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

 

**WASHINGTON,D.C. 20549**

 

**FORM 10-QSB**

 

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

 

**For thequarterly period ended June 30, 2002 Commission File Number: 0-15982**

 

**NATIONAL MERCANTILE 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

 

APPLICABLE ONLY TOCORPORATE ISSUERS:

 

The number of shares outstanding of the issuer’sCommon Stock, no par value, as of July 31, 2002 was 1,635,753.

 

 

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**NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

(Unaudited)

 
|                                                                                                                                                                                            |   | **June 30,  2002**          |    | **December  31,  2001** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|-------------------------|--------|
|                                                                                                                                                                                            |   | **(Dollars in  thousands)** |    |
| ASSETS                                                                                                                                                                                          |   |                        |    |                    |   |
| Cash and due from  banks-demand                                                                                                                                                                 |   | $                           | 20,619  |                    | $      | 12,688 |   |
| Federal funds sold and  securities purchased under agreements to resell                                                                                                                         |   | 35,495                      |    | 39,405                  |   |
| Cash and cash equivalents                                                                                                                                                                       |   | 56,114                      |    | 52,093                  |   |
| Securities  available-for-sale, at fair value; aggregate amortized cost of $29,196 and  $41,532 at June 30, 2002 and December 31, 2001, respectively                                            |   | 29,583                      |    | 41,627                  |   |
| Federal Reserve Bank stock  and other stock, at cost                                                                                                                                            |   | 2,223                       |    | 2,552                   |   |
|                                                                                                                                                                                            |   |                        |    |                    |   |
| Loans receivable                                                                                                                                                                                |   | 256,198                     |    | 261,968                 |   |
| Allowance for credit losses                                                                                                                                                                     |   | (5,374                      | )       | (6,542                  | )      |
| Net loans receivable                                                                                                                                                                            |   | 250,824                     |    | 255,426                 |   |
|                                                                                                                                                                                            |   |                        |    |                    |   |
| Premises and equipment, net                                                                                                                                                                     |   | 6,117                       |    | 6,121                   |   |
| Deferred tax asset, net                                                                                                                                                                         |   | 7,967                       |    | 8,364                   |   |
| Goodwill                                                                                                                                                                                        |   | 5,616                       |    | 5,616                   |   |
| Accrued interest receivable  and other assets                                                                                                                                                   |   | 2,146                       |    | 2,566                   |   |
| Total assets                                                                                                                                                                                    |   | $                           | 360,590 |                    | $      | 374,365 |   |
|                                                                                                                                                                                            |   |                        |    |                    |   |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                                                                                      |   |                        |    |                    |   |
| Deposits:                                                                                                                                                                                       |   |                        |    |                    |   |
| Noninterest-bearing demand                                                                                                                                                                      |   | $                           | 99,817  |                    | $      | 114,645 |   |
| Interest-bearing demand                                                                                                                                                                         |   | 27,406                      |    | 23,425                  |   |
| Money market                                                                                                                                                                                    |   | 54,763                      |    | 40,033                  |   |
| Savings                                                                                                                                                                                         |   | 36,225                      |    | 31,184                  |   |
| Time certificates of  deposit:                                                                                                                                                                  |   |                        |    |                    |   |
| $100,000 or more                                                                                                                                                                                |   | 43,442                      |    | 62,085                  |   |
| Under $100,000                                                                                                                                                                                  |   | 37,409                      |    | 37,768                  |   |
| Total deposits                                                                                                                                                                                  |   | 299,062                     |    | 309,140                 |   |
|                                                                                                                                                                                            |   |                        |    |                    |   |
| Federal funds purchased and  securities sold under agreements to repurchase                                                                                                                     |   | 1,973                       |    | 3,096                   |   |
| Other borrowings                                                                                                                                                                                |   | 15,500                      |    | 17,500                  |   |
| Accrued interest payable  and other liabilities                                                                                                                                                 |   | 3,087                       |    | 3,963                   |   |
| Total liabilities                                                                                                                                                                               |   | 319,622                     |    | 333,699                 |   |
|                                                                                                                                                                                            |   |                        |    |                    |   |
| Guaranteed preferred  beneficial interests in the Company’s junior subordinated deferrable interest  debentures, net                                                                       |   | 14,522                      |    | 14,513                  |   |
| Minority interest in the  Series A preferred stock of consolidated subsidiary, South Bay Bank, N.A, net                                                                                         |   | 827                         |    | 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 June 30, 2002 and December 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 June 30, 2002 and December 31, 2001                                       |   | 1,000                       |    | 1,000                   |   |
| Common stock, no par value;  authorized 10,000,000 shares; outstanding 1,635,753 shares and 1,623,467  shares at June 30, 2002 and December 31, 2001, respectively                              |   | 30,321                      |    | 30,268                  |   |
| Additional paid-in capital                                                                                                                                                                      |   | 1,824                       |    | 1,824                   |   |
| Accumulated deficit                                                                                                                                                                             |   | (13,859                     | )       | (13,802                 | )      |
| Accumulated other  comprehensive income                                                                                                                                                         |   | 228                         |    | 56                      |   |
| Total shareholders’ equity                                                                                                                                                                 |   | 25,619                      |    | 25,477                  |   |
| Total liabilities and  shareholders’ equity                                                                                                                                                |   | $                           | 360,590 |                    | $      | 374,365 |   |

 

See accompanying notes to consolidated financial statements.

 

