** **

**U.S. SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.20549**

 

**FORM 10-QSB**

 

 

**QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE**

# SECURITIES EXCHANGE ACT OF 1934

 

 

**For the quarterly period ended September 30, 2001 Commission File Number:0-15982**

** **

**NATIONAL MERCANTILE BANCORP**

(Exact name ofsmall business issuer as specified in its charter)

** **

| **California**                                       |   | **95-3819685**      |
|------------------------------------------------------|--------|---------------------|
| (State or other  jurisdiction of                     |   | (I.R.S. Employer    |
| incorporation or  organization)                      |   | Identification No.) |
|                                                 |   |                |
| **1840 Century  Park East, Los Angeles, California** |   | **90067**           |
| (Address of  principal executive offices)            |   | (Zip Code)          |

 

** **

** **

| Issuer's telephone number,  including area code **(310) 277-2265**                                                                                                                                                                                                                                                                                        |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                      |
| Indicate  by check mark whether the issuer (1) has filed all reports required to be  filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during  the preceding 12 months (or for such shorter period that the registrant was  required to file such reports), and (2) has been subject to such filing  requirements for the past 90 days. |
|                                                                                                                                                                                                                                                                                                                                                      |

 

|                                  | YES  ý | NO  o |
|---------------------------------------|------------------|------------|
|                                  |             |       |
|                                  |             |       |
| APPLICABLE ONLY TO CORPORATE ISSUERS: |

** **

Thenumber of shares outstanding of the issuer's Common Stock, no par value, as ofNovember 14, 2001 was1,623,267.

 

 

 

**NATIONALMERCANTILE BANCORP AND SUBSIDIARYCONSOLIDATED BALANCE SHEETS**

 

|                                                                                                                                                                                                                                                           |   | **September  30,**          |    |              |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|-------------------|--------|
|                                                                                                                                                                                                                                                           |   | **2001**                    |    | **December  31,** |   |
|                                                                                                                                                                                                                                                           |   | **(Unaudited)**             |    | **2000**          |   |
|                                                                                                                                                                                                                                                           |   | **(Dollars  in thousands)** |    |
| ASSETS                                                                                                                                                                                                                                                         |   |                        |    |              |   |
| Cash  and due from banks-demand                                                                                                                                                                                                                                |   | $                           | 10,525  |              | $      | 7,897 |   |
| Federal  funds sold and securities purchased under agreements to resell                                                                                                                                                                                        |   | 43,950                      |    | 19,700            |   |
| Cash  and cash equivalents                                                                                                                                                                                                                                     |   | 54,475                      |    | 27,597            |   |
| Securities  available-for-sale, at fair value;                                                                                                                                                                                                                 |   |                        |    |              |   |
| aggregate amortized cost of $42,228 and  $64,953 at September 30, 2001 and December 31, 2000, respectively                                                                                                                                                     |   | 42,615                      |    | 64,417            |   |
| FRB  and other stock, at cost                                                                                                                                                                                                                                  |   | 2,369                       |    | 2,733             |   |
|                                                                                                                                                                                                                                                           |   |                        |    |              |   |
| Loans  receivable                                                                                                                                                                                                                                              |   | 104,511                     |    | 110,248           |   |
| Allowance  for credit losses                                                                                                                                                                                                                                   |   | (2,901                      | )       | (2,597            | )      |
| Net  loans receivable                                                                                                                                                                                                                                          |   | 101,610                     |    | 107,651           |   |
| Premises  and equipment, net                                                                                                                                                                                                                                   |   | 612                         |    | 526               |   |
| Accrued  interest receivable and other assets                                                                                                                                                                                                                  |   | 2,356                       |    | 1,919             |   |
| Total  assets                                                                                                                                                                                                                                                  |   | $                           | 204,037 |              | $      | 204,843 |   |
|                                                                                                                                                                                                                                                           |   |                        |    |              |   |
| LIABILITIES  AND SHAREHOLDERS' EQUITY                                                                                                                                                                                                                          |   |                        |    |              |   |
| Deposits:                                                                                                                                                                                                                                                      |   |                        |    |              |   |
| Noninterest-bearing  demand                                                                                                                                                                                                                                    |   | $                           | 63,794  |              | $      | 59,935 |   |
| Interest-bearing  demand                                                                                                                                                                                                                                       |   | 11,241                      |    | 9,004             |   |
| Money  market                                                                                                                                                                                                                                                  |   | 39,736                      |    | 32,351            |   |
| Savings                                                                                                                                                                                                                                                        |   | 1,483                       |    | 1,144             |   |
| Time  certificates of deposit:                                                                                                                                                                                                                                 |   |                        |    |              |   |
| $100,000  or more                                                                                                                                                                                                                                              |   | 27,824                      |    | 25,865            |   |
| Under  $100,000                                                                                                                                                                                                                                                |   | 4,177                       |    | 6,248             |   |
| Total  deposits                                                                                                                                                                                                                                                |   | 148,255                     |    | 134,547           |   |
| Federal funds purchased and securities  sold under agreements to repurchase                                                                                                                                                                                    |   | -                           |    | 7,500             |   |
| Other  borrowings                                                                                                                                                                                                                                              |   | 16,000                      |    | 40,000            |   |
| Accrued  interest payable and other liabilities                                                                                                                                                                                                                |   | 1,947                       |    | 2,093             |   |
| Total  liabilities                                                                                                                                                                                                                                             |   | 166,202                     |    | 184,140           |   |
|                                                                                                                                                                                                                                                           |   |                        |    |              |   |
| Guaranteed preferred beneficial  interests in the Company's junior subordinated deferrable interest  debentures, net                                                                                                                                           |   | 15,000                      |    | -                 |   |
|                                                                                                                                                                                                                                                           |   |                        |    |              |   |
| Shareholders'  equity:                                                                                                                                                                                                                                         |   |                        |    |              |   |
| Preferred stock: (10,000 shares  undesignated)  Series A non-cumulative convertible perpetual preferred stock; authorized  990,000 shares; issued and outstanding 750,680 shares and 770,423 shares at  September 30, 2001 and December 31, 2000, respectively |   | 6,131                       |    | 6,292             |   |
|                                                                                                                                                                                                                                                           |   |                        |    |              |   |

| Common  stock, no par value; authorized 10,000,000 shares; issued and outstanding  1,622,305 shares and 1,547,429 shares at September 30, 2001 and December 31,  2000, respectively |   | 30,263 |   | 29,905 |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|

| Accumulated  deficit                           |   | (13,946 | )       | (14,958 | )      |
|------------------------------------------------|--------|---------|---------|---------|--------|
| Accumulated  other comprehensive income (loss) |   | 387     |    | (536    | )      |
| Total  shareholders' equity                    |   | 22,835  |    | 20,703  |   |
| Total  liabilities and shareholders' equity    |   | $       | 204,037 |    | $      | 204,843 |   |
|                                                |        |         |         |         |        |  |  |

 

See accompanyingnotes to consolidated financial statements.

 

 

**NATIONALMERCANTILE BANCORP AND SUBSIDIARYCONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)**

 
|                                                                                                                                    |   | **Three months ended**

**September 30,**            |       | **Nine months ended  September 30,** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------|------------|--------------------------------------|------------|
|                                                                                                                                    |   |                                                 |       |
|                                                                                                                                    |   | **2001**                                             |       | **2000**                             |       | **2001** |   | **2000** |   |
|                                                                                                                                    |   | **(Dollars in thousands  except per share amounts)** |       |
| Interest income:                                                                                                                        |   |                                                 | ** ** |                                 | ** ** |   | ** ** |   | ** ** |
| Loans, including fees                                                                                                                   |   | $                                                    | 2,267      |                                 | $          | 2,468 |   | $ | 7,189 |   | $ | 6,317 |   |
| Securities  available-for-sale                                                                                                          |   | 679                                                  |       | 1,195                                |       | 2,671 |   | 3,628 |   |
| Federal funds sold and  securities purchased under  agreements to resell                                                           |   | 310                                                  |       | 225                                  |       | 632 |   | 399 |   |
| Total interest income                                                                                                                   |   | 3,256                                                |       | 3,888                                |       | 10,492 |   | 10,344 |   |
| Interest expense:                                                                                                                       |   |                                                 |       |                                 |       |   |   |   |   |
| Interest-bearing  demand.                                                                                                               |   | 26                                                   |       | 29                                   |       | 68 |   | 85 |   |
| Money market and  savings                                                                                                               |   | 254                                                  |       | 321                                  |       | 837 |   | 852 |   |
| Time certificate of  deposits:                                                                                                          |   |                                                 |       |                                 |       |   |   |   |   |
| $100,000 or more                                                                                                                        |   | 313                                                  |       | 289                                  |       | 1,141 |   | 778 |   |
| Under $100,000                                                                                                                          |   | 39                                                   |       | 107                                  |       | 180 |   | 275 |   |
| Total interest expense  on deposits                                                                                                     |   | 632                                                  |       | 746                                  |       | 2,226 |   | 1,990 |   |
| Federal funds purchased  and securities sold underagreements to  repurchase                                                             |   | 2                                                    |       | 61                                   |       | 30 |   | 62 |   |
| Other borrowings                                                                                                                        |   | 177                                                  |       | 655                                  |       | 889 |   | 1,520 |   |
| Total interest expense                                                                                                                  |   | 811                                                  |       | 1,462                                |       | 3,145 |   | 3,572 |   |
| Net interest income  before provision for credit losses                                                                                 |   | 2,445                                                |       | 2,426                                |       | 7,347 |   | 6,772 |   |
| Provision for credit  losses                                                                                                            |   | 450                                                  |       | -                                    |       | 450 |   | (576 | ) |
| Net interest income  after provision for credit losses                                                                                  |   | 1,995                                                |       | 2,426                                |       | 6,897 |   | 7,348 |   |
| Other operating income:                                                                                                                 |   |                                                 |       |                                 |       |   |   |   |   |
| Net gain on sale of  securities available-for-sale                                                                                      |   | 92                                                   |       | -                                    |       | 238 |   | 18 |   |
| International services                                                                                                                  |   | 11                                                   |       | 29                                   |       | 38 |   | 86 |   |
| Investment division                                                                                                                     |   | 28                                                   |       | 23                                   |       | 81 |   | 65 |   |
| Deposit-related and  other customer services                                                                                            |   | 148                                                  |       | 147                                  |       | 457 |   | 447 |   |
| Gain on sale of other  real estate owned                                                                                                |   | -                                                    |       | -                                    |       | - |   | 69 |   |
| Total other operating  income                                                                                                           |   | 279                                                  |       | 199                                  |       | 814 |   | 685 |   |
| Other operating  expenses:                                                                                                              |   |                                                 |       |                                 |       |   |   |   |   |
| Salaries and related  benefits                                                                                                          |   | 1,037                                                |       | 974                                  |       | 3,255 |   | 2,832 |   |
| Net occupancy                                                                                                                           |   | 268                                                  |       | 239                                  |       | 738 |   | 738 |   |
| Furniture and equipment                                                                                                                 |   | 68                                                   |       | 86                                   |       | 206 |   | 255 |   |
| Printing and  communications                                                                                                            |   | 83                                                   |       | 66                                   |       | 237 |   | 211 |   |
| Insurance and  regulatory assessments                                                                                                   |   | 79                                                   |       | 76                                   |       | 241 |   | 217 |   |
| Customer services                                                                                                                       |   | 220                                                  |       | 210                                  |       | 650 |   | 621 |   |
| Computer data  processing                                                                                                               |   | 100                                                  |       | 112                                  |       | 338 |   | 304 |   |
| Legal services                                                                                                                          |   | 56                                                   |       | 53                                   |       | 107 |   | 137 |   |
| Other professional  services                                                                                                            |   | 114                                                  |       | 90                                   |       | 323 |   | 295 |   |
| Other real estate owned  expenses                                                                                                       |   | (1                                                   | )          | -                                    |       | (26 | ) | 3 |   |
| Promotion and other  expenses                                                                                                           |   | 76                                                   |       | 68                                   |       | 212 |   | 206 |   |
| Total other operating  expenses                                                                                                         |   | 2,100                                                |       | 1,974                                |       | 6,281 |   | 5,819 |   |
| Net income before  provision for income taxes andminority interest in  the Company's juniorsubordinated deferrable interest  debentures |   | 174                                                  |       | 651                                  |       | 1,430 |   | 2,214 |   |
| Minority interest in  the Company's juniorsubordinated deferrable interest  debentures                                                  |   | 329                                                  |       | -                                    |       | 329 |   | - |   |
| Net income before  provision for income taxes                                                                                           |   | (155                                                 | )          | 651                                  |       | 1,101 |   | 2,214 |   |
| Provision for income  taxes                                                                                                             |   | 42                                                   |       | 19                                   |       | 89 |   | 45 |   |
| Net income (loss)                                                                                                                       |   | $                                                    | (197       | )                                    | $          | 632 |   | $ | 1,012 |   | $ | 2,169 |   |
| Earnings (loss) per  share:                                                                                                             |   |                                                 |       |                                 |       |   |   |   |   |
| Basic                                                                                                                                   |   | $                                                    | (0.12      | )                                    | $          | 0.64 |   | $ | 0.63 |   | $ | 2.41 |   |
| Diluted                                                                                                                                 |   | $                                                    | (0.12      | )                                    | $          | 0.24 |   | $ | 0.31 |   | $ | 0.85 |   |

