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

 

**WASHINGTON,D.C. 20549**

 

**FORM 10-QSB**

 

**QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHESECURITIES EXCHANGE ACT OF 1934**

 

**Forthe quarterly period ended September 30, 2002**

 

**CommissionFile Number: 0-15982**

 
|                                                             | **NATIONAL  MERCANTILE BANCORP**                                   |                                  |
|------------------------------------------------------------------|--------------------------------------------------------------------|---------------------------------------|
|                                                             | (Exact name of  small business issuer as specified in its charter) |                                  |
|                                                             |                                                               |                                  |
| **California**                                                   |                                                               | **95-3819685**                        |
| (State or other  jurisdiction of  incorporation or organization) |                                                               | (I.R.S. Employer  Identification No.) |
|                                                             |                                                               |                                  |
| **1840 Century Park East, Los Angeles,  California**             |                                                               | **90067**                             |
| (Address of  principal executive offices)                        |                                                               | (Zip Code)                            |
|                                                             |                                                               |                                  |
|                                                                  |                                                                    |                                       |  |  |

Issuer’s telephonenumber, including area code **(310) 277-2265**

 

Indicate by check markwhether the issuer (1) has filed all reports required to be filed by Section 13or 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 suchreports), and (2) has been subject to such filing requirements for the past 90days.

 

YES  ý     NO  o

 

APPLICABLE ONLY TOCORPORATE ISSUERS:

 

The number of shares outstanding of the issuer’s Common Stock, no parvalue, as of October 31, 2002 was 1,648,157.

 

 

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**PART I — FINANCIAL INFORMATION**

 

***Item 1.   FinancialStatements***

 

2

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**NATIONALMERCANTILE BANCORP AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

(Unaudited)

 
|                                                                                                                                                                                                 |   | **September 30,  2002**    |         | **December 31,  2001** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------|--------------|------------------------|--------|
|                                                                                                                                                                                                 |   | **(Dollars in thousands)** |         |
|                                                                                                                                                                                                 |   |                       |         |                   |   |
| ASSETS                                                                                                                                                                                               |   |                       |         |                   |   |
| Cash  and due from banks-demand                                                                                                                                                                      |   | $                          | 19,771       |                   | $      | 12,688 |   |
| Due  from banks - time certificates                                                                                                                                                                  |   | 200                        |         | —                 |   |
| Federal  funds sold and securities purchased under agreements to resell                                                                                                                              |   | 14,040                     |    | 39,405                 |   |
| Cash  and cash equivalents                                                                                                                                                                           |   | 34,011                     |         | 52,093                 |   |
| Securities  available-for-sale, at fair value; aggregate amortized cost of $30,056 and  $41,532 at September 30, 2002 and December 31, 2001, respectively                                            |   | 30,505                     |    | 41,627                 |   |
| Federal  Reserve Bank stock and other stock, at cost                                                                                                                                                 |   | 2,238                      |         | 2,552                  |   |
|                                                                                                                                                                                                 |   |                       |         |                   |   |
| Loans  receivable                                                                                                                                                                                    |   | 264,513                    |         | 261,968                |   |
| Allowance  for credit losses                                                                                                                                                                         |   | (4,756                     | )            | (6,542                 | )      |
| Net  loans receivable                                                                                                                                                                                |   | 259,757                    |         | 255,426                |   |
|                                                                                                                                                                                                 |   |                       |         |                   |   |
| Premises  and equipment, net                                                                                                                                                                         |   | 5,975                      |         | 6,121                  |   |
| Other  real estate owned                                                                                                                                                                             |   | 1,000                      |         | —                 |   |
| Deferred  tax asset, net                                                                                                                                                                             |   | 7,662                      |         | 8,364                  |   |
| Goodwill                                                                                                                                                                                             |   | 5,541                      |         | 5,616                  |   |
| Accrued  interest receivable and other assets                                                                                                                                                        |   | 2,550                      |         | 2,566                  |   |
| Total  assets                                                                                                                                                                                        |   | $                          | 349,239      |                   | $      | 374,365 |   |
|                                                                                                                                                                                                 |   |                       |         |                   |   |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                                                                                                                           |   |                       |         |                   |   |
| Deposits:                                                                                                                                                                                            |   |                       |         |                   |   |
| Noninterest-bearing  demand                                                                                                                                                                          |   | $                          | 102,916      |                   | $      | 114,645 |   |
| Interest-bearing  demand                                                                                                                                                                             |   | 27,243                     |         | 23,425                 |   |
| Money  market                                                                                                                                                                                        |   | 49,514                     |         | 40,033                 |   |
| Savings                                                                                                                                                                                              |   | 38,800                     |         | 31,184                 |   |
| Time  certificates of deposit:                                                                                                                                                                       |   |                       |         |                   |   |
| $100,000  or more                                                                                                                                                                                    |   | 42,585                     |         | 62,085                 |   |
| Under  $100,000                                                                                                                                                                                      |   | 36,329                     |         | 37,768                 |   |
| Total  deposits                                                                                                                                                                                      |   | 297,387                    |         | 309,140                |   |
|                                                                                                                                                                                                 |   |                       |         |                   |   |
| Federal  funds purchased and securities sold under agreements to repurchase                                                                                                                          |   | 1,680                      |         | 3,096                  |   |
| Other  borrowings                                                                                                                                                                                    |   | 7,500                      |         | 17,500                 |   |
| Accrued  interest payable and other liabilities                                                                                                                                                      |   | 2,177                      |         | 3,963                  |   |
| Total  liabilities                                                                                                                                                                                   |   | 308,744                    |         | 333,699                |   |
|                                                                                                                                                                                                 |   |                       |         |                   |   |
| Guaranteed  preferred beneficial interests in the Company’s junior subordinated deferrable  interest debentures, net                                                                            |   | 14,526                     |    | 14,513                 |   |
| Minority  interest in the Series A preferred stock of consolidated subsidiary, South  Bay Bank, N.A, net                                                                                             |   | 907                        |         | 676                    |   |
|                                                                                                                                                                                                 |   |                       |         |                   |   |
| Shareholders’  equity:                                                                                                                                                                          |   |                       |         |                   |   |
| Preferred  stock, no par value:                                                                                                                                                                      |   |                       |         |                   |   |
| Series  A non-cumulative convertible perpetual preferred stock; authorized 990,000  shares; outstanding 745,785 shares and 750,580 shares at September 30, 2002  and December 31, 2001, respectively |   | 6,091                      |         | 6,131                  |   |
| Preferred  stock, no par value:                                                                                                                                                                      |   |                       |         |                   |   |
| Series  B non-cumulative convertible perpetual preferred stock; authorized 1,000  shares; outstanding 1,000 shares at September 30, 2002 and December 31, 2001                                       |   | 1,000                      |         | 1,000                  |   |
| Common  stock, no par value; authorized 10,000,000 shares; outstanding 1,645,357  shares and 1,623,467 shares at September 30, 2002 and December 31, 2001,  respectively                             |   | 30,364                     |         | 30,268                 |   |
| Additional  paid-in capital                                                                                                                                                                          |   | 1,824                      |         | 1,824                  |   |
| Accumulated  deficit                                                                                                                                                                                 |   | (14,481                    | )            | (13,802                | )      |
| Accumulated  other comprehensive income                                                                                                                                                              |   | 264                        |         | 56                     |   |
| Total  shareholders’ equity                                                                                                                                                                     |   | 25,062                     |         | 25,477                 |   |
| Total  liabilities and shareholders’ equity                                                                                                                                                     |   | $                          | 349,239      |                   | $      | 374,365 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

3

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**NATIONALMERCANTILE BANCORP AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
|                                                                                                                                                                                                                       |   | **Three  months ended  September 30,**               |       | **Nine  months ended  September 30,** |       |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------|------------|---------------------------------------|------------|
|                                                                                                                                                                                                                       |   | **2002**                                             |       | **2001**                              |       | **2002** |   | **2001** |   |
|                                                                                                                                                                                                                       |   | **(Dollars  in thousands except per share amounts)** |       |
| Interest  income:                                                                                                                                                                                                          |   |                                                 | ** ** |                                  | ** ** |   | ** ** |   | ** ** |
| Loans,  including fees                                                                                                                                                                                                     |   | $                                                    | 4,363      |                                  | $          | 2,267 |   | $ | 13,115 |   | $ | 7,189 |   |
| Securities  available-for-sale                                                                                                                                                                                             |   | 401                                                  |       | 679                                   |       | 1,331 |   | 2,671 |   |
| Federal  funds sold and securities purchased under agreements to resell                                                                                                                                                    |   | 105                                                  |       | 310                                   |       | 361 |   | 632 |   |
| Total  interest income                                                                                                                                                                                                     |   | 4,869                                                |       | 3,256                                 |       | 14,807 |   | 10,492 |   |
| Interest  expense:                                                                                                                                                                                                         |   |                                                 |       |                                  |       |   |   |   |   |
| Interest-bearing  demand                                                                                                                                                                                                   |   | 86                                                   |       | 26                                    |       | 243 |   | 68 |   |
| Money  market and savings                                                                                                                                                                                                  |   | 388                                                  |       | 254                                   |       | 1,087 |   | 837 |   |
| Time  certificates of deposit:                                                                                                                                                                                             |   |                                                 |       |                                  |       |   |   |   |   |
| $100,000  or more                                                                                                                                                                                                          |   | 172                                                  |       | 313                                   |       | 673 |   | 1,141 |   |
| Under  $100,000                                                                                                                                                                                                            |   | 357                                                  |       | 39                                    |       | 1,117 |   | 180 |   |
| Total  interest expense on deposits                                                                                                                                                                                        |   | 1,003                                                |       | 632                                   |       | 3,120 |   | 2,226 |   |
| Federal  funds purchased and securities sold under agreements to repurchase                                                                                                                                                |   | 21                                                   |       | 2                                     |       | 116 |   | 30 |   |
| Other  borrowings                                                                                                                                                                                                          |   | 92                                                   |       | 177                                   |       | 388 |   | 889 |   |
| Total  interest expense                                                                                                                                                                                                    |   | 1,116                                                |       | 811                                   |       | 3,624 |   | 3,145 |   |
|                                                                                                                                                                                                                       |   |                                                 |       |                                  |       |   |   |   |   |
| Net  interest income before provision for credit losses                                                                                                                                                                    |   | 3,753                                                |       | 2,445                                 |       | 11,183 |   | 7,347 |   |
| Provision  for credit losses                                                                                                                                                                                               |   | 1,525                                                |       | 450                                   |       | 1,825 |   | 450 |   |
| Net  interest income after provision for credit losses                                                                                                                                                                     |   | 2,228                                                |       | 1,995                                 |       | 9,358 |   | 6,897 |   |
|                                                                                                                                                                                                                       |   |                                                 |       |                                  |       |   |   |   |   |
| Other  operating income:                                                                                                                                                                                                   |   |                                                 |       |                                  |       |   |   |   |   |
| Net  gain on sale of securities available-for-sale                                                                                                                                                                         |   | —                                               |       | 92                                    |       | — |   | 238 |   |
| International  services                                                                                                                                                                                                    |   | 13                                                   |       | 11                                    |       | 32 |   | 38 |   |
| Investment  division                                                                                                                                                                                                       |   | 20                                                   |       | 28                                    |       | 62 |   | 81 |   |
| Deposit-related  and other customer services                                                                                                                                                                               |   | 320                                                  |       | 148                                   |       | 941 |   | 457 |   |
| Total  other operating income                                                                                                                                                                                              |   | 353                                                  |       | 279                                   |       | 1,035 |   | 814 |   |
|                                                                                                                                                                                                                       |   |                                                 |       |                                  |       |   |   |   |   |
| Other  operating expenses:                                                                                                                                                                                                 |   |                                                 |       |                                  |       |   |   |   |   |
| Salaries  and related benefits                                                                                                                                                                                             |   | 1,730                                                |       | 1,037                                 |       | 5,135 |   | 3,255 |   |
| Net  occupancy                                                                                                                                                                                                             |   | 348                                                  |       | 268                                   |       | 1,070 |   | 738 |   |
| Furniture  and equipment                                                                                                                                                                                                   |   | 101                                                  |       | 68                                    |       | 315 |   | 206 |   |
| Printing  and communications                                                                                                                                                                                               |   | 126                                                  |       | 83                                    |       | 437 |   | 237 |   |
| Insurance  and regulatory assessments                                                                                                                                                                                      |   | 89                                                   |       | 79                                    |       | 267 |   | 241 |   |
| Customer  services                                                                                                                                                                                                         |   | 155                                                  |       | 220                                   |       | 601 |   | 650 |   |
| Computer  data processing                                                                                                                                                                                                  |   | 224                                                  |       | 100                                   |       | 736 |   | 338 |   |
| Legal  services                                                                                                                                                                                                            |   | 72                                                   |       | 56                                    |       | 452 |   | 107 |   |
| Other  professional services                                                                                                                                                                                               |   | 98                                                   |       | 114                                   |       | 415 |   | 323 |   |
| Other  expenses                                                                                                                                                                                                            |   | 87                                                   |       | 75                                    |       | 284 |   | 186 |   |
| Total  other operating expenses                                                                                                                                                                                            |   | 3,030                                                |       | 2,100                                 |       | 9,712 |   | 6,281 |   |
| Net  income before minority interests and income tax provision                                                                                                                                                             |   | (449                                                 | )          | 174                                   |       | 681 |   | 1,430 |   |
|                                                                                                                                                                                                                       |   |                                                 |       |                                  |       |   |   |   |   |
| Minority  interest in the income of the:                                                                                                                                                                                   |   |                                                 |       |                                  |       |   |   |   |   |
| Company’s  junior subordinated deferrable interest debentures, net                                                                                                                                                    |   | 380                                                  |       | 329                                   |       | 1,153 |   | 329 |   |
| Series  A Preferred Stock of South Bay Bank, N.A.                                                                                                                                                                          |   | 53                                                   |       | —                                |       | 159 |   | — |   |
| Net  income (loss) before income tax provision                                                                                                                                                                             |   | (882                                                 | )          | (155                                  | )          | (631 | ) | 1,101 |   |
| Provision  for income taxes                                                                                                                                                                                                |   | (340                                                 | )          | 42                                    |       | (202 | ) | 89 |   |
| Net  income (loss)                                                                                                                                                                                                         |   | $                                                    | (542       | )                                     | $          | (197 | ) | $ | (429 | ) | $ | 1,012 |   |
|                                                                                                                                                                                                                       |   |                                                 |       |                                  |       |   |   |   |   |   |   |   |   |
| Income  available to common shareholders (net income less accretion of discount of  minority interest in subsidiary preferred stock of $80,000 and $231,000 for  the three months and nine months ended September 30, 2002 |   | $                                                    | (622       | )                                     | (197       | ) | (660 | ) | 1,012 |   |
| Earnings  (loss) per share:                                                                                                                                                                                                |   |                                                 |       |                                  |       |   |   |   |   |
| Basic                                                                                                                                                                                                                      |   | $                                                    | (0.38      | )                                     | $          | (0.12 | ) | $ | (0.40 | ) | $ | 0.63 |   |
| Diluted                                                                                                                                                                                                                    |   | $                                                    | (0.38      | )                                     | $          | (0.12 | ) | $ | (0.40 | ) | $ | 0.31 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