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**NATIONALMERCANTILE BANCORP AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
|                                                                                                                                                                                                                 |   | **Three  months ended  June 30,**                    |   | **Six months  ended  June 30,** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------|--------|---------------------------------|--------|
|                                                                                                                                                                                                                 |   | **2002**                                             |   | **2001**                        |   | **2002** |   | **2001** |   |
|                                                                                                                                                                                                                 |   | **(Dollars in  thousands except per share amounts)** |   |
| Interest income:                                                                                                                                                                                                     |   |                                                 |   |                            |   |   |   |   |   |
| Loans, including fees                                                                                                                                                                                                |   | $                                                    | 4,361  |                            | $      | 2,332 |   | $ | 8,752 |   | $ | 4,922 |   |
| Securities  available-for-sale                                                                                                                                                                                       |   | 447                                                  |   | 902                             |   | 930 |   | 1,992 |   |
| Federal funds sold and  securities purchased under agreements to resell                                                                                                                                              |   | 129                                                  |   | 170                             |   | 256 |   | 322 |   |
|                                                                                                                                                                                                                 |   |                                                 |   |                            |   |   |   |   |   |
| Total interest income                                                                                                                                                                                                |   | 4,937                                                |   | 3,404                           |   | 9,938 |   | 7,236 |   |
| Interest expense:                                                                                                                                                                                                    |   |                                                 |   |                            |   |   |   |   |   |
| Interest-bearing demand                                                                                                                                                                                              |   | 85                                                   |   | 20                              |   | 157 |   | 42 |   |
| Money market and savings                                                                                                                                                                                             |   | 371                                                  |   | 293                             |   | 699 |   | 583 |   |
| Time certificates of  deposit:                                                                                                                                                                                       |   |                                                 |   |                            |   |   |   |   |   |
| $100,000 or more                                                                                                                                                                                                     |   | 194                                                  |   | 393                             |   | 501 |   | 828 |   |
| Under $100,000                                                                                                                                                                                                       |   | 355                                                  |   | 52                              |   | 760 |   | 141 |   |
| Total interest expense on  deposits                                                                                                                                                                                  |   | 1,005                                                |   | 758                             |   | 2,117 |   | 1,594 |   |
| Federal funds purchased and  securities sold under agreements to repurchase                                                                                                                                          |   | 58                                                   |   | 22                              |   | 95 |   | 28 |   |
| Other borrowings                                                                                                                                                                                                     |   | 146                                                  |   | 251                             |   | 296 |   | 712 |   |
| Total interest expense                                                                                                                                                                                               |   | 1,209                                                |   | 1,031                           |   | 2,508 |   | 2,334 |   |
|                                                                                                                                                                                                                 |   |                                                 |   |                            |   |   |   |   |   |
| Net interest income before  provision for credit losses                                                                                                                                                              |   | 3,728                                                |   | 2,373                           |   | 7,430 |   | 4,902 |   |
| Provision for credit losses                                                                                                                                                                                          |   | 150                                                  |   | —                          |   | 300 |   | — |   |
| Net interest income after  provision for credit losses                                                                                                                                                               |   | 3,578                                                |   | 2,373                           |   | 7,130 |   | 4,902 |   |
|                                                                                                                                                                                                                 |   |                                                 |   |                            |   |   |   |   |   |
| Other operating income:                                                                                                                                                                                              |   |                                                 |   |                            |   |   |   |   |   |
| Net gain on sale of  securities available-for-sale                                                                                                                                                                   |   | —                                               |   | 96                              |   | — |   | 146 |   |
| International services                                                                                                                                                                                               |   | 14                                                   |   | 21                              |   | 19 |   | 27 |   |
| Investment division                                                                                                                                                                                                  |   | 20                                                   |   | 30                              |   | 42 |   | 53 |   |
| Deposit-related and other  customer services                                                                                                                                                                         |   | 252                                                  |   | 179                             |   | 621 |   | 309 |   |
| Total other operating  income                                                                                                                                                                                        |   | 286                                                  |   | 326                             |   | 682 |   | 535 |   |
|                                                                                                                                                                                                                 |   |                                                 |   |                            |   |   |   |   |   |
| Other operating expenses:                                                                                                                                                                                            |   |                                                 |   |                            |   |   |   |   |   |
| Salaries and related  benefits                                                                                                                                                                                       |   | 1,766                                                |   | 1,121                           |   | 3,405 |   | 2,218 |   |
| Net occupancy                                                                                                                                                                                                        |   | 349                                                  |   | 227                             |   | 722 |   | 470 |   |
| Furniture and equipment                                                                                                                                                                                              |   | 113                                                  |   | 65                              |   | 214 |   | 138 |   |
| Printing and communications                                                                                                                                                                                          |   | 139                                                  |   | 83                              |   | 311 |   | 154 |   |
| Insurance and regulatory  assessments                                                                                                                                                                                |   | 87                                                   |   | 81                              |   | 178 |   | 162 |   |
| Customer services                                                                                                                                                                                                    |   | 255                                                  |   | 227                             |   | 446 |   | 430 |   |
| Computer data processing                                                                                                                                                                                             |   | 284                                                  |   | 124                             |   | 512 |   | 238 |   |
| Legal services                                                                                                                                                                                                       |   | 206                                                  |   | 21                              |   | 380 |   | 51 |   |
| Other professional services                                                                                                                                                                                          |   | 243                                                  |   | 72                              |   | 317 |   | 209 |   |
| Promotion and other  expenses                                                                                                                                                                                        |   | (43                                                  | )      | 38                              |   | 197 |   | 111 |   |
| Total other operating  expenses                                                                                                                                                                                      |   | 3,399                                                |   | 2,059                           |   | 6,682 |   | 4,181 |   |
| Net income before minority  interests and income tax provision                                                                                                                                                       |   | 465                                                  |   | 640                             |   | 1,130 |   | 1,256 |   |
|                                                                                                                                                                                                                 |   |                                                 |   |                            |   |   |   |   |   |
| Minority interest in the  income of the:                                                                                                                                                                             |   |                                                 |   |                            |   |   |   |   |   |
| Company’s junior  subordinated deferrable interest debentures, net                                                                                                                                              |   | 389                                                  |   | —                          |   | 773 |   | — |   |
| Series A Preferred Stock of  South Bay Bank, N.A                                                                                                                                                                     |   | 106                                                  |   | —                          |   | 106 |   | — |   |
| Net income (loss) before income  tax provision                                                                                                                                                                       |   | (30                                                  | )      | 640                             |   | 251 |   | 1,256 |   |
| Provision for income taxes                                                                                                                                                                                           |   | 32                                                   |   | 34                              |   | 138 |   | 47 |   |
| Net income (loss)                                                                                                                                                                                                    |   | $                                                    | (62    | )                               | $      | 606 |   | $ | 113 |   | $ | 1,209 |   |
|                                                                                                                                                                                                                 |   |                                                 |   |                            |   |   |   |   |   |   |   |
| Income available to common  shareholders (net income less accretion of discount of minority interest in  subsidiary preferred stock of $72,000 and $151,000 for the three months and  six months ended June 30, 2002 |   | $                                                    | (134   | )                               | 606    |   | $ | (38 | ) | 1,209 |   |
| Earnings (loss) per share:                                                                                                                                                                                           |   |                                                 |   |                            |   |   |   |   |   |
| Basic                                                                                                                                                                                                                |   | $                                                    | (0.08  | )                               | $      | 0.38 |   | $ | (0.02 | ) | $ | 0.76 |   |
| Diluted                                                                                                                                                                                                              |   | $                                                    | (0.08  | )                               | $      | 0.19 |   | $ | (0.02 | ) | $ | 0.38 |   |

 

See accompanying notes to consolidated financial statements.

 

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**NATIONALMERCANTILE BANCORP AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOW**

(Unaudited)

 
|                                                                                                       |   | **For the  six-months  ended June 30,** |   |
|------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
|                                                                                                       |   | **2002**                                |   | **2001** |   |
|                                                                                                       |   | **(Dollars  in thousands)**             |   |
| Net cash flow from  operating activities:                                                                  |   |                                    |   |   |   |
| Net income                                                                                                 |   | $                                       | 113    |   | $ | 1,209 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities:                         |   |                                    |   |   |   |
| Depreciation and amortization                                                                              |   | 183                                     |   | 114 |   |
| Provision for credit losses                                                                                |   | 300                                     |   | — |   |
| Gain on sale of securities  available-for-sale                                                             |   | —                                  |   | (146 | ) |
| Net amortization of premium  (discount) on securities available-for-sale                                   |   | 87                                      |   | (3 | ) |
| Net accretion of discounts  on loans purchased                                                             |   | 186                                     |   | (18 | ) |
| Decrease in accrued  interest receivable and other assets                                                  |   | 798                                     |   | 318 |   |
| Decrease in accrued  interest payable and other liabilities                                                |   | (876                                    | )      | (465 | ) |
| Net cash provided by  operating activities                                                                 |   | 791                                     |   | 1,009 |   |
| Cash flows from investing  activities:                                                                     |   |                                    |   |   |   |
| Purchase of securities  available-for-sale                                                                 |   | (2,539                                  | )      | (2,086 | ) |
| Proceeds from sale of  securities available-for-sale                                                       |   | —                                  |   | 6,169 |   |
| Proceeds from repayments  and maturities of securities available-for-sale                                  |   | 14,668                                  |   | 11,476 |   |
| Loan originations and  principal collections, net                                                          |   | 4,116                                   |   | 3,362 |   |
| Redemption of FRB and other  stocks                                                                        |   | 329                                     |   | — |   |
| Net purchases of premises  and equipment                                                                   |   | (170                                    | )      | (221 | ) |
| Net cash provided by  investing activities                                                                 |   | 16,404                                  |   | 18,700 |   |
| Cash flows from financing  activities: Net increase in demand deposits, money market and savings  accounts |   | 8,924                                   |   | 7,601 |   |
| Net increase (decrease) in  time certificates of deposit                                                   |   | (19,002                                 | )      | 4,366 |   |
| Net decrease in securities  sold under agreements to repurchase and federal funds purchased                |   | (1,123                                  | )      | (2,500 | ) |
| Net decrease in other  borrowings                                                                          |   | (2,000                                  | )      | (11,000 | ) |
| Net proceeds from exercise  of stock options                                                               |   | 27                                      |   | 186 |   |
| Net cash used in financing  activities                                                                     |   | (13,174                                 | )      | (1,347 | ) |
| Net increase in cash and  cash equivalents                                                                 |   | 4,021                                   |   | 18,362 |   |
| Cash and cash equivalents,  January 1                                                                      |   | 52,093                                  |   | 27,597 |   |
| Cash and cash equivalents,  June 30                                                                        |   | $                                       | 56,114 |   | $ | 45,959 |   |
|                                                                                                       |   |                                    |   |   |   |
| Supplemental cash flow  information:                                                                       |   |                                    |   |   |   |
|                                                                                                       |   |                                    |   |   |   |
| Cash paid for interest                                                                                     |   | $                                       | 2,454  |   | 2,409 |   |
| Cash paid for income taxes                                                                                 |   | $                                       | — |   | $ | 59 |   |

 

See accompanying notes to consolidated financial statements.

 

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**NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES**

**NOTES TOTHE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

NOTE 1—BASIS OF PRESENTATION AND MANAGEMENTREPRESENTATIONS

 

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 three and six month periods ended June 30, 2002are not necessarily indicative of the results expected for any subsequentperiod or for the full year ending December 31, 2002.  The unaudited consolidated financial statements should be read inconjunction with the audited consolidated financial statements included in theCompany’s Annual Report on Form 10-KSB for the year ended December 31, 2001.

