June 8 (Bloomberg) -- UBS AG, the European bank with the biggest losses from the financial crisis, is in talks with the Swiss government about the repayment of 6 billion francs ($5.5 billion) in aid, two people with knowledge of the matter said.

UBS is weighing options, including a stock sale, to raise funds to pay back the state, said the people, who declined to be identified because the talks are private. The Swiss government in Bern would have to approve any reimbursement plan, they said.

The state bought mandatory convertible notes from UBS as part of the rescue package and can begin exchanging those securities for stock tomorrow, giving it a stake of more than 9 percent. The Zurich-based bank is keen to cut ties to the government so that it can make decisions, including those related to compensation, without interference, the people said.

“Government ownership in a bank at this point looks like a disadvantage in terms of attracting and retaining talent,” said Dirk Hoffmann-Becking, an analyst at Sanford C. Bernstein in London. “It’s a question of whether UBS can get out and whether the Swiss government feels comfortable enough letting them get out.”

Sabine Jaenecke, a UBS spokeswoman, declined to comment.

Swiss Finance Minister Hans-Rudolf Merz told the national council on June 5 that the government has to make a decision on the state’s investment together with the financial regulator, the central bank and UBS in a “responsible” way. He declined to discuss the talks publicly.

‘Stable Enough’

“Responsible means that UBS can repay this mandatory convertible bond when it’s stable enough to fulfill capital requirements,” he said. Merz told NZZ am Sonntag, in an interview published June 7, that the state would place the UBS stake only where it “makes sense” for the bank.

The government wants to recoup its investment, or generate a profit, after agreeing to shore up the bank last October. UBS amassed the biggest loss in Swiss corporate history in 2008.

Merz said after a meeting with UBS Chairman Kaspar Villiger last month that the bank’s shares would need to rise to at least 18 francs before the government would consider selling its investment. UBS is unchanged so far this year at 14.84 francs, valuing the company at 43.5 billion francs.

U.S. banks, including New York-based JPMorgan Chase & Co. and Morgan Stanley, have said they want to pay back funds received from the U.S. government. Both banks raised capital in the past week. For UBS, repaying the state might be viewed by investors as a sign of strength, the people said.

Possible Scenarios

The bank has authorization from its investors to increase its share capital by as much as 10 percent, which wouldn’t allow UBS to repay the state in full at the current price. Under other scenarios, the government could convert the bonds into shares and sell them on the market, or find investors to buy the mandatory convertible notes.

“It would certainly be right for the state to get out from this investment,” Urs Rohner, vice chairman of Credit Suisse’s board of directors, told journalists in Bern today. “In global business, we still see a lot of insecurity among employees at UBS as long as the state is involved.”

UBS’s Tier 1 capital ratio, a gauge of the bank’s ability to absorb losses, stood at 10.5 percent at the end of the first quarter, compared with 14.1 percent at Zurich-based Credit Suisse Group AG, which declined government assistance.

By converting bonds while UBS trades at or below the minimum conversion price of 18.21 francs, the government would get the highest amount of shares.

The government would have to sell shares at a minimum of about 12.5 francs to recoup its investment, taking into account interest payments on the bond, according to calculations based on terms of the deal. The state is entitled to receive interest payments of about 750 million francs per year until the notes mature in June 2011, regardless of the timing of the conversion.

To contact the reporters on this story: Elena Logutenkova in Zurich at elogutenkova@bloomberg.netJacqueline Simmons in Paris at jackiem@bloomberg.net

Last Updated: June 8, 2009 12:32 EDT