FirstFed Financial Corp. is looking to join the handful of other strugglers that have managed to woo investors in recent weeks. But as a California company chock full of option adjustable-rate mortgages, FirstFed could be the biggest test yet for the rebounding capital markets.

"I would say they are probably on the cusp between the ones who can raise capital and the ones who can't," said Bert Ely, an independent analyst in Alexandria, Va. "It is going to be a huge uphill battle."

Heavy losses over the past six quarters have left the company low on capital, and it has warned that its survival is uncertain.

But in a special stockholder meeting last week, FirstFed got approval to increase its share count from 100 million to 5 billion, and now an offering is in the works.

Observers disagree over the chances for success. Some said the company might be past the point of rescue, given a capital hole that they pegged at $200 million to $300 million. It has a cease-and-desist order imposing elevated capital requirements.

Others said that, despite FirstFed's loan trouble, investor interest might exist for the right price. The company has a strong retail network in the Los Angeles area and its nonperforming assets have leveled off in recent months.

Some strugglers, including the $8.4 billion-asset United Community Banks Inc. in Blaisville, Ga., and the $2.3 billion-asset United Western Bancorp Inc. in Denver, have completed stock sales in recent weeks, despite loan trouble that attracted regulatory scrutiny. But they had to offer steep discounts.

United Western raised $80 million, after marking down its shares 20%. United Community, which raised $222.5 million, sold its shares 30% below market. In announcing their offerings, both had said that they anticipated getting a memorandum of understanding from regulators.

Wesley A. Brown, a managing director at the Denver investment bank St. Charles Capital LLC, said struggling companies can find investors now, but only if the discount is attractive enough and the capital raise is certain to be a final fix.

"The hole can't be so big that a recapitalization won't get the job done," he said.

Still, the dilution can be painful.

FirstFed's shares, which have lost 94% of their value over the past year, closed at 40 cents each Wednesday.

Besides approving an increase in the share count, stockholders also gave their permission last week for a reverse stock split. This would help boost the share price by reducing the number of shares outstanding.

Babette Heimbuch, FirstFed's chairman and chief executive officer, declined to comment for this story, citing a quiet period.

But observers said the stock offering is the best course of action for FirstFed, despite the uncertain outlook.

The company is an unlikely candidate to sell itself without government assistance, leaving it without other options, Ely said.

"Their options for survival are raise capital or get taken over by another company," he said. "But if someone was interested in buying them, they would have acted by now. So really, the capital raise is the only hope."

A cease-and-desist order from the Office of Thrift Supervision gave the company's First Federal Bank of California unit until last week to have a leverage ratio of 7% and a total risk-based capital ratio of 14%, levels above the typical minimums needed to be considered well capitalized.

At June 30, the leverage ratio was 4.79% and the total risk-based capital ratio was 9.63%, according to the Federal Deposit Insurance Corp.

Michael Iannaccone, president of MDI Investments Inc. in Chicago, was skeptical of FirstFed's chances.

"There is an incredibly small chance of them being successful. I mean it is really low," Iannaccone said. "I suppose you could invest $300 million and gain control of a $6 billion-asset bank, but it is a big risk. You could lose all the money you invested. There are plenty of other good companies out there trading at below book value, so why would you do that?"

Richard Levenson, the president of the San Diego investment bank Western Financial Corp., said that even among strugglers, FirstFed is a tough sell because of its abundance of ARMs.

FirstFed reported that ARMs - which account for most of its problems - made up 69.81% of its total loans at Aug. 31. The percentage was down 46 basis points from a month earlier and 564 basis points from a year earlier.

That's because FirstFed has been working with borrowers, replacing the ARMs with fixed-rate mortgages for up to 10 years. By the end of the second quarter, it had modified more than 2,000 loans totaling $927.8 million.

Levenson said the severity of the regulatory action doesn't help; a cease-and-desist is harsher than a memorandum of understanding.

Investors could just prefer to wait for the thrift unit to fail and buy it from the FDIC with a loss-sharing agreement, he said. "I question why an investment group would be interested at this stage in an offering of an institution like this in this environment when they know they could just buy it from the FDIC if it can't raise the capital."

But Brown said that there may be investors out there who would prefer a company with a mortgage portfolio, versus a construction portfolio. Also, the investors most likely to participate in a capital raise are not the ones who would be looking to buy the bank from the FDIC.

"There is a host of different investors that are looking for deals in the banking industry," Brown said. "They all have different theses, but they are all looking to hear about good stories and good opportunities."

One of the positives the company could highlight is a slight improvement in asset quality. Its nonperforming assets shrank from 10.15% of total assets at July 31 to 10.03% at Aug. 31.

Additionally, its nonaccruals on single-family mortgages totaled $453.7 million, nearly flat from a year earlier.

Its pipeline of troubled loans seems to have slowed significantly, too. At Aug. 31, 30 to 59 days past due loans were down 52% from a year earlier and 60 to 89 past due loans decreased 87%.

"It looks like worst has passed for them," Ely said.

Though the company is running out of time, the situation likely is not as stringent as the timetable set out in the cease-and-desist order, he added. As long as the company shows it is working toward meeting the goals, the OTS might give it more time.

The OTS would not comment on FirstFed specifically.

But a spokesman said that the regulator does its best to balance between working with strugglers that are actively trying to improve and following the guidelines for dealing with troubled institutions.

"We always try to work with the thrifts that are making good-faith efforts, but those efforts aren't always successful in reaching compliance."

Iannaccone speculated that FirstFed executives could be using the capital raise to show investors that they really tried everything possible to save the company. "If you didn't try everything, they are going to come after you should it fail."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.