 

NOTE 2—EARNINGS (LOSS) PER SHARE

 

Basic earnings (loss) per share is computed using the weighted averagenumber of common shares outstanding during the period.  The weighted average number of common sharesoutstanding used in computing basic earnings (loss) per share was 1,631,451 and1,613,383 for the three months ended June 30, 2002 and 2001, respectively, and1,629,320 and 1,594,019 respectively, for the six months ended June 30, 2002and 2001.  The weighted average numberof common shares and common share equivalents outstanding used in computingdiluted earnings per share was 3,231,429 and 3,213,359,  for the three months and for the six monthsended June 30, 2001, respectively. Diluted loss per share for the three months and six months ended June30, 2002 does not include common share equivalents as they are anti-dilutive.

 

5

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The following table is a reconciliation of net income (loss) and sharesused in the computation of earnings (loss) per basic and diluted common share:

 
|                                         |   | **Net Income  (Loss)** |   | **Shares** |      | **Per Share  Amount** |   |
|----------------------------------------------|--------|------------------------|--------|------------|-----------|-----------------------|--------|
|                                         |   | **(in thousands)**     |   |       |      |                  |   |
| *For the  three months ended June 30, 2002:* |   |                   |   |       |      |                  |   |
| Basic and diluted loss per  share            |   | $                      | (134   | )          | 1,631,451 |                  | $      | (0.08 | ) |
|                                         |   |                   |   |       |      |                  |   |
| *For the  three months ended June 30, 2001:* |   |                   |   |       |      |                  |   |
| Basic EPS                                    |   | $                      | 606    |       | 1,613,383 |                  | $      | 0.38 |   |
|                                         |   |                   |   |       |      |                  |   |
| Effect of dilutive  securities:              |   |                   |   |       |      |                  |   |
| Options and warrants                         |   |                   |   | 116,686    |      |                  |   |
| Convertible preferred stock                  |   |                   |   | 1,501,360  |      |                  |   |
| Diluted EPS                                  |   | 606                    |   | 3,231,429  |      | $                     | 0.19   |   |
|                                         |   |                   |   |       |      |                  |   |
| *For the  six months ended June 30, 2002:*   |   |                   |   |       |      |                  |   |
| Basic and diluted loss per  share            |   | $                      | (38    | )          | 1,629,320 |                  | $      | (0.02 | ) |
|                                         |   |                   |   |       |      |                  |   |
| *For the  six months ended June 30, 2002:*   |   |                   |   |       |      |                  |   |
| Basic EPS                                    |   | 1,209                  |   | 1,594,019  |      | $                     | 0.76   |   |
|                                         |   |                   |   |       |      |                  |   |
| Effect of dilutive  securities:              |   |                   |   |       |      |                  |   |
| Options and warrants                         |   |                   |   | 117,980    |      |                  |   |
| Convertible preferred stock                  |   |                   |   | 1,501,360  |      |                  |   |
| Diluted EPS                                  |   | $                      | 1,209  |       | 3,213,359 |                  | $      | 0.38 |   |

 

NOTE 3—CASH AND CASH EQUIVALENTS

 

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 $32,000 and $34,000 were recorded for thethree months ended June 30, 2002 and 2001, respectively.   Income tax provision for the six monthsended June 30, 2002 and 2001 was $138,000 and $47,000, 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.  The income tax provision recordedfor the first half of 2001 was alternative minimum tax due to the utilizationof previously unrecognized tax benefits to offset the current period tax liability.

 

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For tax purposes at June 30, 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.

 

NOTE 5—BENEFICIAL CONVERSION RIGHTS OF SUBSIDIARYPREFERRED STOCK

 

The Company recorded $1.8 million additional paid in capital, with acorresponding discount to the minority interest in South Bay Series A Preferredstock, during the fourth quarter of 2001 related to the beneficial conversionrights of the preferred stock of its subsidiary, South Bay Bank, N.A.  The discount is being amortized againstretained earnings over the period from the acquisition date through theearliest conversion date of the preferred stock, June 30, 2005 using theeffective yield method.  For the threemonths and six months ended June 30, 2002 the amortization of the discountagainst retained earnings was  $72,000and $151,000, respectively.  Theamortization of the discount is netted against net income to determine incomeavailable to common shareholders for earnings (loss) per share.

 

NOTE6—COMPREHENSIVE INCOME

 

Comprehensive income is comprised of net income and all changes toshareholders’ equity, except those changes resulting from investments byshareholders and distributions to shareholders.  Total comprehensive income is as follows:

 
|                                                                                  |   | **Three  months ended  June 30,** |   | **Six months  ended  June 30,** |   |
|---------------------------------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                                                                                  |   | **2002**                          |   | **2001**                        |   | **2002** |   | **2001** |   |
| Net income (loss)                                                                     |   | $                                 | (62    | )                               | $      | 606 |   | $ | 113 |   | $ | 1,209 |   |
|                                                                                  |   |                              |   |                            |   |   |   |   |   |
| Other comprehensive income,  before tax, and unrealized gains (losses) on securities: |   |                              |   |                            |   |   |   |   |   |
| Unrealized gain (loss) on  securities available for sale                              |   | 496                               |   | (285                            | )      | 292 |   | 231 |   |
| Reclassification adjustment  for realized gains in net income                         |   | —                            |   | 96                              |   | — |   | 146 |   |
| Other comprehensive income  (loss), before tax                                        |   | 496                               |   | (381                            | )      | 292 |   | 85 |   |
|                                                                                  |   |                              |   |                            |   |   |   |   |   |
| Income tax credit related  to items of other comprehensive income                     |   | (203                              | )      | —                          |   | (120 | ) | — |   |
| Other comprehensive income  (loss)                                                    |   | 293                               |   | (381                            | )      | 172 |   | 85 |   |
| Total comprehensive income                                                            |   | $                                 | 231    |                            | $      | 225 |   | $ | 285 |   | $ | 1,294 |   |

 

NOTE 7—RECLASSIFICATIONS

 

Certain prior year data have been reclassified to conform with 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 June 30,2001 do not include any results of operations for South Bay.

 

***RESULTS OFOPERATIONS***

 

The Company recorded a net loss of $62,000, or $0.08 basic and dilutedloss per share, during the second quarter of 2002, compared to net income of$606,000, or $0.38 basic earnings per share and $0.19 diluted earnings pershare, during the second quarter of 2001. The decrease in earnings during the second quarter of 2002 compared to2001 resulted from a combination of narrower net interest margins for the 2002period, greater provisions for loan losses, higher noninterest expenses partlyattributable to nonrecurring expenses associated with the integration of theSouth Bay acquisition and minority interests in the Company’s income of thepreferred stock of South Bay and the Company’s junior subordinated deferrableinterest debentures.   Despite narrowernet interest margins, net interest income increased during the second quarter2002 due to a greater volume of earning assets as a result of the South Bayacquisition.

 

Net income during the first six months of 2002 was $113,000, or $0.02diluted loss per share, compared to net income of  $1.2 million, or $0.38 diluted earnings per share, during thefirst six months of 2001.  The per shareresults for the 2002 period include a $151,000 charge against income availableto shareholders from amortization of the discount of the South Bay preferredstock.  Net loss per basic share was$0.02 during the first six months of 2002 compared to basic earnings per shareof $0.76 during the first six months of 2001. The decrease in net income during the first half of 2002 compared to thefirst half of 2001 likewise resulted from a combination of narrower net interest margins for the 2002 period,greater provisions for loan losses, higher noninterest expenses partlyattributable to nonrecurring expenses associated with the integration of theSouth Bay acquisition, minority interests in the Company’s income of thepreferred stock of South Bay and the Company’s junior subordinated deferrable

 

8

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interestdebentures and greater provisions for income taxes.  Despite narrower net interest margins, net interest incomeincreased during the first half 2002 due to a greater volume of earning assetsas a result of the South Bay acquisition.

 

Return on average assets during the second quarter and first half of2002 was minus 0.07% and 0.06%, respectively, compared to 1.28% and 1.26%during the second quarter and first half of 2001, respectively.  Return on average equity during the secondquarter and first half of 2002 was minus 0.97% and 0.89%, respectively, comparedto 10.94% and 11.13% during the second quarter and first half of 2001,respectively.

