** **

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

**WASHINGTON,D.C. 20549**

 

 

**FORM 10-QSB**

 

 

**QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d) OF THE**

# **SECURITIESEXCHANGE ACT OF 1934**

 

 

**For the quarterly period ended March 31, 2002**

**Commission File Number: 0-15982**

** **

** **

**NATIONALMERCANTILE BANCORP**

(Exact name of smallbusiness issuer as specified in its charter) 

 

** **

| **California**                   |   | **95-3819685**      |
|----------------------------------|--------|---------------------|
| (State or other  jurisdiction of |   | (I.R.S. Employer    |
| incorporation or  organization)  |   | Identification No.) |

 

| **1840  Century Park East, Los Angeles, California** |   | **90067**  |
|------------------------------------------------------|--------|------------|
| (Address of principal  executive offices)            |   | (Zip Code) |

 

Issuer’s 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 |
|-----|--------|--------|----|---|

 

 

APPLICABLEONLY TO CORPORATE ISSUERS:

 

The number ofshares outstanding of the issuer’s Common Stock, no par value, as of May 1,2002 was 1,630,253.

 

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**NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

(Unaudited)

 
|                                                                                                                                                                                        |   | **March 31,**               |    | **December  31,** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|-------------------|--------|
|                                                                                                                                                                                        |   | **2002**                    |    | **2001**          |   |
|                                                                                                                                                                                        |   | **(Dollars in  thousands)** |    |
|                                                                                                                                                                                        |   |                        |    |              |   |
| ASSETS                                                                                                                                                                                      |   |                        |    |              |   |
| Cash and due from  banks-demand                                                                                                                                                             |   | $                           | 21,609  |              | $      | 12,688 |   |
| Federal funds sold and  securities purchased under agreements to resell                                                                                                                     |   | 34,595                      |    | 39,405            |   |
| Cash and cash equivalents                                                                                                                                                                   |   | 56,204                      |    | 52,093            |   |
| Securities  available-for-sale, at fair value; aggregate amortized cost of $30,220 and  $41,532 at March 31, 2002 and Dec 31, 2001, respectively                                            |   | 30,111                      |    | 41,627            |   |
| Federal Reserve Bank stock  and other stock, at cost                                                                                                                                        |   | 2,048                       |    | 2,552             |   |
|                                                                                                                                                                                        |   |                        |    |              |   |
| Loans receivable                                                                                                                                                                            |   | 255,306                     |    | 261,968           |   |
| Allowance for credit losses                                                                                                                                                                 |   | (5,449                      | )       | (6,542            | )      |
| Net loans receivable                                                                                                                                                                        |   | 249,857                     |    | 255,426           |   |
|                                                                                                                                                                                        |   |                        |    |              |   |
| Premises and equipment, net                                                                                                                                                                 |   | 6,107                       |    | 6,121             |   |
| Deferred tax asset, net                                                                                                                                                                     |   | 7,824                       |    | 8,364             |   |
| Goodwill                                                                                                                                                                                    |   | 5,616                       |    | 5,616             |   |
| Accrued interest receivable  and other assets                                                                                                                                               |   | 2,468                       |    | 2,566             |   |
| Total assets                                                                                                                                                                                |   | $                           | 360,235 |              | $      | 374,365 |   |
|                                                                                                                                                                                        |   |                        |    |              |   |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                                                                                  |   |                        |    |              |   |
| Deposits:                                                                                                                                                                                   |   |                        |    |              |   |
| Noninterest-bearing demand                                                                                                                                                                  |   | $                           | 100,674 |              | $      | 114,645 |   |
| Interest-bearing demand                                                                                                                                                                     |   | 28,424                      |    | 23,425            |   |
| Money market                                                                                                                                                                                |   | 46,618                      |    | 40,033            |   |
| Savings                                                                                                                                                                                     |   | 36,206                      |    | 31,184            |   |
| Time certificates of  deposit:                                                                                                                                                              |   |                        |    |              |   |
| $100,000 or more                                                                                                                                                                            |   | 49,291                      |    | 62,085            |   |
| Under $100,000                                                                                                                                                                              |   | 42,091                      |    | 37,768            |   |
| Total deposits                                                                                                                                                                              |   | 303,304                     |    | 309,140           |   |
|                                                                                                                                                                                        |   |                        |    |              |   |
| Federal funds purchased and  securities sold under agreements to repurchase                                                                                                                 |   | 3,017                       |    | 3,096             |   |
| Other borrowings                                                                                                                                                                            |   | 10,500                      |    | 17,500            |   |
| Accrued interest payable  and other liabilities                                                                                                                                             |   | 2,685                       |    | 3,963             |   |
| Total liabilities                                                                                                                                                                           |   | 319,506                     |    | 333,699           |   |
|                                                                                                                                                                                        |   |                        |    |              |   |
| Guaranteed preferred  beneficial interests in the Company’s junior subordinated deferrable interest  debentures, net                                                                   |   | 14,517                      |    | 14,513            |   |
| Minority interest in the  Series A preferred stock of consolidated subsidiary, South Bay Bank, N.A.                                                                                         |   | 755                         |    | 676               |   |
|                                                                                                                                                                                        |   |                        |    |              |   |
| Shareholders’ equity:                                                                                                                                                                  |   |                        |    |              |   |
| Preferred stock, no par value:                                                                                                                                                              |   |                        |    |              |   |
| Series A non-cumulative  convertible perpetual preferred stock; authorized 990,000 shares; outstanding  747,387 shares and 750,580 shares at March 31, 2002 and Dec 31, 2001,  respectively |   | 6,105                       |    | 6,131             |   |
| Preferred stock, no par  value:                                                                                                                                                             |   |                        |    |              |   |
| Series B non-cumulative  convertible perpetual preferred stock;authorized 1,000 shares; outstanding  1,000 shares at March 31, 2002 and December 31, 2001                                   |   | 1,000                       |    | 1,000             |   |
| Common stock, no par value;  authorized 10,000,000 shares; outstanding 1,630,253 shares and 1,623,467  shares at March 31, 2002 and Dec 31, 2001, respectively                              |   | 30,296                      |    | 30,268            |   |
| Additional paid-in capital                                                                                                                                                                  |   | 1,824                       |    | 1,824             |   |
| Accumulated deficit                                                                                                                                                                         |   | (13,705                     | )       | (13,802           | )      |
| Accumulated other  comprehensive income                                                                                                                                                     |   | (63                         | )       | 56                |   |
| Total shareholders’ equity                                                                                                                                                             |   | 25,457                      |    | 25,477            |   |
| Total liabilities and  shareholders’ equity                                                                                                                                            |   | $                           | 360,235 |              | $      | 374,365 |   |
|                                                                                                                                                                                        |   |                        |    |              |   |
| See accompanying notes to  consolidated financial statements.                                                                                                                               |   |                        |    |              |   |
|                                                                                                                                                                                        |   |                        |    |              |   |

** **

 