 

See accompanyingnotes to consolidated financial statements.

 

 

**NATIONALMERCANTILE BANCORP AND SUBSIDIARYCONSOLIDATED STATEMENTS OF CASH FLOWS**

 
|                                                                                        |   | **For the  nine-months  ended September 30,** |   |
|---------------------------------------------------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                                        |   |                                          |
|                                                                                        |   | **2001**                                      |   | **2000** | ** ** |
|                                                                                        |   | **(Dollars in  thousands)**                   |
| Cash flow from  operating activities:                                                       |   |                                          |   |   |   |
| Net income                                                                                  |   | $                                             | 1,012  |   | $ | 2,169 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:          |   |                                          |   |   |   |
| Depreciation  and amortization                                                              |   | 173                                           |   | 146 |   |
| Gain on sale  of other real estate owned                                                    |   | -                                             |   | (69 | ) |
| Provision for  credit losses                                                                |   | 450                                           |   | (576 | ) |
| Net gain on  sale of securities available-for-sale                                          |   | (238                                          | )      | (18 | ) |
| Net accretion  of discount on securities                                                    |   | (21                                           | )      | (22 | ) |
| Net accretion  of discounts on loans purchased.                                             |   | (27                                           | )      | (27 | ) |
| Increase in  accrued interest receivable and other assets                                   |   | (437                                          | )      | (85 | ) |
| (Decrease)  increase in accrued interest payable and other liabilities                      |   | (146                                          | )      | 522 |   |
| Net cash  provided by operating activities                                                  |   | 766                                           |   | 2,040 |   |
| Cash flows  from investing activities:                                                      |   |                                          |   |   |   |
| Purchase of  securities available-for-sale                                                  |   | (7,049                                        | )      | (2,703 | ) |
| Proceeds from  sales of securities available-for-sale                                       |   | 11,206                                        |   | 1,891 |   |
| Proceeds from  repayments and maturities of securities available-for-sale                   |   | 19,191                                        |   | 4,352 |   |
| Loan  originations and principal collections, net                                           |   | 5,618                                         |   | (26,288 | ) |
| Proceeds from  sale of other real estate owned                                              |   | -                                             |   | 486 |   |
| Proceeds from  sale of other assets-SBA guaranteed loans                                    |   | -                                             |   | 209 |   |
| Purchases of  premises and equipment                                                        |   | (259                                          | )      | (62 | ) |
| Net cash  provided by (used in) investing activities                                        |   | 28,707                                        |   | (22,115 | ) |
| Cash flows  from financing activities:                                                      |   |                                          |   |   |   |
| Net increase  in demand deposits, money market and savings accounts                         |   | 13,820                                        |   | 14,669 |   |
| Net increase  (decrease) in time certificates of deposit                                    |   | (112                                          | )      | 5,424 |   |
| Net decrease  in securities sold under agreements to repurchase and federal funds purchased |   | (7,500                                        | )      | - |   |
| Net (decrease)  increase in other borrowings                                                |   | (24,000                                       | )      | 7,800 |   |
| Net proceeds  from issuance ofjunior  subordinated deferrable interest debentures           |   | 15,000                                        |   | - |   |
| Net proceeds  from issuance of common stock                                                 |   | -                                             |   | 4,190 |   |
| Net proceeds  from exercise of stock options                                                |   | 197                                           |   | 14 |   |
| Net cash (used  in) provided by financing activities                                        |   | (2,595                                        | )      | 32,097 |   |
| Net increase  in cash and cash equivalents                                                  |   | 26,878                                        |   | 12,022 |   |
| Cash and cash  equivalents, January 1                                                       |   | 27,597                                        |   | 10,239 |   |
| Cash and cash  equivalents, September 30                                                    |   | $                                             | 54,475 |   | $ | 22,261 |   |
|                                                                                        |   |                                          |   |   |   |
| Supplemental  cash flow information:                                                        |   |                                          |   |   |   |
|                                                                                        |   |                                          |   |   |   |
| Cash paid for  interest                                                                     |   | $                                             | 3,204  |   | $ | 3,578 |   |
| Increase in  market value of securities available for sale                                  |   | 923                                           |   | 864 |   |
| Cash paid for  income taxes                                                                 |   | 131                                           |   | 10 |   |
| Non-cash  investing and financing transactions:                                             |   |                                          |   |   |   |
| Transfer to  OREO from loans receivable, net                                                |   | -                                             |   | 35 |   |

 

See accompanyingnotes to consolidated financial statements.

 

 

**NATIONAL MERCANTILE BANCORP AND SUBSIDIARYNOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

NOTE 1—BASIS OFPRESENTATION AND MANAGEMENT REPRESENTATIONS

 

         The unauditedconsolidated financial statements include the accounts of National MercantileBancorp (the ''Company'') and its wholly owned subsidiary, Mercantile NationalBank (the ''Bank'').  The unauditedconsolidated financial statements reflect the interim adjustments, all of whichare of a normal recurring nature and which, in management's opinion, arenecessary for the fair presentation of the Company's consolidated financialposition and the consolidated results of its operations and cash flows for suchinterim periods. The results for the three and nine month periods endedSeptember 30, 2001 are not necessarily indicative of the results expected forany subsequent period or for the full year ending December 31, 2001. Theunaudited consolidated financial statements should be read in conjunction withthe audited consolidated financial statements included in the Company’s AnnualReport on Form 10-KSB for the year ended December 31, 2000 (''2000 Form10-KSB'').

 

NOTE 2—EARNINGS(LOSS) PER SHARE

 

         Basicearnings (loss) per share is computed using the weighted average number ofcommon shares outstanding during the period. The weighted average number of common shares outstanding used incomputing basic earnings per share was 1,621,751 and 989,823 for the three monthsended September 30, 2001 and 2000, respectively, and 1,603,365 and 898,573,respectively, for the nine months ended September 30, 2001 and 2000.  The weighted average number of common sharesand common share equivalents outstanding used in computing diluted earnings(loss) per share was 1,621,751 and 2,656,737, respectively, for the threemonths ended September 30, 2001 and 2000 and 3,232,544 and 2,556,196,respectively, for the nine months ended September 30, 2001 and 2000.  Diluted loss per share for the three monthsended September 30, 2001 does not include common share equivalents as they areanti-dilutive.

 

 

         Thefollowing table is a reconciliation of net income and shares used in thecomputation of earnings (loss) per basic and diluted common share:

 
|                                              |   | **Net Income  (loss)** |   | **Shares** |      | **Per share****amount** |   |
|---------------------------------------------------|--------|------------------------|--------|------------|-----------|-------------------------|--------|
|                                              |   | **(in thousands)**     |   |       |      |                    |   |
|                                              |   |                   |   |       |      |                    |   |
| *For the three  months ended September 30, 2001:* |   |                   |   |       |      |                    |   |
| Basic and  diluted loss per share                 |   | $                      | (197   | )          | 1,621,751 |                    | $      | (0.12 | ) |
|                                              |   |                   |   |       |      |                    |   |
| *For the three  months ended September 30, 2000:* |   |                   |   |       |      |                    |   |
| Basic EPS                                         |   | $                      | 632    |       | 989,823   |                    | $      | 0.64 |   |
|                                              |   |                   |   |       |      |                    |   |
| Effect of  dilutive securities:                   |   |                   |   |       |      |                    |   |
| Options and  warrants                             |   |                   |   | 126,068    |      |                    |   |
| Convertible  preferred stock                      |   |                   |   | 1,540,846  |      |                    |   |
| Diluted EPS                                       |   | $                      | 632    |       | 2,656,737 |                    | $      | 0.24 |   |
|                                              |   |                   |   |       |      |                    |   |
| *For the nine  months ended September 30, 2001:*  |   |                   |   |       |      |                    |   |
| Basic EPS                                         |   | $                      | 1,012  |       | 1,603,365 |                    | $      | 0.63 |   |
|                                              |   |                   |   |       |      |                    |   |
| Effect of  dilutive securities:                   |   |                   |   |       |      |                    |   |
| Options and  warrants                             |   |                   |   | 127,819    |      |                    |   |
| Convertible  preferred stock                      |   |                   |   | 1,501,360  |      |                    |   |
| Diluted EPS                                       |   | $                      | 1,012  |       | 3,232,544 |                    | $      | 0.31 |   |
|                                              |   |                   |   |       |      |                    |   |
| *For the nine  months ended September 30, 2000:*  |   |                   |   |       |      |                    |   |
| Basic EPS                                         |   | $                      | 2,169  |       | 898,573   |                    | $      | 2.41 |   |
|                                              |   |                   |   |       |      |                    |   |
| Effect of  dilutive securities:                   |   |                   |   |       |      |                    |   |
| Options and  warrants                             |   |                   |   | 116,777    |      |                    |   |
| Convertible  preferred stock                      |   |                   |   | 1,540,846  |      |                    |   |
| Diluted EPS                                       |   | $                      | 2,169  |       | 2,556,196 |                    | $      | 0.85 |   |

 

 

NOTE 3—CASH ANDCASH EQUIVALENTS

 

         For purposesof reporting cash flows, cash and cash equivalents include cash and due frombanks–demand, federal funds sold and securities sold under agreements toresell.