 

NET INTERESTINCOME

 

The increase in net interest income during the three and six monthsended June 30, 2002 compared to the corresponding periods during 2001 resulted primarilyfrom an increase in net average interest earning assets (the difference betweenaverage interest earning assets and average interest bearing liabilities) of$140.4 million and $138.8 million, respectively.  This increase in net average interest earning assets during thethree and six months ended June 30, 2002 compared to corresponding periodsduring 2001 was attributable primarily to the acquisition of South Bay duringthe 4th quarter of 2001. Likewise, average loans receivable increased during the quarter andfirst half ended June 30, 2002 by $154.3 million and $151.0 million,respectively.  Average federal fundssold increased $13.9 million and $17.2 million during the three months and sixmonths ended June 30, 2002, respectively, compared to the corresponding periodsin 2001 while securities available for sale decreased $27.8 million and $29.3million during these same periods.  Thedecrease in securities and corresponding increase in federal funds sold is dueto planned sales of the investment securities to reduce potential market pricevolatility and scheduled principal payments from mortgage-backed securities.

 

Average deposits during the three and six months ended June 30, 2002increased $152.8 million and $156.3 million, respectively, compared to thecorresponding periods in 2001 again largely attributable to the South Bayacquisition.  Average other borrowingsdeclined during the quarter ended and first half ended June 30, 2002 by$6.1million and $11.7 million, respectively, as a result of the utilization ofliquidity to redeem the higher-cost Federal Home Loan Bank advances.  The liquidation of investment securities andrepayment of wholesale funding sources is designed to lower the current cost offunds and reduce the Company’s exposure to market value depreciation in it’sinvestment securities in the event of rising interest rates.

 

During the quarter ended June 30, 2002 average loans receivableincreased 148% to $258.5 million compared to $104.3 million during the quarterended June 30, 2001.  The weightedaverage yield on loans receivable during the quarter ended June

 

9

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30, 2002 decreasedto 6.89% compared to 8.97% during the quarter ended June 30, 2001, reflectingdeclining market interest rates and to a lesser extent, competitive pressuresfrom other commercial banks.

 

Average securities decreased 47.0% to $31.3 million during the quarterended June 30, 2002 compared to $59.1 million during the quarter ended June 30,2001 even after the addition of approximately $30.2 million of investmentsecurities from the South Bay acquisition as a result of a planned sales ofsecurities and increased principal paydowns on amortizing mortgaged-backedsecurities due to declining market interest rates.  The sales of investment securities was executed to reduce theprice volatility of the portfolio and to provide liquidity to change thefunding composition.  The weighted averageyield on securities increased to 6.26% during the second quarter of 2001 comparedto 6.13% during the second quarter 2001, despite declining interest rates dueto the acquisition of South Bay’s higher-yielding portfolio and few additionsto the portfolio in the lower rate environment.

 

Average interest-bearing liabilities increased 99.1% to $214.5 millionduring the quarter ended June 30, 2002 compared to $107.7 million during thequarter ended June 30, 2001 due primarily to increased average interest-bearingdeposits.  Average interest-bearingdeposits increased 132.3% to $196.5 million during the quarter ended June 30,2002 from $84.6 million during the quarter ended June 30, 2001, due primarilyto the acquisition of South Bay.  Asignificant change in the composition of interest-bearing deposits with agreater percentage of money market savings, time certificates of deposit under$100,000 and a lower percentage of demand deposits is also due to theacquisition of South Bay and its consumer banking emphasis.  Average borrowed funds during the secondquarter of 2002 decreased 22.1% to $18.0 million from $23.2 million during thesame period in 2001 due to the planned redemption of higher cost funding.

 

The weighted average cost of interest-bearing liabilities decreased to2.46% during the second quarter of 2002 from 3.84% during the same period of2001, due primarily to decreased weighted average cost of interest-bearingdeposits as a result of declining market interest rates and to a lesser extentother borrowings due to redemptions. The weighted average cost of borrowed funds decreased to 4.20% duringthe second quarter of 2002 from 4.69% during the same period in 2001.  The weighted average cost ofinterest-bearing deposits decreased to 2.30% during the second quarter of 2002from 3.59% during the same period of 2001.

 

Average total deposits increased 106.7% to $295.9 million during thesecond quarter of 2002 compared to $143.2 million during the second quarter of2001 due primarily to the South Bay acquisition in the fourth quarter 2001.

 

10

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During the six months ended June 30, 2002 average loans receivableincreased 142.4 % to $257.1 million compared to $106.1 million during the sameperiod in 2001.  Average securitiesdecreased 46.9% to $33.3 million during the six months ended June 30, 2002compared to $62.6 million during the same period in 2001 due to planned salesof securities to reposition the portfolio in order to reduce market pricevolatility.  Average total depositsduring the six months ended June 30, 2002 increased 110.4% to $297.9 millioncompared to $141.6 million during the same period in 2001.  The growth in both average loans receivableand average deposits was a result of the business combination of South Bay inthe fourth quarter 2001.  Average otherborrowings decreased 35.1% to $18.0 million during the six months ended June30, 2002 compared to $27.8 million during the same period in 2001.

 

11

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The following table presents the components of net interest income for thequarters ended June 30, 2002 and 2001.

 
|                                                                                                                      |   | **Three  months ended**     |       |
|---------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|------------|
|                                                                                                                      |   | **30-Jun-02**               |       | **30-Jun-01** |   |
|                                                                                                                      |   | **Average  Amount**         | ** ** | **Interest  Income/  Expense** | ** ** | **Weighted  Average  Yield/  Rate** | ** ** | **Average  Amount** | ** ** | **Interest  Income/  Expense** | ** ** | **Weighted  Average  Yield/  Rate** |   |
|                                                                                                                      |   | **(Dollars in  thousands)** |       |
| Assets:                                                                                                                   |   |                        |       |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold and  securities purchased under agreements to resell                                                   |   | $                           | 29,898     |   | $ | 127 |   | 1.72 | % | $ | 15,990 |   | $ | 170 |   | 4.26 | % |
| Securities  available-for-sale                                                                                            |   | 31,309                      |       | 483 |   | 6.26 | % | 59,066 |   | 902 |   | 6.13 | % |
| Loans receivable (1) (2)                                                                                                  |   | 258,545                     |       | 4,391 |   | 6.89 | % | 104,253 |   | 2,332 |   | 8.97 | % |
| Total interest earning  assets                                                                                            |   | 319,752                     |       | $ | 5,001 |   | 6.34 | % | 179,309 |   | $ | 3,404 |   | 7.61 | % |
|                                                                                                                      |   |                        |       |   |   |   |   |   |   |   |   |   |   |
| Noninterest earning assets:                                                                                               |   |                        |       |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks –  demand                                                                                    |   | 19,477                      |       |   |   |   |   | 10,916 |   |   |   |   |   |
| Other assets                                                                                                              |   | 24,015                      |       |   |   |   |   | 2,758 |   |   |   |   |   |
| Allowance for credit losses  and net unrealized (loss) gain on securities available-for-sale                              |   | (5,453                      | )          |   |   |   |   | (2,611 | )  |   |   |   |   |
| Total assets                                                                                                              |   | $                           | 357,791    |   |   |   |   |   | $ | 190,372 |   |   |   |   |   |
|                                                                                                                      |   |                        |       |   |   |   |   |   |   |   |   |   |   |
| Liabilities and  shareholders’ equity:                                                                               |   |                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing deposits:                                                                                                |   |                        |       |   |   |   |   |   |   |   |   |   |   |
| Demand                                                                                                                    |   | $                           | 27,759     |   | $ | 72 |   | 1.05 | % | $ | 8,356 |   | $ | 20 |   | 0.96 | % |
| Money market and savings                                                                                                  |   | 85,104                      |       | 328 |   | 1.56 | % | 39,135 |   | 293 |   | 3.00 | % |
| Time certificates of  deposit:                                                                                            |   |                        |       |   |   |   |   |   |   |   |   |   |   |
| $100,000 or more                                                                                                          |   | 46,002                      |       | 307 |   | 2.71 | % | 33,114 |   | 371 |   | 4.49 | % |
| Under $100,000                                                                                                            |   | 37,598                      |       | 405 |   | 4.37 | % | 3,972 |   | 74 |   | 7.47 | % |
| Total time certificates of  deposit                                                                                       |   | 83,600                      |       | 712 |   | 3.45 | % | 37,086 |   | 445 |   | 4.81 | % |
| Total interest-bearing  deposits                                                                                          |   | 196,463                     |       | 1,112 |   | 2.30 | % | 84,577 |   | 758 |   | 3.59 | % |
| Federal funds purchased and  securities sold under agreements to repurchase                                               |   | 2,758                       |       | 37 |   | 5.44 | % | 1,758 |   | 23 |   | 5.25 | % |
| Other borrowings                                                                                                          |   | 15,282                      |       | 150 |   | 3.98 | % | 21,396 |   | 250 |   | 4.69 | % |
| Total interest-bearing  liabilities                                                                                       |   | 214,503                     |       | $ | 1,299 |   | 2.46 | % | 107,731 |   | $ | 1,031 |   | 3.84 | % |
|                                                                                                                      |   |                        |       |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities:                                                                                         |   |                        |       |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing demand  deposits                                                                                      |   | 99,486                      |       |   |   |   |   | 58,591 |   |   |   |   |   |
| Other liabilities                                                                                                         |   | 2,517                       |       |   |   |   |   | 1,826 |   |   |   |   |   |
| Guaranteed preferred  beneficial interests in the Company’s junior subordinated deferrable interest  debentures, net |   | 14,520                      |       |   |   |   |   | — |   |   |   |   |   |
| Minority interest in the  preferred stock of subsidiary                                                                   |   | 788                         |       |   |   |   |   | — |   |   |   |   |   |
| Shareholders’ equity                                                                                                 |   | 25,977                      |       |   |   |   |   | 22,224 |   |   |   |   |   |
| Total liabilities and  shareholders’ equity                                                                          |   | $                           | 357,791    |   |   |   |   |   | $ | 190,372 |   |   |   |   |   |
|                                                                                                                      |   |                        |       |   |   |   |   |   |   |   |   |   |   |
| Net interest income  (spread)                                                                                             |   |                        |       | $ | 3,702 |   | 3.89 | % |   |   | $ | 2,373 |   | 3.78 | % |
|                                                                                                                      |   |                        |       |   |   |   |   |   |   |   |   |   |   |
| Net yield on earning assets  (2)                                                                                          |   |                        |       |   |   | 4.70 | % |   |   |   |   | 5.31 | % |