2

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** **

**NATIONALMERCANTILE BANCORP AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

(Unaudited)

 
|                                                                                                                                                              |   | **For the Three Months Ended** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------|--------|
|                                                                                                                                                              |   | **March 31,**                  |   |
|                                                                                                                                                              |   | **2002**                       |   | **2001** |   |
|                                                                                                                                                              |   | **(Dollars in thousands,**     |   |
|                                                                                                                                                              |   | **except per share data)**     |   |
| Interest income:                                                                                                                                                  |   |                           |   |   |   |
| Loans, including fees                                                                                                                                             |   | $                              | 4,391  |   | $ | 2,590 |   |
| Securities  available-for-sale                                                                                                                                    |   | 483                            |   | 1,090 |   |
| Federal funds sold and  securities purchased under agreements to resell                                                                                           |   | 127                            |   | 152 |   |
| Total interest income                                                                                                                                             |   | 5,001                          |   | 3,832 |   |
| Interest expense:                                                                                                                                                 |   |                           |   |   |   |
| Interest-bearing demand                                                                                                                                           |   | 72                             |   | 22 |   |
| Money market and savings                                                                                                                                          |   | 328                            |   | 290 |   |
| Time certificates of  deposit:                                                                                                                                    |   |                           |   |   |   |
| $ 100,000 or more                                                                                                                                                 |   | 307                            |   | 406 |   |
| Under $100,000                                                                                                                                                    |   | 405                            |   | 118 |   |
| Total interest expense on  deposits                                                                                                                               |   | 1,112                          |   | 836 |   |
| Federal funds purchased and  securities sold under agreements to repurchase                                                                                       |   | 37                             |   | 6 |   |
| Other borrowings                                                                                                                                                  |   | 150                            |   | 461 |   |
| Total interest expense                                                                                                                                            |   | 1,299                          |   | 1,303 |   |
| Net interest income before  provision for credit losses                                                                                                           |   | 3,702                          |   | 2,529 |   |
| Provision for credit losses                                                                                                                                       |   | 150                            |   | — |   |
| Net interest income after  provision for credit losses                                                                                                            |   | 3,552                          |   | 2,529 |   |
| Other operating income:                                                                                                                                           |   |                           |   |   |   |
| Net gain on sale of  securities available-for-sale                                                                                                                |   | —                         |   | 50 |   |
| International services                                                                                                                                            |   | 5                              |   | 6 |   |
| Investment division                                                                                                                                               |   | 22                             |   | 23 |   |
| Deposit-related and other  customer services                                                                                                                      |   | 368                            |   | 130 |   |
| Total other operating  income                                                                                                                                     |   | 395                            |   | 209 |   |
| Other operating expenses:                                                                                                                                         |   |                           |   |   |   |
| Salaries and related  benefits                                                                                                                                    |   | 1,639                          |   | 1,097 |   |
| Net occupancy                                                                                                                                                     |   | 373                            |   | 243 |   |
| Furniture and equipment                                                                                                                                           |   | 101                            |   | 73 |   |
| Printing and communications                                                                                                                                       |   | 172                            |   | 71 |   |
| Insurance and regulatory  assessments                                                                                                                             |   | 91                             |   | 81 |   |
| Client services                                                                                                                                                   |   | 191                            |   | 203 |   |
| Computer data processing                                                                                                                                          |   | 228                            |   | 114 |   |
| Legal services                                                                                                                                                    |   | 174                            |   | 30 |   |
| Other professional services                                                                                                                                       |   | 74                             |   | 137 |   |
| Promotion and other  expenses                                                                                                                                     |   | 239                            |   | 73 |   |
| Total other operating  expenses                                                                                                                                   |   | 3,282                          |   | 2,122 |   |
| Net income before minority  interest and income tax provision                                                                                                     |   | 665                            |   | 616 |   |
| Minority interest in the  Company’s guaranteed preferred beneficial interests in the Company’s junior  subordinated deferrable interest debentures, net |   | 384                            |   | — |   |
| Net income before income  tax provision                                                                                                                           |   | 281                            |   | 616 |   |
| Income tax provision                                                                                                                                              |   | 106                            |   | 13 |   |
| Net income                                                                                                                                                        |   | $                              | 175    |   | $ | 603 |   |
| Earnings per share:                                                                                                                                               |   |                           |   |   |   |
| Basic                                                                                                                                                             |   | $                              | 0.06   |   | $ | 0.38 |   |
| Diluted                                                                                                                                                           |   | $                              | 0.04   |   | $ | 0.19 |   |
|                                                                                                                                                              |   |                           |   |   |   |
| See accompanying notes to  consolidated financial statements.                                                                                                     |   |                           |   |   |   |
|                                                                                                                                                              |   |                           |   |   |   |

** **

 

3

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**NATIONALMERCANTILE BANCORP AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOW**

(Unaudited)

 
|                                                                                        |   | **For the three-months**   |   |
|---------------------------------------------------------------------------------------------|--------|----------------------------|--------|
|                                                                                        |   | **ended March 31,**        |   |
|                                                                                        |   | **2002**                   |   | **2001** |   |
|                                                                                        |   | **(Dollars in thousands)** |   |
| Net cash flow from  operating activities:                                                   |   |                       |   |   |   |
| Net income                                                                                  |   | $                          | 175    |   | $ | 603 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities:          |   |                       |   |   |   |
| Depreciation and  amortization                                                              |   | 257                        |   | 58 |   |
| Provision for credit losses                                                                 |   | 150                        |   | — |   |
| Gain on sale securities  avaiable-for-sale                                                  |   | —                     |   | (50 | ) |
| Net amortization of premium  (discount) on securities available-for-sale                    |   | 53                         |   | (8 | ) |
| Net accretion of discounts  on loans purchased                                              |   | (62                        | )      | (9 | ) |
| Decrease in accrued  interest receivable and other assets                                   |   | 639                        |   | 93 |   |
| Decrease in accrued  interest payable and other liabilities                                 |   | (1,278                     | )      | (532 | ) |
| Net cash provided by (used  in) operating activities                                        |   | (66                        | )      | 155 |   |
| Cash flows from investing  activities:                                                      |   |                       |   |   |   |
| Purchase of securities  available-for-sale                                                  |   | —                     |   | (2,033 | ) |
| Proceeds from sale of  securities available-for-sale                                        |   | —                     |   | 3,951 |   |
| Proceeds from repayments  and maturities of securities available-for-sale                   |   | 11,344                     |   | 2,689 |   |
| Loan originations and  principal collections, net                                           |   | 5,481                      |   | 3,003 |   |
| Redemption of FRB and other  stocks                                                         |   | 504                        |   | — |   |
| Net purchases of premises  and equipment                                                    |   | (239                       | )      | (143 | ) |
| Net cash provided by  investing activities                                                  |   | 17,090                     |   | 7,467 |   |
| Cash flows from financing  activities:                                                      |   |                       |   |   |   |
| Net increase in demand  deposits, money market and savings accounts                         |   | 2,635                      |   | 2,137 |   |
| Net increase (decrease) in  time certificates of deposit                                    |   | (8,471                     | )      | 7,297 |   |
| Net decrease in securities  sold under agreements to repurchase and federal funds purchased |   | (79                        | )      | (2,500 | ) |
| Net decrease in other  borrowings                                                           |   | (7,000                     | )      | (4,000 | ) |
| Net proceeds from exercise  of stock options                                                |   | 2                          |   | 63 |   |
| Net cash provided by (used  in) financing activities                                        |   | (12,913                    | )      | 2,997 |   |
| Net increase in cash and  cash equivalents                                                  |   | 4,111                      |   | 10,619 |   |
| Cash and cash equivalents,  January 1                                                       |   | 52,093                     |   | 27,597 |   |
| Cash and cash equivalents,  March 31                                                        |   | $                          | 56,204 |   | $ | 38,216 |   |
|                                                                                        |   |                       |   |   |   |
| Supplemental cash flow  information:                                                        |   |                       |   |   |   |
|                                                                                        |   |                       |   |   |   |
| Cash paid for interest                                                                      |   | $                          | 1,257  |   | $ | 1,355 |   |
|                                                                                        |   |                       |   |   |   |
| See accompanying notes to  consolidated financial statements.                               |   |                       |   |   |   |
|                                                                                        |   |                       |   |   |   |