 

NOTE 4—INCOMETAXES

 

         Income taxprovision during the three and nine months ended September 30, 2001 was $42,000and $89,000, respectively, for state income tax and federal alternative minimumtax due to the utilization of previously unrecognized tax benefits to offsetthe current period tax liability.   Noincome tax provisions were recorded for the three and nine month periods endedSeptember 30, 2000 except alternative minimum tax.

 

 

         For taxpurposes at December 31, 2000, the Company had: (i) federal net operating losscarry forwards of $18.4 million, which begin to expire in the year 2009; (ii)California net operating loss carry forwards of $1.5 million, of which $1.2million will expire in 2001and $300,000 will expire in 2002; and (iii) analternative minimum tax credit at December 31, 2000 of $295,000 which may becarried forward indefinitely.

 

NOTE 5—SOUTH BAYBANK ACQUISITION

 

         The Companyentered into an Agreement and Plan of Reorganization dated July 18, 2001 (the“Agreement”) with South Bay Bank, National Association, pursuant to which theCompany has agreed to acquire South Bay on the terms and conditions set forthin the Agreement.  The acquisition willbe accomplished through the consolidation of South Bay and an interim nationalbank to be formed by the Company.  As aresult of the consolidation, South Bay will become a wholly owned subsidiary ofthe Company and the shareholders of South Bay will receive cash in theaggregate amount of approximately $29.1 million, or approximately $10.33 pershare (subject to adjustment in certain circumstances) which representsapproximately 1.93 times the book value of South Bay at December 31, 2000.  The Company intends to account for the consolidationas a “purchase” for financial reporting purposes.  The transaction requires the approval of both the Office of theComptroller of the Currency (“OCC”) and the Federal Reserve System(“FRB”).  Final approval for thetransaction is pending.

 

NOTE 6—RECENTACCOUNTING PRONOUNCEMENTS

 

         The FinancialAccounting Standards Board (“FASB”) issued Statement of Financial AccountingStandards ("SFAS") No. 133, “Accounting for Derivative Instrumentsand Hedging Activities,” as amended by SFAS No. 137, “Accounting for DerivativeInstruments and Hedging Activities – Deferral of the Effective Date of FASBStatement No. 133”, and SFAS No. 138, “Accounting for Certain DerivativeInstruments and Certain Hedging Activities – an Amendment of SFAS No.133”.   SFAS Nos. 133 and 138 establishaccounting and reporting standards requiring that every derivative instrumentbe recorded in the balance sheet as either an asset or as a liability measuredat its fair value and that changes in the fair value be recognized currently inthe statements of operations.  The Companyadopted SFAS Nos. 133, 137 and 138 on January 1, 2001.  The impact of the adoption did not have amaterial effect on the Company’s financial position or result of operations atJune 30, 2001 or for the period then ended.

 

         In September2000, the FASB issued SFAS No. 140, “Accounting for Transfer and Servicing ofFinancial Assets and Extinguishments of Liabilities – a replacement of FASBStatement No. 125”.  As of December 31,2000, the Company has adopted accounting and disclosure requirements of SFAS No.140 as set forth in paragraphs 15 and 17 of the Statement, respectively.  All other provisions of the statement wereadopted as of June 30, 2001.  Theadoption of SFAS No. 140 did not have an impact on the financial condition orthe results of operations of the Company.

 

 

         In June2001, the FASB issued SFAS No. 141, “Business Combinations”, SFAS 141supersedes Accounting Principles Board (APB) Opinion No. 16, “BusinessCombinations” and requires that all business combinations within the scope ofthe Statement are to be accounted for using only the purchase method, providesa change in criteria for the separate recognition of intangible assets andrequires more detailed disclosures.  Theprovisions of SFAS No.141 apply to business combinations initiated after June30, 2001, therefore, the Company intends to account for its announcedacquisition of South Bay Bank, N.A. under the provisions of SFAS No. 141 uponconsummation.

 

         Also in June2001, the FASB issued SFAS No. 142, “Goodwill and other Intangible Assets”,which supersedes APB Opinion No. 17, “Intangibles“, and stipulates, among otherprovisions, that goodwill shall not be amortized.  SFAS No. 142 requires that goodwill be regularly tested forimpairment and recognize a goodwill impairment loss when the carrying amount ofgoodwill exceeds it implied fair value. The Company intends to account for any goodwill recognized in itsproposed acquisition of South Bay Bank, N.A. under the provisions of SFAS No.142 upon consummation.  The Companycarries no existing goodwill on its books.

 

NOTE 7—TRUSTPREFERRED SECURITIES ISSUANCE

 

         The Companyformed National Mercantile Capital Trust I (the “Trust”), a statutory businesstrust under the Delaware Business Trust Act pursuant to a Declaration of Trustdated as of June 27, 2001, and a Certificate of Trust filed with the Secretaryof State of the State of Delaware on June 27, 2001, for the sole purpose ofissuing and selling certain securities representing undivided beneficialinterests in the assets of the Trust and investing the proceeds thereof incertain debentures of the Company.  OnJuly 16, 2001 the Trust issued and sold to the Company 464 common securities(liquidation amount of $1,000 per common security) of the Trust (the “CommonSecurities”), representing common beneficial interests in the assets of theTrust.

 

         Also, onJuly 16, 2001 the Trust issued 15,000 of 10.25 percent fixed rate securities(the “Capital Securities”), with a liquidation amount of $1,000 per CapitalSecurity and an aggregate liquidation amount of $15,000,000 due July 25,2031.  The Capital Securities areguaranteed by the Company with respect to distributions and payments uponliquidation, redemption and otherwise to the extent provided in and pursuant tothe terms of a Guarantee Agreement.

 

 

         The Trustused the proceeds from the issuance and the sale of the Capital Securities andthe Common Securities to purchase $15,464,000 aggregate principal amount of theCompany’s 10.25 percent fixed rate junior subordinated deferrable interest debenturesdue July 25, 2031 (the “Debentures”). The Company may redeem the Debentures prior to such date within 90 daysafter: the occurrence of certain tax events; the Trust being deemed aninvestment company; or there is an adverse change in the treatment of theCapital Securities as Tier 1 capital for bank regulatory purposes.  The Company has the right to defer paymentsof interest on the Debentures for up to 10 consecutive semi-annual paymentperiods, but not beyond their stated maturity date.  During any period of interest deferral, the Company may notdeclare or pay cash dividends on, or redeem its capital stock or repay any debtsecurities that rank junior to the Debentures.

 

         The Companyintends to utilize the proceeds from the issuance and sale of the Debenturesfor possible business combination activities.

 

 

NOTE8—RECLASSIFICATIONS

 

         Certainprior year data have been reclassified to conform to current year presentation.

 

 

***Item2.       MANAGEMENT'S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION***

***AND RESULTS OF OPERATIONS***

** **

         NationalMercantile Bancorp (the ''Company'') is the holding company for MercantileNational Bank (the ''Bank'').  The Bankconstitutes substantially all of the business of the Company.  References to the Company in this Item 2reflect the consolidated activities of the Company and the Bank.

** **

RESULTS OF OPERATIONS

** **

         The Companyrecorded a net loss of $197,000, or $0.12 diluted and basic loss per share,during the third quarter of 2001, compared to net income of $632,000, or $0.24diluted earnings per share, during the third quarter of 2000.  Net earnings per basic share for the thirdquarter of 2000 was $0.64.  The net lossfor the 2001 period resulted primarily from a $450,000 provision for creditlosses due to the downgrading of two loans and secondarily due to $329,000minority interest in income of the guaranteed preferred beneficial interests inthe Company’s junior subordinated deferrable interest debentures (the“Debentures”).  Additionally, earningswere impacted by narrowing net interest margins and the maintenance ofrelatively large federal funds position in anticipation of the funding of theacquisition of South Bay Bank.   TheDebentures were issued in July 2001 to fund the Company’s pending acquisitionof South Bay Bank, N.A.  (See Note 7 tothe financial statements).  The impactof narrower net interest margins was offset by a larger volume of earningassets.   Additionally, 2001 earningsbenefited from $92,000 net gains on the sale of securities available for saleas the investment portfolio was repositioned.

 

         Net incomeduring the first nine months of 2001 was $1.0 million, or $0.31 dilutedearnings per share, compared to net income of $2.2 million, or $0.85 diluted earnings per share, during the first ninemonths of 2000.  Net income per basicshare was $0.63 and $2.41 during the first nine months of 2001 and 2000,respectively.  The decrease in netincome during the first nine months of 2001 compared to the same period of 2000resulted primarily from a $576,000 reverse provision for credit losses in 2000related to the recovery of a loan previously charged off and the provision forcredit losses in 2001 discussed above. The Company increased its net interest income before provisions forcredit losses during the first nine months of 2001 to $7.3 million compared to$6.8 million during the same period in 2000 despite narrower net interestmargins as a result of a larger volume of earning assets.  Other operating income was $814,000 for thenine month period ended September 30, 2001 compared to $685,000 during the 2000period.  The increase was primarily dueto gains on sale of securities.  Totalother operating expenses were $6.3 million for the first nine months of 2001compared to $5.8 million for the same period in 2000.  The increase was primarily due to higher salaries and relatedemployee benefits.

 

 

         Return onaverage assets during the first nine months of 2001 was 0.69% compared to 1.67%for the same period of 2000.  Return onaverage equity for the first three quarters of 2001 and 2000 was 6.05% and22.92%, respectively.

