Two of L.A.'s largest financial institutions, each operating under an enforcement order from regulators, could face severe consequences as early as this week if they cannot find a way to raise capital.

California National Bank, the fourth largest bank in Los Angeles by assets, and First Federal Bank of California, the county's No. 2 savings and loan, have been ordered to shore up their capital levels by Sept. 30.

Executives at both banks strongly assert they will be able to meet their deadlines, but the ailing institutions are contending with an unfriendly capital market that has made it difficult for other troubled banks and thrifts to raise money.

"The more problems a bank has, the more difficult it becomes to raise capital," said Joseph Gladue, a bank analyst for B. Riley & Co., who noted regulatory deadlines especially "make investors nervous" because they highlight the potential for the loss of the investment.

FirstFed Financial Corp., the holding company of First Federal Bank of California, was one of the largest lenders of option adjustable-rate mortgages during the housing boom. Since the real estate collapse, the thrift, with 38 branches and assets of $6.3 billion, has watched loan losses mount.

FirstFed recently saw its risk-based capital level dip below 10 percent, the minimum level at which a lender is considered well-capitalized. Capital, the money that actually belongs to the bank, is a leading indicator of a bank's financial strength.

FirstFed received a cease and desist order in January forcing the thrift to stop lending and requiring it to develop a plan to remain well-capitalized.

Cease and desist orders are among the most severe enforcement actions taken by regulators and are issued to stop unsafe banking practices, including operating without adequate board oversight or sufficient capital.

Cal National, which has 68 branches and more than $7 billion in assets, sustained massive losses in 2008 on investments in mortgage giants Fannie Mae and Freddie Mac. It has watched its capital levels drop to among the lowest of all California banks. At the end of the second quarter, the bank's total risk-based capital ratio was a meager 2 percent.

In late May it got a consent order from regulators, which directed the bank to raise capital essentially to get an infusion of cash and develop a plan to maintain the necessary ratios by Sept. 30. If Cal National is unable to do so, then the order requires "a disposition plan, which shall detail the board's proposal to sell or merge the bank, or liquidate" the bank's assets.

"Time is running out," said James Barth, a senior fellow who studies financial markets at the Milken Institute in Santa Monica. "It's a difficult environment and it becomes ever more difficult as time runs out to raise capital."

Expected loan losses

Cal National, owned by Oak Park, Ill.-based FBOP Corp., has contended for the past year that its core earnings are strong and it would be holding steady if not for its one-time, roughly $500 million loss due to its investments in the government mortgage giants. Still, its problem loans are increasing.

Gregory Mitchell, chief executive of Cal National, insists no plans are being made to sell the bank and that capital-raising efforts are progressing.

"I remain very confident. FBOP is making very good progress on raising equity and we expect to hit our goals," he said, without providing details about those efforts.

However, the bank applied to the Treasury Department's Troubled Asset Relief Program last year and has not received money. The program was designed to loan money to fundamentally sound banks.

FBOP, which owns seven banks across the country in addition to Cal National, also has reportedly tried unsuccessfully to raise capital over the past year, including applying to the TARP program.

Besides Cal National, three of the company's other banks are undercapitalized and the Federal Reserve ordered FBOP this month to submit a plan by Sept. 30 to raise its own capital levels.

Calls placed to Michael Kelly, the Chicago businessman who owns and is chief executive of the company, and Michael Dunning, FBOP chief financial officer, were not returned.

For privately held banks such as Cal National, the capital raising options available are limited, Gladue said. He pointed to private equity investment as one of the more realistic options.

Private equity firms have made inroads into the banking industry in the past year with high-profile deals such as the acquisition of the assets of failed IndyMac Bank in Pasadena and BankUnited in Coral Gables, Fla.

"There has been a lot of action from regulators to try to facilitate that to help stabilize the banking industry," Gladue said.

For publicly traded companies, new stock offerings have become an appealing option. In recent weeks, a number of local institutions, including East West Bancorp Inc. in Pasadena and CVB Financial Corp. in Ontario, each have boosted capital through equity offerings.

ARM-ed and dangerous

Now, FirstFed is looking into the possibility of selling stock.

The thrift has scheduled a stockholder meeting for this week to approve a plan to issue new shares.

"We're really focused on raising the capital. We really think that will be successful," said Babette Heimbuch, chief executive of FirstFed.

The 80-year-old institution's problems stem largely from a lending binge during 2005, when it originated more than $4 billion in option-ARM loans. The loans, which feature low introductory rates that can rise substantially down the road, have gone bad in large numbers in the recession.

In the first half of the year, FirstFed has endured losses of nearly $300 million. Its capital ratio, meanwhile, has fallen to 9.63 percent after topping 20 percent last year.

Executives have already taken action to help stave off receivership. The thrift has embarked upon a massive, multi-billion-dollar loan modification program that executives say is proving successful. The thrift has also laid off employees, sold real estate and restructured its outstanding debt.

Still, Heimbuch admits that there are "not really" any options left besides the stock offering.

The thrift's thinly traded shares, which hit a high of $69 a share two years ago, have traded for less than $1 for much of this year. But executives are hopeful that regulators will allow the bank to pursue an equity offering as a means of raising capital.

"From the viewpoint of the regulator, if there's still an opportunity for you to raise capital, that's what they want to happen," she said. "They don't want to take you over (but) the reality is we need capital."

Like Cal National, FirstFed was told to develop a disposition plan if it cannot raise capital. But in the current environment, few institutions are willing to buy a bank straight up. Instead, with nearly 100 bank failures in 2009 alone, healthy financial institutions are waiting for prospective acquisitions to be shut down, at which point their assets can be acquired on the cheap.

Following most of the recent bank failures, the Federal Deposit Insurance Corp. has entered into loss-sharing arrangements, which shield acquiring institutions from large losses on distressed loans.

"As the deadline looms in terms of bringing in additional capital, any potential acquirer would wait and bid on it on an FDIC-assisted basis," said Richard Levenson, president of Western Financial Corp., a San Diego investment banking firm that helps community banks raise capital.

He added that while there are interested investors out there, many are wary of committing capital until it is clear that the industry is on the rebound. In the case of FirstFed and Cal National, he said, the prospects are further dimmed by the fact that they have already been trying for months to raise capital.

"The bottom line," Levenson said, "is that if the capital was available to a bank, the capital would be in already."

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