 

 

4

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**NATIONAL MERCANTILE BANCORP ANDSUBSIDIARIES**

###### **NOTES TO THEUNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

NOTE 1—BASIS OFPRESENTATION AND MANAGEMENT REPRESENTATIONS

 

The unaudited consolidated financial statements include the accounts ofNational Mercantile Bancorp (the ‘‘Company’’) and its wholly ownedsubsidiaries, (i) Mercantile National Bank, (ii) South Bay Bank, N.A., and(iii) National Mercantile Capital Trust I. The unaudited consolidated financial statements reflect all interimadjustments, which are of a normal recurring nature and which, in management’sopinion, are necessary for the fair presentation of the Company’s consolidatedfinancial position and results of operations and cash flows for such interimperiods. The results for the quarter ended March 31, 2002 are not necessarilyindicative of the results expected for any subsequent period or for the fullyear ending December 31, 2002. The unaudited consolidated financial statementsshould be read in conjunction with the audited consolidated financialstatements included in the Company’s Annual Report on Form 10-KSB for the yearended December 31, 2001.

 

NOTE 2—EARNINGS PER SHARE

 

         Basic earnings per share is computedusing the weighted average number of common shares outstanding during theperiod.  The weighted average number ofcommon shares outstanding used in computing basic earnings per share for thethree months ended March 31, 2002 and 2001 was 1,627,166 and 1,574,440,respectively.  The weighted averagenumber of common shares and common share equivalents outstanding used incomputing diluted earnings per share for the three months ended March 31, 2002and 2001 was 4,058,940 and 3,195,073, respectively.

 

 

5

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The following table is a reconciliation of income and shares used inthe computation of basic and diluted earnings per share:

 

|                                          |   |               |       |       |       | **Per share** |       |
|-----------------------------------------------|--------|--------------------|------------|------------|------------|---------------|------------|
|                                          |   | **Net Income**     |       | **Shares** |       | **amount**    |       |
|                                          |   | **(in thousands)** | ** ** |       | ** ** |          | ** ** |
| *For the  three months ended March 31, 2002:* |   |               |       |       |       |          |       |
| Basic EPS                                     |   | $                  | 175        |       | 1,627,166  |          | $          | 0.11 |   |
|                                          |   |               |       |       |       |          |       |
| Effect of dilutive  securities:               |   |               |       |       |       |          |       |
| Options and warrants                          |   |               |       | 53,925     |       |          |       |
| Convertible preferred stock                   |   |               |       | 2,377,849  |       |          |       |
| Diluted EPS                                   |   | $                  | 175        |       | 4,058,940  |          | $          | 0.04 |   |
|                                          |   |               |       |       |       |          |       |
| *For the  three months ended March 31, 2001:* |   |               |       |       |       |          |       |
| Basic EPS                                     |   | $                  | 603        |       | 1,574,440  |          | $          | 0.38 |   |
|                                          |   |               |       |       |       |          |       |
| Effect of dilutive  securities:               |   |               |       |       |       |          |       |
| Options and warrants                          |   |               |       | 119,273    |       |          |       |
| Convertible preferred stock                   |   |               |       | 1,501,360  |       |          |       |
| Diluted EPS                                   |   | $                  | 603        |       | 3,195,073  |          | $          | 0.19 |   |
|                                          |   |               |       |       |       |          |       |

 

NOTE 3—CASH AND CASHEQUIVALENTS

 

For purposes of reporting cash flows, cash and cash equivalents includecash and due from banks-demand, federal funds sold and securities sold underagreements to resell.

 

NOTE 4—INCOME TAXES

 

Income tax provisions of $106,000 and $13,000 were recorded for thethree months ended March 31, 2002 and 2001, respectively.  The Company allocated a portion of thepurchase price in its acquisition of South Bay Bank, N.A. during the fourthquarter of 2001 toward the recognition of tax benefits related to net operatingloss carry forwards (NOLs) that previously were carried on its books atzero.  No income tax provision wasrecorded for the first quarter of 2001, other than alternative minimum tax, dueto the utilization of previously unrecognized tax benefits to offset thecurrent period tax liability.

For tax purposes at March 31, 2002, the Company had: (i) federal netoperating loss carry forwards of approximately $16.6 million, which begin toexpire in the year 2009; and (iii) an alternative minimum tax credit of$297,000 which may be carried forward indefinitely.

 

 

6

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NOTE 5—BENEFICIALCONVERSION RIGHTS OF SUBSIDIARY PREFERRED STOCK

 

       The Company recorded $1.8million additional paid in capital, with a corresponding discount to theminority interest in South Bay Series A Preferred stock, during the fourthquarter of 2001 related to the beneficial conversion rights of the preferredstock of its subsidiary, South Bay Bank, N.A. The discount is being amortized against retained earnings over theperiod from the acquisition date through the earliest conversion date of thepreferred stock, June 30, 2005 using the effective yield method.  For the three months ended March 31, 2002the amount of the discount amortized against retained earnings was  $79,000.

 

NOTE 6—RECLASSIFICATIONS

 

Certain prior year data have been reclassified to conform to currentyear presentation.

 

 

7

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

***AND RESULTS OF OPERATIONS***

National Mercantile Bancorp (“National Mercantile” on a parent-onlybasis, and the ‘‘Company’’ on a consolidated basis) is the holding company fortwo subsidiary banks, Mercantile National Bank (“Mercantile”) and South BayBank, N.A. (“South Bay”) (and collectively, “the Banks”).  National Mercantile’s principal assets arethe capital stock of Mercantile and South Bay. National Mercantile Capital Trust I is a Delaware statutory businesstrust formed for the exclusive purpose of issuing and selling trust preferredsecurities and also is a consolidated subsidiary of the Company.

National Mercantile acquired South Bay on December 14, 2001.  The acquisition was accounted for as apurchase, and thus the results of operations for the quarter ended March 31,2001 do not include any results of operations for South Bay.

**RESULTS OF OPERATIONS**

The Company recorded net income of $175,000, or $0.04 diluted earningsper share, for the first quarter of 2002, compared to net income of $603,000,or $0.19 diluted earnings per share, for the first quarter of 2001.   Net income per basic share was $0.06 and$0.38 for the first quarter of 2002 and 2001, respectively.  The decrease in net income resulted from a$1.2 million increase in noninterest expense, a $384,000 minority interest inthe trust preferred securities, a $150,000 increase in provision for creditlosses and a $93,000 increase in income tax provision partially offset by a$1.2 million increase in net interest income and a $200,000 increase in noninterestincome.

Return on average assets during the first quarter of 2002 decreased to0.19% from 1.25% during the first quarter of 2001. Return on average equitydeclined to 2.78% during the first quarter of 2002 from 11.32% during the firstquarter of 2001 as a result of lower earnings and a larger equity base in 2002.