4

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**NATIONALMERCANTILE BANCORP AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

** **
|                                                                                         |   | **For the  nine-months  ended September 30,** |   |
|----------------------------------------------------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                                         |   | **2002**                                      |   | **2001** |   |
|                                                                                         |   | **(Dollars  in thousands)**                   |   |
| Net  cash flow from operating activities:                                                    |   |                                          |   |   |   |
| Net  income (loss)                                                                           |   | $                                             | (429   | ) | $ | 1,012 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities:           |   |                                          |   |   |   |
| Depreciation  and amortization                                                               |   | 350                                           |   | 173 |   |
| Provision  for credit losses                                                                 |   | 1,825                                         |   | 450 |   |
| Gain  on sale of securities available-for-sale                                               |   | —                                        |   | (238 | ) |
| Net  amortization of premium (discount) on securities available-for-sale                     |   | 133                                           |   | (21 | ) |
| Net  accretion of premium (discounts) on loans purchased                                     |   | 267                                           |   | (27 | ) |
| Increase  (decrease) in accrued interest receivable and other assets                         |   | 793                                           |   | (437 | ) |
| Decrease  in accrued interest payable and other liabilities                                  |   | (1,699                                        | )      | (146 | ) |
|                                                                                         |   |                                          |   |   |   |
| Net  cash provided by operating activities                                                   |   | 1,240                                         |   | 766 |   |
|                                                                                         |   |                                          |   |   |   |
| Cash  flows from investing activities:                                                       |   |                                          |   |   |   |
| Purchase  of securities available-for-sale                                                   |   | (7,002                                        | )      | (7,049 | ) |
| Proceeds  from sale of securities available-for-sale                                         |   | —                                        |   | 11,206 |   |
| Proceeds  from repayments and maturities of securities available-for-sale                    |   | 18,199                                        |   | 19,191 |   |
| Loan  originations and principal collections, net                                            |   | (7,423                                        | )      | 5,618 |   |
| Redemption  of FRB and other stocks                                                          |   | 314                                           |   | — |   |
| Purchases  of premises and equipment                                                         |   | (191                                          | )      | (259 | ) |
|                                                                                         |   |                                          |   |   |   |
| Net  cash provided by investing activities                                                   |   | 3,897                                         |   | 28,707 |   |
| Cash  flows from financing activities:                                                       |   |                                          |   |   |   |
| Net  increase in demand deposits, money market and savings accounts                          |   | 9,186                                         |   | 13,820 |   |
| Net  decrease in time certificates of deposit                                                |   | (20,939                                       | )      | (112 | ) |
| Net  decrease in securities sold under agreements to repurchase and federal funds  purchased |   | (1,416                                        | )      | (7,500 | ) |
| Net  proceeds from issuance of junior subordinated deferrable interest debentures            |   | —                                        |   | 15,000 |   |
| Net  decrease in other borrowings                                                            |   | (10,000                                       | )      | (24,000 | ) |
| Dividends  paid on subsidiary preferred stock                                                |   | (106                                          | )      | — |   |
| Net  proceeds from exercise of stock options                                                 |   | 56                                            |   | 197 |   |
|                                                                                         |   |                                          |   |   |   |
| Net  cash used in financing activities                                                       |   | (23,219                                       | )      | (2,595 | ) |
| Net  increase in cash and cash equivalents                                                   |   | (18,082                                       | )      | 26,878 |   |
| Cash  and cash equivalents, January 1                                                        |   | 52,093                                        |   | 27,597 |   |
|                                                                                         |   |                                          |   |   |   |
| Cash  and cash equivalents, June 30                                                          |   | $                                             | 34,011 |   | $ | 54,475 |   |
|                                                                                         |   |                                          |   |   |   |
| Supplemental  cash flow information:                                                         |   |                                          |   |   |   |
|                                                                                         |   |                                          |   |   |   |
| Cash  paid for interest                                                                      |   | $                                             | 3,949  |   | $ | 3,204 |   |
| Cash  paid for income taxes                                                                  |   | $                                             | — |   | $ | 131 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

5

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**NATIONAL MERCANTILE BANCORP AND SUBSIDIARY**

###### **NOTESTO 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 subsidiaries, (i) MercantileNational Bank, (ii) South Bay Bank, N.A., and (iii) National Mercantile CapitalTrust I.  The unaudited consolidatedfinancial statements reflect all interim adjustments, which are of a normalrecurring nature and which, in management’s opinion, are necessary for the fairpresentation of the Company’s consolidated financial position and results of operationsand cash flows for such interim periods. The results for the three and ninemonth periods ended September 30, 2002 are not necessarily indicative of theresults expected for any subsequent period or for the full year ending December31, 2002.  The unaudited consolidatedfinancial statements should be read in conjunction with the auditedconsolidated financial statements included in the Company’s Annual Report onForm 10-KSB for the year ended December 31, 2001.

 

NOTE 2—EARNINGS (LOSS)PER SHARE

 

Basic earnings(loss) per share is computed using the weighted average number of common sharesoutstanding during the period.  Theweighted average number of common shares outstanding used in computing basicearnings (loss) per share was 1,637,991 and 1,621,751 for the three monthsended September 30, 2002 and 2001, respectively, and 1,632,242 and 1,603,365respectively, for the nine months ended September 30, 2002 and 2001.  The weighted average number of common sharesand common share equivalents outstanding used in computing diluted earnings(loss) per share was 1,621,751 and 3,232,544, for the three months and for thenine months ended September 30, 2001, respectively.  Diluted loss per share for the three months and nine months endedSeptember 30, 2002 and the three months ended September 30, 2001 does notinclude common share equivalents as they are anti-dilutive.

 

6

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The followingtable is a reconciliation of net income (loss) and shares used in the computationof earnings (loss) per basic and diluted common share:

 

|                                             |   | **Net  Income**     |   | **Shares** |      | **Per  share  amount** |   |
|--------------------------------------------------|--------|---------------------|--------|------------|-----------|------------------------|--------|
|                                             |   | **(in  thousands)** |   |       |      |                   |   |
| *For the three months ended September 30, 2002:* |   |                |   |       |      |                   |   |
| Basic  and diluted loss per share                |   | $                   | (622   | )          | 1,637,991 |                   | $      | (0.38 | ) |
|                                             |   |                |   |       |      |                   |   |
| *For the three months ended September 30, 2001:* |   |                |   |       |      |                   |   |
| Basic  EPS                                       |   | $                   | (197   | )          | 1,621,751 |                   | $      | (0.12 | ) |
|                                             |   |                |   |       |      |                   |   |
| *For the nine months ended September 30, 2002:*  |   |                |   |       |      |                   |   |
| Basic  and diluted loss per share                |   | $                   | (660   | )          | 1,632,242 |                   | $      | (0.40 | ) |
|                                             |   |                |   |       |      |                   |   |
| *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 |   |

### *** ***

NOTE 3—CASH AND CASHEQUIVALENTS

 

For purposes ofreporting cash flows, cash and cash equivalents include cash and due from banks– demand, federal funds sold and securities sold under agreements to resell.

 

NOTE 4—ALLOWANCE FORCREDIT LOSSES

 

Provisions forcredit losses charged to operations reflect management’s judgment of theadequacy of the allowance for credit losses and are determined through periodicanalysis of the loan portfolio.  Thisanalysis includes a detailed review of the classification and categorization ofproblem loans and loans to be charged off; an assessment of the overall qualityand collectibility of the portfolio; and consideration of the loan lossexperience, trends in problem loan concentrations of credit risk, as well ascurrent and expected future economic conditions (particularly SouthernCalifornia). Management, in conjunction with an outside firm, performs aperiodic risk and credit analysis, the results of which are reported to theBoard of Directors.

