NOTE (2) – Going Concern, Regulatory Matters and Recapitalization of the Company

Going Concern

The Company’s financial statements have been prepared assuming that the Company will continue as a going-concern, which contemplates continuity of operations, and realization of assets and liquidation of liabilities in the ordinary course of business. The ability of the Company to continue as a going concern is dependent on many factors, including regulatory actions. The following discussion describes matters that raise substantial doubt about the Company’s ability to continue as a going concern, as well as management’s plans for responding to these matters.

Holding Company Liquidity

The Company has limited liquidity to pay operating expenses over an extended period of time and will need to raise additional capital within the next 12 to 18 months to continue paying operating expenses, including allocations of shared expenses from the Bank, on a timely basis. Additionally, the Company stopped paying interest expense on its $6.0 million aggregate principal amount of Floating Rate Junior Subordinated Debentures (the “Debentures”) in September 2010 and does not have sufficient capital to repay the Debentures when they mature on March 17, 2014. Also, the Company had to restructure its $5.0 million senior line of credit, payable to another financial institution (see Note 7). This restructuring was completed as part of the Company’s recapitalization that closed on August 22, 2013. Pursuant to that restructuring the Company exchanged $2.6 million of common stock equivalents for $2.6 million principal amount of the line of credit and the lender forgave all of the $1.8 million of accrued interest on the entire amount of the line of credit as of the closing of the recapitalization. The Company must obtain approval from the Federal Reserve Bank of San Francisco (the “FRB”) before making principal or interest payments on the remaining $2.4 million principal amount of the modified senior loan. The Company has received approval from the FRB to make the first payment of interest only due in November 2013 (see Note 7).

The Company’s principal sources of funds have historically been dividends from the Bank and, to a lesser extent, additional capital from investors. At the current time the Bank cannot pay dividends to the Company because of its recent operating losses and because of limitations in a Consent Order the Bank entered into with the Office of the Comptroller of the Currency (“OCC”) on October 30, 2013. Management does not anticipate that the Bank will receive approval to pay dividends for at least the next several quarters. Accordingly, the Company will not be able to meet its payment obligations on its debt noted above within the foreseeable future unless the Company is able to secure new capital.

Regulatory Matters

As a result of significant deficiencies in the Company’s and the Bank’s operations noted in a regulatory examination in early 2010, the Company and the Bank were declared to be in “troubled condition” and entered into cease and desist orders (the “Orders”) issued by the OCC’s regulatory predecessor effective September 9, 2010, requiring, among other things, that the Company and the Bank take remedial actions to improve the Bank’s loan underwriting and internal asset review procedures, to reduce the amount of its non-performing assets and to improve other aspects of the Bank’s business, as well as the Company’s management of its business and the oversight of the Company’s business by the Board of Directors. Effective October 30, 2013, the Order for the Bank was superseded by a Consent Order entered into by the Bank and the OCC. As part of the Consent Order, the Bank is required to attain, and thereafter maintain, a Tier 1 (Core) Capital to Adjusted Total Assets ratio of at least 9% and a Total Risk-Based Capital to Risk-Weighted Assets ratio of at least 13%, both of which ratios are greater than the respective 4% and 8% levels for such ratios that are generally required under OCC regulations. The Bank’s regulatory capital exceeded both of these higher capital ratios at September 30, 2013 (see Note 10).

Additionally, the Consent Order issued by the OCC imposes certain other requirements on the Bank. These requirements include the following, among others:

·	The Bank must create a Compliance Committee consisting of at least three independent Directors to monitor compliance with the Consent Order, among other matters.
·	The Board of the Bank must prepare and submit a Strategic Plan and a Capital Plan that is consistent with the Strategic Plan. The Capital Plan requirement includes requirements regarding targeted capital ratios and prior approval requirements for the payment of dividends, both of which are mentioned above.
·	The Bank must implement an enhanced set of business operational and corporate governance processes, as well as create a commercial real estate concentration risk management program and a written program to reduce the level of assets considered doubtful, substandard or special mention. This latter program requirement includes requirements to monitor the levels of such assets on an ongoing basis and prepare and implement corrective actions as deemed necessary.
·	The Bank must also implement an independent ongoing loan review system and adopt new policies with respect to maintaining an adequate allowance for loan and lease losses (“ALLL”).

