(Bloomberg) — The mood was practically giddy when the heads of two regional banks hosted a town hall in the spring of 2021.

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The industry’s long drought in mergers was ending, and two lenders below the public’s radar, New York Community Bancorp and Flagstar, were poised to become more formidable by joining forces.

“I look at it as a blank page,” NYCB’s Thomas Cangemi said. “I call it a Picasso that we’re going to paint together.”

Three years later, the lender known for catering to New York City landlords is in serious trouble. Last week, it revealed major weaknesses in its ability to monitor risks and replaced Cangemi as CEO with the second fiddle at that town hall, Flagstar’s Sandro DiNello. Investors are worried the new boss will set aside even more money to cover souring loans, on top of a $552 million hit that shocked the market in January. Credit raters have slashed it to junk and its shares have cratered 73% this year.

How NYCB got here is a tale of percolating financial risks, changing rules and shifting regulators. New rent restrictions became law in 2019, but instead of acknowledging a hit to its loan book, the bank got bigger. Back-to-back acquisitions, first Flagstar and then parts of Signature Bank, almost doubled the firm’s size and set it on a collision course with new rules for banks holding more than $100 billion of assets.

The crash came this year. Amid regulatory pressure, NYCB bolstered reserves and shareholders unloaded its stock.

It’s a story with broad implications: Legions of rivals are under pressure to merge so they can afford to make the jump from street-corner branch networks to tech-driven financial services. But it’s a perilous moment for the industry. High interest rates and cracks in commercial real estate are eroding the value of assets on balance sheets. Depositors are able to pull cash faster than ever. Shareholders have learned to dump stocks at the first sign of serious trouble.

Indeed, NYCB was a stock-market darling before it announced plans in late January to horde cash.

“Everything was going well, and all of a sudden — bingo — you have a day like that,” said Michael Manzulli, once the chairman of the bank’s board. “And you go: ‘Wow.’”

Some longtime fans have remained loyal. After the bank bolstered reserves, Mark Hammond, who ran Flagstar through the financial crisis and is the son of its founder, was optimistic enough to snatch up NYCB’s hobbled stock. In an interview last month, he pooh-poohed the “paranoia” about real estate. Then last week’s disclosures sent the stock down an additional 43%.

Spokespeople for the bank didn’t respond to requests for comment. The firm has said that it doesn’t expect the weaknesses in its controls to result in changes to its allowance for credit losses. And commercial real estate veterans say that when loans do sour, lenders have broad latitude to work out solutions with borrowers. In early February, the company said depositors had entrusted more money to the bank this year.

NYCB started off small, before a former teller landed on a big strategy.

Six decades ago, Joseph Ficalora, the grandson of Sicilian immigrants, joined Queens County Savings Bank. Coming back from the Vietnam War, he didn’t take his father’s advice to get a union job in sanitation, instead enrolling in a management training program at the bank. He quickly climbed the ranks. By the time the firm changed its name to New York Community Bank in 2000, he’d already been running the place for years.

Ficarola’s strategy was straightforward. He bought rivals, preserved their identities to appeal to mom-and-pop depositors and loaned their savings to Manhattan real estate investors. His sweet spot was multifamily apartment buildings with rents controlled or stabilized. While tenants could be relied on to stick around and keep cash flowing, many landlords adopted a more lucrative approach, fixing up buildings to take advantage of rules allowing them to raise rents.

By 2004, he had cobbled together seven banks into the third-biggest thrift in the US. As it hit $23 billion of assets, up from $1.9 billion in three years, he could brag about watching 35 rival branches disappear from just one spot in Flushing.

NYCB was just getting started. It bought $11 billion of assets from the failed AmTrust Bank in 2009 and $2.2 billion of deposits from Aurora Bank in 2012. Yet a proposal to get even bigger by buying Astoria Bank fell apart in 2016, with analysts suggesting that regulators may have balked. That year, NYCB rewarded its boss handsomely with unusually lucrative perks.

Around that time, a Queens reporter asked Ficalora about the secret of his success, eliciting a quick answer: “Always be an asset to your boss, never a threat.” But in late 2020, the bank surprised investors by announcing Ficalora would be stepping down just three days later. Cangemi, the longtime chief financial officer, would replace him.

If there was any ill will, it didn’t show in a recent photo: Ficalora, who was named the Associazione Culturale Italiana di New York’s Man of the Year in 2018, stood smiling near his successor when Cangemi got the honor last year.

Cangemi took over a bank facing hurdles. In 2019, New York renters won sweeping new protections that stopped landlords from raising rents on regulated apartments. Owners were outraged, and their banks found themselves under pressure. NYCB’s loan portfolio was almost all mortgages, mostly multifamily, and most of those subject to New York rent rules.

The pandemic triggered more stress. When offices emptied and companies pared their square footage, it spelled yet more trouble for the industry’s bankers.

But the pain didn’t show up right away. Despite predictions that the new rent rules would lead to losses for landlords and their lenders, NYCB’s level of troubled loans hovered near record lows in 2020 and 2021, perhaps helped by rock-bottom interest rates and the government’s pandemic response. Cangemi chalked it up to careful lending — its “unprecedented track record of strong asset quality, which goes back over 50 years.”