 

Loans charged offduring the third quarter and first nine months of 2002 were $2.2 million and$4.0 million, respectively, compared to $22,000 and $372,000 during the thirdquarter and first nine months of 2001, respectively.  The increase in loans charged off in 2002 is primarily due tononperforming loans from the South Bay acquisition.  Recoveries of loans previously

 

7

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charged off were $16,000and $352,000 during the third quarter and first nine months of 2002 compared to$110,000 and $226,000 million for the same periods in 2001.

 

The followingtable sets forth information concerning the Company’s allowance for creditlosses for the periods indicated. 

 
|                                                     |   | **Three  months ended**     |       | **Nine  months ended**      |       |
|----------------------------------------------------------|--------|-----------------------------|------------|-----------------------------|------------|
|                                                     |   | **September  30,  2002**    |       | **September  30,  2001**    |       | **September  30,  2002** |   | **September  30,  2001** |   |
|                                                     |   | **(Dollars  in thousands)** |       | **(Dollars  in thousands)** |       |
|                                                     |   |                        | ** ** |                        | ** ** |   | ** ** |   | ** ** |
| Balance,  beginning of period(1)                         |   | $                           | 5,374      |                        | $          | 2,363 |   | $ | 6,542 |   | 2,597 |   |
| Loans  charged off:                                      |   |                        |       |                        |       |   |   |   |   |
| Real  estate construction and land development           |   | —                      |       | —                      |       | 31 |   | — |   |
| Commercial  loans:                                       |   |                        |       |                        |       |   |   |   |   |
| Secured  by commercial real properties                   |   | 44                          |       | —                      |       | 44 |   | — |   |
| Other  - secured and unsecured                           |   | 2,065                       |       | —                      |       | 3,807 |   | 268 |   |
| Consumer  installment and unsecured loans to individuals |   | 50                          |       | 22                          |       | 81 |   | 104 |   |
| Total  loan charge-offs                                  |   | 2,159                       |       | 22                          |       | 3,963 |   | 372 |   |
|                                                     |   |                        |       |                        |       |   |   |   |   |
| Recoveries  of loans previously charged off:             |   |                        |       |                        |       |   |   |   |   |
| Real  estate construction and land development           |   | —                      |       | —                      |       | 191 |   | 6 |   |
| Commercial  loans:                                       |   |                        |       |                        |       |   |   |   |   |
| Other  - secured and unsecured                           |   | 12                          |       | 94                          |       | 107 |   | 197 |   |
| Consumer  installment and unsecured loans to individuals |   | 4                           |       | 16                          |       | 54 |   | 23 |   |
| Total  recoveries of loans previously charged off        |   | 16                          |       | 110                         |       | 352 |   | 226 |   |
| Net  charge-offs                                         |   | 2,143                       |       | (88                         | )          | 3,611 |   | 146 |   |
| Provision  for credit losses                             |   | 1,525                       |       | 450                         |       | 1,825 |   | 450 |   |
| Balance,  end of period                                  |   | $                           | 4,756      |                        | $          | 2,901 |   | $ | 4,756 |   | $ | 2,901 |   |
|                                                          |        |                             |            |                             |            |  |  |  |  |  |  |  |  |

 

----

(1)          The balance at September 30, 2002 reflected the consolidated balance ofMercantile and South Bay, while the balance at September 30, 2001 reflected thebalance only of Mercantile.

 

Credit quality isaffected by many factors beyond the control of the Company, including local andnational economies, and facts may exist which are not known to the Company thatadversely affect the likelihood of repayment of various loans in the loanportfolio and realization of collateral upon a default. Accordingly, noassurance can be given that the Company will not sustain loan losses materiallyin excess of the allowance for credit losses. In addition, the Office of theComptroller of the Currency (“OCC”), as an integral part of its examinationprocess, periodically reviews the allowance for credit losses and could requireadditional provisions for credit losses.

 

Based on continuedloan growth, the level of nonperforming loans and a relatively constant levelof charge-offs, it is anticipated that the level of the allowance for creditlosses will remain adequate through the remainder of 2002.

 

8

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NOTE 5—INCOME TAXES

 

Income taxbenefits of $340,000 and $202,000 were recorded for the three months and ninemonths ended September 30, 2002.  Incometax provision during the three and nine months ended September 30, 2001 was$42,000 and $89,000, respectively, for state income tax and federal alternativeminimum tax due to the utilization of previously unrecognized tax benefits tooffset the current period tax liability. In conjunction with the acquisition of South Bay, the Company reversedthe valuation allowance on the deferred tax asset with the related benefitreducing goodwill.

 

For tax purposesat September 30, 2002, the Company had: (i) federal net operating loss carryforwards of approximately $17.3 million, which begin to expire in the year2009; and (ii) an alternative minimum tax credit of $297,000 which may becarried forward indefinitely.

 

NOTE 6—BENEFICIALCONVERSION RIGHTS OF SUBSIDIARY PREFERRED STOCK

 

The Companyrecorded $1.8 million additional paid in capital, with a corresponding discountto the minority interest in South Bay Series A Preferred stock, during thefourth quarter of 2001 related to the beneficial conversion rights of thepreferred stock of its subsidiary, South Bay Bank, N.A.  The discount is being amortized againstretained earnings over the period from the acquisition date through theearliest conversion date of the preferred stock, June 30, 2005 using theeffective yield method.  For the threemonths and nine months ended September 30, 2002 the amortization of thediscount against retained earnings was $80,000 and 231,000, respectively. The amortization of the discount is netted against net income todetermine income available to common shareholders for loss per share.

 

9

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NOTE 7—COMPREHENSIVEINCOME

 

Comprehensiveincome is comprised of net income and all changes to shareholders’ equity,except those changes resulting from investments by shareholders anddistributions to shareholders.  Totalcomprehensive income is as follows:

 
|                                                                                   |   | **Three  months ended  September 30,** |   | **Nine  months ended  September 30,** |   |
|----------------------------------------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|--------|
|                                                                                   |   | **2002**                               |   | **2001**                              |   | **2002** |   | **2001** |   |
| Net  income (loss)                                                                     |   | $                                      | (542   | )                                     | $      | (197 | ) | $ | (429 | ) | $ | 1,012 |   |
|                                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Other  comprehensive income, before tax, and unrealized gains (losses) on  securities: |   |                                   |   |                                  |   |   |   |   |   |
| Unrealized  gain (loss) on securities available for sale                               |   | 62                                     |   | 692                                   |   | 354 |   | (149 | ) |
| Reclassification  adjustment for realized gains in net income                          |   | —                                 |   |                                  |   | — |   |   |   |
| Other  comprehensive income (loss), before tax                                         |   | 62                                     |   | 692                                   |   | 354 |   | (149 | ) |
|                                                                                   |   |                                   |   |                                  |   |   |   |   |   |
| Income  tax credit related to items of other comprehensive income                      |   | (25                                    | )      | (284                                  | )      | (145 | ) | 61 |   |
| Other  comprehensive income (loss)                                                     |   | 37                                     |   | 408                                   |   | 209 |   | (88 | ) |
| Total  comprehensive income                                                            |   | $                                      | (505   | )                                     | $      | 211 |   | $ | (220 | ) | $ | 924 |   |

 

NOTE 8—RECLASSIFICATIONS

 

Certain prior yeardata have been reclassified to conform to current year presentation.

 

10

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***Item 2.******                      MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS***

 

NationalMercantile Bancorp (“National Mercantile” on a parent-only basis, and the“Company” on a consolidated basis) is the holding company for two subsidiarybanks, Mercantile National Bank (“Mercantile”) and South Bay Bank, N.A. (“SouthBay”) (and collectively, “the Banks”). National Mercantile’s principal assets are the capital stock ofMercantile and South Bay.  NationalMercantile Capital Trust I is a Delaware statutory business trust formed forthe exclusive purpose of issuing and selling trust preferred securities andalso is a consolidated subsidiary of the Company.

 

NationalMercantile acquired South Bay on December 14, 2001.  The acquisition was accounted for as a purchase, and thus theresults of operations for the 2001 periods do not include any results ofoperations for South Bay.

 

***RESULTS OFOPERATIONS***

 

The Companyrecorded a net loss of $542,000, or $0.38 basic and diluted loss per share,during the third quarter of 2002, compared to a net loss of $197,000, or $0.12basic loss per share during the third quarter of 2001.   The earnings during the third quarter of2002 were negatively impacted by a $1.5 million provision for loan losses whilethe same quarter of 2001 reflected a provision for loan losses of$450,000.  The operating results for thethree months ended September 30, 2002 were also impacted by narrower netinterest margins and higher noninterest expenses partly attributable toexpenses associated with the South Bay acquisition and minority interests of(i) the South Bay preferred stock, and (ii) the minority interests of theguaranteed preferred beneficial interests in the Company’s junior subordinateddeferrable interest debentures (the “Trust Preferred Securities”), in theCompany’s income.    In comparing theresults of operations, most income and expense items are greater in the 2002periods than the 2001 periods as a result of the acquisition of South Bay inDecember 2001.  Accordingly, the 2002periods include the operations of South Bay.

 

Despite narrowernet interest margins, net interest income increased during the third quarter2002 compared to 2001 due to a greater volume of earning assets as a result ofthe South Bay acquisition.  The 2002period was positively impacted by greater other income of $320,000 compared to$279,000 for the third quarter 2001 despite non-recurring net gains on sales ofsecurities of $92,000 in 2001.  Thisincrease was primarily attributable to deposit-related and other customerservice income due to the greater level of deposits from the South Bayacquisition.  The third quarter of 2001was negatively impacted by the maintenance of a relatively large low-yieldingfederal funds position in anticipation of the funding of the acquisition ofSouth Bay.

 

The Companyrecorded a net loss of $429,000, or $0.40 basic and diluted loss per share, duringthe nine months ended September 30, 2002, compared to net income of $1.0million, or $0.63 basic earnings per

 

11

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share and $0.31 dilutedearnings per share, during the nine months ended September 30, 2001.   The per share results for the 2002 periodinclude a $231,000 non-cash charge against income available to shareholdersrepresenting amortization of the discount of the minority interest of the SouthBay Series A Preferred Stock.  Thedecrease in earnings during the first nine months of 2002 compared to 2001resulted primarily from narrower net interest margins for the 2002 period,greater provisions for loan losses, higher noninterest expenses partlyattributable to nonrecurring expenses associated with the integration of theSouth Bay acquisition and minority interests of the South Bay Series Apreferred stock, and of the Trust Preferred Securities, in the Company’sincome.  Net interest income increasedsignificantly during the first nine months of 2002 compared to 2001 due to agreater volume of earning assets as a result of the South Bay acquisition.  Net interest income during the first ninemonths of 2002 compared to 2001 increased despite narrower net interest marginsas a result of a larger volume of earning assets.  Other operating income increased significantly for the nine-monthperiod ended September 30, 2002 primarily due to greater deposit-related andother customer service income.

 

Return on averageassets during the third quarter and first nine months of 2002 was minus 0.60%and minus 0.16%, respectively, compared to minus 0.40% and 0.69% during thethird quarter and first nine months of 2001, respectively.  Return on average equity during the thirdquarter and first nine months of 2002 was minus 8.46% and minus 2.25%,respectively, compared to minus 3.62% and 6.05% during the third quarter andfirst three quarters of 2001, respectively.