         The increase in net interest incomeduring the first quarter of 2002 resulted primarily from an increase of $137.2million or 74.2% in average interest earning assets to $322.3 million from$185.1 million during the first quarter of 2001.  The effect of the greater volume of interest earning assets,however, was partially offset by a decrease in the net yield on interestearning assets of 88 basis points to 4.66% during the first quarter of 2002compared to 5.54% during the first quarter of 2001.  The decrease in the net yield on interest earning assets was dueto declining rates of interest during 2001 driven by the Federal Reserve Bank’sresponse to the slowing economy.  Theincrease in average interest earning assets and interest-bearing liabilitieswas primarily due to the acquisition of South Bay during the fourth quarter2001.

         Average loans receivable increased$147.8 million or 136.9% for the three months ended March 31, 2002 compared tothe same period in 2001.  The weightedaverage yield on loans receivable declined 277 basis points to 6.96% for thefirst quarter 

 

 

8

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2002 from 9.73%for the first quarter 2001 due to adjustable rate loans tied to prime rate andborrower refinancing of fixed rate loans in the low interest rateenvironment.  The loans receivableacquired in the acquisition of South Bay during the fourth quarter 2001 were asimilar mix of fixed and variable rate loans as the existing loans.  Securities available for sale decreased$31.0 million or 46.8% as part of a planned action to carry higher yieldingloans and to reduce the exposure to a decline in market value in the event thatmarket rates begin to rise.  The weightedaverage yield on securities available for sale was 5.56% and 6.67% for thethree months ended March 31, 2002 and 2001, respectively, representing a 111basis point decline for the 2002 period. The decline in yield was due to purchases of securities in the decliningrate environment during 2001 and to a lesser extent, adjustable rate securitiesin the portfolio.  Federal funds soldaveraged $31.4 million and yielded 1.64% during the first quarter of 2002 comparedto an average of $10.9 million yielding 5.64% for the same period in 2001.

Average total deposits increased $159.8 million or 114.2% to $299.8million during the first quarter of 2002 compared to $140.0 million during thefirst quarter of 2001.  Federal fundspurchased and securities sold under agreements to repurchase averaged $3.1million and $361,000 for the three months ended March 31, 2002 and 2001,respectively.  Average total otherborrowings decreased $17.1 million or 53.6% to $14.9 million during the quarterended March 31, 2002 compared to $32.0 million during the quarter ended March31, 2001 reflecting a planned reduction in these relatively high cost fundsprovided for by a reduction in securities available for sale.

The weighted average cost of interest bearing liabilities declined 222basis points to 2.39% during the first quarter of 2002 from 4.61% the duringthe first quarter of 2001.  This changewas a result of a decrease in the weighted average cost of interest bearingdeposits to 2.23% during the first quarter of 2002 compared to 4.12% during thefirst quarter of 2001 due primarily to overall lower market interest rates butparticularly in the lower cost of time certificates of deposit whichrepresented 47.5% of average total interest-bearing deposits.  The impact of the decline in market rates onthe Company’s interest-bearing liabilities was muted as a result of theacquisition of South Bay’s deposits which had a greater percentage of highercosting time certificates than the Company’s deposits prior to the combination.  The decline also was supported by a decreasein the cost of other borrowings to 4.09% during the first quarter of 2002 from5.83% during the first quarter of 2001. The overall decline in the cost of funds is a result of interest ratereductions by the Federal Reserve Bank during 2001 affecting nearly allinterest-bearing instruments.

Average noninterest-bearing demand deposits increased $39.9 million or69.2% during the first quarter 2002 to $97.5 million from $57.6 millionprimarily due to the acquisition of South Bay.

 

 

9

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Provision for credit losses for the quarters ended March 31, 2002 was$150,000 while there was no provision for the same period in 2001.  Loan charge-offs during the first quarter of2002 were $1.4 million compared to $179,000 during the first quarter of2001.  Recoveries were $160,000 duringthe first quarter of 2002, compared to $34,000 during the first quarter of2001.

Other operating income increased to $395,000 during the first quarterof 2002 from $209,000 during the first quarter of 2001 largely due to thedeposit-related fees earned on the deposit accounts acquired in the South Bayacquisition.  There were no gains on thesale of securities for the 2002 period compared to a $50,000 net gain in 2001.

The Company did not have any OREO activity during the first quarter of2002 or 2001.

Other operating expense increased by $1.2 million to $3.3 millionduring the first quarter of 2002 compared to $2.1 million during first quarterof 2001.  This increase was reflected asfollows; (i) salaries and related benefits increased $542,000, or 49.4%; (ii)net occupancy expense increased $130,000 or 53.5%; (iii) printing andcommunications expense increased $101,000 or 142.3%; (iv) computer data processingexpense increased $114,000, or 100.0%; (v) legal expenses increased $144,000,or 480.0% primarily due to costs associated with the collection ofnon-performing loans; and (vi) promotion and other expense increased $166,000,or 227.4%.  The increase in noninterestexpense is largely due to the acquisition of South Bay Bank and the operationof its two banking offices. Additionally, salaries and related benefits increased during the 2002period due to the opening of the Encino branch banking office in March 2001 andthe addition of lending staff during the second half of 2001.

The following table presents the components of net interest income forthe quarters ended March 31, 2002 and 2001.

 

 

10

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**Average Balance Sheet and**

