* Bank hybrids rally on hopes for mass redemptions
* Some banks may cling to hybrids while they boost capital
By Jane Merriman
LONDON, Sept 17 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
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
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
"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
"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
"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
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)