 

NET INTEREST INCOME

 

The increase innet interest income during the three and nine months ended September 30, 2002compared to the corresponding periods during 2001 resulted primarily from anincrease in average interest earning assets of $129.7 million and $138.7million, respectively, attributable primarily to the acquisition of South Bayin December 2001.  The South Bayacquisition also had the effect of increasing the amounts, and correspondinginterest income and expense, of nearly all categories of interest earningsassets and liabilities.  Accordingly,average interest bearing liabilities increased $90.8 million to $207.4 millionfrom $116.6 million.  Net interestspread decreased for the three months ended September 30, 2002 to 3.98% from4.17% for the same period last year due to a greater decline in the yield onearning assets than the decline in the cost of interest bearingliabilities.  The net yield on earningassets declined, however, to 4.71% for the third quarter ended September 30,2002 from 5.20% for the third quarter ended September 30, 2001 due tononinterest bearing liabilities funding lower yielding earning assets.  For the nine months ended September 30, 2002the net interest spread was 3.92% compared to 4.01% for the same period in 2001likewise due to a more rapid decline in the yield on earning assets.  The net yield on earning assets

 

12

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for the nine months endedSeptember 30, 2002 and 2001 was 4.67% and 5.41%, respectively, due tononinterest bearing liabilities funding lower yielding earning assets.

 

While Mercantileand South Bay have similar volumes of interest earning assets and interestbearing liabilities, a significant difference existed in the composition ofSouth Bay’s interest earning assets and interest bearing liabilitiies, and therelated yields and costs.  Accordingly, theacquisition of South Bay in December 2001 has affected the net interest spreadduring the 2002 periods.  During 2002loans receivable of South Bay were $34.3 million, or 31%, greater thanMercantile while lower-yielding Federal funds sold and investment securities atSouth Bay were $29.1 million less than Mercantile.  The greater relative volume of higher yielding earning assets atSouth Bay than Mercantile has increased the yield of the Company’s totalinterest earning assets approximately 0.50% in 2002.

 

Significantdifferences in the composition and related costs of funding liabilities betweenMercantile and South Bay also affected the Company’s net interest spread andnet yield on earning assets for the 2002 periods.  Average noninterest bearing deposits at Mercantile during thenine months ended September 30, 2002 were $43.5 million greater than South Baywhile average interest bearing liabilities at Mercantile were $43.0 millionless than South Bay.  For the ninemonths ended September 30, 2002, time certificates of deposits averaged $60.6million and $86.2 million at Mercantile and South Bay, respectively, with ratesof 2.29% and 2.99%, respectively.  Thegreater relative volume of higher costing funding liabilities at South Bay thanMercantile has increased the rate on the Company’s total interest bearingliabilities approximately 0.50% in 2002.

 

In 2002 theCompany has replaced higher costing liabilities at South Bay with Federal fundssold from Mercantile in order to lower the Company’s overall cost offunds.  Additionally, the Company hasallocated greater resources at South Bay, primarily in salaries, to increaseits emphasis on business banking. Management expects this emphasis to result in further diversification ofthe loan portfolio through growth of commercial loans, in additional to growthof lower cost funds, particularly noninterest bearing.

 

Average federalfunds sold decreased $9.1 million during the three months ended September 30,2002 compared to the same quarter in 2001 due to the maintenance in the 2001period of cash liquidity in anticipation of funding the acquisition of SouthBay.  Average federal funds soldincreased $8.8 million during the nine months ended September 30, 2002 comparedto the corresponding period in 2001. Securities available for sale decreased $17.4 million and $25.3 millionduring the three and nine months ended September 30, 2002 compared tocorresponding periods during 2001.  Thedecrease in securities and corresponding increase in federal funds sold is due toplanned sales of the investment securities to reduce potential market pricevolatility and scheduled principal payments from mortgage-backedsecurities.  Additionally, the Companyhas maintained

 

13

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greater liquidity during 2002 to facilitate a change in the compositionof South Bay’s funding base in order to lower cost of funds and increasedeposit stability.

 

During the quarterended September 30, 2002 average loans receivable increased 148.9% to $261.1million compared to $104.9 million during the quarter ended September 30,2001.  The weighted average yield onloans receivable during the quarter ended September 30, 2002 decreased to 6.63%compared to 8.57% during the quarter ended September 30, 2001, reflecting theaccelerated decline in market interest rates during the fourth quarter of2001.  The sustained decline in interestrates has impacted adjustable rate loans tied to rate indexes as well as newlyoriginated fixed rate loans and existing fixed rate loans upon renewal atmaturity.

 

Average securitiesavailable-for-sale decreased 36.3% to $30.6 million during the quarter endedSeptember 30, 2002 compared to $48.1 million during the quarter ended September30, 2001, notwithstanding the addition of approximately $30.2 million ofinvestment securities from the South Bay acquisition, as a result of plannedsales of securities and increased principal paydowns on amortizingmortgaged-backed securities due to declining market interest rates.  The Company sold investment securities toreduce the price volatility of the portfolio and to provide liquidity.  The weighted average yield on securitiesdecreased to 5.20% during the third quarter of 2002 compared to 5.60% duringthe third quarter 2001.  The decreasewas relatively moderate despite the significant decline in interest rates dueto the acquisition of South Bay’s higher-yielding portfolio and few additionsto the portfolio in the lower rate environment.

 

Average interestbearing liabilities increased 77.8% to $207.4 million during the quarter endedSeptember 30, 2002 compared to $116.6 million during the quarter endedSeptember 30, 2001 due primarily to increased average interest bearingdeposits.  Average interest bearingdeposits increased 98.8% to $198.0 million during the quarter ended September30, 2002 from $99.6 million during the quarter ended September 30, 2001, dueprimarily to the acquisition of South Bay. A significant change in the composition of interest bearing depositswith a greater percentage of money market and savings deposits, timecertificates of deposit under $100,000 and a lower percentage of demanddeposits was also due to the acquisition of South Bay and its consumer bankingemphasis.  Average borrowed funds duringthe third quarter of 2002 decreased 54.6% to $7.6 million from $16.8 millionduring the same period in 2001 due to the planned redemption of these highercost funding sources.

 

The weightedaverage cost of interest bearing liabilities decreased to 2.13% during thethird quarter of 2002 from 2.76% during the same period of 2001, due primarilyto a lower weighted average cost of interest bearing deposits as a result ofdeclining market interest rates.  Theweighted average cost of interest bearing deposits decreased to 2.01% duringthe third quarter of 2002 from 2.52% during the same period of 2001.  The weighted average cost of borrowed fundsincreased to 4.78% during the third quarter of 2002 from 4.17% during the sameperiod in 2001 due to the maturity of lower cost borrowings.

 

14

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Average totaldeposits increased 88.0% to $301.2 million during the third quarter of 2002compared to $160.2 million during the third quarter of 2001 due primarily tothe South Bay acquisition in the fourth quarter 2001.   Average noninterest bearing demand deposits increased $42.6million to $103.2 million due to the South Bay acquisition as well as anemphasis on business banking for the related demand deposit growth.

 

During the ninemonths ended September 30, 2002 average loans receivable increased 146.0% to$258.5 million compared to $105.0 million during the same period in 2001.  Average securities available-for-saledecreased 43.9% to $32.4 million during the nine months ended September 30, 2002compared to $57.7 million during the same period in 2001 due to planned salesof securities to reposition the portfolio in order to reduce market pricevolatility.  Average total depositsduring the nine months ended September 30, 2002 increased 102.4% to $299.0million compared to $148.0 million during the same period in 2001.  The growth in both average loans receivableand average deposits was a result of the business combination of South Bay inthe fourth quarter 2001.  Average otherborrowings decreased 46.3% to $12.6 million during the nine months endedSeptember 30, 2002 compared to $23.4 million during the same period in 2001.

 

15

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The following tablepresents the components of net interest income for the quarters ended September30, 2002 and 2001.

 
|                                                                                                                      |   | **Three  months ended**     |    |
|---------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|
|                                                                                                                      |   | **30-Sep-02**               |    | **30-Sep-01** |   |
|                                                                                                                      |   | **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                                                   |   | $                           | 24,454  |   | $ | 105 |   | 1.70 | % | $ | 33,522 |   | $ | 310 |   | 3.67 | % |
| Securities  available-for-sale                                                                                            |   | 30,621                      |    | 401 |   | 5.20 | % | 48,069 |   | 679 |   | 5.60 | % |
| Loans  receivable(1)(2)                                                                                                   |   | 261,109                     |    | 4,363 |   | 6.63 | % | 104,909 |   | 2,267 |   | 8.57 | % |
|                                                                                                                      |   | 2,268                       |    | 9 |   | 1.57 | % | — |   | — |   | — |   |
| Total  interest earning assets                                                                                            |   | 316,184                     |    | $ | 4,869 |   | 6.11 | % | 186,500 |   | $ | 3,256 |   | 6.93 | % |
|                                                                                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest  earning assets:                                                                                              |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Cash  and due from banks - demand                                                                                         |   | 20,051                      |    |   |   |   |   | 11,641 |   |   |   |   |   |
| Other  assets                                                                                                             |   | 23,827                      |    |   |   |   |   | 2,590 |   |   |   |   |   |
| Allowance  for credit losses and net unrealized (loss) gain on securities  available-for-sale                             |   | (5,927                      | )       |   |   |   |   | (2,401 | ) |   |   |   |   |
| Total  assets                                                                                                             |   | $                           | 354,135 |   |   |   |   |   | $ | 198,330 |   |   |   |   |   |
|                                                                                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Liabilities  and shareholders’ equity:                                                                               |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Interest  bearing deposits:                                                                                               |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Demand                                                                                                                    |   | $                           | 27,970  |   | $ | 86 |   | 1.22 | % | $ | 9,986 |   | $ | 26 |   | 1.03 | % |
| Money  market and savings                                                                                                 |   | 91,443                      |    | 388 |   | 1.68 | % | 54,384 |   | 254 |   | 1.85 | % |
| Time  certificates of deposit:                                                                                            |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| $100,000  or more                                                                                                         |   | 41,801                      |    | 172 |   | 1.63 | % | 31,853 |   | 313 |   | 3.90 | % |
| Under  $100,000                                                                                                           |   | 36,808                      |    | 357 |   | 3.85 | % | 3,383 |   | 39 |   | 4.57 | % |
| Total  time certificates of deposit                                                                                       |   | 78,609                      |    | 529 |   | 2.67 | % | 35,236 |   | 352 |   | 3.96 | % |
| Total  interest bearing deposits                                                                                          |   | 198,022                     |    | 1,003 |   | 2.01 | % | 99,606 |   | 632 |   | 2.52 | % |
| Federal  funds purchased and securities sold under agreements to repurchase                                               |   | 1,782                       |    | 21 |   | 4.68 | % | 217 |   | 2 |   | 3.66 | % |
| Other  borrowings                                                                                                         |   | 7,638                       |    | 92 |   | 4.78 | % | 16,826 |   | 177 |   | 4.17 | % |
| Total  interest bearing liabilities                                                                                       |   | 207,442                     |    | $ | 1,116 |   | 2.13 | % | 116,649 |   | $ | 811 |   | 2.76 | % |
|                                                                                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities:                                                                                         |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest  bearing demand deposits                                                                                      |   | 103,220                     |    |   |   |   |   | 60,601 |   |   |   |   |   |
| Other  liabilities                                                                                                        |   | 2,994                       |    |   |   |   |   | 1,599 |   |   |   |   |   |
| Guaranteed  preferred beneficial interests in the Company’s junior subordinated  deferrable interest debentures, net |   | 14,524                      |    |   |   |   |   |   |   |   |   |   |   |
| Minority  interest in the preferred stock of subsidiary                                                                   |   | 869                         |    |   |   |   |   |   |   |   |   |   |   |
| Shareholders’  equity                                                                                                |   | 25,086                      |    |   |   |   |   | 19,481 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity                                                                          |   | $                           | 354,135 |   |   |   |   |   | $ | 198,330 |   |   |   |   |   |
|                                                                                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Net  interest income (spread)                                                                                             |   |                        |    | $ | 3,753 |   | 3.98 | % |   |   | $ | 2,445 |   | 4.17 | % |
|                                                                                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Net  yield on earning assets(2)                                                                                           |   |                        |    |   |   | 4.71 | % |   |   |   |   | 5.20 | % |

 

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(1)          Includes average balance of nonperforming loans of $5.8 million and$500,000 for 2002 and 2001, respectively.

