May 6 (Bloomberg) -- UBS AG will exit the U.S. municipal bond market, abandoning a business it sought to dominate for almost a decade.

UBS said it will sell or close its New York-based municipal securities department, which employs about 300 people, as it overhauls its investment banking operations amid $17.3 billion first-quarter losses. Jerker Johansson, chief executive officer of the investment banking unit, said the firm is choosing to focus on businesses that can meet ``return on capital targets'' and have ``future growth potential.''

The exit ``is symbolic because it marks a retreat from its days of aggressive expansion in the U.S.,'' said Simon Adamson, a credit analyst at bond research firm CreditSights Inc. in London, who has an ``underperform'' rating on the Zurich-based company's debt. ``We're starting to see the longer-term damage to its franchise from the losses in the past six months.''

The decision follows unprecedented turmoil in the $2.6 trillion municipal market, which had its worst start in 12 years in the first quarter as investors shunned securities backed by insurers whose top ratings came under scrutiny. The auction-rate securities market, where state and local governments raised $166 billion, collapsed in February when dealers such as UBS stopped buying debt lacking bidders.

Net Loss

UBS, Switzerland's biggest bank, today reported a net loss of 11.5 billion francs ($10.9 billion) in the first quarter and plans to cut about 5,500 jobs, or 7 percent of its workforce. The lender also said it anticipates selling $15 billion in distressed assets to a newly created fund managed by BlackRock Inc.

Some of the traders in the municipal bond department will be transferred into the wealth management division at UBS, which will continue to buy and sell tax-exempt securities for clients, said Rohini Pragasam, a bank spokeswoman.

``The decision follows an ongoing review of the investment banking businesses,'' she said. Johansson said in a conference call today that the bank is in talks with possible buyers for the municipal group without providing more details.

UBS is among securities firms, including Merrill Lynch & Co. and Morgan Stanley, that have been sued by clients who say they were sold auction-rate securities inappropriately and told they were as safe as cash. UBS in March said it wrote down the value of auction-rate debt it held for clients by about 5 percent.

Task Force Formed

Nine state regulators last month formed a task force to look into whether laws were broken when the auction-rate securities were sold to investors. The Securities and Exchange Commission is working with the Financial Industry Regulatory Authority on a probe into the sale of the bonds.

A global credit squeeze sparked by the subprime mortgage slump has led to at least $312 billion of credit losses and writedowns by banks and securities firms worldwide. Market disruptions sent municipalities' auction-rate interest costs soaring as high as 20 percent and left investors stuck in the investments.

U.S. prosecutors are also conducting a criminal investigation into anticompetitive conduct in the public finance market.

``Every time a firm collides with a difficult market, it's tempting to jettison those businesses with low margins as part of your retrenchment strategies,'' said Joseph Giglio, professor at Northeastern University in Boston and head of Chase Municipal Securities in 1991 when the former Chase Manhattan Corp. exited the business.

Head to Head

UBS expanded its municipal bond business after it bought Paine Webber Group for $11.5 billion in 2000, going head to head with Citigroup Inc. for most of the last decade for the top spot in tax-exempt underwriting rankings. The company's announced departure also echoes Salomon Brothers decision in 1987 when it dismissed 12 percent of its staff to concentrate on higher profit parts of its banking business.

UBS's ranking among managers of sales of U.S. municipal debt dropped in the last three years, based on data compiled by Thomson Reuters. In 2004, the firm was first; by 2007, UBS was third, behind Citigroup and Merrill Lynch & Co. During the first quarter, UBS arranged $7.6 billion of bond sales for state and local governments, placing it behind Citigroup and Lehman Brothers Holdings Inc., according to Thomson Reuters data.

The bank fired about 40 employees in its public finance department in April 2007 following a management shuffle within its fixed-income department that was aimed at boosting revenue that lagged behind competitors.

Concentrated Market

UBS's exit will further concentrate control of the municipal bond underwriting business, said Christopher Taylor, former executive director of the Municipal Securities Rulemaking Board. JPMorgan Chase & Co. agreed to acquire Bear Stearns Cos. in March, combining two other top 10 underwriters.

``This is not at all healthy,'' said Taylor, who stepped down from the regulatory group last year. ``I have serious concerns when you reduce the number of players.''

The bank plans to manage less than $500 million of the roughly $11 billion in municipal bond sales planned for coming weeks, according to data compiled by Bloomberg.

``It is a difficult time'' for the municipal bond market, said Jorge Irizarry, president of the Government Development Bank of Puerto Rico said. UBS is advising the commonwealth on a possible lease deal involving its ports.

To contact the reporter on this story: Michael McDonald in Boston at mmcdonald10@bloomberg.net; John Glover in London at johnglover@bloomberg.net.

Last Updated: May 6, 2008 16:29 EDT