Flagstar Financial and the New York City Multifamily Meltdown

June 25, 2025 | In this issue of The Institutional Risk Analyst, we return to Flagstar Financial Inc. (FLG) to see how the $95 billion asset bank is fairing after a near-death event in 2024. The bank f/k/a New York Community Bank nearly collapsed in early March last year, when its stock plummeted and the bank required a $1 billion emergency equity infusion by a group of veteran bankers led by former Treasury Secretary Steve Mnuchin to stay afloat. We owned Flagstar prior to the December 2022 merger with NYCB but do not have a position in the stock today.

The crisis at FLG was triggered by a combination of factors, including concerns about its commercial real estate (CRE) portfolio, particularly its exposure to New York City rent-regulated multifamily properties, and a "material weakness" in its loan review process. In effect, NYCB got no credit for the addition of the national mortgage business of Flagstar. Since that time, the management team led by Chairman, President, and Chief Executive Officer, Joseph M. Otting has sold assets and businesses to finance the remediation of its toxic multifamily book.

We’ve written extensively about the bank in previous issues of The IRA (“NYCB Cleans House Badly, NAIC Gives Insurers Pass on Realized Losses,”), so today we are going to focus on the bank’s latest results and outlook for 2025.  In order to survive, FLG has sold a lot of valuable businesses, including mortgage warehouse, servicing and third-party origination, which represented the future of the bank (“Profile: NYCB + Flagstar Bancorp”). What’s left is essentially a restructuring/liquidation exercise that continues to consume cash and shareholder value as the bank slowly shrinks.

As we noted in our last comment, loan demand across the US banking industry is weak and pricing for commercial loans is falling. In this market, FLG is seeking to grow its C&I book and also create a new private banking business, which is one of the most competitive areas of banking today. Like many institutions that are working out a difficult loan portfolio, each quarter brings new expenses that are an unpleasant surprise for suffering shareholders. CEO Otting commented in the Q1 2025 earnings call:

“First quarter 2025 results included two notable items. These items include $6 million in lease cost acceleration related to our previously announced branch closures and $5 million in trailing costs related to the sale of our mortgage servicing/sub-servicing and third-party origination business during the fourth quarter of last year. In addition, the Company also incurred $8 million of merger related expenses during the quarter. As adjusted for these items, the net loss for first quarter 2025 was $86 million and the net loss attributable to common stockholders was $94 million or $0.23 per diluted share.”

In simple terms, FLG is not making money and does not seem to have any immediate prospects to pull itself out of a slow downward spiral of balance sheet shrinkage and operating losses.  Whereas before 2024, FLG was a peer performer in most respects, today the bank’s financial performance is significantly below-peer, the bottom quartile in many cases. The net-interest income for FLG was just 1.69% of average assets vs 2.9% average for Peer Group 1, this owing to low yields and high funding costs, as shown in the table below.

Source: FFIEC

Tier-one leverage for FLG was 8.45% in Q1 vs an average of 9.9% for Peer Group 1. But of more concern is the continued dependence on non-core funding sources to support the balance sheet. You might think that the use of hot money to support the FLG balance sheet is a recent development, but in fact the old NYCB made extensive use of non-core funding to support growth.

Tragically, FLG was forced to sell the profitable national residential lending and servicing business, which generated significant low-risk liquidity for the bank. The comments by CEO Otting about the "risky" nature of the Flagstar residential mortgage business are just plain wrong, but you can understand the need for obfuscation by the former OCC chief. Notice that noncore funding dependence is slowly falling, but remains well above peer levels.

Source: FFIEC

The pre-Flagstar NYCB business model worked OK when credit loss rates were low. Indeed, lending on multifamily assets using hot money worked for decades for NYCB and other NYC lenders, when mortgages on apartment properties were considered prime assets. In the age of progressive socialism in states such as New York where FLG is based, however, multifamily assets are now assumed to be impaired by astute underwriters. Should Zohran Mamdani, an opely socialist state lawmaker, wins the New York City Mayor’s race, the value of NYC multifamily assets will likely sink, directly impacting FLG’s multifamily portfolio. 

