Value Investors Club / MALAGA FINANCIAL CORP (MLGF)

Description

Malaga Bank (MLGF)

Price: 22.35

Shares: 6,041,950

Market Cap: $135m

Tangible Book: $106m

What this idea lacks in sizzle it makes up for in simplicity. It’s a well-run bank that is growing TBV mid-high single digit

and paying a low single digit dividend with a track record to indicate it can sustain this pace. Banks are a commodity

business, but some do some stuff better than others. Malaga is sustainably not stupid and careful with expenses. They

have an above average deposit base that funds an average loan book. Their underwriting and cost management has

been fantastic. It currently trades at 1.27x TBV with a 3.5% yield and 12x earnings. With an 11% equity ratio, a high cost

piece of debt in its capital structure, and generally rough interest rate environment to operate in, Malaga trades at a

discount to its normalized ROE potential. Malaga should continue to grow BVPS+Dividends at a double digit rate over

the next 5 years and could be taken out at a premium price to tangible book multiple, resulting in a mid teens CAGR on

an investment at today’s prices.

Malaga Bank is a LA Metro Area lender with a branch network in Rancho Palos Verdes, which is something of an island of

calm at the southwest tip of LA. The area isn’t densely populated and is mostly single family homes, with commercial

developments restricted to a few clusters. Malaga is the dominant local banking option and competes with Wells, BofA,

Citi, OneWest, and Union Bank, all of which are significantly larger but not involved in the community.

One element of Malaga’s lower costs is their larger average deposit size from local affluent residents ($163k and $118k

median household income in Palos Verdes Estates and Rancho Palos Verdes vs. $50k in Los Angeles). Deposit growth

has been quite strong in recent years without a lot of branch expansion. This has also lessened the banks reliance on

FHLB funding, which will have a positive impact on NIMs in coming years. Historically management found it cheaper and

easier to use FHLB loans to finance their bank but have tried to increase the mix of deposits over the past 10 years.

Within the past 5 years they have also switched their deposit base to move savings accounts instead of time deposits.

As the CEO and board get older – several in their 60-70s – they probably realize an exit through acquisition is the best

option and having an attractive deposit mix will increase their proceeds from it.

There is a $96m low cost deposit from the state of California on the balance sheet. This is a state program, but even a

bank as large as HSBC was using it until California decided to end that relationship

(http://blogs.wsj.com/moneybeat/2015/05/20/california-drops-hsbc-from-deposit-program/). California has had

deposits at Malaga since inception. I interpret this as part the state government needing to put its money somewhere

and part back door subsidy for California banks.

The loan book primarily target multifamily housing (75% of loan book). They look to lend at 50-55% LTV and the max is

70%. Their goal is to be competitive on price but not sacrifice anything on underwriting. NPLS/Loans peaked a 0.23% in

2009 and reserves/NPLs remained above 100% every year. Cumulative net charges off for the past 10 years are a

rounding error. Almost the entire loan book matures in less than 5 years, so there shouldn’t be a massive hit if/when

rates rise. While the LA rental market is currently robust due to supply/demand fundamentals – highest % of renters in

US and constrained land supply – there are graveyards filled to the brim with banks that made suicidal underwriting

decisions in Southern California the past 30 years, so I wouldn’t discount management’s role in producing such a sterling

underwriting track record. The CEO has been at the helm 14 years and the BoD is the original board that founded the

bank in 1985. There is a long demonstrable track record of underwriting excellence and the people responsible for it

remain involved. It's current ROE isn't a reflection of earning higher interest rates today at the expense of credit quality down the line, which is why despite not having a birds eye valuation difference from some high ROE peers, it remains more attractive than them on a through the cycle basis.

The bank has effectively leveraged its cost base with a very consistent 35% efficiency ratio, which is industry leading –

peer average is 76%. The other way of looking at costs is expenses as a % of assets, which are about 1.2% compared to

3% for peers. This is possible by focusing on the existing branch network and primarily MFH lending –both of which

result in a high ticket per transaction. The bank has kept noninterest expense relatively flat the past 5 years, which is

impressive considering the general fixed cost inflation many businesses faces, let alone banks with a shifting regulatory

and IT landscape. I attribute this to the owner-operator mentality of the CEO and the board as well as the bank limiting

its involvement to a select number of business lines.

The bank issued a $10m 9.25% bond in 2009 to members of the board of directors that is due at the end of 2016. While

not the best appearance, they could have just as well taken the opportunity to increase their stakes in the bank by

issuing shares at depressed prices. The bank can repay this with internally generated capital and will save $600k/yr

aftertax if they repay it using equity or $520k/yr with 1% deposits.

In sum:

- Strong expense management

- Strong underwriting

- Earnings growth from lowering their cost of funding from both reducing FHLB borrowing and repaying high cost

debt

- Potential acquisition target

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

None

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			2015	2016
Price:	22.48	EPS	0	0
Shares Out. (in M):	6	P/E	12	0
Market Cap (in $M):	135	P/FCF	0	0
Net Debt (in $M):	0	EBIT	0	0
TEV (in $M):	0	TEV/EBIT	0	0