 

NET INTERESTINCOME

 

         The increasein net interest income during the three and nine months ended September 30,2001 compared to the corresponding periods during 2000 resulted primarily froman increase in net average interest earning assets (the difference betweenaverage interest earning assets and average interest bearing liabilities) of$4.5 million and $5.0 million, respectively. The increase in net average interest earning assets was due primarilyto: (i) the growth in the Company’s loan portfolio, primarily in the secondhalf of 2000 and firstquarter of 2001, resulting in increases in the average loans receivableof $8.0 million and $19.1 million in the three and nine month periods of 2001,respectively, compared to 2000; and (ii) the Company’s decision to increase itsliquidity (principally federal funds) to facilitate the proposed acquisition ofSouth Bay Bank, N.A. for cash.  Theseincreases were funded by deposits and by payoffs and sales of securities, asduring the three and nine months ended September 30, 2001, average depositsincreased $30.7 million and $21.7 million, respectively, and average securitiesdecreased by $23.2 million and $14.7 million, respectively.  The growth in both average loans receivableand average deposits was a result of the Company’s effort toward expanding andbuilding new customer relationships within existing market niches of business,entertainment, healthcare and community based nonprofit organizations.  The decrease in the average investmentsecurities portfolio was due to increased principal paydowns of mortgage backedsecurities resulting from decreasing market interest rates and to sales ofthese securities.

 

         The netinterest income increased for the three months ended September 30, 2001 to4.17% from 3.51% for the same period last year due to a greater decline in costof interest-bearing liabilities than the yield on earning assets.  The net yield declined, however, to 5.20%for the third quarter ended September 30, 2001 from 5.31% for the third quarterended September 30, 2000 due to noninterest bearing liabilities funding loweryielding earning assets.  For the ninemonths ended September 30, 2001 the net interest income was 4.01% compared to3.67% for the same period in 2000 likewise due to a more rapid decline in thecost of funding liabilities.  The netyield on earnings assets for the nine months ended September 30, 2001 and 2000was 5.41% and 5.42%, respectively, nearly flat due to a significantly greatervolume of noninterest bearing liabilities funding earning assets.

 

         During thequarter ended September 30, 2001 average loans receivable increased 8.2% to$104.9 million compared to $97.0 million during the quarter ended September 30,2000.  The weighted average yield onloans receivable during the quarter ended September 30, 2001 decreased to 8.57%compared to 10.13% during the quarter ended September 30, 2000, reflectingdeclining market interest rates.

 

 

         Averagesecurities decreased 32.6% to $48.1 million during the quarter ended September30, 2001 compared to $71.3 million during the quarter ended September 30, 2000as a result of sales of securities and increased principal paydowns onamortizing mortgaged-backed securities due to declining market interestrates.  The weighted average yield onsecurities decreased to 5.60% during the third quarter of 2001 compared to6.67% during the third quarter 2000, primarily due to decreased market interestrates which impacted the Company’s variable-rate mortgaged-backed securities,which comprised 24% of the securities portfolio at September 30, 2001 andrepositioning of the investment portfolio to shorten the overall duration.

 

         Averageinterest-bearing liabilities were nearly flat at $116.6 million during thequarter ended September 30, 2001 compared to $116.5 million during the quarterended September 30, 2000.  Averageinterest-bearing deposits increased 36.2% to $99.6 million during the quarterended September 30, 2001 from $73.1 million during the quarter ended September30, 2000, due to the growth of money market and savings deposits, timecertificates of deposit of $100,000 and over and demand deposits.  $14.5 million of the increase in moneymarket deposits was due to the Company’s placement of most of the proceeds ofits July 2001 issuance of the Debentures in a deposit with the Bank.  Average borrowings during the third quarterof 2001 decreased 57.7% to $16.8 million from $39.7 million during the sameperiod in 2000 as the Company replaced other borrowings used to fund its loangrowth in 2000 with lower cost deposits.

 

         The weightedaverage cost of interest-bearing liabilities decreased to 2.76% during thethird quarter of 2001 from 4.99% during the same period of 2000, due to thematurity of higher-cost funding and the repricing of funding liabilities in anenvironment of lower overall market interest rates.  Additionally, time certificates of deposit, which reprice moreslowly than other deposit types, decreased to 35.4% of total deposits for thethree months ended September 30, 2001 from 38.4% of total deposits during thesame period in 2000.  The weightedaverage cost of borrowed funds decreased to 4.17% during the third quarter of2001 from 6.56% during the same period in 2000.  The weighted average cost of interest-bearing deposits decreasedto 2.52% during the third quarter of 2001 from 4.06% during the same period of2000.

 

         Averagetotal deposits increased 23.7% to $160.2 million during the third quarter of2001 compared to $129.5 million during the third quarter of 2000 due to thegrowth in interest-bearing deposits discussed above and $4.3 million growth innoninterest-bearing demand deposits to $60.6 million.

 

 

         During thenine months ended September 30, 2001 average loans receivable increased 22.2 %to $105.0 million compared to $85.9 million during the same period in 2000 dueto significant growth in the fourth quarter 2000 and first quarter 2001.  Average securities decreased 20.3% to $57.7million during the nine months ended September 30, 2001 compared to $72.4million during the same period in 2000 due to a reduction in other borrowingsand to provide liquidity for growth in loans. Average total deposits during the nine months ended September 30, 2001increased 17.2% to $148.0 million compared to $126.3 million during the sameperiod in 2000.  Average borrowed fundsdecreased 26.7% to $23.4 million during the nine months ended September 30,2001 compared to $32.0 million during the same period in 2000.

 

PROVISION FOR CREDIT LOSSES

 

         The Companyrecorded a $450,000 provision for credit losses during the third quarter endedSeptember 30, 2001 related to the downgrade of two loans.  No provision was made in 2000.  During the second quarter of 2000 theCompany recorded a reverse provision for credit losses of $576,000 as a resultof approximately $1.3 million net recovery related to a previously charged offloan.  The Company did not record anyreverse provision for credit losses during 2001.

 

OTHER OPERATINGINCOME

 

         Otheroperating income, excluding gains and losses on the sale of securities andassets, totaled $187,000 during the third quarter of 2001, slightly lower thanthe $199,000 recorded during the third quarter of 2000, due to lower fees frominternational services. During the nine months ended September 30, 2001, otheroperating income, excluding gains and losses on the sale of securities andassets, totaled $576,000 compared to $598,000 during the comparable period of2000.  Similar to the quarterly results,the slight decline was due to a reduction in international service incomenearly offset by increases in investment division income and service charges ondeposit accounts.

 

         The Companyrealized net gains on sale of securities of $92,000 and $238,000 during thethird quarter and first nine months of 2001, respectively, compared to a netgain of $18,000 for the first nine months in 2000.  These net gains were made possible by the declining interest rateenvironment which increased the market value of the Company’s fixed ratesecurities.  The ability to generategains on securities is highly dependent on the interest rate environment, andthus there is no assurance the Company will generate any gains on sales ofsecurities in future periods.  TheCompany had no outstanding other real estate owned in 2001 and accordingly didnot record any gain or loss on sale of other real estate owned during thatperiod compared to a net gain of $69,000 recorded during 2000.

 

 

OTHER OPERATINGEXPENSES

 

         Otheroperating expenses increased 6.4% to $2.1 million during the second quarter of2001 compared to $2.0 million during the second quarter of 2000.  This increase was due primarily to increasein salaries and related benefits of $63,000, with smaller variances among otherexpense categories.  The increase insalaries and related benefits was due to the Company’s continued expansion ofbusiness and entertainment loan production staff including additional staffingfor new market niches of healthcare and community based nonprofit organizationsand a new branch office opened in March 2001.

 

         Otheroperating expenses increased 7.9% to $6.3 million during the nine months endedSeptember 30, 2001 compared to $5.8 million during the same period of 2000, dueprimarily to $423,000 increase in salaries and related benefits expenseresulting from costs associated with the Company’s expansion of bankingservices and staff mentioned above.

 

         The Companyreported $329,000 allocation of income for the minority interest in theCompany’s junior subordinated deferrable interest debentures for the thirdquarter and nine months ended September 30, 2001 related to the trust preferredsecurities issued in July 2001 in order to partially fund the pendingacquisition of South Bay Bank.

 

 

         Thefollowing table presents the components of net interest income for the quartersended September 30, 2001 and 2000.

 

**Average Balance Sheet andAnalysis of Net Interest Income**

 

|                                                                                  |   | **Three months ended**     |    |
|---------------------------------------------------------------------------------------|--------|----------------------------|---------|
|                                                                                  |   | **September 30, 2001**     |    | **September 30, 2000** |   |
|                                                                                  |   | **Average  Amount**        |    | **Interest  Income/  Expense** |   | **Weighted  Average  Yield/  Rate** |   | **Average  Amount** |   | **Interest  Income/  Expense** |   | **Weighted  Average  Yield/  Rate** |   |
|                                                                                  |   | **(Dollars in thousands)** |
|                                                                                  |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Assets:                                                                               |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold and  securities purchased under agreements to resell               |   | $                          | 33,522  |   | $ | 310 |   | 3.67 | % | $ | 13,605 |   | $ | 225 |   | 6.58 | % |
| Securities  available-for-sale                                                        |   | 48,069                     |    | 679 |   | 5.60 | % | 71,275 |   | 1,195 |   | 6.67 | % |
| Loans receivable (1)  (2)                                                             |   | 104,909                    |    | 2,267 |   | 8.57 | % | 96,950 |   | 2,468 |   | 10.13 | % |
| Total interest earning  assets                                                        |   | 186,500                    |    | $ | 3,256 |   | 6.93 | % | 181,830 |   | $ | 3,888 |   | 8.51 | % |
|                                                                                  |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest earning  assets:                                                          |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks  - demand                                                     |   | 11,641                     |    |   |   |   |   | 9,228 |   |   |   |   |   |
| Other assets                                                                          |   | 2,590                      |    |   |   |   |   | 2,582 |   |   |   |   |   |
| Allowance for credit  losses and net unrealized loss on securities available-for-sale |   | (2,401                     | )       |   |   |   |   | (4,776 | )  |   |   |   |   |
| Total assets                                                                          |   | $                          | 198,330 |   |   |   |   |   | $ | 188,864 |   |   |   |   |   |
|                                                                                  |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Liabilities and  shareholders' equity:                                                |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits:                                                           |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Demand                                                                                |   | $                          | 9,986   |   | $ | 26 |   | 1.03 | % | $ | 7,556 |   | $ | 29 |   | 1.53% |   |
| Money market and  savings                                                             |   | 54,384                     |    | 254 |   | 1.85 | % | 37,521 |   | 321 |   | 3.40% |   |
| Time certificates of  deposit:                                                        |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| $100,000 or more                                                                      |   | 31,853                     |    | 313 |   | 3.90 | % | 20,399 |   | 289 |   | 5.64% |   |
| Under $100,000                                                                        |   | 3,383                      |    | 39 |   | 4.57 | % | 7,665 |   | 107 |   | 5.55% |   |
| Total time certificates  of deposit                                                   |   | 35,236                     |    | 352 |   | 3.96 | % | 28,064 |   | 396 |   | 5.61% |   |
| Total interest bearing  deposits                                                      |   | 99,606                     |    | 632 |   | 2.52 | % | 73,141 |   | 746 |   | 4.06% |   |
| Federal funds purchased  and securities sold under agreements to repurchase           |   | 217                        |    | 2 |   | 3.66 | % | 3,596 |   | 61 |   | 6.75% |   |
| Other borrowings                                                                      |   | 16,826                     |    | 177 |   | 4.17 | % | 39,732 |   | 655 |   | 6.56% |   |
| Total interest bearing  liabilities                                                   |   | 116,649                    |    | $ | 811 |   | 2.76 | % | 116,469 |   | $ | 1,462 |   | 4.99% |   |
|                                                                                  |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest bearing  liabilities:                                                     |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest bearing  demand deposits                                                  |   | 60,601                     |    |   |   |   |   | 56,320 |   |   |   |   |   |
| Other liabilities                                                                     |   | 1,599                      |    |   |   |   |   | 1,699 |   |   |   |   |   |
| Shareholders' equity                                                                  |   | 19,481                     |    |   |   |   |   | 14,376 |   |   |   |   |   |
| Total liabilities and  shareholders' equity                                           |   | $                          | 198,330 |   |   |   |   |   | $ | 188,864 |   |   |   |   |   |
|                                                                                  |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Net interest income  (spread)                                                         |   |                       |    | $ | 2,445 |   | 4.17 | %  |   |   | $ | 2,426 |   | 3.51 | % |
|                                                                                  |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Net yield on earning  assets (2)                                                      |   |                       |    |   |   | 5.20 | %  |   |   |   |   | 5.31 | % |

 

----

(1)  Includes average balance of nonperforming loans of $500,000 and$700,000 for 2001 and 2000, respectively.