 

----

(1) Includes average balance of nonperforming loans of $6.9 million and$500,000 for 2002 and 2001, respectively.

(2) Yields and amounts earnedon loans receivable include loan fees of $279,000 and $119,000 for the three monthsended June 30, 2002 and 2001, respectively.

 

12

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The following tablepresents the components of net interest income for the six months ended June30, 2002 and 2001.

 
|                                                                                                                      |   | **Six months  ended**       |    |
|---------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|
|                                                                                                                      |   | **June 30, 2002**           |    | **June 30,  2001** |   |
|                                                                                                                      |   | **Average  Amount**         |    | **Interest  Income/  Expense** |   | **Weighted  Average  Yield/  Rate** |   | **Average  Amount** |   | **Interest  Income/  Expense** |   | **Weighted  Average  Yield/  Rate** |   |
|                                                                                                                      |   | **(Dollars in  thousands)** |
| Assets:                                                                                                                   |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold and  securities purchased under agreements to resell                                                   |   | $                           | 30,655  |   | 256 |   | 1.68 | % | $ | 13,464 |   | $ | 322 |   | 4.82 | % |
| Securities  available-for-sale                                                                                            |   | 33,264                      |    | 930 |   | 5.64 | % | 62,647 |   | 1,992 |   | 6.41 | % |
| Loans receivable (1) (2)                                                                                                  |   | 257,128                     |    | 8,752 |   | 6.86 | % | 106,089 |   | 4,922 |   | 9.36 | % |
| Total interest earning  assets                                                                                            |   | 321,047                     |    | $ | 9,938 |   | 6.24 | % | 182,200 |   | $ | 7,236 |   | 8.01 | % |
|                                                                                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest earning assets:                                                                                               |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks -  demand                                                                                         |   | 20,351                      |    |   |   |   |   | 10,886 |   |   |   |   |   |
| Other assets                                                                                                              |   | 24,139                      |    |   |   |   |   | 2,606 |   |   |   |   |   |
| Allowance for credit losses  and net unrealized (loss) gain on securities available-for-sale                              |   | (5,924                      | )       |   |   |   |   | (2,673 | ) |   |   |   |   |
| Total assets                                                                                                              |   | $                           | 359,613 |   |   |   |   |   | $ | 193,019 |   |   |   |   |   |
|                                                                                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Liabilities and  shareholders’ equity:                                                                               |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing deposits:                                                                                                |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Demand                                                                                                                    |   | $                           | 27,658  |   | $ | 157 |   | 1.14 | % | $ | 8,189 |   | $ | 42 |   | 1.03 | % |
| Money market and savings                                                                                                  |   | 81,834                      |    | 699 |   | 1.72 | % | 37,824 |   | 583 |   | 3.11 | % |
| Time certificates of  deposit:                                                                                            |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| $100,000 or more                                                                                                          |   | 48,917                      |    | 501 |   | 2.07 | % | 32,278 |   | 828 |   | 5.17 | % |
| Under $100,000                                                                                                            |   | 40,975                      |    | 760 |   | 3.74 | % | 5,158 |   | 141 |   | 5.51 | % |
| Total time certificates of  deposit                                                                                       |   | 89,892                      |    | 1,261 |   | 2.83 | % | 37,436 |   | 969 |   | 5.22 | % |
| Total interest-bearing  deposits                                                                                          |   | 199,384                     |    | 2,117 |   | 2.14 | % | 83,449 |   | 1,594 |   | 3.85 | % |
| Federal funds purchased and  securities sold under agreements to repurchase                                               |   | 2,952                       |    | 95 |   | 6.49 | % | 1,060 |   | 28 |   | 5.33 | % |
| Other borrowings                                                                                                          |   | 15,069                      |    | 296 |   | 3.96 | % | 26,720 |   | 712 |   | 5.37 | % |
| Total interest-bearing  liabilities                                                                                       |   | 217,405                     |    | $ | 2,508 |   | 2.33 | % | 111,229 |   | $ | 2,334 |   | 4.23 | % |
|                                                                                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities:                                                                                         |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing demand  deposits                                                                                      |   | 98,507                      |    |   |   |   |   | 58,114 |   |   |   |   |   |
| Other liabilities                                                                                                         |   | 2,868                       |    |   |   |   |   | 1,766 |   |   |   |   |   |
| Guaranteed preferred  beneficial interests in the Company’s junior subordinated deferrable interest  debentures, net |   | 14,518                      |    |   |   |   |   |   |   |   |   |   |   |
| Minority interest in the  preferred stock of subsidiary                                                                   |   | 752                         |    |   |   |   |   |   |   |   |   |   |   |
| Shareholders’ equity                                                                                                 |   | 25,563                      |    |   |   |   |   | 21,910 |   |   |   |   |   |
| Total liabilities and  shareholders’ equity                                                                          |   | $                           | 359,613 |   |   |   |   |   | $ | 193,019 |   |   |   |   |   |
|                                                                                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Net interest income  (spread)                                                                                             |   |                        |    | $ | 7,430 |   | 3.92 | % |   |   | $ | 4,902 |   | 3.78 | % |
|                                                                                                                      |   |                        |    |   |   |   |   |   |   |   |   |   |   |
| Net yield on earning assets  (2)                                                                                          |   |                        |    |   |   | 4.67 | % |   |   |   |   | 5.43 | % |

 

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(1) Includes average balance of nonperforming loans of $7.2 million and$550,000 for 2002 and 2001, respectively.

(2) Yields and amounts earnedon loans receivable include loan fees of $160,000 and $210,000 for the sixmonths ended June 30, 2002 and 2001, respectively.

 

13

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The following tables set forth, for the periodsindicated, the changes in interest earned and interest paid resulting fromchanges in volume and changes in rates. Average balances in all categories in each reported period were used inthe volume computations.  Average yieldsand rates in each reported period were used in rate computations.

