Gerhard Bruckermann

“When I arrived, Depfa wasn’t just German,” says Gerhard Bruckermann. “It was ultra-German. This was 13 years ago, just after privatization, and nobody thought about profitability.”

How times change. Last year, Depfa increased group net income by 57% to €370 million. Its return on equity was 29%. And Depfa today is at the very least a European bank. Of its staff, the largest single group by nationality are the Irish. The Germans are in second place.

Now Bruckermann is leading Depfa on the next leg of its internationalization as it takes on the US.

Depfa argues that going to America is a logical extension of the bank’s core business of public sector and infrastructure lending. Its public sector lending grew by €10 billion last year. This included an increase in German public-sector business for the first time in several years.

“Going into the US last year was a continuation of our policy but it captured a little more limelight because the US is such a big market,” says Bruckermann. “And it is structured differently from the rest of the world.”

The US bond market is dominated by tax-exempt municipal bonds. The cornerstone of Depfa’s US strategy is to provide credit enhancement for those municipal bonds. It hopes to get its insurance licence – only insurers can guarantee bonds in the US – and be in business by mid-2004.

Depfa is counting on opportunities for new entrants in the American bond enhancement business. While levels of public debt explode in the US and municipalities pre-pay their old debt and issue new bonds at lower interest rates, there is a limit to how much cash investors can put into tax-exempt munis. So issuance of taxable munis is growing. Therefore investors are looking at issuers’ credit quality and back-up, not just buying municipal bonds for their tax advantages.

The domestic US players are the monoline insurers. But they are hitting regulatory limits on the amount of bonds they can guarantee. And Depfa has two planks to its US strategy. As well as guaranteeing municipal bonds, it wants to provide liquidity to issuers.

“The US insurers cannot provide for the timeliness of payment,” says Bruckermann. “That’s a big issue. Liquidity facilities are in short supply for municipal authorities in the US, and the rating agencies want liquidity supplied by banks with at least an AA rating.”

And last year, the bank was co-lead arranger of a $400 million loan for the SR 125 South Toll Road in California.

Depfa now needs to get its name known across the US among local authorities and their financial advisers, especially the local or regional banks that underwrite tax-exempt munis and tender out the related credit enhancement work. The bank has a team of 20 in the US and could double its numbers by the end of 2004 if the more labour intensive insurance business takes off.

At the end of 2003, Depfa’s US exposure stood at e6 billion. The bank has said that it envisages adding $14 billion of new US business in 2004.

Its US ambition has already had an impact on its European operations. On March 1, it announced that it was putting its German public-sector loans business, Deutsche Pfandbriefbank, up for sale. Bruckermann is optimistic that a sale will go through by the end of September.

“A number of very well regarded institutions are looking,” he says. “They see the potential. By the end of May or early June, I’d like to narrow down the number of institutions we’re talking to. Some interested parties are already talking about exclusivity.”

Deutsche Pfandbriefbank soaks up around 45% of Depfa Group’s regulatory equity. To pass on its US bond insurance exposure to reinsurance companies, the bank needs to create an AAA-rated insurance company in the US. That means allocating enough equity to keep the rating agencies happy.

And US infrastructure loans are 100% risk-weighted, so they eat equity. But Bruckermann says that Depfa has to do infrastructure lending if it wants to cover the US regional and local government sector properly. Selling Deutsche Pfandbriefbank should enable Depfa to keep its return on equity target of 20% after tax.

The sale, which doesn’t include Deutsche Pfandbriefbank’s Tokyo branch, involves disposing of roughly half of Depfa Group’s assets. It also lets Depfa move shareholders’ equity out of the high-tax German environment and into the low-tax US environment. After the sale, Bruckermann will, he says, be Depfa’s longest-serving employee.

Depfa isn’t the first European to tackle the US credit enhancement market. CDC IXIS’s financial guarantee business has been a slow starter in the US, with local insurers complaining that a state-owned business could compete with them unfairly.

But Bruckermann says that the signs for Depfa are good so far. “How do you test acceptance? You look at the secondary market performance of the bonds that you have guaranteed,” he says. “This is measured in detail in the US and it determines the value of your credit enhancement product. And the bonds that have our liquidity facility are doing well.”

Bruckermann is also adamant that Depfa is still committed to Germany.

“In the past, the German public-sector finance market has been commoditized,” he says. “The arch-product has been the Schuldschein – a one-page tradable loan, contracted over the phone. And the municipalities got most of their funding from their local savings banks. Now it is becoming more differentiated and complex, we’re starting to cover it again.”

Away from the bank, Bruckermann, 56, tries to find time to visit his farm in Andalusia. “It’s very remote and beautiful, in the mountains,” he says. “I’ve just started a nursery to try to help reforestation.” Some time soon, Bruckermann will find out if Depfa can take root in the US.