Blaming rates, Flagstar says turnaround will take more time

• Key insight: Flagstar Bank said the completion of its strategic overhaul will be achieved in 2028, not 2027 as previously planned, due to the impacts of higher interest rates and inflationary pressure.
  
• What's at stake: The New York-based regional bank, which nearly collapsed in 2024, said deposit growth will be a key factor in the success of its efforts to diversify its balance sheet.

Flagstar Bank's multiyear turnaround will take longer than expected, executives warned Friday, as the Long Island-based regional bank deals with the impact of higher interest rates and inflation.

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Instead of achieving its long-stated financial targets next year, Flagstar now expects to reach those goals in 2028. It drastically reduced its net income outlook for full-year 2026 and full-year 2027, hiking the amount it expects to set aside for loan losses in each of those years. It's also halting share buybacks for now, with an expectation of resuming them sometime in 2027.

It wasn't the news that investors were hoping to hear. Flagstar's stock was down more than 9% by mid-afternoon. 

Flagstar has been in turnaround mode for nearly three years, ever since it nearly collapsed in early 2024 after disclosing troubles in its commercial real estate portfolio. Flagstar's latest outlook marks its third consecutive quarter of downward guidance revisions, but Friday's changes were by far the largest.

The $87.4 billion-asset bank is now calling for net income of $85 million to $95 million for all of 2026, down from $225 million to $300 million it predicted in July. Its forecast for 2027 net income — $400 million to $500 million — was cut nearly in half from $800 million to $900 million.

Provisions for loan losses are now expected to be $160 million to $170 million for full-year 2026, an increase from the July guide of $90 million to $140 million. In 2027, provisions should be in the range of $175 million to $225 million, up from the $100 million to $150 million the company forecast earlier.

"We remain committed to our long-term strategy of transforming Flagstar into a top-performing regional bank," CEO Joseph Otting told analysts during the bank's third-quarter earnings call. "This is a change in timing, not in our strategy nor expectations." 

Flagstar executives tried to focus on the positives. For starters, the bank continues to ramp up its commercial-and-industrial loan portfolio, and much of its outlook for 2027 and 2028 reflects a substantial amount of fixed-asset repricing that will either reset loans at much higher interest rates or result in payoffs, which will provide funding to originate more commercial-and-industrial loans, Chief Financial Officer Lee Smith said.

Some $10.7 billion of Flagstar's commercial real estate loans have floating interest rates, which will benefit the bank as rates rise, he said. The bank's total commercial real estate loan balance was $31.4 billion as of Sept. 30.

A key factor in reaching Flagstar's financial targets will be its ability to grow deposits in a highly competitive environment, Smith said. Rising interest rates are pushing up the industry's deposit costs.

"I don't think there's any question about our ability to generate assets, and then the fixed-asset repricing, that is all mechanical," Smith told analysts. "So, you know, to me, I think the question is, can we deliver on the deposit growth?"

Flagstar thinks it can generate between $800 million and $1 billion of deposits per quarter as it pursues relationship-based banking that requires customers to place deposits with Flagstar in order to get loans.

By expanding its commercial-and-industrial loan book and bringing in the accompanying deposits, Flagstar expects its balance sheet to grow its assets by $1 billion per quarter in 2027 and 2028, reaching about $92.1 billion by the end of 2027 and about $97 billion by the end of 2028.

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Part of Flagstar's overhaul has involved shifting away from its heavy concentration of multifamily housing loans, particularly rent-regulated multifamily loans in New York City.
Higher interest rates and inflation have strained the portfolio, increasing capitalization rates on rent-regulated buildings and raising operating expenses at a time when rents have been frozen, Smith said.

As of Sept. 30, the New York multifamily portfolio totaled $12.9 billion, down 4% from the second quarter. The rent-regulated portion of the portfolio was $8.1 billion, also down 4% sequentially.

As for whether Flagstar would ever sell parts of its rent-regulated book, Otting said maybe, but in the meantime it has a team in place dedicated to resolving problematic loans in that book.

"I mean, we … obviously monitor the market closely and, you know, if there was an opportunistic opportunity to sell some of that, we would," Otting said on the call. "But I would say we have … currently nothing on the table to do that."