hold). Some foreign banks that are worth considering include Deutsche Bank AG (DB - Analyst Report) and Westpac Banking Corporation (WBK) with a Zacks Rank #1 (Strong Buy), while Itau Unibanco Holding S.A. (ITUB - Analyst Report) carries a Zacks Rank #2 (Buy).

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