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Jefferies Ventures Into Munis With Depfa Buy

Following a crippling year for many of the top municipal bond firms, Jefferies Group Inc. - a mid-tier investment bank with no muni operations - is venturing into the fragmented public finance market.

The New York-based brokerage announced Friday it agreed to buy Depfa First Albany Securities LLC from Depfa Bank PLC. The price was not disclosed.

Depfa First Albany was ranked as both the 17th-biggest managing underwriter and financial adviser for public finance deals last year, according to Thomson Reuters.

The foray of a middle-market bank into munis reflects a significant reshaping of the market over the past year.

Of the 10 top managing underwriters in 2007, one closed its muni business, one went bankrupt, and one was sold off in a government-sanctioned shotgun wedding. Most took government bailout money.

Jefferies, which has largely sidestepped the credit crisis, saw the acquisition as a chance to enter the municipal market "in a comprehensive and high-quality way," Richard B. Handler, chief executive officer of Jefferies, said in a statement.

With 10 offices in the U.S. and about 75 public finance professionals, Depfa First Albany runs three muni businesses: investment banking, sales and trading, and research. The company has participated in $235 billion in underwritings over the last five years.

"We are pleased to integrate this established public finance team into Jefferies' fixed-income department, which now totals nearly 250 professionals," Handler said.

The companies expect the sale to close by the end of the first quarter, subject to regulatory approval in the U.S. and Europe.

Matt Fabian, managing director at Municipal Market Advisors, said the market is much more attractive for smaller firms than it was at the beginning of last year.

Until recently, muni trading was a "homogenous" business, Fabian said. With the value of insurance unquestioned and differences in prices between high- and low-grade bonds or short-term and long-term bonds negligible, trading munis was best left to big, bulge-bracket firms.

Because prices were homogenous, profitable trading came from scale - high volume at tight spreads. Now that prices are more volatile and "heterogenous," regional dealers and traders can specialize and trade based not on scale but better understanding and bond-by-bond evaluations, according to Fabian.

"It's an ongoing evolution away from the major market-makers to smaller broker-dealers," he said. "Several of the regional dealers have expanded their presence, expanded the assets they've put to work."

Lucien B. Calhoun, president of Calhoun Baker Inc., a public finance adviser in Flourtown, Pa., echoed Fabian's belief in the emergence of smaller players in the market.

Public finance is a steady, lucrative business, he said, and companies will always be willing to participate.

"What you'll see is the regional players will become more prominent," Calhoun said. "In investment banking, where the large firms have been incinerating themselves, regional firms and new firms will emerge to fill the niches that they've vacated."

Kenneth D. Gibbs, chief executive officer of Depfa First Albany, will be president of the municipal securities division at Jefferies. Neil Flanagan, managing director at Depfa, will be managing director and head of public finance at Jefferies. Alan S. Greco, head of sales and trading, will retain that title.

Hypo AG, parent of Depfa Bank, announced late last year it planned to restructure its business - drastically reducing headcount - to focus on real estate and public sector finance through "Pfandbrief" lending, a form of covered bond.

The German government last fall stepped in to support Hypo because of problems at Depfa Bank, which relied on a short-term borrowing to support a long-term balance sheet, a strategy that is no longer "sustainable," according to Hypo officials.

Since that time, Depfa First Albany continued to operate insulated from the parents' problems. It served as the senior underwriter on 62 issues with a par value of $3.33 billion in 2008, ranking 17th, compared to the $1.54 billion it underwrote in 2007 on 57 deals, which ranked 33d, according to Thomson Reuters.

The firm also has a financial advisory business that ranked 17th nationwide last year, working on 37 issues with a par value of $3.27 billion.

Depfa First Albany also increased the size of its remarketing book to approximately $7 billion from $2 billion, in part thanks to picking up $3 billion of UBS Securities LLC's book.

Like many other investment banks that lacked exposure to the structured finance products and complex derivatives that have led to billions in losses at Wall Street's - and the muni market's - biggest firms, Depfa First Albany sees opportunities in the current market to expand.

When the municipals group moved to Depfa from First Albany in 2007 it encompassed 65 professionals split between bankers, salesmen.

The new hires in the interim include Flanagan, who joined in August to run Depfa First Albany's public finance department after leaving Bear, Stearns & Co., where he had worked since 1990.

Flanagan recently said he was drawn to Depfa First Albany because of qualities such as a strong institutional sales desk, cohesive staff, and its core focus of helping public-sector entities meet their financing needs.

Among other goals, First Albany wants to build on its existing framework to increase its underwriting business. Executives say it will benefit from bringing its entire group, rather than just parts of it, over to Jefferies.

"We are a franchise that is of the municipal business. We like this business, we are part of this business," Gibbs said. "We are a client-focused franchise and we see great opportunities for client-focused people in the environment going forward."

Flanagan added that he is "very enthusiastic about the business. We look forward to hiring more individuals to join our talented group and further grow our business."

Jefferies, a full-service investment bank that focuses on growing and mid-sized companies, has benefited as a middle-market investment bank without many of the credit exposures that have doomed larger rivals.

It is not immune to the global credit crisis - the firm lost $538.8 million last year and saw revenue fall nearly 35% - but its large extraordinary expenses last year came from the exceptional compensation charge of expensing prior years' employee stock awards and not large write-downs.

Jefferies last year cut its staff to 2,214 from 2,555, but has also added in certain areas as other firms have laid off professionals. It has, for instance, used the crisis to beef up its international equities and mortgage-backed securities trading departments.

Jefferies ranked third as a financial adviser on U.S. merger and acquisitions transactions under $100 million in 2008, working on 20 deals with a par value of $1.02 billion, according to Thomson Reuters. It ranked 14th as a U.S. underwriter on equity transactions, working on nine deals with a par value of $741.8 million.

Depfa was one of a number of European institutions to get involved in the U.S. public finance market in recent years. After building its own U.S. public finance businesses it purchased the municipal business of First Albany Capital Inc. in 2007 to form the broker-dealer Depfa First Albany Securities. Hypo agreed to purchase Depfa Bank just a few months after the First Albany transaction was announced.

Depfa is not the only company that looked to sell its municipal division last year. UBS Securities closed its municipal business in June after it failed to find a buyer for its group.

Amy B. Resnick contributed to this story.

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