 

|                                                                        |   | **Six months ended June 30,  2002 vs 2001** |       |
|-----------------------------------------------------------------------------|--------|---------------------------------------------|------------|
|                                                                        |   |                                        | ** ** |   | ** ** | **Net  Increase  (Decrease)** |   |
|                                                                        |   | **Increase (decreased) due to(1)**          | ** ** |   |
|                                                                        |   | **Volume**                                  |       | **Rate** |   |   |
|                                                                        |   |                                        |       |   |   |   |   |
| Interest Income:                                                            |   |                                        |       |   |   |   |   |
| Federal funds sold and  securities purchased under agreements to resell     |   | $                                           | 411        |   | $ | (477 | ) | $ | (66 | ) |
| Securities  available-for-sale                                              |   | (934                                        | )          | (128 | ) | (1,062 | ) |
| Loans receivable (2)                                                        |   | 7,007                                       |       | (3,177 | ) | 3,830 |   |
| Total interest-earning  assets                                              |   | $                                           | 6,484      |   | $ | (3,782 | ) | $ | 2,702 |   |
|                                                                        |   |                                        |       |   |   |   |   |
| Interest Expense:                                                           |   |                                        |       |   |   |   |   |
| Interest-bearing deposits:                                                  |   |                                        |       |   |   |   |   |
| Demand                                                                      |   | $                                           | 100        |   | $ | 15 |   | $ | 115 |   |
| Money market and savings                                                    |   | 678                                         |       | (562 | ) | 116 |   |
|                                                                        |   |                                        |       |   |   |   |   |
| Time certificates of  deposit:                                              |   |                                        |       |   |   |   |   |
| $100,000 or more                                                            |   | 427                                         |       | (754 | ) | (327 | ) |
| Under $100,000                                                              |   | 979                                         |       | (360 | ) | 619 |   |
| Total time certificates of  deposit                                         |   | 1,406                                       |       | (1,114 | ) | 292 |   |
| Total interest-bearing  deposits                                            |   | 2,184                                       |       | (1,661 | ) | 523 |   |
| Federal funds purchased and  securities sold under agreements to repurchase |   | 52                                          |       | 14 |   | 66 |   |
| Other borrowings                                                            |   | (310                                        | )          | (106 | ) | (416 | ) |
| Total interest-bearing  liabilities                                         |   | $                                           | 1,926      |   | $ | (1,753 | ) | $ | 173 |   |
|                                                                        |   |                                        |       |   |   |   |   |
| Net interest income                                                         |   | $                                           | 4,558      |   | $ | (2,029 | ) | $ | 2,529 |   |

 

----

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

(2)               Table does not include interest income thatwould have been earned on nonaccrual loans.

 

PROVISION FOR LOANLOSSES

 

The provision for loan losses for the three months and six months endedJune 30, 2002 was $150,000 and $300,000 respectively.  The Company did not record a provision for credit losses duringthe second quarter or first half of 2001.

 

OTHER OPERATINGINCOME

 

Other operating income, excluding gains and losses on the sale ofsecurities and assets, totaled $286,000 during the second quarter of 2002, anincrease of 24.4% from $230,000 during the second quarter of 2001.  During the six months ended

 

14

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June 30, 2001,other operating income, excluding gains and losses on the sale of securitiesand assets, totaled $682,000, an increase of 75.3% from $389,000 during thecomparable period of 2001.  Servicecharges on deposit accounts increased $73,000 or 40.8% and $312,000 or 101.0% during the three and six monthsended June 30, 2002, respectively, compared to corresponding periods in2001.  This increase reflects thegreater volume of deposit accounts as a result of the acquisition of South Bay.

 

The Company realized no gains or losses on sale of securities during2002, compared to net gains of $96,000 and $146,000 during the second quarterand first half of 2001.

 

OTHER OPERATINGEXPENSES

 

Other operating expenses increased 65.1% to $3.4 million during thesecond quarter of 2002 compared to $2.1 million during the second quarter of2001.  This increase was due primarilyto an increase in salaries and related benefits of $645,000, an increase in netoccupancy expense of $122,000, both due to operating the two additional bankingoffices from the South Bay acquisition. Additionally, computer data processing increased $160,000 or 129.0%during the quarter ended June 30, 2002 compared to the same period last yeardue to the operation of South Bay in the 2002 period, but also due toapproximately $80,000 nonrecurring expense of converting South Bay’s dataprocessing system.  Legal expenses were$206,000 for the second quarter 2002 compared to $21,000 for the second quarter2001 due to increased costs associated with problem loan workouts.

 

Other operating expenses increased 59.8% to $6.7 million during the sixmonths ended June 30, 2002 compared to $4.2 million during the same period of2001, due primarily to $1.2 million increase in salaries and related benefitsexpense and a $252,000 increase in net occupancy expense resulting from costsassociated with operating South Bay’s two banking offices.  Legal services were $380,000 for the firsthalf of 2002 compared to $51,000 for the same period in 2001 due to increasedlegal fees associated with problem loan workouts.

 

Minority interest in the income of subsidiaries of the South Bay SeriesA preferred stock was $106,000 for the three months and six months ended June30, 2002 representing dividend payments on the subsidiary preferred stock.  There was no minority interest in the incomeof subsidiaries for the corresponding 2001 periods.  Minority interest in the Company’s income of the juniorsubordinated deferrable interest debentures was $389,000 and $773,000 for thethree months and six months ended June 30, 2002 representing the interestexpense of the trust preferred securities. There was no trust preferred interest expense during the 2001 periods.

 

15

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***BALANCE SHEET ANALYSIS***

 

INVESTMENT SECURITIES

 

The following comparative period-end table sets forthcertain information concerning the estimated fair values and unrealized gainsand losses of investment securities portfolio, consisting of available-for-salesecurities:

 
|                                                                      |   | **June 30, 2002**           |       | **December 31, 2001**        |       |
|---------------------------------------------------------------------------|--------|-----------------------------|------------|------------------------------|------------|
|                                                                      |   | **Total  unrealized  cost** | ** ** | **Gross  unrealized  gains** | ** ** | **Gross  unrealized  loss** | ** ** | **Estimated  fair  value** | ** ** | **Total  unrealized  cost** | ** ** | **Gross  unrealized  gains** | ** ** | **Gross  unrealized  loss** | ** ** | **Estimated  fair  value** |   |
|                                                                      |   | **(Dollars in thousands)**  |       | **(Dollars in thousands)**   |       |
|                                                                      |   |                        |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| U.S. Treasury securities                                                  |   | $                           | —     |                         | $          | — |   | $ | — |   | $ | — |   | $ | 2,001 |   | 13 |   | $ | — |   | $ | 2,014 |   |
| GNMA-issued/guaranteed  mortgage pass through certificates                |   | 3,517                       |       | 58                           |       | — |   | 3,575 |   | 4,503 |   | — |   | 27 |   | 4,476 |   |
| Other U.S. government and  federal agency securities                      |   | 1,992                       |       | 14                           |       | — |   | 2,006 |   | — |   | — |   | — |   | 0 |   |
| FHLMC/FNMA-issued mortgage  pass through certificates                     |   | 16,509                      |       | 344                          |       | — |   | 16,853 |   | 15,928 |   | 179 |   | 32 |   | 16,075 |   |
| CMO’s and REMIC’s issued by  U.S. government-sponsored agencies |   | 5,178                       |       | 132                          |       | — |   | 5,310 |   | 16,590 |   | 162 |   | 29 |   | 16,723 |   |
| Privately issued corporate  bonds, CMO’s and REMIC’s securities |   | 2,000                       |       | —                       |       | 161 |   | 1,839 |   | 2,510 |   | 4 |   | 175 |   | 2,339 |   |
|                                                                      |   | $                           | 29,196     |                         | $          | 548 |   | $ | 161 |   | $ | 29,583 |   | $ | 41,532 |   | $ | 358 |   | $ | 263 |   | $ | 41,627 |   |
|                                                                      |   |                        |       |                         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| FRB and other equity stocks                                               |   | 2,223                       |       | —                       |       | — |   | 2,223 |   | 2,552 |   | — |   | — |   | 2,552 |   |
|                                                                           |        |                             |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The total amortized cost of investment securitiesdecreased $12.3 million to $29.2 million at June 30, 2002 from $41.5 million atDecember 31, 2001 due primarily to principal paydowns on amortizingmortgaged-backed securities brought about by decreasing market interest rates.  The investment securities had net unrealizedgains of $387,000 at June 30, 2002 compared to $ 95,000 at December 31, 2001.

 

At June 30, 2002 the Company did not hold securitiesof any issuer, other than the U.S. government and U.S. government agencies andcorporations, in which the aggregate book value exceeded 10% of the Company’sshareholders’ equity.

 

16

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LOAN PORTFOLIO

 

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

 
|                                                            |   | **June 30,  2002**         |    | **December 31,  2001** |   |
|-----------------------------------------------------------------|--------|----------------------------|---------|------------------------|--------|
|                                                            |   | **Amount**                 |    | **Percent**            |   | **Amount** |   | **Percent** |   |
|                                                            |   | **(Dollars in thousands)** |    |
| Commercial loans:                                               |   |                       |    |                   |   |   |   |   |   |
| Secured by one to four  family residential properties           |   | $                          | 28,453  |                   | 11     | % | $ | 27,069 |   | 10 | % |
| Secured by multifamily  residential properties                  |   | 9,472                      |    | 4                      | %      | 8,492 |   | 3 | % |
| Secured by commercial real  properties                          |   | 97,593                     |    | 38                     | %      | 95,142 |   | 36 | % |
| Other - secured and  unsecured                                  |   | 74,123                     |    | 29                     | %      | 85,292 |   | 33 | % |
| Real estate construction  and land development                  |   | 31,997                     |    | 12                     | %      | 30,811 |   | 12 | % |
| Home equity lines of credit                                     |   | 6,410                      |    | 3                      | %      | 6,511 |   | 3 | % |
| Consumer installment and  unsecured loans to individuals        |   | 8,301                      |    | 3                      | %      | 8,795 |   | 3 | % |
| Total loans outstanding                                         |   | 256,349                    |    | 100                    | %      | 262,112 |   | 100 | % |
|                                                            |   |                       |    |                   |   |   |   |   |   |
| Deferred net loan origination  fees and purchased loan discount |   | (151                       | )       |                   |   | (144 | ) |   |   |
| Loans receivable, net                                           |   | $                          | 256,198 |                   |   |   | $ | 261,968 |   |   |   |

 

portfolio.