**Analysis of Net Interest Income**

 
|                                                                                                                      |   | **Three months ended**      |    |
|---------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|
|                                                                                                                      |   | **March 31, 2002**          |    | **March 31, 2001** |   |
|                                                                                                                      |   |                        |    |   |   | **Weighted** |   |   |   |   |   | **Weighted** |   |
|                                                                                                                      |   |                        |    | **Interest** |   | **Average** |   |   |   | **Interest** |   | **Average** |   |
|                                                                                                                      |   | **Average**                 |    | **Income/** |   | **Yield/** |   | **Average** |   | **Income/** |   | **Yield/** |   |
|                                                                                                                      |   | **Amount**                  |    | **Expense** |   | **Rate** |   | **Amount** |   | **Expense** |   | **Rate** |   |
|                                                                                                                      |   | **(Dollars  in thousands)** |    |
| Assets:                                                                                                                   |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold and  securities purchased under agreements to resell                                                   |   | $                           | 31,412  |   | $ | 127 |   | 1.64 | % | $ | 10,939 |   | $ | 152 |   | 5.64 | % |
| Securities  available-for-sale                                                                                            |   | 35,219                      |    | 483 |   | 5.56 | % | 66,229 |   | 1,090 |   | 6.67 | % |
| Loans receivable (1) (2)                                                                                                  |   | 255,711                     |    | 4,391 |   | 6.96 | % | 107,925 |   | 2,590 |   | 9.73 | % |
| Total interest earning  assets                                                                                            |   | 322,342                     |    | $ | 5,001 |   | 6.29 | % | 185,093 |   | $ | 3,832 |   | 8.40 | % |
|                                                                                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest earning assets:                                                                                               |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks —  demand                                                                                    |   | 21,225                      |    | 10,856 |   |   |   |   |   |   |   |   |   |
| Other assets                                                                                                              |   | 24,263                      |    | 2,452 |   |   |   |   |   |   |   |   |   |
| Allowance for credit losses  and net unrealized (loss) gain on securities available-for-sale                              |   | (6,395                      | )       |   |   |   |   | (2,735 | ) |   |   |   |   |
| Total assets                                                                                                              |   | $                           | 361,435 |   |   |   |   |   | $ | 195,666 |   |   |   |   |   |
|                                                                                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Liabilities and  shareholders’ equity:                                                                               |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing deposits:                                                                                                |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Demand                                                                                                                    |   | $                           | 27,557  |   | $ | 72 |   | 1.06 | % | $ | 8,022 |   | $ | 22 |   | 1.11 | % |
| Money market and savings                                                                                                  |   | 78,564                      |    | 328 |   | 1.69 | % | 36,513 |   | 290 |   | 3.22 | % |
| Time certificates of  deposit:                                                                                            |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| $100,000 or more                                                                                                          |   | 51,832                      |    | 307 |   | 2.40 | % | 29,141 |   | 406 |   | 5.65 | % |
| Under $100,000                                                                                                            |   | 44,352                      |    | 405 |   | 3.70 | % | 8,644 |   | 118 |   | 5.54 | % |
| Total time certificates of  deposit                                                                                       |   | 96,184                      |    | 712 |   | 3.00 | % | 37,785 |   | 524 |   | 5.62 | % |
| Total interest-bearing  deposits                                                                                          |   | 202,305                     |    | 1,112 |   | 2.23 | % | 82,320 |   | 836 |   | 4.12 | % |
| Federal funds purchased and  securities sold under agreements to repurchase                                               |   | 3,146                       |    | 37 |   | 4.77 | % | 361 |   | 6 |   | 6.74 | % |
| Other borrowings                                                                                                          |   | 14,856                      |    | 150 |   | 4.09 | % | 32,044 |   | 461 |   | 5.83 | % |
| Total interest-bearing  liabilities                                                                                       |   | 220,307                     |    | $ | 1,299 |   | 2.39 | % | 114,725 |   | $ | 1,303 |   | 4.61 | % |
|                                                                                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities:                                                                                         |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing demand  deposits                                                                                      |   | 97,528                      |    |   |   |   |   | 57,636 |   |   |   |   |   |
| Other liabilities                                                                                                         |   | 3,219                       |    |   |   |   |   | 1,704 |   |   |   |   |   |
| Guaranteed preferred  beneficial interests in the Company’s junior subordinated deferrable interest  debentures, net |   | 14,516                      |    |   |   |   |   |   |   |   |   |   |   |
| Minority interest in the  preferred stock of subsidiary                                                                   |   | 716                         |    |   |   |   |   |   |   |   |   |   |   |
| Shareholders’ equity                                                                                                 |   | 25,149                      |    |   |   |   |   | 21,601 |   |   |   |   |   |
| Total liabilities and  shareholders’ equity                                                                          |   | $                           | 361,435 |   |   |   |   |   | $ | 195,666 |   |   |   |   |   |
|                                                                                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Net interest income  (spread)                                                                                             |   |                        |    | $ | 3,702 |   | 3.90 | % |   |   | $ | 2,529 |   | 3.79 | % |
|                                                                                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Net yield on earning assets  (2)                                                                                          |   |                        |    |   |   | 4.66 | % |   |   |   |   | 5.54 | % |

 

----

(1)Includes average balance of nonperforming loans of $7.1 million and $750,000for 2002 and 2001, respectively.

(2)Yields and amounts earned on loans receivable include loan fees of $141,000 and$91,000 for the three months ended March 31, 2002 and 2001, respectively.

 

 

11

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The following table sets forth, for the periods indicated, the changesin interest earned and interest paid resulting from changes in volume andchanges in rates.  Average balances inall categories in each reported period were used in the volumecomputations.  Average yields and ratesin each reported period were used in rate computations.

 

**Increase (Decrease) in Interest Income/Expense Due to Changein**

**Average Volume and Average Rate**

 
|                                                                        |   | **Quarter ended March 31,**        |       |
|-----------------------------------------------------------------------------|--------|------------------------------------|------------|
|                                                                        |   | **2002 vs 2001**                   |       |
|                                                                        |   |                               |       |   |   | **Net** |   |
|                                                                        |   | **Increase (decreased) due to(1)** |       | **Increase** |   |
|                                                                        |   | **Volume**                         | ** ** | **Rate** |   | **(Decrease**) |   |
|                                                                        |   |                               |       |   |   |   |   |
| Interest Income:                                                            |   |                               |       |   |   |   |   |
| Federal funds sold and  securities purchased under agreements to resell     |   | $                                  | 284        |   | (309 | ) | $ | (25 | ) |
| Securities  available-for-sale                                              |   | (510                               | )          | (97 | ) | (607 | ) |
| Loans receivable (2)                                                        |   | 3,547                              |       | (1,746 | ) | 1,801 |   |
| Total interest-earning  assets                                              |   | $                                  | 3,321      |   | $ | (2,152 | ) | $ | 1,169 |   |
|                                                                        |   |                               |       |   |   |   |   |
| Interest Expense:                                                           |   |                               |       |   |   |   |   |
| Interest-bearing deposits:                                                  |   |                               |       |   |   |   |   |
| Demand                                                                      |   | $                                  | 54         |   | $ | (4 | ) | $ | 50 |   |
| Money market and savings                                                    |   | 334                                |       | (296 | ) | 38 |   |
|                                                                        |   |                               |       |   |   |   |   |
| Time certificates of  deposit:                                              |   |                               |       |   |   |   |   |
| $100,000 or more                                                            |   | 316                                |       | (415 | ) | (99 | ) |
| Under $100,000                                                              |   | 487                                |       | (200 | ) | 287 |   |
| Total time certificates of  deposit                                         |   | 804                                |       | (616 | ) | 188 |   |
| Total interest-bearing  deposits                                            |   | 1,191                              |       | (915 | ) | 276 |   |
| Federal funds purchased and  securities sold under agreements to repurchase |   | 46                                 |       | (15 | ) | 31 |   |
| Other borrowings                                                            |   | (247                               | )          | (64 | ) | (311 | ) |
| Total interest-bearing  liabilities                                         |   | $                                  | 990        |   | $ | (994 | ) | $ | (4 | ) |
|                                                                        |   |                               |       |   |   |   |   |
| Net interest income                                                         |   | $                                  | 2,331      |   | $ | (1,158 | ) | $ | 1,173 |   |

----

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

(2)          Table does not includeinterest income that would have been earned on nonaccrual loans.

