Multifamily loan concentration is no weakness, this bank says

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Malaga Financial in Palos Verdes Estates, Calif., is comfortable being contrarian.

At a time when many community banks are determined to diversify their loan portfolios to avoid concentrations, the $1.2 billion-asset Malaga is sticking to a business model that focuses heavily on multifamily lending. Those loans, which largely involve low- and moderate-income properties, made up nearly 85% of Malaga's $1 billion portfolio on June 30.

While Randy Bowers, Malaga's chairman, president and CEO, said he is open to other loan categories, including mortgage banking, he has yet to find anything he feels passionate about.

It thinks about new business lines "periodically,” Bowers said. “We haven’t seen anything attractive enough."

Highly concentrated business models like Malaga's have become atypical in the banking industry.

In recent years, regulators have sought to limit banks’ exposure to commercial real estate, including multifamily lending, though they have been willing to make concessions for lenders that demonstrate a strong track record. In December, they lifted a key concentration limit for New York Community Bancorp in Westbury that had limited the $53 billion-asset company’s portfolio of multifamily and CRE loans to 850% of total risk-based capital.

Malaga, which regularly fields questions from its regulators, has "been able to get them to understand our model and appreciate what we do," Bowers said. "They don’t give us a pass, by any means, but we’ve worked well with them.”

A big challenge for Malaga is low-cost funding at a time when banks are putting a greater emphasis on liquidity.

Total loans at the company rose by 18% in the four-year period that ended June 30, outpacing 2% deposit growth over that time, based on data from the Federal Deposit Insurance Corp. As a result, Malaga's loan-to-deposit ratio has increased from 117% to 135%.

The company makes up the difference with wholesale funding.

“The third quarter continued to be challenging" for gathering deposits, Bowers said. "Competition for deposits intensified while rates on loan originations continued to decline."

Multifamily lenders face hurdles tying deposits to their loans, said Bryan Shaffer, a principal and managing director at George Smith Partners, a Los Angeles real estate capital advisory firm.

Because rents at buildings in Malaga's portfolio are paid mostly by check or money order, "owners feel more comfortable a lot of the time having their property managers deposit them in a bank they can walk to," he said. More often than not, that leaves Malaga, with a small branch network, out of the picture.

Even where lenders can attract the deposit account, they aren't especially lucrative, since property owners also use them to pay investors and operating expenses, Shaffer said.

Bowers' commitment to multifamily projects also comes at a time when that sector faces challenges from a new state law limiting annual rent increases to 5%, plus the local inflation rate. California’s voters rejected an even tougher rent-control measure last fall.

The law has created uncertainty over investor appetite for multifamily development, said Tom Bannon, CEO of the California Apartments Association.

“There’s a cloud now over whether people will invest in rental housing,” Bannon said. “The only way you’re going to remove that cloud is if in fact California, the state legislature and city councils make a decision that new housing is a priority. And currently, it’s not.”

Bowers, for his part, said Malaga is equipped to handle statewide rent controls, noting that tough restrictions were already in place in several Los Angeles-area jurisdictions. He said rent control could benefit lenders by keeping overall rents in check.

Shaffer agreed, noting that higher rents at new buildings, which aren't covered by either state or local rent control laws, are pushing people to older, rent-controlled buildings where costs are lower. As a result their occupancy rates are in the 95% to 100% range.

New York Community expressed similar confidence in July, after New York enacted a rent control law with similar restrictions. In a recent investor presentation, the company characterized its $30 billion-asset multifamily portfolio as being “well insulated against the recent changes in the rent regulation laws.”

A plus for Malaga has been credit quality.

The company had one loan — totaling $321,000 — that was delinquent 90 days or more on Sept. 30.

Bowers attributes that to Malaga's ability to "pick and choose” the best deals. The bottom-line results have been substantial. Malaga reported net income totaling $11.1 million for the first nine months of 2019 on top of $15.4 million in 2018. Annualized return on assets through Sept. 30 is 1.30%

Bower's biggest concern is increased competition for those deals, fueled by a decision by Fannie Mae and Freddie Mac to increase multifamily loan purchases. The number of lenders competing for multifamily deals in Malaga’s market has jumped from about a dozen a few years ago to roughly 40 today, he said.

“A lot [of lenders] have seen this is a good asset class and have jumped in,” he said.

It's not just the increase in the number of competitors, Shaffer said. Malaga could also be impacted if one of the market heavyweights, like JPMorgan Chase, decides it wants a piece of the smaller loans that make up Malaga's bread and butter.

Even so, Malaga isn’t planning to adjust its strategy or enter new markets.

“We’re not going to allow the competition to sway us,” Bowers said. "And I don’t see how you can be familiar with [other markets] from a base in California."

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Community banks Multifamily Law and regulation California