 

Total loans outstanding decreased by $5.8 million to $256.3 million atJune 30, 2002 compared to $262.1 million at December 31, 2001.  This decrease resulted primarily from $11.2million or 13.1% decrease in commercial loans as the Company experienced ahigher volume of payoffs from scheduled maturities and prepayments than loanoriginations in this category during the first six months of 2002 from itslevel at December 31, 2001.

 

17

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

 
|                                                                                                                        |   | **June 30,  2002**         |   | **December 31,  2001** |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|----------------------------|--------|------------------------|--------|
|                                                                                                                        |   | **(Dollars in thousands)** |   |
|                                                                                                                        |   |                       |   |                   |   |
| Nonaccrual loans                                                                                                            |   | $                          | 7,755  |                   | $      | 7,807 |   |
| Troubled debt  restructurings                                                                                               |   | —                     |   | 953                    |   |
| Loans contractually past  due ninety or more days with respect to either principal or interest and  still accruing interest |   | —                     |   | 642                    |   |
| Nonperforming loans                                                                                                         |   | 7,755                      |   | 9,402                  |   |
| Other real estate owned                                                                                                     |   | —                     |   | —                 |   |
| Other assets-SBA guaranteed  loan                                                                                           |   | 285                        |   | —                 |   |
| Total nonperforming assets                                                                                                  |   | $                          | 8,040  |                   | $      | 9,402 |   |
|                                                                                                                        |   |                       |   |                   |   |
| Allowance for credit losses  as a percent of nonaccrual loans                                                               |   | 69.3                       | %      | 83.8                   | %      |
| Allowance for credit losses  as a percent of nonperforming loans                                                            |   | 69.3                       | %      | 69.6                   | %      |
| Total nonperforming assets  as a percent of loans receivable                                                                |   | 3.1                        | %      | 3.6                    | %      |
| Total nonperforming assets  as a percent of total shareholders’ equity                                                 |   | 31.4                       | %      | 36.9                   | %      |

 

Nonaccrual loans remained nearly flat at June 30, 2002 compared toDecember 31, 2001; however, nonperforming loans decreased by $1.6 million or17.5% during the first half of 2002 to $7.8 million compared to $9.4 million atDecember 31, 2001 due primarily to loan charge-offs of $1.7 million partiallyoffset by additional loans classified as nonaccrual.  The troubled debt restructuring of $953,000 at December 31, 2001has failed to maintain compliance with the modified terms and has beenclassified as nonaccrual at June 30, 2002.

 

There were no loans contractually past due 90 days or more with respectto either principal or interest and still accruing interest at June 30, 2002compared to $642,000 at December 31, 2001.

 

As a result of these changes, the amount of nonperforming assets atJune 30, 2002 decreased 14.5% from the level at December 31, 2001.

 

*ALLOWANCE FOR CREDIT LOSSES*

 

Provisions for credit losses charged to operations reflect management’sjudgment of the adequacy of the allowance for credit losses and are determinedthrough periodic analysis of the loan portfolio.  This analysis includes a detailed review of the classificationand categorization of problem loans and loans to be charged off; an assessmentof the overall quality and collectibility of the portfolio; and considerationof the loan loss experience, trends in problem loan concentrations of creditrisk,

 

18

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as well as currentand expected future economic conditions (particularly Southern California).Management, in combination with an outside firm, performs a periodic risk andcredit analysis, the results of which are reported to the Board of Directors.

 

Loans charged off during the second quarter and first half of 2002 were$401,000 and $1.8 million, respectively, compared to $171,000 and $350,000during the second quarter and first half of 2001, respectively.  Recoveries of loans previously charged offwere $176,000 and $336,000 during the second quarter and first half of 2002compared to $82,000 and $116,000 during the second quarter and first half of2000, respectively.

 

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

 
|                                                     |   | **Three months ended**     |   | **Six months ended**       |   |
|----------------------------------------------------------|--------|----------------------------|--------|----------------------------|--------|
|                                                     |   | **June 30,  2002**         |   | **June 30,  2001**         |   | **June 30,  2002** |   | **June 30,  2001** |   |
|                                                     |   | **(Dollars in thousands)** |   | **(Dollars in thousands)** |   |
|                                                     |   |                       |   |                       |   |   |   |   |   |
| Balance, beginning of  period (1)                        |   | $                          | 5,449  |                       | $      | 2,452 |   | $ | 6,542 |   | $ | 2,597 |   |
| Loan charged off:                                        |   |                       |   |                       |   |   |   |   |   |
| Real estate construction  and land development           |   | —                     |   |                       |   | 31 |   |   |   |
| Commercial loans:                                        |   |                       |   |                       |   |   |   |   |   |
| Other - secured and  unsecured                           |   | 400                        |   | 89                         |   | 1,742 |   | 268 |   |
| Consumer installment and  unsecured loans to individuals |   | 1                          |   | 82                         |   | 31 |   | 82 |   |
| Total loan charge-offs                                   |   | 401                        |   | 171                        |   | 1,804 |   | 350 |   |
|                                                     |   |                       |   |                       |   |   |   |   |   |
| Recoveries of loans previously  charged off:             |   |                       |   |                       |   |   |   |   |   |
| Real estate construction  and land development           |   | 84                         |   | 6                          |   | 191 |   | 6 |   |
| Commercial loans:                                        |   |                       |   |                       |   |   |   |   |   |
| Other - secured and  unsecured                           |   | 47                         |   | 74                         |   | 95 |   | 103 |   |
| Consumer installment and  unsecured loans to individuals |   | 45                         |   | 2                          |   | 50 |   | 7 |   |
| Total recoveries of loans  previously charged off        |   | 176                        |   | 82                         |   | 336 |   | 116 |   |
| Net charge-offs                                          |   | 225                        |   | 89                         |   | 1,468 |   | 234 |   |
| Provision for credit losses                              |   | 150                        |   | —                     |   | 300 |   | — |   |
| Balance, end of period                                   |   | $                          | 5,374  |                       | $      | 2,363 |   | $ | 5,374 |   | $ | 2,363 |   |

 

----

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

 

 

Credit quality is affected by many factors beyond the control of theCompany, including local and national economies, and facts may exist which arenot known to the Company that adversely affect the likelihood of repayment ofvarious loans in the loan portfolio and realization of collateral upon adefault. Accordingly, no assurance can be given that the Company will notsustain loan losses materially in excess of the allowance for credit losses. Inaddition, the Office of the Comptroller of the 

 

19

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Currency (“OCC”),as an integral part of its examination process, periodically reviews theallowance for credit losses and could require additional provisions for creditlosses.

 

Based on continued loan growth, the level of nonperforming loans and arelatively constant level of charge-offs, it is anticipated that the level ofthe allowance for credit losses will remain adequate through the remainder of2001.