 

 

12

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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 available-for-sale securities:

 

**Estimated Fair Values of and Unrealized**

**Gains and Losses on Investment Securities**

 
|                                                                            |   | **March 31, 2002**         |       | **December 31, 2001**      |       |
|---------------------------------------------------------------------------------|--------|----------------------------|------------|----------------------------|------------|
|                                                                            |   | **Total**                  |       | **Gross**                  |       | **Gross** |   | **Estimated** |   | **Total** |   | **Gross** |   | **Gross** |   | **Estimated** |   |
|                                                                            |   | **amortized**              |       | **unrealized**             |       | **unrealized** |   | **fair** |   | **amortized** |   | **unrealized** |   | **unrealized** |   | **fair** |   |
|                                                                            |   | **cost**                   |       | **gains**                  |       | **loss** |   | **value** |   | **cost** |   | **gains** |   | **loss** |   | **value** |   |
|                                                                            |   | **(Dollars in thousands)** |       | **(Dollars in thousands)** | ** ** |
|                                                                            |   |                       | ** ** |                       | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| U.S. Treasury securities                                                        |   | $                          | —     |                       | $          | — |   | $ | — |   | $ | — |   | $ | 2,001 |   | 13 |   | $ | — |   | $ | 2,014 |   |
| GNMA-issued/guaranteed  mortgage pass through certificates                 |   | 3,971                      |       | 2                          |       | 10 |   | 3,963 |   | 4,503 |   | — |   | 27 |   | 4,476 |   |
| Other U.S. government and federal agency securities                             |   | 1,990                      |       | 14                         |       | — |   | 2,004 |   | — |   | — |   | — |   | 0 |   |
| FHLMC/FNMA-issued mortgage pass through certificates                            |   | 14,880                     |       | 64                         |       | 83 |   | 14,861 |   | 15,928 |   | 179 |   | 32 |   | 16,075 |   |
| CMO’s and REMIC’s issued by U.S.  government-sponsored  agencies |   | 7,190                      |       | 120                        |       | — |   | 7,310 |   | 16,590 |   | 162 |   | 29 |   | 16,723 |   |
| Privately issued corporate bonds, CMO’s and REMIC’s  securities       |   | 2,189                      |       | 1                          |       | 217 |   | 1,973 |   | 2,510 |   | 4 |   | 175 |   | 2,339 |   |
|                                                                            |
|                                                                            |   | $                          | 30,220     |                       | $          | 201 |   | $ | 310 |   | $ | 30,111 |   | $ | 41,532 |   | $ | 358 |   | $ | 263 |   | $ | 41,627 |   |
|                                                                                 |        |                            |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As indicated in the tableabove, total amortized cost of investment securities decreased $11.3 million to$30.2 million at March 31, 2002 from $41.5 million at December 31, 2001.  This change was due to repayments or  paydowns on principal amortizing securitiesduring the first quarter of 2002.  TheCompany had a net unrealized loss of $109,000 at March 31, 2002 on itsinvestment securities portfolio compared to a net unrealized gain of $95,000 atDecember 31, 2001.

As of March 31, 2002 theCompany did not hold securities of any issuer, other than U.S. governmentagencies and corporations, the aggregate book value of which exceeded 10% ofthe Company’s shareholders’ equity.

 

 

13

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LOAN PORTFOLIO

 

The following comparative period-end table sets forth certaininformation concerning the composition of the loan portfolio. 

 

**LoanPortfolio Composition**

 
|                                                     |   | **March 31,**              |    | **December 31,** |   |
|----------------------------------------------------------|--------|----------------------------|---------|------------------|--------|
|                                                     |   | **2002**                   |    | **2001**         |   |
|                                                     |   | **Amount**                 |    | **Percent**      |   | **Amount** |   | **Percent** |   |
|                                                     |   | **(Dollars in thousands)** |    |
| Commercial loans:                                        |   |                       |    |             |   |   |   |   |   |
| Secured by one to four  family residential properties    |   | $                          | 26,348  |             | 10     | % | $ | 27,069 |   | 10 | % |
| Secured by multifamily  residential properties           |   | 8,833                      |    | 3                | %      | 8,492 |   | 3 | % |
| Secured by commercial real  properties                   |   | 92,613                     |    | 36               | %      | 95,142 |   | 36 | % |
| Other — secured and  unsecured                      |   | 81,867                     |    | 32               | %      | 85,292 |   | 33 | % |
| Real estate construction  and land development           |   | 30,765                     |    | 12               | %      | 30,811 |   | 12 | % |
| Home equity lines of credit                              |   | 6,191                      |    | 2                | %      | 6,511 |   | 3 | % |
| Consumer installment and  unsecured loans to individuals |   | 8,791                      |    | 3                | %      | 8,795 |   | 3 | % |
| Total loans outstanding                                  |   | 255,408                    |    | 100              | %      | 262,112 |   | 100 | % |
|                                                     |   |                       |    |             |   |   |   |   |   |
| Deferred net loan origination                            |   |                       |    |             |   |   |   |   |   |
| Fees and purchased loan  discount                        |   | (102                       | )       |             |   | (144 | ) |   |   |
| Loans receivable, net                                    |   | $                          | 255,306 |             |   |   | $ | 261,968 |   |   |   |
|                                                     |   |                       |    |             |   |   |   |   |   |

 

Total loans outstanding decreased by $6.7 million to $255.4 million atMarch 31, 2002 compared to $262.1 million at December 31, 2001.  The Company experienced a higher volume ofloan payoffs than loan originations in its commercial real estate loans andother commercial loans during the first quarter of 2002 from the levelsoutstanding at December 31, 2001.  The declinein commercial real estate is due in part to borrowers refinancing credit duringhistorically low interest rate environment. The decline in other commercial loans during the first quarter reflectsa cyclical pattern of heavier borrowing during the fourth calendar quarter.

 

 

14

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The following comparative period-end table sets forth certaininformation concerning nonperforming assets. 

 

**NonperformingAssets**

 
|                                                                                                                        |   | **March 31,**              |   | **December 31,** |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|----------------------------|--------|------------------|--------|
|                                                                                                                        |   | **2002**                   |   | **2001**         |   |
|                                                                                                                        |   | **(Dollars in thousands)** |   |
|                                                                                                                        |   |                       |   |             |   |
| Nonaccrual loans                                                                                                            |   | $                          | 5,716  |             | $      | 7,807 |   |
| Troubled debt  restructurings                                                                                               |   | 968                        |   | 953              |   |
| Loans contractually past  due ninety or more days with respect to either principal or interest and  still accruing interest |   | —                     |   | 642              |   |
| Nonperforming loans                                                                                                         |   | 6,684                      |   | 9,402            |   |
| Other real estate owned                                                                                                     |   | —                     |   | —           |   |
| Other assets-SBA guaranteed  loan                                                                                           |   | 285                        |   | —           |   |
| Total nonperforming assets                                                                                                  |   | $                          | 6,969  |             | $      | 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                                                            |   | 81.5                       | %      | 69.6             | %      |
| Total nonperforming assets  as a percent of loans receivable                                                                |   | 2.7                        | %      | 3.6              | %      |
| Total nonperforming assets  as a percent of total shareholders’ equity                                                 |   | 27.4                       | %      | 36.9             | %      |

 

Nonaccrual loans decreased $2.1 million at March 31, 2002 to $5.7million from $7.8 million at December 31, 2001 due primarily to collection ofnonaccrual loans and a loan charge-off of $1.0 million.  As a result, the amount of nonperformingassets at March 31, 2002 decreased 25.9% from the level at December 31, 2001.

Troubled debt restructurings (TDRs) at December 31, 2001 were $953,000representing one loan acquired in the South Bay acquisition.  This loan was restructured to provide for an8-month extension with accrued interest capitalized and a reduction in the loanrate.  The borrower has subsequentlydefaulted and the loan is reflected in nonaccrual loans at March 31, 2002.

At March 31, 2002, TDRs of $968,000 represent a loan to finance theproduction of a film.  The film is collateralfor the loan and the delivery of the film was supported by a completionbond.  The loan has been restructuredwith us agreeing to forego foreclosure on the collateral in exchange for thebonding company’s guarantee of payment of interest and 55% of any deficiency onour loan balance after application of the film’s revenues to the loan for acertain period of time.  After thattime, we agreed to share with the bonding company in the residual revenue fromthe collateral.  The Company has chargedoff $342,000 based upon an analysis of an expected deficiency not including theresidual revenue.  The loan has beenpaid down $130,000 subsequent to March 31, 2002.