(2)  Yieldsand amounts earned on loans receivable include loan fees of $88,000 and $56,000for the three months ended                September 30, 2001 and2000, respectively.

 

 

The followingtable presents the components of net interest income for the six months endedJune 30, 2001 and 2000.

 
| **Average Balance Sheet and**                                                        |   |                        |     |                    |   |         |   |        |     |         |          |         |          |
|--------------------------------------------------------------------------------------|--------|-----------------------------|----------|-------------------------|--------|--------------|--------|-------------|----------|--------------|---------------|--------------|---------------|
| **Analysis of Net Interest Income**                                                  |   |                        |     |                    |   |         |   |        |     |         |          |         |          |
|                                                                                 |   |                        |     |                    |   |         |   |        |     |         |          |         |          |
|                                                                                 |   | **Nine  months ended**      |     |
|                                                                                 |   | **September  30, 2001**     |     | **September  30, 2000** |   |
|                                                                                 |   |                        |     |                    |   | **Weighted** |   |        |     |         |          | **Weighted** |          |
|                                                                                 |   |                        |     | **Interest**            |   | **Average**  |   |        |     | **Interest** |          | **Interest** |          |
|                                                                                 |   | **Average**                 |     | **Income/**             |   | **Yield/**   |   | **Average** |     | **Income/**  |          | **Yield/**   |          |
|                                                                                 |   | **Amount**                  |     | **Expense**             |   | **Rate**     |   | **Amount**  |     | **Expense**  |          | **Rate**     |          |
|                                                                                 |   | **(Dollars  in thousands)** |     |
| Assets:                                                                              |   |                        |     |                    |   |         |   |        |     |         |          |         |          |
| Federal funds sold and securities purchased  under agreements to resell              |   | $                           | 18,801   |                    | $      | 632          |   | 4.49        | %        | $            | 8,449         |         | $             | 399 |   | 6.31 | % |
| Securities available-for-sale                                                        |   | 57,695                      |     | 2,671                   |   | 6.19         | %      | 72,421      |     | 3,628        |          | 6.69         | %             |
| Loans receivable (1) (2)                                                             |   | 105,031                     |     | 7,189                   |   | 9.15         | %      | 85,942      |     | 6,317        |          | 9.82         | %             |
| Total  interest earning assets                                                       |   | 181,527                     |     | $                       | 10,492 |         | 7.73   | %           | 166,812  |         | $             | 10,344       |          | 8.28 | % |
|                                                                                 |   |                        |     |                    |   |         |   |        |     |         |          |         |          |
| Noninterest earning assets:                                                          |   |                        |     |                    |   |         |   |        |     |         |          |         |          |
| Cash  and due from banks - demand                                                    |   | 11,210                      |     |                    |   |         |   | 9,233       |     |         |          |         |          |
| Other  assets                                                                        |   | 2,595                       |     |                    |   |         |   | 2,624       |     |         |          |         |          |
| Allowance  for credit losses and net unrealized loss onsecurities available-for-sale |   | (2,497                      |   ) |                    |   |         |   | (5,026      |   ) |         |     |         |     |
| Total  assets                                                                        |   | $                           | 192,835  |                    |   |         |   |        | $        | 173,643      |          |         |          |   |   |
|                                                                                 |   |                        |     |                    |   |         |   |        |     |         |          |         |          |
| Liabilities and shareholders' equity:                                                |   |                        |     |                    |   |         |   |        |     |         |          |         |          |
| Interest bearing deposits:                                                           |   |                        |     |                    |   |         |   |        |     |         |          |         |          |
| Demand                                                                               |   | $                           | 8,787    |                    | $      | 68           |   | 1.03        | %        | $            | 8,140         |         | $             | 85 |   | 1.39 | % |
| Money  market and savings                                                            |   | 43,429                      |     | 837                     |   | 2.58         | %      | 35,721      |     | 852          |          | 3.19         | %             |
| Time  certificates of deposit:                                                       |   |                        |     |                    |   |         |   |        |     |         |          |         |          |
| $100,000 or more                                                                     |   | 32,328                      |     | 1,141                   |   | 4.72         | %      | 19,374      |     | 778          |          | 5.36         | %             |
| Under  $100,000                                                                      |   | 4,364                       |     | 180                     |   | 5.51         | %      | 6,976       |     | 275          |          | 5.27         | %             |
| Total  time certificates of deposit                                                  |   | 36,692                      |     | 1,321                   |   | 4.81         | %      | 26,350      |     | 1,053        |          | 5.34         | %             |
| Total  interest bearing deposits                                                     |   | 88,908                      |     | 2,226                   |   | 3.35         | %      | 70,211      |     | 1,990        |          | 3.79         | %             |
| Federal funds purchased and securities sold  under agreements to repurchase          |   | 781                         |     | 30                      |   | 5.14         | %      | 1,223       |     | 62           |          | 6.77         | %             |
| Other borrowings                                                                     |   | 23,439                      |     | 889                     |   | 5.07         | %      | 32,015      |     | 1,520        |          | 6.34         | %             |
| Total  interest bearing liabilities                                                  |   | 113,128                     |     | $                       | 3,145  |         | 3.72   | %           | 103,449  |         | $             | 3,572        |          | 4.61 | % |
|                                                                                 |   |                        |     |                    |   |         |   |        |     |         |          |         |          |
| Noninterest bearing liabilities:                                                     |   |                        |     |                    |   |         |   |        |     |         |          |         |          |
| Noninterest  bearing demand deposits                                                 |   | 59,078                      |     | 35,218                  |   |         |   | 56,046      |     |         |          |         |          |
| Other  liabilities                                                                   |   | 1,666                       |     | 1,026                   |   |         |   | 1,506       |     |         |          |         |          |
| Shareholders' equity                                                                 |   | 18,963                      |     |                    |   |         |   | 12,642      |     |         |          |         |          |
| Total liabilities and shareholders' equity                                           |   | $                           | 192,835  |                    |   |         |   |        | $        | 173,643      |          |         |          |   |   |
|                                                                                 |   |                        |     |                    |   |         |   |        |     |         |          |         |          |
| Net interest income (spread)                                                         |   |                        |     | $                       | 7,347  |         | 4.01   | %           |     |         | $             | 6,772        |          |   |   |
|                                                                                 |   |                        |     |                    |   |         |   |        |     |         |          |         |          |
|                                                                                 |   |                        |     |                    |   |         |   |        |     |         |          |         |          |
| Net  yield on earning assets (2)                                                     |   |                        |     |                    |   | 5.41         | %      |        |     |         |          | 5.42         | %             |

 

----

(1)Includes average balance of nonperforming loans of $550,000 and $715,000 for2001 and 2000, respectively.  

(2)Yields and amounts earned on loans receivable include loan fees of $298,000 and$115,000 for the nine months ended September 30, 2001 and 2000, respectively.

 

 

         Thefollowing tables set forth, for the periods indicated, the changes in interestearned and interest paid resulting from changes in volume and changes inrates.  Average balances in allcategories in each reported period were used in the volume computations.  Average yields and rates in each reportedperiod were used in rate computations.

 
| Increase  (Decrease) in Interest Income/Expense Due to Change in            |   |                                  |   |         |   |           |   |
|-----------------------------------------------------------------------------|--------|---------------------------------------|--------|--------------|--------|----------------|--------|
| **Average Volume and Average Rate**                                         |   |                                  |   |         |   |           |   |
|                                                                        |   |                                  |   |         |   |           |   |
|                                                                        |   | **Three Months Ended  September 30,** |   |
|                                                                        |   | **2001 vs 2000**                      |   |
|                                                                        |   |                                  |   |         |   | **Net**        |   |
|                                                                        |   | **Increase (decreased)  due to(1)**   |   | **Increase** |   |
|                                                                        |   | **Volume**                            |   | **Rate**     |   | **(Decrease)** |   |
|                                                                        |   | **(Dollars in thousands)**            |   |
| Interest Income:                                                            |   |                                  |   |         |   |           |   |
| Federal funds sold  securities purchased under agreements to resell         |   | $                                     | 174    |         | $      | (375           | )      | $ | (201 | ) |
| Securities  available-for-sale                                              |   | (326                                  | )      | (190         | )      | (516           | )      |
| Loans receivable (2)                                                        |   | 185                                   |   | (100         | )      | 85             |   |
| Total interest-earning  assets                                              |   | $                                     | 33     |         | $      | (665           | )      | $ | (632 | ) |
|                                                                        |   |                                  |   |         |   |           |   |
| Interest Expense:                                                           |   |                                  |   |         |   |           |   |
| Interest-bearing  deposits:                                                 |   |                                  |   |         |   |           |   |
| Demand                                                                      |   | $                                     | 6      |         | $      | (9             | )      | $ | (3 | ) |
| Money market and  savings                                                   |   | 79                                    |   | (146         | )      | (67            | )      |
|                                                                        |   |                                  |   |         |   |           |   |
| Time certificates of  deposit:                                              |   |                                  |   |         |   |           |   |
| $100,000 or more                                                            |   | 113                                   |   | (89          | )      | 24             |   |
| Under $100,000                                                              |   | (49                                   | )      | (19          | )      | (68            | )      |
| Total time certificates  of deposit                                         |   | 64                                    |   | (108         | )      | (44            | )      |
| Total interest-bearing deposits                                             |   | 149                                   |   | (263         | )      | (114           | )      |
| Federal funds purchased  and securities sold under agreements to repurchase |   | (31                                   | )      | (28          | )      | (59            | )      |
| Other borrowings                                                            |   | (240                                  | )      | (238         | )      | (478           | )      |
| Total interest-bearing  liabilities                                         |   | $                                     | (122   | )            | $      | (529           | )      | $ | (651 | ) |
|                                                                        |   |                                  |   |         |   |           |   |
| Net interest income                                                         |   | $                                     | 155    |         | $      | (136           | )      | $ | 19 |   |