(2)          Yields and amounts earned on loans receivable include loan fees of$116,000 and $88,000 for the three months ended September 30, 2002 and 2001,respectively.

 

16

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The following tablepresents the components of net interest income for the nine months endedSeptember 30, 2002 and 2001.

 
|                                                                                                                      |   | **Nine  months ended**     |    |
|---------------------------------------------------------------------------------------------------------------------------|--------|----------------------------|---------|
|                                                                                                                      |   | **September  30, 2002**    |    | **September  30, 2001** |   |
|                                                                                                                      |   | **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                                                   |   | $                          | 28,588  |   | 361 |   | 1.69 | % | $ | 18,801 |   | $ | 632 |   | 4.49 | % |
| Securities  available-for-sale                                                                                            |   | 32,383                     |    | 1,331 |   | 5.50 | % | 57,695 |   | 2,671 |   | 6.19 | % |
| Loans  receivable(1)(2)                                                                                                   |   | 258,455                    |    | 13,115 |   | 6.78 | % | 105,031 |   | 7,189 |   | 9.15 | % |
| Other                                                                                                                     |   | 756                        |    | 9 |   | 1.59 | % | — |   | — |   | — |   |
| Total  interest earning assets                                                                                            |   | 320,182                    |    | $ | 14,807 |   | 6.18 | % | 181,527 |   | $ | 10,492 |   | 7.73 | % |
|                                                                                                                      |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest  earning assets:                                                                                              |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Cash  and due from banks - demand                                                                                         |   | 20,251                     |    |   |   |   |   | 11,210 |   |   |   |   |   |
| Other  assets                                                                                                             |   | 24,035                     |    |   |   |   |   | 2,595 |   |   |   |   |   |
| Allowance  for credit losses and net unrealized (loss) gain on securities  available-for-sale                             |   | (5,925                     | )       |   |   |   |   | (2,497 | ) |   |   |   |   |
| Total  assets                                                                                                             |   | $                          | 358,543 |   |   |   |   |   | $ | 192,835 |   |   |   |   |   |
|                                                                                                                      |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Liabilities  and shareholders’ equity:                                                                               |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Interest  bearing deposits:                                                                                               |   |                       |    |  

  |   |   |   |   |   |   |   |   |   |
| Demand                                                                                                                    |   | $                          | 27,762  |   | $ | 243 |   | 1.17 | % | $ | 8,787 |   | $ | 68 |   | 1.03 | % |
| Money  market and savings                                                                                                 |   | 85,037                     |    | 1,087 |   | 1.71 | % | 43,429 |   | 837 |   | 2.58 | % |
| Time  certificates of deposit:                                                                                            |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| $100,000  or more                                                                                                         |   | 46,545                     |    | 673 |   | 1.93 | % | 32,328 |   | 1,141 |   | 4.72 | % |
| Under  $100,000                                                                                                           |   | 39,586                     |    | 1,117 |   | 3.77 | % | 4,364 |   | 180 |   | 5.51 | % |
| Total  time certificates of deposit                                                                                       |   | 86,131                     |    | 1,790 |   | 2.78 | % | 36,692 |   | 1,321 |   | 4.81 | % |
| Total  interest bearing deposits                                                                                          |   | 198,930                    |    | 3,120 |   | 2.10 | % | 88,908 |   | 2,226 |   | 3.35 | % |
| Federal  funds purchased and securities sold under agreements to repurchase                                               |   | 2,562                      |    | 116 |   | 6.05 | % | 781 |   | 30 |   | 5.14 | % |
| Other  borrowings                                                                                                         |   | 12,592                     |    | 388 |   | 4.12 | % | 23,439 |   | 889 |   | 5.07 | % |
| Total  interest bearing liabilities                                                                                       |   | 214,084                    |    | $ | 3,624 |   | 2.26 | % | 113,128 |   | $ | 3,145 |   | 3.72 | % |
|                                                                                                                      |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest  bearing liabilities:                                                                                         |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest  bearing demand deposits                                                                                      |   | 100,078                    |    |   |   |   |   | 59,078 |   |   |   |   |   |
| Other  liabilities                                                                                                        |   | 2,910                      |    |   |   |   |   | 1,666 |   |   |   |   |   |
| Guaranteed  preferred beneficial interests in the Company’s junior subordinated  deferrable interest debentures, net |   | 14,520                     |    |   |   |   |   |   |   |   |   |   |   |
| Minority  interest in the preferred stock of subsidiary                                                                   |   | 791                        |    |   |   |   |   |   |   |   |   |   |   |
| Shareholders’  equity                                                                                                |   | 25,404                     |    |   |   |   |   | 18,963 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity                                                                          |   | $                          | 357,787 |   |   |   |   |   | $ | 192,835 |   |   |   |   |   |
|                                                                                                                      |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Net  interest income (spread)                                                                                             |   |                       |    | $ | 11,183 |   | 3.92 | % |   |   | $ | 7,347 |   | 4.01 | % |
|                                                                                                                      |   |                       |    |   |   |   |   |   |   |   |   |   |   |
| Net  yield on earning assets(2)                                                                                           |   |                       |    |   |   | 4.67 | % |   |   |   |   | 5.41 | % |

 

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(1)          Includes average balance of nonperforming loans of $5.8 million and$550,000 for 2002 and 2001, respectively.

(2)          Yields and amounts earned on loans receivable include loan fees of$395,000 and $298,000 for the nine months ended September 30, 2002 and 2001,respectively.

 

17

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The followingtables set forth, for the periods indicated, the changes in interest earned andinterest paid resulting from changes in volume and changes in rates.  Average balances in all categories in eachreported period were used in the volume computations.  Average yields and rates in each reported period were used inrate computations.

 
|                                                                        |   | **Nine  months ended September 30,  2002 vs 2001** |   |
|-----------------------------------------------------------------------------|--------|----------------------------------------------------|--------|
|                                                                        |   |                                               |   |   |   | **Net  Increase  (Decrease)** |   |
|                                                                        |   | **Increase  (decreased) due to(1)**                |   |   |
|                                                                        |   | **Volume**                                         |   | **Rate** |   |   |
|                                                                        |   |                                               |   |   |   |   |   |
| Interest  Income:                                                           |   |                                               |   |   |   |   |   |
| Federal  funds sold and securities purchased under agreements to resell     |   | $                                                  | 329    |   | $ | (600 | ) | $ | (271 | ) |
| Securities  available-for-sale                                              |   | (1,172                                             | )      | (168 | ) | (1,340 | ) |
| Loans  receivable(2)                                                        |   | 10,501                                             |   | (4,575 | ) | 5,926 |   |
| Other                                                                       |   | 9                                                  |   | — |   | 9 |   |
|                                                                        |   |                                               |   |   |   |   |   |
| Total  interest earning assets                                              |   | $                                                  | 9,658  |   | $ | (5,343 | ) | $ | 4,315 |   |
|                                                                        |   |                                               |   |   |   |   |   |
| Interest  Expense:                                                          |   |                                               |   |   |   |   |   |
| Interest  bearing deposits:                                                 |   |                                               |   |   |   |   |   |
| Demand                                                                      |   | $                                                  | 147    |   | $ | 28 |   | $ | 175 |   |
| Money  market and savings                                                   |   | 802                                                |   | (552 | ) | 250 |   |
|                                                                        |   |                                               |   |   |   |   |   |
| Time  certificates of deposit:                                              |   |                                               |   |   |   |   |   |
| $100,000  or more                                                           |   | 502                                                |   | (970 | ) | (468 | ) |
| Under  $100,000                                                             |   | 1,453                                              |   | (516 | ) | 937 |   |
|                                                                        |   |                                               |   |   |   |   |   |
| Total  time certificates of deposit                                         |   | 1,955                                              |   | (1,486 | ) | 469 |   |
| Total  interest bearing deposits                                            |   | 2,904                                              |   | (2,010 | ) | 894 |   |
| Federal  funds purchased and securities sold under agreements to repurchase |   | 68                                                 |   | 18 |   | 86 |   |
| Other  borrowings                                                           |   | (411                                               | )      | (90 | ) | (501 | ) |
|                                                                        |   |                                               |   |   |   |   |   |
| Total  interest bearing liabilities                                         |   | $                                                  | 2,561  |   | $ | (2,082 | ) | $ | 479 |   |
|                                                                        |   |                                               |   |   |   |   |   |
| Net  interest income                                                        |   | $                                                  | 7,097  |   | $ | (3,261 | ) | $ | 3,836 |   |

 

----

(1)          The change in interest income or interest expense that is attributableto both changes in average volume and average rate has been allocated to thechanges due to (i) average volume and (ii) average rate in proportion to therelationship of the absolute amounts of changes in each.

(2)          Table does not include interest income that would have been earned onnonaccrual loans.

 

18

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PROVISION FOR CREDITLOSSES

 

The Companyrecorded a $1.5 million provision for credit losses during the quarter endedSeptember 30, 2002 related to the charge off of $2.1 million of non-performingloans that were originated at South Bay prior to the acquisition.  During the quarter ended September 30, 2001a $450,000 provision for credit losses was recorded.  Provisions for loan losses of $1.8 million and $450,000 wererecorded for the nine months ended September 30, 2002 and 2001, respectively.

 

OTHER OPERATING INCOME

 

Other operatingincome, excluding gains and losses on the sale of securities and assets,totaled $353,000 during the third quarter of 2002, an increase of 59.5% from$187,000 during the third quarter of 2001. During the nine months ended September 30, 2001, other operating income,excluding gains and losses on the sale of securities and assets, totaled $1.0million, an increase of 56.4% from $576,000 during the comparable period of2001.  Service charges on depositaccounts increased  $172,000 or 116.2%and $484,000 or 105.9% during the three and nine months ended September 30,2002, respectively, compared to corresponding periods in 2001.  This increase reflects the greater volume ofdeposit accounts as a result of the acquisition of South Bay.

 

The Companyrealized no gains or losses on sale of securities during 2002, compared to netgains of $92,000 and $238,000 during the third quarter and first nine months of2001.

 

OTHER OPERATING EXPENSES

 

Other operatingexpenses increased 44.3% to $3.0 million during the third quarter of 2002compared to $2.1 million during the third quarter of 2001.  This increase was due primarily to anincrease in salaries and related benefits of $693,000, an increase in net occupancyexpense of $80,000, both due to operating two additional banking offices fromthe South Bay acquisition. Additionally, computer data processing expenses increased $124,000 or129.0% during the quarter ended September 30, 2002 compared to the same periodlast year due to the operation of South Bay in the 2002 period.

 

Other operatingexpenses increased 54.6% to $9.7 million during the nine months ended September30, 2002 compared to $6.3 million during the same period of 2001, due primarilyto $1.9 million increase in salaries and related benefits expense, a $332,000increase in net occupancy expense and a $398,000 increase in computer dataprocessing expenses resulting from costs associated with operating South Bay’stwo banking offices.   Approximately$120,000 of the data processing expenses are nonrecurring costs of convertingSouth Bay’s data processing system. Legal services were $452,000 for the first nine

 

19

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months of 2002 compared to $107,000 for the same period in 2001 due toincreased legal fees associated with problem loan workouts.  Increases in most other noninterest expensecategories during the nine months ended September 30, 2002 compared to 2001were due to the operation of South Bay in the 2002 period.