One person who worked on risk around that time, asking not to be identified discussing internal operations, said regulators had long harped on the bank’s concentration in multifamily lending. But the response wasn’t always receptive. An executive was so gruff with regulators during a meeting that a colleague held a sidebar with the officials to make sure they weren’t offended, the person said.

The lender has long taken pride in its track record. NYCB has bragged that aside from some ill-fated taxi medallion loans its average losses over the past three decades amount to about 0.04% of its loan book each year, while the figure is almost 20 times higher for rivals in a key index.

Without evident loan losses, Cangemi could focus on the itch to grow. He lamented at the town hall that getting hung up on an earlier transaction had left the firm in “a very difficult spot.”

Things loosened around the end of 2020, when Huntington Bancshares Inc., M&T Bank Corp. and Webster Financial Corp. unveiled plans to swallow rivals.

Cangemi and DiNello soon announced their deal, too. Flagstar was the Midwest’s biggest publicly owned savings bank and one of the country’s largest residential mortgage servicers, but its history wasn’t pretty.

It was founded by Tom Hammond, who’d moved to Detroit from Nebraska with fond memories of hitchhiking to bird havens with his uncased shotgun. He boasted of bagging most of the game available in Alaska, the mountains of Europe and the South Pacific.

Flagstar got bagged, too. The bank was pummeled so badly during the global financial crisis that it was rescued by private equity firm MatlinPatterson Global Advisers. In the years that followed, the bank scrambled to clean up its act.

Flagstar agreed in 2012 to pay $133 million to settle a US lawsuit accusing the bank of submitting false documents to insure ineligible loans. A year later the bank reached a deal to pay $110 million to settle accusations from MBIA Inc. that it falsely represented the quality of loans. A $121.5 million settlement with Fannie Mae followed, and the Consumer Financial Protection Bureau ordered the bank to stop illegally blocking attempts by borrowers to save their homes.

“When I got there, the bank was a train wreck,” said David Wade, who joined in 2013 and left last year as a senior mortgage underwriter. “Things had just gotten so bad.”

But for 2021, DiNello could brag of “exceptionally successful” earnings. Things were so good that Wade and his colleagues didn’t understand the direction of the takeover when it was announced that April. “In fact, initially, a lot of us were thinking this was a Flagstar acquisition, not the other way around,” Wade said. “It was a while before we realized, well, those guys actually have more money than us.”

For years, community groups had pushed the banks and their regulators to support underserved tenants. Then, during the merger talks, something behind the scenes caught the groups’ attention.

In April 2022, the banks announced they’d want to operate under a national bank charter, meaning they’d no longer need to win approval from the Federal Deposit Insurance Corp. The Association for Neighborhood & Housing Development, a nonprofit founded in 1974, was suspicious.

“They were unable to secure the necessary approvals from their regulator at the FDIC, and are now going through another regulator in the hopes that they will be more favorable,” the group wrote to regulators a few months later. “How is NYCB able to do this?”

The Office of the Comptroller of the Currency eventually approved the deal, with a condition: The right to approve dividends through this November.

Once the deal closed, it was quickly followed by another — a partial takeover of rival Signature after its collapse. Both fed NYCB new customers and sticky accounts. The moves also helped ease its reliance on multifamily lending, which fell to 46% in early 2023 from 55% at the end of the year.

Even so, the old headaches in Washington and New York hadn’t disappeared. Investors were trying to measure the impact of $2.7 trillion in commercial real estate loans held by US banks as values tumbled and borrowers stared down sky-high interest rates.

And the takeovers had catapulted NYCB’s assets past $100 billion, triggering more rigorous regulation. Federal watchdogs taking a look could see that the bank’s new peers had more capital and deeper reserves for souring losses. Its top risk and audit executives exited their posts quietly.

Read More: NYCB’s Talks With Watchdog Led to Moves That Rocked Market

NYCB shocked shareholders and analysts with a one-two punch on Jan. 31. Its provision for loan losses jumped 10 times more than expected as the bank flagged trouble with a pair of loans for a co-op and office space. It slashed its quarterly dividend 70%.

“It’s like when you have a car that you love and you sell it to somebody, and you see them a year later and they’ve just torn it all up and not taken care of it,” said Wade, the former senior mortgage underwriter.

A week later, Moody’s Investors Service cited governance challenges and financial risks when it cut its credit to junk. Last week, Moody’s cut it even further.

At the 2021 town hall, DiNello and his counterpart didn’t show much anxiety about the future. “We laugh about it,” Cangemi said, according to a transcript filed with regulators. “We’re not going to go backwards. We’re going to go forward.”

But DiNello had the last word. “We’ve got to take all of this talk, all this opportunity that we envision, and we got to make it happen,” he said. “We’re all going to look back on this in the next few years and we’re going to think: ‘Wow.’”

–With assistance from Hannah Levitt, Katanga Johnson, Bre Bradham, Diana Li, Jennifer Surane and Steve Dickson.

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