 

 

15

----

 

There were no loans past due 90 days or more and still accruinginterest at March 31, 2002 compared to $642,000 at December 31, 2001.

 

*Allowance For Credit Losses*

 

The following table sets forth information concerning the Company’sallowance for credit losses for the periods indicated.

 

 

**Analysis ofChanges in Allowance for Credit Losses**

 
|                                                                                                                                                                              |   | **Three months ended**     |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------|------------|
|                                                                                                                                                                              |   | **March 31,**              |       | **March 31,** |   |
|                                                                                                                                                                              |   | **2002**                   |       | **2001** |   |
|                                                                                                                                                                              |   | **(Dollars in thousands)** |       |
|                                                                                                                                                                              |   |                       | ** ** |   | ** ** |
| Balance, beginning of  period (1)                                                                                                                                                 |   | $                          | 6,542      |   | $ | 2,597 |   |
| Loan charged off:                                                                                                                                                                 |   |                       |       |   |   |
| Real estate construction  and land development                                                                                                                                    |   | 31                         |       |   |   |
| Commercial loans:                                                                                                                                                                 |   |                       |       |   |   |
| Other — secured and  unsecured                                                                                                                                               |   | 1,342                      |       | 179 |   |
| Consumer installment and  unsecured loans to individuals                                                                                                                          |   | 30                         |       | — |   |
| Total loan charge-offs                                                                                                                                                            |   | 1,403                      |       | 179 |   |
|                                                                                                                                                                              |   |                       |       |   |   |
| Recoveries of loans  previously charged off:                                                                                                                                      |   |                       |       |   |   |
| Real estate construction  and land development                                                                                                                                    |   | 107                        |       |   |   |
| Commercial loans:                                                                                                                                                                 |   |                       |       |   |   |
| Other — secured and  unsecured                                                                                                                                               |   | 48                         |       | 29 |   |
| Consumer installment and  unsecured loans to individuals                                                                                                                          |   | 5                          |       | 5 |   |
| Total recoveries of loans  previously charged off                                                                                                                                 |   | 160                        |       | 34 |   |
| Net charge-offs                                                                                                                                                                   |   | 1,243                      |       | 145 |   |
| Provision for credit losses                                                                                                                                                       |   | 150                        |       | — |   |
| Balance, end of period                                                                                                                                                            |   | $                          | 5,449      |   | $ | 2,452 |   |
|                                                                                                                                                                              |   |                       |       |   |   |
|                                                                                                                                                                                   |   |                       |       |   |   |
| (1) The balance at March  31, 2002 reflected the consolidated balance of Mercantile and South Bay,  while the balance at March 31, 2001 reflected the balance only of Mercantile. |   |

 

 

16

----

 

***CAPITAL ADEQUACY REQUIREMENTS***

 

         At March 31, 2002 the Company and theBanks were in compliance with all applicable regulatory capital requirementsand the Banks were “well capitalized” under the Prompt Corrective Action rulesof the Office of the Comptroller of the Currency.  The following table sets forth the regulatory capital standardsfor well capitalized institutions, and the capital ratios for the Company andthe Banks as of March 31, 2002 and December 31, 2001.

 

**RegulatoryCapital Information**

**of theCompany and Bank**

** **

 
|                          |   | **Well Capitalized** |   | **March 31,** |   | **December 31,** |   |
|-------------------------------|--------|----------------------|--------|---------------|--------|------------------|--------|
|                          |   | **Standards**        |   | **2002**      |   | **2001**         |   |
| **Company:**                  |   |                 |   |          |   |             |   |
| Tier 1 leverage               |   | 5.00                 | %      | 5.58          | %      | 5.55             | %      |
| Tier 1 risk-based capital     |   | 6.00                 | %      | 7.24          | %      | 6.85             | %      |
| Total risk-based capital      |   | 10.00                | %      | 12.13         | %      | 11.53            | %      |
|                          |   |                 |   |          |   |             |   |
| **Mercantile  National Bank** |   |                 |   |          |   |             |   |
| Tier 1 leverage               |   | 5.00                 | %      | 7.53          | %      | 6.85             | %      |
| Tier 1 risk-based capital     |   | 6.00                 | %      | 10.85         | %      | 10.50            | %      |
| Total risk-based capital      |   | 10.00                | %      | 12.10         | %      | 11.76            | %      |
|                          |   |                 |   |          |   |             |   |
| **South Bay  Bank**           |   |                 |   |          |   |             |   |
| Tier 1 leverage               |   | 5.00                 | %      | 9.14          | %      | 8.72             | %      |
| Tier 1 risk-based capital     |   | 6.00                 | %      | 10.57         | %      | 9.63             | %      |
| Total risk-based capital      |   | 10.00                | %      | 11.82         | %      | 10.90            | %      |
|                          |   |                 |   |          |   |             |   |

 

 

***LIQUIDITY***

 

The Company manages its liquidity through a combination of coredeposits, federal funds purchased, repurchase agreements, collateralizedborrowing lines, and a portfolio of securities available for sale.  Liquidity is also provided by maturinginvestment securities and loans.

 

***ASSET LIABILITY MANAGEMENT***

 

The following table shows that the Company’s cumulative one yearinterest rate sensitivity gap indicated an asset sensitive position of $3.1million at March 31, 2002, a change from an asset sensitive position of $27.0million at December 31, 2001.  Thischange resulted primarily from a reduction in assets repricing in less thanthree months consisting of federal funds sold and loans receivable.  This change was offset slightly by adecrease in time certificate of deposit accounts and other borrowings thatreprice within one year.  The Company’sasset sensitive position during a period of slowly declining interest 

 

 

17

----

 

rates is notexpected to have a significant negative impact on net interest income sincerates paid on the Company’s large base of interest bearing demand, savings andmoney market deposit accounts historically have not changed proportionatelywith changes in interest rates. However, since the Company is asset sensitive, in a period of rapidlydeclining rates such as 475 basis point reductions by the Federal Reserveduring 2001, the rapid decline will have a negative effect on the Company’s netinterest income in the future quarters as deposit rates are adjusted.

 