 

----

| (1) | The  change in interest income or interest expense that is attributable to both  changes in average volumeand average  rate has been allocated to the changes due to (i) average volume and (ii)  average rate inproportion to the relationship of the  absolute amounts of changes in each. |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Table  does not include interest income that would have been earned on nonaccrual  loans.                                                                                                                                                                                                    |

 

###### Increase(Decrease) in Interest Income/Expense Due to Change in

**Average Volumeand Average Rate**

 
|                                                                        |   | **Nine months  ended September 30,********2001  vs 2000** |   |
|-----------------------------------------------------------------------------|--------|-----------------------------------------------------------|--------|
|                                                                        |   |                                                      |   | **Net** |   |
|                                                                        |   | **Increase  (decrease) due to(1)**                        |   | **Increase** |   |
|                                                                        |   | **Volume**                                                |   | **Rate** |   | **(Decrease)** |   |
|                                                                        |   | **(Dollars in thousands)**                                |   |
| Interest  Income:                                                           |   |                                                      |   |   |   |   |   |
| Federal funds  sold and securities purchased under agreements to resell     |   | $                                                         | 348    |   | $ | (115 | ) | $ | 233 |   |
| Securities  available-for-sale                                              |   | (684                                                      | )      | (273 | ) | (957 | ) |
| Loans  receivable (2)                                                       |   | 1,302                                                     |   | (430 | ) | 872 |   |
| Total interest  earning assets                                              |   | $                                                         | 966    |   | $ | (818 | ) | $ | 148 |   |
|                                                                        |   |                                                      |   |   |   |   |   |
| Interest  Expense:                                                          |   |                                                      |   |   |   |   |   |
| Interest  bearing deposits:                                                 |   |                                                      |   |   |   |   |   |
| Demand                                                                      |   | $                                                         | 5      |   | $ | (22 | ) | $ | (17 | ) |
| Money market  and savings                                                   |   | 149                                                       |   | (164 | ) | (15 | ) |
| Time  certificates of deposit:                                              |   |                                                      |   |   |   |   |   |
| $100,000 or more                                                            |   | 456                                                       |   | (93 | ) | 363 |   |
| Under $100,000                                                              |   | (108                                                      | )      | 13 |   | (95 | ) |
| Total time  certificates of deposit                                         |   | 348                                                       |   | (80 | ) | 268 |   |
| Total interest  bearing deposits                                            |   | 502                                                       |   | (266 | ) | 236 |   |
| Federal funds  purchased and securities sold under agreements to repurchase |   | (17                                                       | )      | (15 | ) | (32 | ) |
| Other  borrowings                                                           |   | (326                                                      | )      | (305 | ) | (631 | ) |
| Total interest  bearing liabilities                                         |   | $                                                         | 159    |   | $ | (586 | ) | $ | (427 | ) |
|                                                                        |   |                                                      |   |   |   |   |   |
| Net interest  income                                                        |   | $                                                         | 807    |   | $ | (232 | ) | $ | 575 |   |

----

        (1)           The change in interest income orinterest expense that is attributable to both changes in average volume andaverage rate has been allocated to the changes due to (i) average volume and(ii) average rate inproportion tothe relationship of the absolute amounts of changes in each.

        (2)           Tabledoes not include interest income that would have been earned on nonaccrualloans.

 

***BALANCE SHEET ANALYSIS***

 

INVESTMENT SECURITIES

 

                Thefollowing comparative period-end table sets forth certain informationconcerning the estimated fair values and unrealized gains and losses ofinvestment securities portfolio, consisting of available-for-sale securities:

 

**Estimated Fair Values ofand Unrealized**

**Gains and Losses on InvestmentSecurities**

 

 
|   |   |  September 30, 2001 |   | **December 31, 2000** |   |  
 

 

**Total amortized cost**

 

**Gross unrealized  gainsns**

 

**Gross****unrealized los****s**

 

**Estimated fair value**

 

**Total amortized cost**

 

**Gross unrealized  gainsns**

 

**Gross****unrealized los****s**

 

**Estimated fair value**

 

 

 

** (Dollars in thousands)**

 

**(Dollars in thousands)**

 

 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury  securities

 

$

2,003

 

$

25

 

$

-

 

$

2,028

 

$

2,008

 

$

9

 

$

-

 

$

2,017

 

GNMA-issued/guaranteed  mortgage pass through certificates

 

5,051

 

41

 

-

 

5,092

 

5,288

 

118

 

-

 

5,406

 

Other U.S. government  and federal agency securities

 

-

 

-

 

-

 

-

 

1,952

 

42

 

-

 

1,994

 

FHLMC/FNMA-issued  mortgage pass through certificates

 

9,431

 

311

 

-

 

9,742

 

15,172

 

86

 

36

 

15,222

 

CMO's and REMIC's issued  by U.S.government-sponsored  agencies

 

22,824

 

186

 

43

 

22,967

 

36,532

 

1

 

669

 

35,864

 

Privately issued  corporate bonds, CMOs and REMICs

 

2,919

 

3

 

136

 

2,786

 

4,001

 

-

 

87

 

3,914

 

 

 

$

42,228

 

$

566

 

$

179

 

$

42,615

 

$

64,953

 

$

256

 

$

792

 

$

64,417

 

 

                Thetotal amortized cost of investment securities decreased $22.7 million  to $42.2 million at September 30, 2001 from$65.0 million at December 31, 2000 due primarily to $11.2 million sales ofsecurities and  $19.1 million maturitiesand principal paydowns on amortizing mortgaged-backed securities brought aboutby decreasing market interest rates. The Company had a net unrealized gain in securities of $387,000 atSeptember 30, 2001 compared to a net unrealized loss of $536,000 at December31, 2000.

 

                AtSeptember 30, 2001 the Company did not hold securities of any issuer, otherthan U.S. government agencies and corporations, in which the aggregate bookvalue exceeded 10% of the Company's shareholders' equity.

 

LOAN PORTFOLIO

** **

         Thefollowing comparative period-end table sets forth certain informationconcerning the composition of the loan portfolio.

 

**Loan PortfolioComposition**

 

 

 

 

**September 30,**

 

**December 31,**

 

 

 

**2001**

 

**2000**

 

 

 

**Amount**

 

**Percent**

 

**Amount**

 

**Percent**

 

 

 

(Dollars in thousands)

** **

Commercial  loans:

 

 

 

 

 

 

 

 

 

Secured by one  to four family  residential  properties

 

$

5,837

 

6

%

$

6,578

 

6

%

Secured by  multifamily   residential  properties

 

3,638

 

3

 

3,765

 

3

 

Secured by  commercial realproperties

 

38,368

 

37

 

40,540

 

37

 

Other -  secured and  unsecured

 

49,417

 

47

 

53,433

 

48

 

Real estate  construction and land development

 

3,500

 

4

 

1,890

 

2

 

Home equity  lines of credit

 

352

 

-

 

644

 

1

 

Consumer  installment and  unsecured loans to individuals

 

3,587

   

3

   

3,729

   

3

   

Total loans  outstanding

 

104,699

 

100

%

110,579

 

100

%

 

 

 

 

 

 

 

 

 

 

Deferred net  loan origination  fees and purchased loan discount

 

(188

)

 

 

(331

 )

 

 

Loans  receivable, net

 

$

104,511

 

 

 

$

110,248

 

 

 

 

         Total loansoutstanding decreased by $5.9 million to $104.7 million at September 30, 2001compared to $110.6 million at December 31, 2000.  This decrease resulted primarily from a higher volume of payoffsthan loan originations during the first nine months of 2001 from its level atDecember 31, 2000 largely due to borrowers refinancing loans in a relativelycompetitive low-interest rate environment.

         Thefollowing comparative period-end table sets forth certain informationconcerning nonperforming assets.

 

**Nonperforming Assets**

 

 

 

September 30,

 

**December 31,**

 

 

 

**2001**

 

**2000**

 

 

 

**(Dollars in  thousands)**

 

 

 

 

 

 

 

Nonaccrual  loans

 

$

2,178

 

$

683

 

Troubled debt  restructurings

 

-

 

-

 

Loans  contractually past due 90 or more days with respect to either principal or  interest and still accruing interest

 

-

 

-

 

Nonperforming  loans

 

2,178

 

683

 

Other real  estate owned

 

-

 

-

 

Other  assets-SBA guaranteed loan

 

-

 

-

 

Total  nonperforming assets

 

$

2,178

 

$

683

 

 

 

 

 

 

 

Allowance for  credit losses as a percent of nonaccrual loans

 

133.2

%

380.2

%

Allowance for  credit losses as a percent of nonperforming loans

 

133.2

  %

380.2

  %

Total  nonperforming assets as a percent of loans receivable

 

2.0

%

0.6

%

Total  nonperforming assets as a percent of total shareholders' equity

 

9.5

%

3.3

%

 

         Nonaccrualloans increased by $1.5 million during the first nine months of 2001 to $2.2million compared to $683,000 at December 31, 2000 due primarily to thedowngrade of two loans during the third quarter.

 

         Loandelinquencies greater than 30 days past due decreased to $357,000 or 0.3% ofloans outstanding at September 30, 2001 compared to $1.3 million or 1.2% ofloans outstanding at December 31, 2000.

* *

*ALLOWANCEFOR CREDIT LOSSES*

** **

         Provisionsfor credit losses charged to operations reflect management’s judgment of the adequacyof the allowance for credit losses and are determined through periodic analysisof the loan portfolio.  This analysisincludes a detailed review of the classification and categorization of problemloans and loans to be charged off; an assessment of the overall quality andcollectibility of the portfolio; and consideration of the loan loss experience,trends in problem loan concentrations of credit risk, as well as current andexpected future economic conditions (particularly Southern California). Management,in combination with an outside firm, performs a periodic risk and creditanalysis, the results of which are reported to the Board of Directors.

         Loanscharged off during the third quarter and first nine months of 2001 were $22,000and $372,000, respectively, compared to $7,000 and $114,000 during the thirdquarter and first nine months of 2000, respectively.  Recoveries of loans previously charged off were $110,000 and$226,000 during the third quarter and first nine months of 2001 compared to $46,000and $1.4 million for the same periods in 2000. The relatively large recovery in 2000 is due primarily to one large loanrecovery of approximately $1.3 million.

 

The following table sets forth information concerning theCompany's allowance for credit losses for the periods indicated. 

