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Ackman Loses Against Banks' Bondholders

While hedge fund manager Bill Ackman intensifies his proxy fight against Target to change the makeup of the retailer's board, the head of Pershing Square Capital Management has already lost an inning against banks' bondholders.

According to Reuters blogger Felix Salmon, Ackman has backed himself into a corner with Target. Salmon wrote this morning that Ackman, when setting up his Target fund in 2007, had all the best intentions, hoping to maximize results through financial engineering. But times have changed: "Today, talk of spin-offs and lease-backs is extremely unfashionable: we're living in a back-to-basics business culture, and that's no bad thing. [...] So we get mission creep: Ackman is now targeting the board, rather than management, for reasons which are increasingly vague."

Or maybe Ackman is just trying to divert attention from his so-far failed attempt to have banks' bondholders foot the bill for the recent stress tests' capital requirements. Indeed, results of government's stress tests on the 19 largest banks and responses they've provoked have also proven him wrong. Late last month Ackman went on a media frenzy, including an appearance on Charlie Rose, saying that to raise capital banks will have to ask bondholders to exchange debt for equity. Such an exchange would not only result in high losses for bondholders, but also in sinking the banks' stocks, providing, conveniently, a nice return for Ackman, who's been bearish on bank stocks.

For now, banks seem to have chosen a different path than the one predicted, or at least pushed, by Ackman. A number of them, including Bank of America, Citigroup and Fifth Third, will restructure existing capital, but mostly by exchanging preferred stock (not senior or subordinated debt) into common stock. Other alternatives include selling stock -- favored by Morgan Stanley and Wells Fargo -- or selling businesses, as Bank of America is likely to do.

What's more, stress tests may have actually been a boon for bondholders, according to a credit research note written by Barclays Capital, but not available online. "We believe the stress test was beneficial for bondholders for two reasons: 1) it demonstrated that the banks can withstand significant loan losses over a two-year period; and 2) it will result in the addition of capital," wrote Jonathan Glionna and Miguel Crivelli, both analysts at Barclays.

Additional capital, especially stock, is important for bondholders because it adds subordination, or cushion, to support their debt. There's one little wrinkle, however, noted by Barlcays: it will only works with new capital, which will represent about $30 billion of the required $75 billion. The other $45 billion of common equity needed is coming from internal sources, such as converting preferred stock to common, which won't increase the capital beneath senior or subordinated debt.

Still, at this point in the game, bondholders seem to be winning their most recent match with Ackman.

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