Note 2 – Going Concern Considerations and Future Plans

The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business for the foreseeable future. However, the events and circumstances described in this Note create substantial doubt about the Company’s ability to continue as a going concern.

During the first three months of 2014, we reported net loss attributable to common shareholders of $976,000, compared with net loss attributable to common shareholders of $524,000 for the first three months of 2013. The increase in net loss in 2014 compared to 2013 is primarily attributable to declining interest income driven by the sizeable reduction in our loan portfolio and the absence of income from fiduciary activities in the current quarter compared to $517,000 in the first quarter of 2013 as we curtailed providing trust services early in 2013.

At March 31, 2014, we continued to be involved in various legal proceedings in which we dispute the material factual allegations. After conferring with our legal advisors, we believe we have meritorious grounds on which to prevail. If we do not prevail, the ultimate outcome of any one of these matters could have a material adverse effect on our financial condition, results of operations, or cash flows. These matters are more fully described in Note 13 – “Contingencies”.

For the year ended December 31, 2013, we reported a net loss to common shareholders of $3.4 million, compared to a net loss to common shareholders of $33.4 million for the year ended December 31, 2012. This loss coupled with the comprehensive loss for the year reduced shareholders equity to $35.9 million, from $47.2 million at the end of 2012. This reduction was attributable primarily to OREO expense of $4.5 million resulting from fair value write-downs driven by new appraisals and reduced marketing prices, net loss on sales, and ongoing operating expense, along with $4.7 million in loan collection expenses. The reduction was also attributable to a reduction in the fair value of securities of $8.4 million, net, as well as the accrual of dividends and accretion to preferred shareholders of $2.1 million. We also had lower net interest margin due to lower average loans outstanding, loans re-pricing at lower rates, and the level of non-performing loans in our portfolio.

In the fourth quarter of 2011 we began deferring interest payments on our junior subordinated notes, which resulted in a deferral of distributions on our trust preferred securities. If we cannot pay all unpaid deferred distributions on our trust preferred securities for more than twenty consecutive quarters, we will be in default, and the holders of our trust preferred securities would become entitled to payment of the full amount of outstanding principal plus accrued and unpaid interest. At March 31, 2014, cumulative accrued and unpaid interest on our junior subordinated notes totaled $1.7 million. Future cash dividends on our common stock are subject to the prior payment of all deferred distributions on our trust preferred securities.

In June 2011, the Bank agreed to a Consent Order with the FDIC and KDFI in which the Bank agreed, among other things, to improve asset quality, reduce loan concentrations, and maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Consent Order was included in our Current Report on 8-K filed on June 30, 2011. In October 2012, the Bank entered into a new Consent Order with the FDIC and KDFI again agreeing to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Bank also agreed that if it should be unable to reach the required capital levels, and if directed in writing by the FDIC, then the Bank would within 30 days develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution or otherwise immediately obtain a sufficient capital investment into the Bank to fully meet the capital requirements.

We expect to continue to work with our regulators toward capital ratio compliance as outlined in the written capital plan previously submitted by the Bank. The new Consent Order also requires the Bank to continue to adhere to the plans implemented in response to the June 2011 Consent Order, and includes the substantive provisions of the June 2011 Consent Order. The new Consent Order was included in our Current Report on 8-K filed on September 19, 2012. As of March 31, 2014, the capital ratios required by the Consent Order were not met.

In order to meet these capital requirements, the Board of Directors and management are continuing to evaluate strategies to achieve the following objectives:

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Increasing capital through a possible public offering or private placement of common stock to new and existing shareholders. We have engaged a financial advisor to assist our Board in evaluating our options for increasing capital and redeeming our Series A Preferred Stock.

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Continuing to operate the Company and Bank in a safe and sound manner. This strategy may require us to reduce our lending concentrations, remediate non-performing loans, and reduce other noninterest expense through the disposition of OREO.

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Management succession and adding resources to the management team. John T. Taylor succeeded Maria Bouvette as CEO for PBI Bank in 2012 and CEO of the Company in 2013. In addition, we appointed new executives to lead key functions of our banking operations. John R. Davis became Chief Credit Officer of PBI Bank in 2012, with responsibility for establishing and executing credit quality policies and overseeing credit administration for the organization. We have also augmented our staffing in the commercial lending area, now led by Joe C. Seiler.

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Evaluating our internal processes and procedures, distribution of labor, and work-flow to ensure we have adequately and appropriately deployed resources in an efficient manner in the current environment.

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Executing on our commitment to improve credit quality and reduce loan concentrations and balance sheet risk.

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We have reduced the size of our loan portfolio significantly from $1.3 billion at December 31, 2010 to $682.6 million at March 31, 2014.

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Our Consent Order calls for us to reduce our construction and development loans to not more than 75% of total risk-based capital. We have now been in compliance for eight quarters. Construction and development loans totaled $41.8 million, or 50% of total risk-based capital, at March 31, 2014, down from $43.3 million, or 52% of total risk-based capital, at December 31, 2013.

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Our Consent Order also requires us to reduce non-owner occupied commercial real estate loans, construction and development loans, and multi-family residential real estate loans as a group, to not more than 250% of total risk-based capital. While we have made significant progress, we were not in compliance with this concentration limit at March 31, 2014. These loans totaled $226.9 million, or 273% of total risk-based capital, at March 31, 2014 and $237.0 million, or 284% of total risk-based capital, at December 31, 2013.

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We have reduced the construction loan portfolio from $199.5 million at December 31, 2010 to $41.8 million at March 31, 2014. Our non-owner occupied commercial real estate loans declined from $293.3 million at December 31, 2010 to $146.4 million at March 31, 2014.

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Executing on our commitment to sell other real estate owned and reinvest in quality income producing assets.

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The remediation process for loans secured by real estate has led the Bank to acquire significant levels of OREO since 2010. The Bank acquired $20.6 million, $33.5 million, $41.9 million, and $90.8 million during 2013, 2012, 2011, and 2010, respectively. For the three months ended March 31, 2014, we acquired $17.4 million of OREO.

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We have incurred significant losses in disposing of this real estate. We incurred losses totaling $2.6 million, $9.3 million, $42.8 million, and $13.9 million in 2013, 2012, 2011, and 2010, respectively, from sales at less than carrying values and fair value write-downs attributable to declines in appraisal valuations and changes in our pricing strategies. During the three months ended March 31, 2014, we incurred OREO losses totaling $250,000 from declining values as evidenced by new appraisals and reduced marketing prices in connection with our sales strategies.

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To ensure we maximize the value we receive upon the sale of OREO, we continually evaluate sales opportunities. Proceeds from the sale of OREO totaled $2.1 million during the three months ended March 31, 2014 and $30.8 million, $22.5 million, $26.0 million and $25.0 million during the years ended December 31, 2013, 2012, 2011, and 2010, respectively.

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At December 31, 2013, the OREO portfolio consisted of 62% construction, development, and land assets. At March 31, 2014, this concentration decreased to 42%; however, the balance increased from $19.2 million to $19.4 million. Commercial real estate represents 16% of the OREO portfolio at March 31, 2014 compared with 19% at December 31, 2013. 1-4 family residential properties represent 25% of the OREO portfolio at March 31, 2014 compared with 16% at December 31, 2013, and multi-family properties represent 15% of the OREO portfolio at March 31, 2014, compared to 1% at December 31, 2013.

Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a consent order. Based on individual circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious adverse actions.