 

**Analysis ofChanges in Allowance for Credit Losses**

 

 

 

 

**Three months  ended**

 

**Nine months  ended**

 

 

 

**September 30,**

 

**September 30,**

 

 

 

**2001**

 

**2000**

 

**2001**

 

**2000**

 

 

 

**(Dollars in  thousands)**

 

 

 

 

** **

 

** **

 

** **

 

** **

 

 

 

** **

 

** **

 

** **

 

** **

Balance,  beginning of period

 

$

2,363

 

$

2,546

 

$

2,597

 

$

1,896

 

Loan charged  off:

 

 

 

 

 

 

 

 

 

Commercial  loans:

 

 

 

 

 

 

 

 

 

Secured by one  to four family residential properties

 

-

 

-

 

-

 

-

 

Secured by  commercial real properties

 

-

 

-

 

-

 

-

 

Other -  secured and unsecured

 

-

 

7

 

268

 

7

 

Consumer  installment and unsecured loans to individuals

 

22

 

-

 

104

 

107

 

Total loan  charge-offs

 

22

 

7

 

372

 

114

 

 

 

 

 

 

 

 

 

 

 

Recoveries of  loans previously charged off:

 

 

 

 

 

 

 

 

 

Commercial  loans:

 

 

 

 

 

 

 

 

 

Secured by one  to four family residential properties

 

-

 

6

 

-

 

 

 

Secured by  commercial real properties

 

-

 

-

 

-

 

 

 

Other -  secured and unsecured

 

94

 

12

 

197

 

1,336

 

Consumer  installment and unsecured loans to individuals

 

16

 

34

 

23

 

43

 

Total  recoveries of loans previously charged off

 

110

 

46

 

226

 

1,379

 

Net  charge-offs (recoveries)

 

(88

)

(39

)

146

 

(1,265

)

Provision for  credit losses

 

450

 

-

 

450

 

(576

)

Balance, end  of period

 

$

2,901

 

$

2,585

 

$

2,901

 

$

2,585

 

*** ***

         Creditquality is affected by many factors beyond the control of the Company,including local and national economies, and facts may exist which are not knownto the Company which adversely affect the likelihood of repayment of variousloans in the loan portfolio and realization of collateral upon a default.Accordingly, no assurance can be given that the Company will not sustain loanlosses materially in excess of the allowance for credit losses. In addition,the Office of the Comptroller of the Currency (“OCC”), as an integral part ofits examination process, periodically reviews the allowance for credit lossesand could require additional provisions for credit losses.

 

         Based oncontinued loan growth, the level of nonperforming loans and a relativelyconstant level of charge-offs, it is anticipated that the level of theallowance for credit losses will remain adequate through the remainder of 2001.

***Recent Accounting Pronouncements***

 

                TheFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards ("SFAS") No. 133, “Accounting for DerivativeInstruments and Hedging Activities,” as amended by SFAS No. 137, “Accountingfor Derivative Instruments and Hedging Activities – Deferral of the EffectiveDate of FASB Statement No. 133”, and SFAS No. 138, “Accounting for CertainDerivative Instruments and Certain Hedging Activities – an Amendment of SFASNo. 133”.   SFAS Nos. 133 and 138establish accounting and reporting standards requiring that every derivativeinstrument be recorded in the balance sheet as either an asset or as aliability measured at its fair value and that changes in the fair value berecognized currently in the statements of operations.  The Company adopted SFAS Nos. 133, 137 and 138 on January 1,2001.  The impact of the adoption didnot have a material effect on the Company’s financial position or result ofoperations at September 30, 2001 or for the nine months then ended.

 

                InSeptember 2000, the FASB issued SFAS No. 140, “Accounting for Transfer andServicing of Financial Assets and Extinguishments of Liabilities – areplacement of FASB Statement No. 125”. Tthe Company has adopted accounting and disclosure requirements of SFASNo. 140 as set forth in paragraphs 15 and 17 of the Statement as of December31, 2000, and other provisions of the statement as of June 30, 2001.  The adoption of SFAS No. 140 did not have animpact on the financial condition or the results of operations of the Companyat September 30, 2001 or for the nine months then ended.

 

                In June2001, the FASB issued SFAS No. 141, “Business Combinations”, SFAS 141supersedes Accounting Principles Board (APB) Opinion No. 16, “BusinessCombinations” and requires that all business combinations within the scope ofthe Statement are to be accounted for using only the purchase method, providesa change in criteria for the separate recognition of intangible assets andrequires more detailed disclosures.  Theprovisions of SFAS No.141 apply to business combinations initiated after June30, 2001.  If its acquisition of SouthBay Bank, N.A. is consummated, the Company intends to account for theacquisition under the provisions of SFAS No. 141 upon consummation.

 

                In June2001, the FASB issued SFAS No. 142, “Goodwill and other Intangible Assets”,which supersedes APB Opinion No. 17, “Intangibles“, and stipulates, among otherprovisions, that goodwill shall not be amortized.  SFAS No. 142 requires that goodwill be regularly tested forimpairment and recognize a goodwill impairment loss when the carrying amount ofgoodwill exceeds it implied fair value. If its acquisition of South Bay Bank, N.A. is consummated, the Companyintends to account for any goodwill recognized in the acquisition under the provisionsof SFAS No. 142.  At September 30,2001the Company had no goodwill on its books.

DEBENTURES

 

         In July 2001the Company issued $15,464,000 aggregate principal amount of 10.25% fixed-ratejunior subordinated deferrable interest debentures due July 2031 (the“Debentures”) to National Mercantile Capital Trust I, a Delaware statutorybusiness trust formed by the Company (the “Trust”) for the sole purpose ofselling interests in the Trust and using the proceeds to purchase theDebentures.  The Trust obtained thefunds to purchase the Debentures from the private placement of $15,000,000 of10.25% fixed rate capital securities due July 2031, which securities areguaranteed by the Company with respect to distributions and payments uponliquidation, and from the sale of common interests to the Company.  The Company may call the Capital Securitiescommencing in July 2006.  The Companyintends to utilize the proceeds from the issuance of the Debentures to pay aportion of the cash purchase price for South Bay Bank, N.A., or, if thatacquisition is not consummated, for another business combination.  The Company may include a portion of theDebentures as Tier 1 capital for regulatory capital purposes.

 

CAPITAL ADEQUACY REQUIREMENTS

 

         At September30, 2001 the Company and the Bank were in compliance with all applicableregulatory capital requirements and the Bank was “well capitalized” under thePrompt Corrective Action rules of the OCC. The following table sets forth the regulatory capital standards for wellcapitalized institutions and the capital ratios for the Company and the Bank asof September 30, 2001 and December 31, 2000.

 

**RegulatoryCapital Information**

**of the Companyand Bank**

 

 

 

**Well  Capitalized**

 

**September 30,**

 

**December 31,**

 

 

 

**Standards**

 

**2001**

 

**2000**

 

**Company:**

 

 

 

 

 

 

 

Tier 1  leverage

 

N/A

 

14.79

%

10.73

%

Tier 1  risk-based capital

 

N/A

 

24.50

%

17.00

%

Total  risk-based capital

 

N/A

 

31.92

%

18.26

%

 

 

 

 

 

 

 

 

**Bank:**

 

 

 

 

 

 

 

Tier 1  leverage

 

5.00

%

9.70

%

9.31

%

Tier 1  risk-based capital

 

6.00

%

15.99

%

14.74

%

Total  risk-based capital

 

10.00

%

17.25

%

16.00

%

 

***LIQUIDITY***

 

         The Companycontinues to manage its liquidity through a combination of core deposits,federal funds purchased, repurchase agreements, collateralized borrowing linesat the FHLB, and a portfolio of securities available-for-sale.  Liquidity is also provided by maturinginvestment securities and loans.  Averagecore deposits (excludes money desk and escrow deposits) and shareholders’equity comprised 82.2% of total funding at September 30, 2001, compared to62.5% at December 31, 2000.

 

***ASSET LIABILITY MANAGEMENT***

 

         Thefollowing table shows that the Company’s cumulative one year interest ratesensitivity gap indicated an asset sensitive position of $18.4 million atSeptember 30, 2001, an increase from an asset sensitive position of $12.3million at December 31, 2000.  Thischange resulted from the Company’s a relatively heavy position maintained inshort-term liquid assets during the third quarter 2001 in anticipation of theclosing of the South Bay Bank acquisitions and a reduction in the volume ofshort-repricing funding liabilities.

 

         TheCompany’s asset sensitive position during a period of rapidly declining rates,such as 450 basis points reduction in the discount rate by the Federal ReserveBoard during the first nine months of 2001, has a negative effect on theCompany’s net interest income as changes in the rates of interest-bearingdeposits historically have not changed proportionately with changes in marketinterest rates.  Additionally, thesignificant decline in market rates of interest during 2001 has resulted incompression of deposit rates limiting the ability to preserve margins asearning asset rates decline.

 

 

**September 30,  2001**

 

 

 

**Maturing or  repricing in**

 

 

 

**Less**

 

**After three**

 

**After one**

 

 

 

 

 

 

 

**than**

 

**Months**

 

**year**

 

 

 

 

 

 

 

**three**

 

**but within**

 

**but within**

 

**After**

 

 

 

 

 

**months**

 

**one year**

 

**5 years**

 

**5 years**

 

**Total**

 

 

 

**(Dollars in  thousands)**

 

Rate-Sensitive  Assets:

 

 

 

 

 

 

 

 

 

 

 

Federal funds  sold and securities purchased under agreements to resell

 

$

43,950

 

$

-

 

$

-

 

$

-

 

$

43,950

 

Securities  available-for-sale, at amortized cost

 

1,864

 

2,028

 

10,848

 

27,875

 

42,615

 

FRB and other  stock, at cost

 

-

 

-

 

-

 

2,369

 

2,369

 

Loans  receivable

 

61,098

 

6,340

 

24,734

 

12,339

 

104,511

 

Total rate-sensitive  assets

 

106,912

 

8,368

 

35,582

 

42,583

 

193,445

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rate-Sensitive  Liabilities:  (1)

 

 

 

 

 

 

 

 

 

 

 

Interest  bearing deposits:

 

 

 

 

 

 

 

 

 

 

 

Demand, money  market and savings

 

52,460

 

-

 

-

 

-

 

52,460

 

Time  certificates of deposit

 

21,474

 

9,433

 

704

 

390

 

32,001

 

Other  borrowings

 

9,500

 

4,000

 

2,500

 

-

 

16,000

 

Total  rate-sensitive liabilities

 

83,434

 

13,433

 

3,204

 

390

 

100,461

 

Interest  rate-sensitivity gap

 

23,478

 

(5,065

)

32,378

 

42,193

 

92,984

 

Cumulative  interest rate-sensitivity gap

 

$

23,478

 

$

18,413

 

$

50,791

 

$

92,984

 

 

 

Cumulative  ratio of rate sensitive assets to rate-sensitive liabilities

 

128

%

119

%

151

%

193

%

 

 

(1)Deposits which are subject to immediate withdrawal are presented as repricingwithin three months or less.      The distribution of othertime deposits is based on scheduled maturities.