 

MINORITY INTEREST ININCOME

 

Minority interest ofsubsidiaries in the Company’s income relating to the South Bay Series Apreferred stock was $53,000 and $159,000 for the three months and nine monthsended September 30, 2002, respectively, representing dividend payments on thesubsidiary preferred stock.  There wasno minority interest in the income of the South Bay Series A preferred stockfor the corresponding 2001 periods.  Theminority interest of the Trust Preferred Securities in the Company’s income was$380,000 and $1.2 million for the three months and nine months ended September30, 2002 representing the interest expense of the Trust Preferred Securitiesthat are classified as mezzanine equity for accounting purposes.  The minority interest of the Trust PreferredSecurities in the Company’s income was $329,000 for the three months and ninemonths ended September 30, 2001.

 

20

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***BALANCE SHEET ANALYSIS***

 

INVESTMENT SECURITIES

 

The following comparativeperiod end table sets forth certain information concerning the estimated fairvalues and

unrealized gains andlosses of the investment securities portfolio, consisting of available-for-salesecurities:

 
|                                                                      |   | **September  30, 2002**     |   | **December  31, 2001**       |   |
|---------------------------------------------------------------------------|--------|-----------------------------|--------|------------------------------|--------|
|                                                                      |   | **Total  amortized  cost**  |   | **Gross  unrealized  gains** |   | **Gross  unrealized  loss** |   | **Estimated  fair  value** |   | **Total  amortized  cost** |   | **Gross  unrealized  gains** |   | **Gross  unrealized  loss** |   | **Estimated  fair  value** |   |
|                                                                      |   | **(Dollars  in thousands)** |   | **(Dollars  in thousands)**  |   |
| U.S.  Treasury securities                                                 |   | $                           | — |                         | $      | — |   | $ | — |   | $ | — |   | $ | 2,001 |   | 13 |   | $ | — |   | $ | 2,014 |   |
| GNMA-issued/guaranteed  mortgage pass through certificates           |   | 2,992                       |   | 73                           |   | — |   | 3,065 |   | 4,503 |   | — |   | 27 |   | 4,476 |   |
| Other  U.S. government and federal agency securities                      |   | 1,993                       |   | 13                           |   | — |   | 2,006 |   | — |   | — |   | — |   | 0 |   |
| FHLMC/FNMA-issued  mortgage pass through certificates                     |   | 15,067                      |   | 489                          |   | — |   | 15,556 |   | 15,928 |   | 179 |   | 32 |   | 16,075 |   |
| CMO’s  and REMIC’s issued by U.S. government-sponsored agencies |   | 5,716                       |   | 60                           |   | 1 |   | 5,775 |   | 16,590 |   | 162 |   | 29 |   | 16,723 |   |
| Privately  issued corporate bonds, CMO’s and REMIC’s securities |   | 4,288                       |   | —                       |   | 185 |   | 4,103 |   | 2,510 |   | 4 |   | 175 |   | 2,339 |   |
|                                                                      |   | $                           | 30,056 |                         | $      | 635 |   | $ | 186 |   | $ | 30,505 |   | $ | 41,532 |   | $ | 358 |   | $ | 263 |   | $ | 41,627 |   |
|                                                                      |   |                        |   |                         |   |   |   |   |   |   |   |   |   |   |   |   |   |
| FRB  and other equity stocks                                              |   | $                           | 2,238  |                         | — |   | — |   | $ | 2,238 |   | 2,552 |   | — |   | — |   | 2,552 |   |
|                                                                           |        |                             |        |                              |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The total amortized costof investment securities decreased $11.5 million to $30.1 million at September30, 2002 from $41.5 million at December 31, 2001 due primarily to principalpaydowns on amortizing mortgaged backed securities brought about by decreasingmarket interest rates.  The investmentsecurities had net pre-tax unrealized gains of $449,000 at September 30, 2002compared to $95,000 at December 31, 2001. Federal Reserve Bank (FRB) stock and other equity stocks are redeemableat cost.

 

At September 30, 2002 theCompany did not hold securities of any issuer, other than U.S. governmentagencies and corporations, in which the aggregate book value exceeded 10% ofthe Company’s shareholders’ equity.

 

21

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LOAN PORTFOLIO

 

The following comparativeperiod-end table sets forth certain information concerning the composition ofthe loan portfolio. 

 

|                                                            |   | **September  30,  2002**    |    | **December  31,  2001** |   |
|-----------------------------------------------------------------|--------|-----------------------------|---------|-------------------------|--------|
|                                                            |   | **Amount**                  |    | **Percent**             |   | **Amount** |   | **Percent** |   |
|                                                            |   | **(Dollars  in thousands)** |    |
| Commercial  loans:                                              |   |                        |    |                    |   |   |   |   |   |
| Secured  by one to four family residential properties           |   | $                           | 27,228  |                    | 10     | % | $ | 27,069 |   | 10 | % |
| Secured  by multifamily residential properties                  |   | 9,444                       |    | 4                       | %      | 8,492 |   | 3 | % |
| Secured  by commercial real properties                          |   | 103,242                     |    | 39                      | %      | 95,142 |   | 36 | % |
| Other  - secured and unsecured                                  |   | 78,486                      |    | 30                      | %      | 85,292 |   | 33 | % |
| Real  estate construction and land development                  |   | 31,962                      |    | 12                      | %      | 30,811 |   | 12 | % |
| Home  equity lines of credit                                    |   | 6,351                       |    | 2                       | %      | 6,511 |   | 3 | % |
| Consumer  installment and unsecured loans to individuals        |   | 8,055                       |    | 3                       | %      | 8,795 |   | 3 | % |
| Total  loans outstanding                                        |   | 264,768                     |    | 100                     | %      | 262,112 |   | 100 | % |
|                                                            |   |                        |    |                    |   |   |   |   |   |
| Deferred  net loan origination fees and purchased loan discount |   | (255                        | )       |                    |   | (144 | ) |   |   |
| Loans  receivable, net                                          |   | $                           | 264,513 |                    |   |   | $ | 261,968 |   |   |   |

 

Total loans outstandingincreased by $2.7 million to $264.8 million at September 30, 2002 compared to$262.1 million at December 31, 2001. This increase resulted primarily from $2.4 million, or 1.1%, increase incommercial loans during the first nine months of 2002.  Commercial loans secured by commercial realestate properties increased to 39% from 36% of total loans outstanding atSeptember 30,2002 compared to December 31, 2001.

 

22

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The following comparativeperiod-end table sets forth certain information concerning nonperformingassets.  

 

|                                                                                                                        |   | **September  30,  2002**    |   | **December  31,  2001** |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|--------|-------------------------|--------|
|                                                                                                                        |   | **(Dollars  in thousands)** |   |
| Nonaccrual  loans                                                                                                           |   | $                           | 4,991  |                    | $      | 7,807 |   |
| Troubled  debt restructurings                                                                                               |   | —                      |   | 953                     |   |
| Loans  contractually past due ninety or more days with respect to either principal  or interest and still accruing interest |   | 85                          |   | 642                     |   |
| Nonperforming  loans                                                                                                        |   | 5,076                       |   | 9,402                   |   |
| Other  real estate owned                                                                                                    |   | 1,000                       |   | —                  |   |
| Other  assets-SBA guaranteed loan                                                                                           |   | 285                         |   | —                  |   |
| Total  nonperforming assets                                                                                                 |   | $                           | 6,361  |                    | $      | 9,402 |   |
|                                                                                                                        |   |                        |   |                    |   |
| Allowance  for credit losses as a percent of nonaccrual loans                                                               |   | 95.3                        | %      | 83.8                    | %      |
| Allowance  for credit losses as a percent of nonperforming loans                                                            |   | 93.7                        | %      | 69.6                    | %      |
| Total  nonperforming assets as a percent of loans receivable                                                                |   | 2.4                         | %      | 3.6                     | %      |
| Total  nonperforming assets as a percent of total shareholders’ equity                                                 |   | 21.4                        | %      | 36.9                    | %      |

 

Nonaccrual loansdecreased by $3.0 million during the first nine months of 2002 to $6.4 millioncompared to $9.4 million at December 31, 2001 due to charge-offs of $4.0million, primarily related to loans originated at South Bay prior to theacquisition, partially offset by additional loans classified asnonaccrual.  The troubled debtrestructuring of $953,000 at December 31, 2001 failed to maintain compliancewith modified terms and the loan collateral has been foreclosed and recordedwith capitalized costs, at fair value, in other real estate owned at September30, 2002.  The additional interestincome that would have been recorded in the nine months ended September 30,2002 from nonaccrual loans and troubled debt restructurings would have beenapproximately $475,000 if these loans had been current for the entire period.

 

Loans contractually pastdue 90 days or more with respect to either principal or interest and stillaccruing interest at September 30, 2002 were $285,000 at September 30, 2002compared to $642,000 at December 31, 2001.

 

As a result of thesechanges, the amount of nonperforming assets at September 30, 2002 decreased32.3% from the level at December 31, 2001.

 

*ALLOWANCEFOR CREDIT LOSSES*

 

Provisions for creditlosses charged to operations reflect management’s judgment of the adequacy ofthe allowance for credit losses and are determined through periodic analysis ofthe loan portfolio.  This analysis includesa detailed review of the classification and categorization of problem loans andloans 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 conjunction

 

23

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with an outside advisory firm, performs a periodic risk and creditanalysis, the results of which are reported to the Board of Directors.

 

Loans charged off duringthe third quarter and first nine months of 2002 were $2.2 million and $4.0million, respectively, compared to $22,000 and $372,000 during the thirdquarter and first nine months of 2001, respectively.  The increase in loans charged off in 2002 is primarily due topre-acquisition nonperforming loans originated of South Bay.  Recoveries of loans previously charged offwere $16,000 and $352,000 during the third quarter and first nine months of2002 compared to $110,000 and $226,000 million for the same periods in 2001.

 

The following table setsforth information concerning the Company’s allowance for credit losses for theperiods indicated. 

 
|                                                     |   | **Three  months ended**     |   | **Nine  months ended**      |   |
|----------------------------------------------------------|--------|-----------------------------|--------|-----------------------------|--------|
|                                                     |   | **September  30,  2002**    |   | **September  30,  2001**    |   | **September  30,  2002** |   | **September  30,  2001** |   |
|                                                     |   | **(Dollars  in thousands)** |   | **(Dollars  in thousands)** |   |
| Balance,  beginning of period(1)                         |   | $                           | 5,374  |                        | $      | 2,363 |   | $ | 6,542 |   | 2,597 |   |
| Loans  charged off:                                      |   |                        |   |                        |   |   |   |   |   |
| Real  estate construction and land development           |   | —                      |   | —                      |   | 31 |   | — |   |
| Commercial  loans:                                       |   |                        |   |                        |   |   |   |   |   |
| Secured  by commercial real properties                   |   | 44                          |   | —                      |   | 44 |   | — |   |
| Other  - secured and unsecured                           |   | 2,065                       |   | —                      |   | 3,807 |   | 268 |   |
| Consumer  installment and unsecured loans to individuals |   | 50                          |   | 22                          |   | 81 |   | 104 |   |
| Total  loan charge offs                                  |   | 2,159                       |   | 22                          |   | 3,963 |   | 372 |   |
|                                                     |   |                        |   |                        |   |   |   |   |   |
| Recoveries  of loans previously charged off:             |   |                        |   |                        |   |   |   |   |   |
| Real  estate construction and land development           |   | —                      |   | —                      |   | 191 |   | 6 |   |
| Commercial  loans:                                       |   |                        |   |                        |   |   |   |   |   |
| Other  - secured and unsecured                           |   | 12                          |   | 94                          |   | 107 |   | 197 |   |
| Consumer  installment and unsecured loans to individuals |   | 4                           |   | 16                          |   | 54 |   | 23 |   |
| Total  recoveries of loans previously charged off        |   | 16                          |   | 110                         |   | 352 |   | 226 |   |
| Net  charge offs (recoveries)                            |   | 2,143                       |   | (88                         | )      | 3,611 |   | 146 |   |
| Provision  for credit losses                             |   | 1,525                       |   | 450                         |   | 1,825 |   | 450 |   |
| Balance,  end of period                                  |   | $                           | 4,756  |                        | $      | 2,901 |   | $ | 4,756 |   | $ | 2,901 |   |
|                                                          |        |                             |        |                             |        |  |  |  |  |  |  |  |  |

 

----

(1)          The balance at September 30, 2002 reflected the consolidated balance ofMercantile and South Bay, while the balance at September 30, 2001 reflected thebalance only of Mercantile.

