* Bank hybrids rally on hopes for mass redemptions
* Some banks may cling to hybrids while they boost capital
LONDON, Sept 17 (Reuters) - Investors betting European banks will promptly redeem high volumes of subordinated debt could be disappointed, as some look likely to keep the bonds for as long as regulators will let them, to preserve their capital ratios.
Banks have used hybrid Tier 1 bonds in the past to maintain obligatory capital levels to cushion against bad loans, but these bonds will no longer count as capital under new rules unveiled at the weekend by the Basel Committee on Banking Supervision. [ID:nLDE68B0H9]
The new capital regime aims to make banks more robust and better able to withstand future crises.
The regulators have given banks 10 years from 2013 to phase out their hybrids, which are a cross between equity and debt but cheaper than equity because coupon payments are tax deductible.
Clarity on the phase-out, or "grandfathering" period helped spur a big rally in Tier 1 bond spreads in the secondary markets early this week.
"Tier 1s saw a massive uplift on Monday after Basel because people assumed the bonds would get called (redeemed) at their earliest call (redemption) dates," said one financials credit trader.
Tier 1 bonds are typically perpetual, but with a redemption date after five or 10 years. The market convention is for the bonds to be redeemed at these call dates.
The Tier 1 market rallied by about 6 to 7 points, but has since given up some of these gains as a few doubts have crept in about the likelihood of a raft of quick redemptions at premiums to the bonds' par values.
Some banks will need to keep hold of existing Tier 1 bonds while they still qualify as capital to help maintain their capital ratios.
"For all the optimism that investors would get taken out quickly at a premium, it could actually be a slow process," said Gary Jenkins, head of fixed-income research at Evolution Securities.
"It's expensive debt for banks," he said, referring to the higher coupons banks have to offer fixed-income investors for taking on the extra risk that hybrid bonds pose.
"But while it makes a contribution to capital, it could be best left where it is," he said. "It's not all going to be bought back tomorrow."
In a note to investors, Jenkins highlighted as an example an Upper Tier 2 bond issue from Santander's (SAN.MC) Abbey unit, which will not be redeemed at its first call date at the end of this month.
"You'll find some Tier 1 bonds with call dates prior to 2013 may not get called (redeemed) at first call," said Roger Doig, credit analyst at Schroders.
He said banks would be under pressure to boost equity capital via retained earnings under the new Basel regulations.
"So if they have some Tier 1s, they are likely to want to leave them outstanding as long as they can to give them time to boost equity via retained earnings, which is preferable to doing rights issues."
There are about 24 billion euros of Tier 1 bonds with redemptions coming up for European banks in 2010 and 2011, according to data from Bank of America Merrill Lynch. (Editing by Will Waterman)