 

**Rate-Sensitive Assets and Liabilities**

 

 

 

 

**December 31,  2000**

 

 

 

**Maturing or  repricing in**

 

 

 

**Less**

 

**After three**

 

**After one**

 

 

 

 

 

 

 

**than**

 

**months**

 

**year**

 

 

 

 

 

 

 

**three**

 

**but within**

 

**but within**

 

**After**

 

 

 

 

 

**months**

 

**one year**

 

**5 years**

 

**5 years**

 

**Total**

 

 

 

**(Dollars in  thousands)**

 

Rate-Sensitive  Assets:

 

 

 

 

 

 

 

 

 

 

 

Federal funds  sold and securities purchased under agreements to resell

 

$

19,700

 

$

-

 

$

-

 

$

-

 

$

19,700

 

Securities  available-for-sale, at amortized cost

 

18,014

 

10,227

 

24,728

 

11,984

 

64,953

 

FRB and other  stock, at cost

 

-

 

-

 

-

 

2,733

 

2,733

 

Loans  receivable

 

68,667

 

14,149

 

23,871

 

3,561

 

110,248

 

Total  rate-sensitive assets

 

106,381

 

24,376

 

48,599

 

18,278

 

197,634

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rate-Sensitive  Liabilities:  (1)

 

 

 

 

 

 

 

 

 

 

 

Interest  bearing deposits:

 

 

 

 

 

 

 

 

 

 

 

Demand, money  market and savings

 

42,499

 

-

 

-

 

-

 

42,499

 

Time  certificates of deposit

 

21,150

 

9,782

 

753

 

428

 

32,113

 

Other  borrowings

 

45,000

 

-

 

2,500

 

-

 

47,500

 

Total  rate-sensitive liabilities

 

108,649

 

9,782

 

3,253

 

428

 

122,112

 

Interest  rate-sensitivity gap

 

(2,268

)

14,594

 

45,346

 

17,850

 

75,522

 

Cumulative  interest rate-sensitivity gap

 

$

(2,268

)

$

12,326

 

$

57,672

 

$

75,522

 

 

 

Cumulative  ratio of rate sensitive assets to rate-sensitive liabilities

 

98

%

110

%

147

%

162

%

 

 

 

(1)Deposits which are subject to immediate withdrawal are presented as repricingwithin three months or less.      The distribution of other timedeposits is based on scheduled maturities.*SOUTH BAY BANK*

 

                TheCompany entered into an Agreement and Plan of Reorganization dated July 18,2001 (the “Agreement”) with South Bay Bank, National Association, pursuant towhich the Company has agreed to acquire South Bay on the terms and conditionsset forth in the Agreement.  Theacquisition will be accomplished through the consolidation of South Bay and aninterim national bank to be formed by the Company.  As a result of the consolidation, South Bay will become a whollyowned subsidiary of the Company and the shareholders of South Bay will receivecash in the aggregate amount of approximately $29.1 million, or approximately$10.33 per share (subject to adjustment in certain circumstances) whichrepresents approximately 1.93 times the book value of South Bay at December 31,2000.  The Company intends to accountfor the consolidation as a “purchase” for financial reporting purposes.  The transaction is pending final regulatoryapproval and is expected to close during the fourth quarter 2001.  No assurances can be given that the Companywill consummate the acquisition of South Bay Bank.

 

**FACTORS WHICH MAY AFFECT FUTURE OPERATING RESULTS**

** **

**We face risk from changes in interest rates.**

 

                Thesuccess of our business depends, to a large extent, on our net interestincome.  Changes in market interestrates can affect our net interest income by affecting the spread between ourinterest earning assets and interest bearing liabilities.  This may be due to the different maturitiesof our interest earning assets and interest bearing liabilities, as well as anincrease in the general level of interest rates.  Changes in market interest rates also affect, among other things:

 

•      Ourability to originate loans;

 

•      Theability of our borrowers to make payments on their loans;

 

•      Thevalue of our interest earning assets and our ability to realize gains from thesale of these assets;

 

•      Theaverage life of our interest earning assets;

 

•      Ourability to generate deposits instead of other available funding alternatives;and

 

•      Ourability to access the wholesale funding market.

 

                Interestrates are highly sensitive to many factors, including governmental monetarypolicies, domestic and international economic and political conditions andother factors beyond our control.

 

 

 

 

**We face risk from possible declines in the quality of ourassets.**

 

                Our financial condition dependssignificantly on the quality of our assets. While we have developed and implemented underwriting policies andprocedures to guide us in the making of loans, compliance with these policiesand procedures in making loans does not guarantee repayment of the loans.  If the level of our nonperforming assetsrises, our results of operations and financial condition will be affected.  A borrower’s ability to pay its loan inaccordance with its terms can be adversely affected by a number of factors,such as a decrease in the borrower’s revenues and cash flows due to adversechanges in economic conditions or a decline in the demand for the borrower’sproducts and/or services.

 

**Our allowances for credit losses may be inadequate.**

 

                We establish allowances forcredit losses against each segment of our loan portfolio.  At September 30, 2001, our allowance forcredit losses equaled 2.8% of loans receivable and 133.2% of nonperformingloans.  Although we believed that we hadestablished adequate allowances for credit losses as of September 30, 2001, thecredit quality or our assets is affected by many factors beyond our control,including local and national economic conditions, and the possible existence offacts which are not known to us which adversely affect the likelihood ofrepayment of various loans in our loan portfolio and realization of thecollateral upon a default.  Accordingly,we can give no assurance that we will not sustain loan losses materially inexcess of the allowance for credit losses. In addition, the OCC, as an integral part of its examination process,periodically reviews our allowance for credit losses and could requireadditional provisions for credit losses. Material future additions to the allowance for credit losses may also benecessary due to increases in the size and changes in the composition of ourloan portfolio.  Increases in ourprovisions for credit losses would adversely affect our results of operations.

 

**Economic conditionsmay worsen.**

 

                Ourbusiness is strongly influenced by economic conditions in our market area(principally, the Greater Los Angeles metropolitan area) as well as regionaland national economic conditions and in our niche markets, including theentertainment industry in Southern California. During the past several months that national economy has beenrecessionary.  Should the economiccondition deteriorate further, the financial condition of our borrowers couldweaken, which could lead to higher levels of loan defaults or a decline in thevalue of collateral for our loans.  Inaddition, an unfavorable economy could reduce the demand for our loans andother products and services.**Because a significant amount of the loans we make are to borrowers inCalifornia, our operations could suffer as a result of local recession ornatural disasters in California.**

 

                At September 30, 2001,approximately 50% of our loans outstanding were collateralized by propertieslocated in California.  Because of thisconcentration in California, our financial position and results of operationshave been and are expected to continue to be influenced by general trends inthe California economy and its real estate market.  Real estate market declines may adversely affect the values ofthe properties collateralizing loans. If the principal balances of our loans, together with any primaryfinancing on the mortgaged properties, equal or exceed the value of themortgaged properties, we could incur higher losses on sales of propertiescollateralizing foreclosed loans.  Inaddition, California historically has been vulnerable to certain naturaldisaster risks, such as earthquakes and erosion-caused mudslides, which are nottypically covered by the standard hazard insurance policies maintained byborrowers.  Uninsured disasters mayadversely impact our ability to recover losses on properties affected by suchdisasters and adversely impact our results of operations.

 

Our business is very competitive.

** **

                There is intense competition inSouthern California and elsewhere in the United States for bankingcustomers.  We experience competitionfor deposits from many sources, including credit unions, insurance companiesand money market and other mutual funds, as well as other commercial banks andsavings institutions.  We compete forloans and deposits primarily with other commercial banks, mortgage companies,commercial finance companies and savings institutions.  In recent years certain out-of-statefinancial institutions have entered the California market, which has alsoincreased competition.  Many of ourcompetitors have greater financial strength, marketing capability and namerecognition than we do, and operate on a statewide or nationwide basis.  In addition, recent developments intechnology and mass marketing have permitted larger companies to market loansand deposits more aggressively to our small business customers.  Such advantages may give our competitorsopportunities to realize greater efficiencies and economies of scale than wecan.  We can provide no assurance thatwe will be able to compete effectively against our competition.

 

Our business is heavily regulated.

 

                Both National MercantileBancorp, as a bank holding company, and Mercantile National Bank, as a nationalbank, are subject to significant governmental supervision and regulation, whichis intended primarily for the protection of depositors.  Statutes and regulations affecting us may bechanged at any time, and the interpretation of these statutes and regulationsby examining authorities also may change. We cannot assure you that future changes in applicable statutes andregulations or in their interpretation will not adversely affect our business.
****
**Our ability to useour net operating losses may be limited.**

 

                During the past three years,although we have had taxable income, we have not paid any income taxes otherthan alternative minimum taxes because of our net operating losscarryforwards.  As of December 31, 2000,we had net operating loss carryforwards of $18.4 million and $1.5 million forfederal and state tax purposes, respectively. Our federal net operating loss carryforward begins to expire in2009.  Our state net operating losscarryforwards continue to expire but remain available in reducing amountsthrough 2002.  Our ability to use thesecarryforwards in the future would be significantly limited if we experience an“ownership change” within the meaning of Section 382 of the Internal RevenueCode.  Future issuances of common stockand transfers of our capital stock could have that effect.  If our use of these carryforwards islimited, we would be required to pay taxes on our taxable income to the extentour taxable income exceeded the limited amounts which could be offset, and ournet income would be lower.
****
 

**PART II—OTHER INFORMATION**

** **

***Item 1.   LEGALPROCEEDINGS***

** **

None.

 

***Item 2.   CHANGESIN SECURITIES***

** **

None.

 

***Item 3.   DEFAULTSUPON SENIOR SECURITIES***

*** ***

None.

 

***Item 4.   SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDER***

*** ***

None.

*** ***

***Item 5.   OTHERINFORMATION***

*** ***

                                None.

** **

***Item 6.   EXHIBITSAND REPORTS ON FORM 8-K***

*** ***

(a) *Exhibits.*

* *

(a)              None.

 

(b) *Reports on Form 8-K.*

* *

     On July 24, 2001, the Company filed areport on Form 8-K reporting under Item 5 the Agreement and Plan ofReorganization dated July 18, 2001 with South Bay Bank, N.A.

 
SIGNATURES
** **

         Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 

 

 

**NATIONAL MERCANTILE BANCORP**

 

 

 

(Registrant)

 

 

 

 

 

 

 

 

 

 

 

 

DATE:

November  14, 2001

 

/s/  Scott A. Montgomery

 

 

 

**SCOTT A. MONTGOMERY**

 

 

 

Chief Executive Officer

 

 

 

 

DATE:

November 14, 2001

 

/s/   DAVID R. BROWN

 

 

 

**DAVID R. BROWN**

 

 

 

Chief Financial Officer

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