 

Credit quality isaffected by many factors beyond the control of the Company, including local andnational economies, and facts may exist which are not known to the Company thatadversely affect the likelihood of repayment of various loans in the loanportfolio and realization of collateral upon a default. Accordingly, noassurance can be given that the Company will not sustain loan losses materiallyin excess of the allowance for credit losses. In addition, the Office of theComptroller of the

 

24

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Currency (“OCC”), as an integral part of its examination process,periodically reviews the allowance for credit losses and could requireadditional provisions for credit losses.

 

Based on loan growth, thelevel of nonperforming loans and a relatively constant level of charge offs, itis anticipated that the allowance for credit losses will remain adequatethrough the remainder of 2002.

 

***CAPITAL ADEQUACY REQUIREMENTS***

 

At September 30, 2002 theCompany and the Banks were in compliance with all applicable regulatory capitalrequirements and the Banks were “well capitalized” under the Prompt CorrectiveAction rules of the OCC.  The followingtable sets forth the regulatory capital standards for well capitalizedinstitutions and the capital ratios for the Company and the Banks as ofSeptember 30, 2002 and December 31, 2001.

 

|                         |   | **Well  Capitalized  Standards** |   | **September  30,  2002** |   | **December  31,  2001** |   |
|------------------------------|--------|----------------------------------|--------|--------------------------|--------|-------------------------|--------|
| **Company:**                 |   |                             |   |                     |   |                    |   |
| Tier  1 leverage             |   | 5.00                             | %      | 6.52                     | %      | 5.55                    | %      |
| Tier  1 risk-based capital   |   | 6.00                             | %      | 8.09                     | %      | 6.85                    | %      |
| Total  risk-based capital    |   | 10.00                            | %      | 11.62                    | %      | 11.53                   | %      |
|                         |   |                             |   |                     |   |                    |   |
| **Mercantile National Bank** |   |                             |   |                     |   |                    |   |
| Tier  1 leverage             |   | 5.00                             | %      | 7.58                     | %      | 6.85                    | %      |
| Tier  1 risk-based capital   |   | 6.00                             | %      | 10.49                    | %      | 10.50                   | %      |
| Total  risk-based capital    |   | 10.00                            | %      | 11.75                    | %      | 11.76                   | %      |
|                         |   |                             |   |                     |   |                    |   |
| **South Bay Bank**           |   |                             |   |                     |   |                    |   |
| Tier  1 leverage             |   | 5.00                             | %      | 8.64                     | %      | 8.72                    | %      |
| Tier  1 risk-based capital   |   | 6.00                             | %      | 9.89                     | %      | 9.63                    | %      |
| Total  risk-based capital    |   | 10.00                            | %      | 11.15                    | %      | 10.90                   | %      |

 

***LIQUIDITY***

 

The Company continues tomanage its liquidity through a combination of core deposits, federal fundspurchased, repurchase agreements, collateralized borrowing lines at the FHLB,and a portfolio of securities available-for-sale.  Liquidity is also provided by maturing investment securities andloans.

 

National Mercantile is alegal entity separate and distinct from the Banks, and therefore it mustprovide for its own liquidity.  NationalMercantile’s principal sources of funds are proceeds from the sales ofsecurities and dividends or capital distributions from the Banks.  In addition to its own operating expenses,National Mercantile is responsible for the payment of the interest on theoutstanding issues of Trust Preferred Securities.  The semi-annual interest payments on the Trust PreferredSecurities, under the terms of the indenture, are deferrable at the Company’soption, for a period up to ten consecutive semi-annual payments, but in anyevent not beyond June 25, 2031.

 

25

----

 

In general, a nationalbank may not, without prior OCC approval, pay a dividend if the total of alldividends declared in any calendar year exceeds the total of the bank’s netprofits (as defined) for that year combined with its retained net profits forthe preceding two calendar years, less any required transfer to surplus or afund for the retirement of any preferred stock.  With a vote of two-thirds or more of its shareholders, a nationalbank may make a capital distribution resulting in the reduction of itspermanent capital.  No capitaldistribution or dividend can be made if the national bank were to be “undercapitalized” following such capital distribution or dividend, and it could beexpected that OCC approval would not be likely if such capital distribution ordividend would result in the bank’s being less than “well capitalized”.  A national bank may not declare a dividendin excess of its undivided profits.  TheOCC and the Federal Reserve have also issued banking circulars emphasizing thatthe level of cash dividends should bear a direct correlation to the level of anational bank’s current and expected earnings stream, the bank’s need tomaintain an adequate capital base and other factors.  Further, the OCC would not permit a dividend or capitaldistribution if it believed that such dividend or capital distribution wouldconstitute an unsafe or unsound practice.

 

Under such restrictions,Mercantile National and South Bay are presently unable to pay dividends toNational Mercantile.   Other than thedeferrable interest payments on the Trust Preferred Securities, NationalMercantile has adequate cash resources from other sources to meet itsforeseeable cash needs.

 

***ASSET LIABILITYMANAGEMENT***

 

The following table showsthe Company’s cumulative one-year interest rate sensitivity gap indicating anasset sensitive position of $8.1 million at September 30, 2002, compared to anasset sensitive position of $27.0 million at December 31, 2001.

 

The Company’s assetsensitive position during a period of slowly declining interest rates is notexpected to have a significant negative impact on net interest income since theCompany has a large base of immediately adjustable interest bearing demand,savings and money market deposit accounts.  However, since the Company is asset sensitive, in a period ofrapidly declining rates, such as the environment that was experienced during2001, the rapid decline will have a negative effect on the Company’s net interestincome as changes in the rates of interest bearing deposits historically havenot changed proportionately with changes in market interest rates.  Additionally, in relatively low anddeclining interest rate environments, the interest rates paid on fundingliabilities may begin to reach floors preventing further downward adjustmentswhile rates on earning assets continue to adjust downward.

 

26

----

 

 
|                                                                        |   | **September 30, 2002**        |   |
|-----------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                        |   | **Maturing or repricing in**  |   |
|                                                                        |   | **Less  than  three  months** |   | **After three  months  but within  one year** |   | **After one  year  but within  5 years** |   | **After  5 years** |   | **Total** |   |
|                                                                        |   | **(Dollars in thousands)**    |   |
| Rate-Sensitive  Assets:                                                     |   |                          |   |   |   |   |   |   |   |   |   |
| Federal  funds sold and securities purchased under agreements to resell     |   | $                             | 14,040 |   | $ | — |   | $ | — |   | $ | — |   | $ | 14,040 |   |
| Securities  available-for-sale, at amortized cost                           |   | —                        |   | — |   | 2,300 |   | 28,205 |   | 30,505 |   |
| FRB  and other stock, at cost                                               |   | —                        |   | — |   | — |   | 2,238 |   | 2,238 |   |
| Loans  receivable(2)                                                        |   | 165,792                       |   | 16,023 |   | 52,971 |   | 23,768 |   | 258,554 |   |
| Total  rate-sensitive assets                                                |   | 179,832                       |   | 16,023 |   | 55,271 |   | 54,211 |   | 305,337 |   |
|                                                                        |   |                          |   |   |   |   |   |   |   |   |   |
| Rate-Sensitive  Liabilities:(1)                                             |   |                          |   |   |   |   |   |   |   |   |   |
| Interest  bearing deposits:                                                 |   |                          |   |   |   |   |   |   |   |   |   |
| Demand,  money market and savings                                           |   | 115,557                       |   | — |   | — |   | — |   | 115,557 |   |
| Time  certificates of deposit                                               |   | 37,409                        |   | 33,075 |   | 8,430 |   | — |   | 78,914 |   |
| Federal  funds purchased and securities sold under agreements to repurchase |   | —                        |   | 1,680 |   | — |   | — |   | 1,680 |   |
| Other  borrowings                                                           |   | —                        |   | — |   | 7,500 |   | — |   | 7,500 |   |
| Total rate-sensitive  liabilities                                           |   | 152,966                       |   | 34,755 |   | 15,930 |   | — |   | 203,651 |   |
| Interest  rate-sensitivity gap                                              |   | 26,866                        |   | (18,732 | ) | 39,341 |   | 54,211 |   | 101,686 |   |
| Cumulative  interest rate-sensitivity gap                                   |   | $                             | 26,866 |   | $ | 8,134 |   | $ | 47,475 |   | $ | 101,686 |   |   |   |
| Cumulative  ratio of rate sensitive assets to rate-sensitive liabilities    |   | 118                           | %      | 104 | % | 123 | % | 150 | % |   |   |
|                                                                             |        |                               |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)          Deposits which are subject to immediate withdrawal are presented asrepricing within three months or less. The distribution of other time depositsis based on scheduled maturities.

(2)          Does not include nonaccrual loans and unearned income and deferred fees.

 

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|                                                                     |   | **December  31, 2001**        |   |
|--------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                     |   | **Maturing  or repricing in** |   |
|                                                                     |   | **Less  than  three  months** |   | **After  three  months  but within  one year** |   | **After  one  year  but within  5 years** |   | **After  5 years** |   | **Total** |   |
|                                                                     |   | **(Dollars  in thousands)**   |   |
| Rate-Sensitive  Assets:                                                  |   |                          |   |   |   |   |   |   |   |   |   |
| Federal  funds sold and securities purchased under agreements to resell  |   | $                             | 39,405 |   | $ | — |   | $ | — |   | $ | — |   | $ | 39,405 |   |
| Securities  available-for-sale, at amortized cost                        |   | 2,014                         |   | — |   | 96 |   | 39,517 |   | 41,627 |   |
| FRB  and other stock, at cost                                            |   |                          |   | — |   | — |   | 2,552 |   | 2,552 |   |
| Loans  receivable                                                        |   | 164,631                       |   | 19,838 |   | 58,051 |   | 19,447 |   | 261,967 |   |
| Total  rate-sensitive assets                                             |   | 206,050                       |   | 19,838 |   | 58,147 |   | 61,516 |   | 345,551 |   |
|                                                                     |   |                          |   |   |   |   |   |   |   |   |   |
| Rate-Sensitive  Liabilities:(1)                                          |   |                          |   |   |   |   |   |   |   |   |   |
| Interest  bearing deposits:                                              |   |                          |   |   |   |   |   |   |   |   |   |
| Demand,  money market and savings                                        |   | 94,642                        |   | — |   | — |   |   |   | 94,642 |   |
| Time  certificates of deposit                                            |   | 48,253                        |   | 37,853 |   | 13,747 |   | — |   | 99,853 |   |
| Other  borrowings                                                        |   | 12,657                        |   | 5,439 |   | 2,500 |   | — |   | 20,596 |   |
| Total  rate-sensitive liabilities                                        |   | 155,552                       |   | 43,292 |   | 16,248 |   | 0 |   | 215,091 |   |
| Interest  rate-sensitivity gap                                           |   | 50,498                        |   | (23,454 | ) | 41,900 |   | 61,516 |   | 130,460 |   |
| Cumulative  interest rate-sensitivity gap                                |   | $                             | 50,498 |   | $ | 27,044 |   | $ | 68,944 |   | $ | 130,460 |   |   |   |
| Cumulative  ratio of rate sensitive assets to rate-sensitive liabilities |   | 132                           | %      | 114 | % | 132 | % | 161 | % |   |   |
|                                                                          |        |                               |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)          Deposits which are subject to immediate withdrawal are presented asrepricing within three months or less. The distribution of other time depositsis based on scheduled maturities.