**Rate-Sensitive Assets and Liabilities**

 
|                                                                        |   | **March 31, 2002**           |   |
|-----------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                        |   | **Maturing or repricing in** |   |
|                                                                        |   | **Less**                     |   | **After three** |   | **After one** |   |   |   |   |   |
|                                                                        |   | **than**                     |   | **months** |   | **year** |   |   |   |   |   |
|                                                                        |   | **three**                    |   | **but within** |   | **but within** |   | **After** |   |   |   |
|                                                                        |   | **months**                   |   | **one year** |   | **5 years** |   | **5 years** |   | **Total** |   |
|                                                                        |   |                         |   |   |   |   |   |   |   |   |   |
|                                                                        |   | **(Dollars in thousands)**   |   |
| Rate-Sensitive Assets:                                                      |   |                         |   |   |   |   |   |   |   |   |   |
| Federal funds sold and  securities purchased under agreements to resell     |   | $                            | 34,595 |   | $ | — |   | $ | — |   | $ | — |   | $ | 34,595 |   |
| Securities  available-for-sale, at amortized cost                           |   | —                       |   | — |   | 78 |   | 30,033 |   | 30,111 |   |
| FRB and other stock, at  cost                                               |   | 2,048                        |   | — |   | — |   | 0 |   | 2,048 |   |
| Loans receivable (2)                                                        |   | 148,888                      |   | 18,602 |   | 64,566 |   | 17,351 |   | 249,407 |   |
| Total rate-sensitive assets                                                 |   | 185,531                      |   | 18,602 |   | 64,644 |   | 47,384 |   | 316,161 |   |
|                                                                        |   |                         |   |   |   |   |   |   |   |   |   |
| Rate-Sensitive  Liabilities:  (1)                                      |   |                         |   |   |   |   |   |   |   |   |   |
| Interest bearing deposits:                                                  |   |                         |   |   |   |   |   |   |   |   |   |
| Demand, money market and  savings                                           |   | 111,248                      |   | — |   | — |   | — |   | 111,248 |   |
| Time certificates of  deposit                                               |   | 40,837                       |   | 35,875 |   | 14,670 |   | — |   | 91,382 |   |
| Federal funds purchased and  securities sold under agreements to repurchase |   | 1,210                        |   | 1,807 |   | — |   | — |   | 3,017 |   |
| Other borrowings                                                            |   | 4,000                        |   | 4,000 |   | 2,500 |   | — |   | 10,500 |   |
| Total rate-sensitive  liabilities                                           |   | 157,295                      |   | 41,682 |   | 17,170 |   | — |   | 216,147 |   |
| Interest rate-sensitivity  gap                                              |   | 28,236                       |   | (23,080 | ) | 47,474 |   | 47,384 |   | 100,014 |   |
| Cumulative interest  rate-sensitivity gap                                   |   | $                            | 28,236 |   | $ | 5,156 |   | $ | 52,630 |   | $ | 100,014 |   |   |   |
| Cumulative ratio of rate  sensitive assets to rate-sensitive liabilities    |   | 118                          | %      | 103 | % | 124 | % | 146 | % |   |   |
|                                                                             |        |                              |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Deposits which are subject toimmediate withdrawal are presented as repricing within three months or less.The distribution of other time deposits is based on scheduled maturities.

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

 

 

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**Rate-SensitiveAssets and Liabilities**
|                                                                     |   | **December  31, 2001**       |   |
|--------------------------------------------------------------------------|--------|------------------------------|--------|
|                                                                     |   | **Maturing or repricing in** |   |
|                                                                     |   | **Less**                     |   | **After three** |   | **After one** |   |   |   |   |   |
|                                                                     |   | **than**                     |   | **months** |   | **year** |   |   |   |   |   |
|                                                                     |   | **three**                    |   | **but within** |   | **but within** |   | **After** |   |   |   |
|                                                                     |   | **months**                   |   | **one year** |   | **5 years** |   | **5 years** |   | **Total** |   |
|                                                                     |   |                         |   |   |   |   |   |   |   |   |   |
|                                                                     |   | **(Dollars in thousands)**   |   |
| Rate-Sensitive Assets:                                                   |   |                         |   |   |   |   |   |   |   |   |   |
| Federal funds sold and  securities purchased under agreements to resell  |   | $                            | 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 toimmediate withdrawal are presented as repricing within three months or less.The distribution of other time deposits is based on scheduled maturities.

 

 

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# **FACTORS WHICH MAYAFFECT FUTURE OPERATING RESULTS**

 

Our results ofoperations and financial condition are affected by many factors, including thefollowing.

 

***We face risk fromchanges 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:

·              Ourability to originate loans;

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

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

·              Theaverage life of our interest-earning assets;

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

·              Ourability to access the wholesale funding market.

        Interest rates arehighly sensitive to many factors, including governmental monetary policies,domestic and international economic and political conditions and other factorsbeyond our control.

 

***We face risk frompossible 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 non-performing assetsrises, our results of operations and financial condition will be affected.  A borrower’s ability to pay its loan inaccordance with its terms can be adversely affected by a number of factors,such as a decrease in the borrower’s revenues and cash flows due to adversechanges in economic conditions or a decline in the demand for the borrower’sproducts and/or services.

 

***Our allowances forcredit losses may be inadequate.***

 

        We establish allowances for creditlosses against each segment of our loan portfolio.  At March 31, 2002, our allowance for credit losses equaled 2.13%of loans receivable and 81.5% of nonperforming loans.  Although we believed that we had established adequate allowancesfor credit losses as of March 31, 2002, the credit quality of our assets isaffected by many 

 

 

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factors beyond ourcontrol, including local and national economic conditions, and the possibleexistence of facts which are not known to us which adversely affect thelikelihood of repayment of various loans in our loan portfolio and realizationof 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 Office of the Comptrollerof the Currency, as an integral part of its examination process, periodicallyreviews our allowance for credit losses and could require additional provisionsfor credit losses.  Material futureadditions to the allowance for credit losses may also be necessary due toincreases in the size and changes in the composition of our loanportfolio.  Increases in our provisionsfor credit losses would adversely affect our results of operations.

 

***Economic conditionsmay worsen.***

 

         Our business is strongly influencedby economic conditions in our market area (principally, the Greater Los Angelesmetropolitan area) as well as regional and national economic conditions and inour niche markets, including the entertainment industry in SouthernCalifornia.  During the past severalyears 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.

 

***Because asignificant amount of the loans we make are to borrowers in California, ouroperations could***

***suffer as a resultof local recession or natural disasters in California*****.**

 

      At March 31, 2002, approximately 62% ofour loans outstanding were collateralized by properties located inCalifornia.  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.

 

 

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***Our business isvery 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 out-of-state financialinstitutions have entered the California market, which has also increasedcompetition.  Many of our competitorshave greater financial strength, marketing capability and name recognition thanwe do, and operate on a statewide or nationwide basis.  In addition, recent developments intechnology and mass marketing have permitted larger companies to market loansmore aggressively to our small business customers.  Such advantages may give our competitors opportunities to realizegreater efficiencies and economies of scale than we can.  We can provide no assurance that we will beable to compete effectively against our competition.

 

***Our business isheavily regulated*****.**

 

       Both National Mercantile Bancorp, as abank holding company, and Mercantile and South Bay, as national banks, aresubject to significant governmental supervision and regulation, which isintended primarily for the protection of depositors.  Statutes and regulations affecting us may be changed at any time,and the interpretation of these statutes and regulations by examiningauthorities also may change.  We cannotassure you that future changes in applicable statutes and regulations or intheir interpretation will not adversely affect our business.

 

 

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**PART II—OTHER INFORMATION**

 

 

 

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

 

(a) *Exhibits.*

 

                  None

 

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

 

         Form 8-K/A April 12, 2002 (Item 2).

 

         Form 8-K March 21, 2002 (Item 5).

 

**SIGNATURES**

 

         Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

|   |   |         |   |   |   |                                                  |
|--------|--------|--------------|--------|--------|--------|-------------------------------------------------------|
|   |   |         |   |   |   | **National Mercantile Bancorp**                       |
|   |   |         |   |   |   | (Registrant)                                          |
|   |   |         |   |   |   |                                                  |
| DATE:  |   | May 15, 2002 |   |   |   | /s/ David R.  Brown                                   |
|   |   |         |   |   |   | **David  R. Brown**                                   |
|   |   |         |   |   |   | Principal Financial and  Principal Accounting Officer |

 

 

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