The Consent Order does not include certain restrictions on the Bank that had been imposed by the Order, such as the specific limitation on the Bank’s ability to increase its assets during any quarter or certain limitations on employment agreements and compensation arrangements. Management believes that the Order issued to the Company, which has been administered by the FRB since July 2012, remains in effect. This Order imposes limitations and restriction on several matters, including the following:

·	The Company may not declare or pay any dividends or make any other capital distributions without the prior written approval of the FRB.
·	The Company may not make any changes in its directors or senior executive officers without prior notice to and receipt of notice of non-objection from the FRB.
·	The Company is subject to limitations on severance and indemnification payments and on entering into or amending employment agreements and compensation arrangements, and on the payment of bonuses to Bank directors and officers.
·	The Company may not incur, issue, renew, repurchase, make payments on or increase any debt or redeem any capital stock without prior notice to and receipt of written notice of non-objection from the FRB.

Recapitalization of the Company

Management’s plan to address the conditions described above has consisted of completing a recapitalization of the Company and then raising additional equity capital for the Company and negotiating an extension of the maturity of the Debentures. The Company completed the recapitalization on August 22, 2013, which improved the Company’s liquidity and capital structure, and enhanced the Bank’s capital ratios as described below. The Company’s ability to continue as a going concern is dependent on the timely implementation and success of these next steps: raising more capital and extending the maturity of the Debentures. There can be no assurance that management’s plan will be achieved.

The recapitalization strengthened and simplified the Company’s capital structure through completion of the following transactions:

(1) The issuance of 8,776 shares of Series F Non-cumulative Voting Preferred Stock (the “Common Stock Equivalents”) in exchange for the five series of the Company’s formerly outstanding preferred stock with an aggregate liquidation value or preference of $17.6 million, including the TARP Preferred Stock that was issued to the Treasury Department pursuant to the Capital Purchase Program component of the Treasury Department’s Troubled Asset Relief Program, which the parties agreed to value at $8.8 million based on the price at which shares of the Common Stock were sold in the Subscription Offering referred to below;

(2) The issuance of 2,646 shares of Common Stock Equivalents in exchange for all of the accumulated dividends on the TARP Preferred Stock, totaling $2.6 million as of the date of the exchange;

(3) The issuance of 2,575 shares of Common Stock Equivalents in exchange for $2.6 million principal amount of the Company’s bank debt (the “Debt Exchange”);

(4) The modification of the terms of the remaining $2.4 million principal amount of the senior line of credit to, among other matters, extend the maturity and eliminate the default rate;

(5) The forgiveness of the $1.8 million of accrued interest on the entire amount of the Company’s bank debt as of the date of the exchange;

(6) The exchange of 698 shares of Common Stock Equivalents issued in the Debt Exchange for 6,982 shares of Series G Non-Voting Preferred Stock; and

(7) The issuance of 4,235,500 shares of Common Stock in private sales (the “Subscription Offering”) at a price of $1.00 per share, yielding $4.2 million in gross proceeds. Of the $4.2 million in gross proceeds, $1.2 million were used to invest additional capital into the Bank and to repay all of the inter-company payables due to the Bank from the Company. As a result, the Bank’s capital ratios increased on a pro forma basis as of June 30, 2013 from 9.48% to 9.75% for Tier 1 Capital, from 14.98% to 15.51% for Tier 1 Risk Based Capital and from 16.27% to16.80% for Total Risk Based Capital.

The Common Stock Equivalents are a new series of preferred stock of the Company that will automatically convert into shares of the Company’s common stock, at the rate of 1,000 shares of common stock for each of the shares of Common Stock Equivalents upon stockholder approval of an amendment to the Company’s certificate of incorporation increasing the number of shares of common stock the Company is authorized to issue so as to permit such conversion. The Series G Non-Voting Preferred Stock will automatically convert into shares of non-voting common stock of the Company upon approval by the stockholders of an amendment of the Company’s certificate of incorporation authorizing the Company to issue non-voting common stock. The board of directors of the Company will present the amendments required to effect such conversions at the Company’s Annual Meeting of Stockholders, which will be held on November 27, 2013. Management believes that the conversions will improve the Company’s ability to raise additional capital.