Whether located in New York, Chicago or Los Angeles, local politicians of all persuasions have little ability to address persistent inflation. The cost of operating multifamily residential assets in New York is only ever rising, thus when the state legislature tries to limit rent increases to “help” consumers, all they are doing is hurting consumers by limiting the supply of housing. These policies also hurt banks like FLG and other lenders in New York City and its environs by reducing the value of assets and discouraging new loans on rent-controlled properties. 

The scale of the progressive value destruction in New York is truly massive. New York City multifamily real estate prices have experienced a significant decline since 2019, with some reports indicating a drop of up to 67% for rent-regulated buildings. This decline is attributed to a combination of factors, including the 2019 Housing Stability and Tenant Protection Act (HSTPA), rising interest rates, and increased operating costs.

Since the New York State legislature passed the 2019 rent control law, the supply of rental apartments in New York City has fallen as landlords take older, unrenovated units off the market. New York City Housing Authority (NYCHA)'s portfolio reportedly has more than 5,000 empty apartments, a number that has increased recently due to the staggering cost of operating over 500,000 city owned rental properties.

Today the City of New York is one of the world’s largest slum lords. With NYCHA tenants paying below the cost of operating the buildings, this means that the half million NYC owned properties are poorly maintained and have little value in the private market. Figure annual operating costs for a private landlord are around $3,500 per month per unit. Rent for a studio in a NYCHA property might average around $1,149 per month, while a two-bedroom could be around $1,391, according to NYC.gov. The average private market rental for a one-bedroom apartment in New York City is around $5,273, according to Rent.com.

Since the success of the new business model at FLG requires a reduction in the bank’s exposure to multifamily properties, and since many of these properties are impaired due to the toxic combination of inflation and socialist politics, it seems reasonable to ask whether Otting and his team will be successful. Timing is important here, since the delinquency rate for both residential and commercial properties is on the rise and banks are employing increased forbearance to conceal nonperforming assets. CFO Lee Smith stated on the Q1 2025 earnings call:

"We continue to see significant par payoffs in our commercial real-estate portfolio and we closed on the two nonaccrual loan sales that had been moved to available-for-sale during the fourth quarter with a combined book value of $290 million, resulting in a small gain of $9 million on these loan sales. We will continue to explore all options as it relates to reducing our multifamily and commercial real-estate portfolios and non-performing loans and will execute on what is in the best economic interest of the bank."

While FLG has made some signifiant progress on reducing its multifamily credit exposures, the overall size of the non-performing loan book is growing as the bank shrinks, never a good sign. Also, the new business model targeted by Otting and the FLG management team is not very compelling in terms of growth in assets or earnings. From $123 billion in assets in December 2022 when NYCB acquired Flagstar, the bank is down to $95 billion at Q1 2025.

Flagstar Financial FLG | Q1 2025

Source: FDIC/BankRegData

The combination of NYCB and the legacy Flagstar Bank business might have survived after the 2019 rent control legislation, but the addition of some of the assets of Signature Bank added to the complexity of the institution and lowered the odds of success in our view. The reports of new loan originations are great, for example, but FLG's gross yield on its loan book is 5.1% or a point below the average yield for Peer Group 1. Interest expense is a point higher than the average for Peer Group 1. Do the math. The components of FLG's funding are shown in the chart below from BankRegData.

Flagstar Financial FLG | Q1 2025

Source: FDIC/BankRegData

Yet leaving aside asset quality problems and funding mix, the real question is why federal and New York State regulaltors allowed the undermanaged NYCB to acquire any other bank in the first place. NYCB's management team, let's recall, were largely a bunch of New York real estate pros who thought they were a "commercial lender." In fact, NYCB grew up in the very political business of financing multifamily rental housing in New York City when asset values were rising every year. Duh. But no more. Better Markets summed up the situation in March 2024:

"NYC Bancorp is the holding company for Flagstar Bank (“Flagstar”) and the former New York Community Bank (“NYCB”) as well as Signature Bank. After trying and failing to get FDIC and Fed approval, NYC Bancorp shopped for a more friendly regulator, the OCC, which resulted in Flagstar’s acquisition of NYCB on December 1, 2022. The result of this regulatory arbitrage was Flagstar ballooned from $25 billion in assets to $90 billion in assets. With the ink barely dry on that merger, the banking regulators—just 100 or so days later—approved Flagstar’s acquisition of Signature Bank, causing its total assets to jump to $123 billion."

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