Morningstar DBRS Confirms Flagstar Financial, Inc.'s Long-Term Issuer Rating at BBB (low), Stable Trend

DBRS, Inc. (Morningstar DBRS) confirmed Flagstar Financial, Inc.'s (Flagstar or the Company) credit ratings, including the Company's Long-Term Issuer Rating at BBB (low) and Short-Term Issuer Rating at R-2 (middle). Morningstar DBRS also confirmed the long-term credit ratings of Flagstar's primary banking subsidiary, Flagstar Bank, N.A. (the Bank), at BBB and its short-term credit ratings at R-2 (high). The trend for all credit ratings is Stable. The Bank's Intrinsic Assessment (IA) is BBB, while its Support Assessment remains SA1. The Company's Support Assessment is SA3 and its Long-Term Issuer Rating is positioned one notch below the Bank's IA.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations and Stable trends reflect Morningstar DBRS' expectation that Flagstar is on track to continue to execute on its transformation and to return to profitability this year. However, earnings will likely remain pressured over the near term as the Company continues its transformation into a more diversified regional banking company. The last year was a period of transition for Flagstar following the sizable capital infusion in March 2024 from high-profile and experienced investors and a number of key management changes. The Company has also built on balance sheet liquidity and reduced the level of uninsured deposits. All these changes helped to restore confidence in the Company.

Management completed an in-depth review of Flagstar's commercial real estate (CRE) loan portfolio, resulting in a significant increase in nonaccrual loans and classified assets as well as an appropriate increase in the allowance for credit losses. This review encompassed the potential adverse effect of headwinds in the form of higher interest rates and higher operating costs, which adversely affected borrowers, and property valuations, including unfavorable rent regulations for some New York property owners. Flagstar is working through problem loans and has reduced its exposure, with efforts under way to further diversify the loan portfolio. To achieve this, the Company has continued to hire experienced commercial bankers.

The Bank's Intrinsic Assessment of BBB has been assigned at the upper end of the Intrinsic Assessment Range. This largely reflects Morningstar DBRS' expectation that profitability metrics will improve in coming quarters versus the outsized losses over the last year.

CREDIT RATING DRIVERS
Morningstar DBRS would upgrade the credit ratings if Flagstar is able to show substantial progress delivering on the Company's initiatives, including reporting consistent profitability in line with higher-rated peers.

Conversely, an inability to execute on the Company's strategic initiatives, including returning to profitability and reducing CRE exposure or operational missteps that negatively affect the franchise strength, would result in a credit rating downgrade.

CREDIT RATING RATIONALE

Franchise Combined Building Block (BB) Assessment: Good/Moderate
Flagstar's franchise is currently a work in progress as it looks to build a more diversified commercial banking company. The Company has added seasoned bankers with expertise in certain verticals to help build out its commercial and industrial lending book as it de-emphasizes its roots in multifamily lending and mortgage banking. Following the capital infusion last year, the Company has added new management as well as refreshed the board of directors. Overall, the Bank operates 418 branches in 11 states and has about 80 private client banking teams with offices in 10 cities.

Earnings Combined Building Block (BB) Assessment: Weak/Very Weak
Flagstar continues to be loss-making as it works on its transition plan and has substantially built reserves against its loan portfolio. Additionally, heightened levels of on balance sheet liquidity have also hampered the return to profitability. Positively, losses have been declining and the Company is expected to return to profitability in a few quarters as loan loss provisioning needs normalize and other efforts to return the Company to profitability, including reducing expenses, take hold.

Risk Combined Building Block (BB) Assessment: Weak
Flagstar's has a high exposure to CRE and multifamily loans, which it is working to reduce. As part of the review of the loan portfolio, the Company increased its reserve levels. Morningstar DBRS notes that, while nonaccrual loans are now elevated, more than half are still performing. Net charge-offs have also increased, but the Company has been able to significantly reduce its exposure to office loans and multifamily loans, with a number of loans repaid at par.

Funding and Liquidity Combined Building Block (BB) Assessment: Good/Moderate
The Company has focused on improving liquidity and reducing reliance on wholesale borrowings. Positively, Flagstar has also been able to grow deposits while reducing the level of uninsured deposits to 17%. Additionally, on balance sheet liquidity now exceeds the level of uninsured deposits. At YE2024, cash and securities represented 26% of total assets.

Capitalization Combined Building Block (BB) Assessment: Good/Moderate
Flagstar's capital levels are improved significantly following the capital raise and other efforts to increase capital levels. Morningstar DBRS views capital levels as sufficient for the Company to work through this period of transition as it repositions its franchise to become a more diversified commercial banking company. The CET1 ratio was 11.9% at YE2024, up significantly from 9.0% at YE2023.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://dbrs.morningstar.com/research/447599.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Governance (G) Factors
The Governance factor had a relevant effect on the credit analysis:

The Governance factor is relevant to Flagstar's credit ratings and previously affected the credit ratings and trends assigned to the Company. There had been relevant governance failures that could negatively affect the Company's financial wellbeing or reputation. Last year, the Company reported a material weakness in internal controls related to its internal loan review, which is still being remediated. As a result, this factor was previously incorporated into Flagstar's Risk Management and Franchise grid grades.

There were no Environmental or Social factors that had a relevant or significant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) at https://dbrs.morningstar.com/research/437781.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 4, 2024), https://dbrs.morningstar.com/research/433881. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024), https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The primary sources of information used for these credit ratings include Morningstar, Inc. and company documents. Other sources include Morningstar DBRS. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings was of satisfactory quality.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' trends and credit ratings are under regular surveillance.

For more information on this credit or on this industry, visit https://dbrs.morningstar.com.

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