 

In October 2002, theOffice of the Comptroller of the Currency (“OCC”) requested that Mercantileexecute an informal non-binding document, a memorandum of understanding(“MOU”), relating to its interest rate risk management.  The MOU would provide for Mercantile to takecertain actions that the OCC believes would strengthen Mercantile interest raterisk management process, including the retention of an independent consultantto review Mercantile National’s interest rate risk measurement systems byFebruary 28, 2003.  Mercantile intendsto execute the MOU.

 

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**FACTORSWHICH MAY AFFECT FUTURE OPERATING RESULTS**

 

**We facerisk from changes in interest rates.**

 

The success of ourbusiness depends, to a large extent, on our net interest income.  Changes in market interest rates can affectour net interest income by affecting the spread between our interest earningassets and interest bearing liabilities. This may be due to the different maturities of our interest earningassets and interest bearing liabilities, as well as an increase in the generallevel of interest rates.  Changes inmarket interest rates also affect, among other things:

 

•                  Our abilityto originate loans;

•                  The abilityof our borrowers to make payments on their loans;

•                  The value ofour interest earning assets and our ability to realize gains from the sale ofthese assets;

•                  The averagelife of our interest earning assets;

•                  Our abilityto generate deposits instead of other available funding alternatives; and

•                  Our abilityto 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 facerisk from possible declines in the quality of our assets.**

 

Our financial conditiondepends significantly 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.

 

**Ourallowances for credit losses may be inadequate.**

 

We establish allowancesfor credit losses against each segment of our loan portfolio.  At September 30, 2002, our allowance forcredit losses equaled 1.8% of loans receivable and 93.7% of nonperforming loans.  Although we believed that we had establishedadequate allowances for credit losses as of September 30, 2002, the creditquality or our assets is affected by many factors beyond our control, includinglocal and national economic conditions, and the possible existence of factswhich are not known to us which adversely affect the likelihood of repayment ofvarious loans in our loan portfolio and realization of

 

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the collateral upon a default. Accordingly, we can give no assurance that we will not sustain loanlosses materially in excess of the allowance for credit losses.  In addition, the OCC, as an integral part ofits examination process, periodically reviews our allowance for credit lossesand could require additional provisions for credit losses.  Material future additions to the allowancefor credit losses may also be necessary due to increases in the size andchanges in the composition of our loan portfolio.  Increases in our provisions for credit losses would adverselyaffect our results of operations.

 

**Economicconditions may worsen.**

 

Our business is stronglyinfluenced by economic conditions in our market area (principally, the GreaterLos Angeles metropolitan area) as well as regional and national economicconditions and in our niche markets, including the entertainment industry inSouthern California.  During the pastseveral years economic conditions in these areas have been favorable.  Should the economic condition in these areasdeteriorate, the financial condition of our borrowers could weaken, which couldlead to higher levels of loan defaults or a decline in the value of collateralfor our loans.  In addition, anunfavorable economy could reduce the demand for our loans and other productsand services.

 

**Becausea significant amount of the loans we make are to borrowers in California, ouroperations could suffer as a result of local recession or natural disasters inCalifornia.**

 

At September 30, 2002,approximately 67% 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.

 

**Ourbusiness is very competitive.**

 

There is intensecompetition in Southern California and elsewhere in the United States forbanking customers.  We experiencecompetition for deposits from many sources, including credit unions, insurancecompanies and money market and other mutual funds, as well as other commercialbanks and savings institutions.  Wecompete for loans and deposits primarily with other commercial banks, mortgagecompanies, 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

 

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our competitors have greater financial strength, marketing capabilityand name recognition than we do, and operate on a statewide or nationwidebasis.  In addition, recent developmentsin technology and mass marketing have permitted larger companies to marketloans and 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 that wewill be able to compete effectively against our competition.

 

**Ourbusiness is heavily regulated.**

 

National MercantileBancorp, as a bank holding company, and Mercantile and South Bay, as nationalbanks, are subject to significant governmental supervision and regulation,which is 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.

 

**We testgoodwill annually and must record any impairment as a charge to earnings.**

 

Statement of FinancialAccounting Standards No. 142 “Goodwill and Other Intangible Assets” (“SFAS No.142”), among other provisions, prescribes that goodwill and intangible assetsthat have indefinite useful lives will not be amortized but rather testedannually, or more frequently upon the occurrence of certain events, forimpairment.  SFAS No. 142 providesspecific guidance for the testing of goodwill for impairment, which may requirere-measurement of the fair value of the reporting unit.  Impairment losses are to be reported as acharge to current period earnings.

 

We recorded goodwill of$5.6 million in connection with the South Bay acquisition in December2001.  During the fourth quarter of2002, we will complete the required impairment tests of goodwill.  In the event that the test determines thatour goodwill is impaired, we will record a charge to earnings.

 

**We determineannually whether our deferred tax asset will be realized and must establish avaluation allowance if necessary to reduce it to its realizable value.**

 

In conjunction with theacquisition of South Bay, we reversed our valuation allowance of $6.1 millionon the deferred tax asset with the related benefit reducing goodwill.  On a periodic basis, at least annually, weperform an analysis to determine if it is more likely than not that some or allof the gross deferred tax asset will not be realized.  Factors used in the analysis that are reflective of the futurerealization of a deferred tax asset are:

 

•                  A relatively consistent strongearnings history;

•                  Future earnings are assured;

 

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•                  Expected adequate future taxableincome arising from the reversal of temporary differences to realize the taxasset;

 

An evaluation allowancemay be established to reduce the deferred tax asset to its realizablevalue.  The determination of whether avaluation allowance is necessary involves considering the positive and negativefactors related to whether the deferred tax asset is more likely than not to berealized.  Any adjustment required tothe valuation allowance is coupled with a related entry to income tax expense.  A charge to earnings will be made in theevent that we determine that a valuation allowance to the deferred tax asset isnecessary.

 

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***ITEM 3. CONTROLSAND PROCEDURES***

 

The Company’s management,including the Chief Executive Officer and Chief Financial Officer, haveconducted an evaluation of the effectiveness of the Company’s disclosurecontrols and procedures pursuant to Rule 13a-14 under the Securities ExchangeAct of 1934, as amended, within 90 days of the filing of this quarterlyreport.  Based on that evaluation, the Chief Executive Officer and theChief Financial Officer believe that the Company’s disclosure controls andprocedures were effective in ensuring that information required to bedisclosed by the Company in this quarterly report has been made known to themin a timely manner.

 

During the quarter endedSeptember 30, 2002, there were no significant changes in the Company’s internalcontrols or in other factors that could significantly affect those controls.

 

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**PART II—OTHER INFORMATION**

 

***Item 1.   LEGAL PROCEEDINGS***

 

None.

 

***Item 2.   CHANGES INSECURITIES***

 

None.

 

***Item 3.   DEFAULTS UPON SENIOR SECURITIES***

 

None.

 

***Item 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS***

 

None.

 

***Item 5.   OTHERINFORMATION***

 

None.

 

***Item 6.   EXHIBITS ANDREPORTS ON FORM 8-K***

 

(a)  *Exhibits.*

 

None.

 

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

 

OnAugust 7, 2002, the Company filed a report on Form 8-K reporting under Item 4 achange in the Company’s Certifying Accountant.

 

OnAugust 22, 2002, the Company filed a report on Form 8-K reporting under Item 5the Company’s press release regarding second quarter 2002 operating results.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                         | **NATIONAL MERCANTILE BANCORP** |   |
|------------------------------|---------------------------------|--------|
|                         | (Registrant)                    |
|                         |                            |
|                         |                            |
| DATE:  November 7, 2002 | /s/  SCOTT A. MONTGOMERY   |   |
|                         | **SCOTT A. MONTGOMERY**         |
|                         | Chief Executive Officer         |
|                         |                            |
|                         |                            |
| DATE:  November 7, 2002 | /s/  DAVID  R. BROWN       |   |
|                         | **DAVID R. BROWN**              |
|                         | Chief Financial Officer         |

 

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Certification

 

I, Scott Montgomery,certify that:

 

1.     I have reviewed this quarterly report onForm 10-QSB of National Mercantile Bancorp;

 

2.     Based on my knowledge, this quarterlyreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.     Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.     The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

(a)   designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

 

(b)   evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

 

(c)   presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.     The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

(a)   all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

(b)   any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.     The registrant’s other certifying officersand I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date:  November 7, 2002 | /s/  Scott Montgomery |   |
|------------------------------|----------------------------|--------|
|                         | Scott Montgomery           |
|                         | Chief Executive Officer    |

 

36

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** **

** **

Certification

 

I, David Brown, certifythat:

 

1.     I have reviewed this quarterly report onForm 10-QSB of National Mercantile Bancorp;

 

2.     Based on my knowledge, this quarterlyreport does not contain any untrue statement of a material fact or omit tostate a material fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3.     Based on my knowledge, the financialstatements, and other financial information included in this quarterly report,fairly present in all material respects the financial condition, results ofoperations and cash flows of the registrant as of, and for, the periodspresented in this quarterly report;

 

4.     The registrant’s other certifying officersand I are responsible for establishing and maintaining disclosure controls andprocedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for theregistrant and we have:

 

(a)   designed such disclosure controls andprocedures to ensure that material information relating to the registrant,including its consolidated subsidiaries, is made known to us by others withinthose entities, particularly during the period in which this quarterly reportis being prepared;

 

(b)   evaluated the effectiveness of theregistrant’s disclosure controls and procedures as of a date within 90 daysprior to the filing date of this quarterly report (the “Evaluation Date”); and

 

(c)   presented in this quarterly report ourconclusions about the effectiveness of the disclosure controls and proceduresbased on our evaluation as of the Evaluation Date;

 

5.     The registrant’s other certifying officersand I have disclosed, based on our most recent evaluation, to the registrant’sauditors and the audit committee of registrant’s board of directors (or personsperforming the equivalent function):

 

(a)   all significant deficiencies in the design oroperation of internal controls which could adversely affect the registrant’sability to record, process, summarize and report financial data and haveidentified for the registrant’s auditors any material weaknesses in internalcontrols; and

 

(b)   any fraud, whether or not material, thatinvolves management or other employees who have a significant role in theregistrant’s internal controls; and

 

6.     The registrant’s other certifying officersand I have indicated in this quarterly report whether or not there weresignificant changes in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date:  November 7, 2002 | /s/  David Brown   |   |
|------------------------------|-------------------------|--------|
|                         | David Brown             |
|                         | Chief Financial Officer |

 

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