 

***CAPITAL ADEQUACY REQUIREMENTS***

 

At June 30, 2002 the Company and the Bank were in compliance with allapplicable regulatory capital requirements and the Bank was “well capitalized”under the Prompt Corrective Action rules of the OCC.  The following table sets forth the regulatory capital standardsfor well capitalized institutions and the capital ratios for the Company andthe Bank as of June 30, 2002 and December 31, 2001.

|                          |   | **Well Capitalized  Standards** |   | **June 30,  2002** |   | **December 31,  2001** |   |
|-------------------------------|--------|---------------------------------|--------|--------------------|--------|------------------------|--------|
| **Company:**                  |   |                            |   |               |   |                   |   |
| Tier 1 leverage               |   | 5.00                            | %      | 6.38               | %      | 5.55                   | %      |
| Tier 1 risk-based capital     |   | 6.00                            | %      | 8.02               | %      | 6.85                   | %      |
| Total risk-based capital      |   | 10.00                           | %      | 11.49              | %      | 11.53                  | %      |
|                          |   |                            |   |               |   |                   |   |
| **Mercantile  National Bank** |   |                            |   |               |   |                   |   |
| Tier 1 leverage               |   | 5.00                            | %      | 7.23               | %      | 6.85                   | %      |
| Tier 1 risk-based capital     |   | 6.00                            | %      | 10.53              | %      | 10.50                  | %      |
| Total risk-based capital      |   | 10.00                           | %      | 11.79              | %      | 11.76                  | %      |
|                          |   |                            |   |               |   |                   |   |
| **South Bay  Bank**           |   |                            |   |               |   |                   |   |
| Tier 1 leverage               |   | 5.00                            | %      | 8.90               | %      | 8.72                   | %      |
| Tier 1 risk-based capital     |   | 6.00                            | %      | 10.59              | %      | 9.63                   | %      |
| Total risk-based capital      |   | 10.00                           | %      | 11.84              | %      | 10.90                  | %      |

 

***LIQUIDITY***

 

The Company continues to manage its liquidity through a combination ofcore deposits, federal funds purchased, repurchase agreements, collateralizedborrowing lines at the FHLB, and a portfolio of securitiesavailable-for-sale.  Liquidity is alsoprovided by maturing investment securities and loans.

*** ***

***ASSET LIABILITY MANAGEMENT***

 

The following table shows that the Company’s cumulative one-year interestrate sensitivity gap was an asset sensitive position of $6.3 million at June30, 2002 compared to $27.0 million at December 31, 2001.  The Company’s asset sensitive positionduring a period of slowly declining interest rates is not expected to have asignificant negative impact on net interest 

 

20

----

 

income since theCompany has a large base of immediately adjustable interest bearing demand,savings and money market deposit accounts. However, since the Company is asset sensitive, in a period of rapidlydeclining rates, such as the environment that was experienced during 2001, therapid decline will have a negative effect on the Company’s net interest incomeas changes in the rates of interest-bearing deposits historically have notchanged proportionately with changes in market interest rates.  Additionally, relatively low and declininginterest rate environments, the interest rates paid on funding liabilities may beginto reach floors preventing further downward adjustments while rates on earningassets continue to adjust 

 
|                                                                        |   | **June 30, 2002**             |   |
|-----------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                        |   | **Maturing or repricing in**  |   |
|                                                                        |   | **Less  than  three  months** |   | **After three  months  but within  one year** |   | **After one  year  but within  5 years** |   | **After  5 years** |   | **Total** |   |
|                                                                        |   | **(Dollars in thousands)**    |   |
| Rate-Sensitive Assets:                                                      |   |                          |   |   |   |   |   |   |   |   |   |
| Federal funds sold and  securities purchased under agreements to resell     |   | $                             | 35,495 |   | $ | — |   | $ | — |   | $ | — |   | $ | 35,495 |   |
| Securities  available-for-sale, at amortized cost                           |   | —                        |   | — |   | 2,571 |   | 27,012 |   | 29,583 |   |
| FRB and other stock, at  cost                                               |   |                          |   | — |   | — |   | 2,223 |   | 2,223 |   |
| Loans receivable (2)                                                        |   | 155,264                       |   | 14,468 |   | 54,912 |   | 23,612 |   | 248,256 |   |
| Total rate-sensitive assets                                                 |   | 190,759                       |   | 14,468 |   | 57,483 |   | 52,847 |   | 315,557 |   |
|                                                                        |   |                          |   |   |   |   |   |   |   |   |   |
|                                                                        |   |                          |   |   |   |   |   |   |   |   |   |
| Rate-Sensitive Liabilities:  (1)                                            |   |                          |   |   |   |   |   |   |   |   |   |
| Interest bearing deposits:                                                  |   |                          |   |   |   |   |   |   |   |   |   |
| Demand, money market and  savings                                           |   | 118,394                       |   | — |   | — |   | — |   | 118,394 |   |
| Time certificates of  deposit                                               |   | 42,522                        |   | 27,554 |   | 10,775 |   | — |   | 80,851 |   |
| Federal funds purchased and  securities sold under agreements to repurchase |   | 0                             |   | 0 |   | — |   | — |   | — |   |
| Other borrowings                                                            |   | 8,000                         |   | 2,500 |   | 5,000 |   | — |   | 15,500 |   |
| Total rate-sensitive  liabilities                                           |   | 168,916                       |   | 30,054 |   | 15,775 |   | — |   | 214,745 |   |
| Interest rate-sensitivity  gap                                              |   | 21,843                        |   | (15,586 | ) | 41,708 |   | 52,847 |   | 100,812 |   |
| Cumulative interest  rate-sensitivity gap                                   |   | $                             | 21,843 |   | $ | 6,257 |   | $ | 47,965 |   | $ | 100,812 |   |   |   |
| Cumulative ratio of rate  sensitive assets to rate-sensitive liabilities    |   | 113                           | %      | 103 | % | 122 | % | 147 | % |   |   |
|                                                                             |        |                               |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

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

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

 

downward.

 

21

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|                                                                     |   | **December 31, 2001**         |   |
|--------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                     |   | **Maturing or repricing in**  |   |
|                                                                     |   | **Less  than  three  months** |   | **After three  months  but within  one year** |   | **After one  year  but within  5 years** |   | **After  5 years** |   | **Total** |   |
|                                                                     |   | **(Dollars in thousands)**    |   |
| Rate-Sensitive Assets:                                                   |   |                          |   |   |   |   |   |   |   |   |   |
| Federal funds sold and  securities purchased under agreements to resell  |   | $                             | 39,405 |   | $ | — |   | $ | — |   | $ | — |   | $ | 39,405 |   |
| Securities  available-for-sale, at amortized cost                        |   | 2,014                         |   | — |   | 96 |   | 39,517 |   | 41,627 |   |
| FRB and other stock, at  cost                                            |   |                          |   | — |   | — |   | 2,552 |   | 2,552 |   |
| Loans receivable (2)                                                     |   | 164,632                       |   | 19,838 |   | 58,051 |   | 19,447 |   | 261,968 |   |
| Total rate-sensitive assets                                              |   | 206,051                       |   | 19,838 |   | 58,147 |   | 61,516 |   | 345,552 |   |
|                                                                     |   |                          |   |   |   |   |   |   |   |   |   |
| 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                                           |   | 50,499                        |   | (23,454 | ) | 41,900 |   | 61,516 |   | 130,461 |   |
| Cumulative interest  rate-sensitivity gap                                |   | $                             | 50,499 |   | $ | 27,045 |   | $ | 68,945 |   | $ | 130,461 |   |   |   |
| Cumulative ratio of rate  sensitive assets to rate-sensitive liabilities |   | 132                           | %      | 114 | % | 132 | % | 161 | % |   |   |
|                                                                          |        |                               |        |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

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

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

 

22

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**FACTORSWHICH MAY AFFECT FUTURE OPERATING RESULTS**

** **

**Weface risk from changes in interest rates.**

 

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

 

•                  Our abilityto originate loans;

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

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

•                  The averagelife of our interest earning assets;

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

•                  Our abilityto access the wholesale funding market.

 

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

** **

**Weface risk from possible declines in the quality of our assets.**

 

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

** **

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

 

Weestablish allowances for credit losses against each segment of our loanportfolio.  At June 30, 2002, ourallowance for credit losses equaled 2.1% of loans receivable and 69.3% ofnonperforming loans.  Although webelieved that we had established adequate allowances for credit losses as ofJune 30, 2002, the credit quality or our assets is affected by many factorsbeyond our control, including local and national economic conditions, and thepossible existence of facts which are not known 

 

23

----

 

tous which adversely affect the likelihood of repayment of various loans in ourloan portfolio and realization of the collateral upon a default.  Accordingly, we can give no assurance thatwe will not sustain loan losses materially in excess of the allowance forcredit losses.  In addition, the OCC, asan integral part of its examination process, periodically reviews our allowancefor credit losses and could require additional provisions for creditlosses.  Material future additions tothe allowance for credit losses may also be necessary due to increases in thesize and changes in the composition of our loan portfolio.  Increases in our provisions for credit losseswould adversely affect our results of operations.

** **

** Economic conditions may worsen.**

 

Ourbusiness is strongly influenced by economic conditions in our market area(principally, the Greater Los Angeles metropolitan area) as well as regionaland national economic conditions and in our niche markets, including theentertainment industry in Southern California. During the past several years economic conditions in these areas havebeen favorable.  Should the economiccondition in these areas deteriorate, the financial condition of our borrowerscould weaken, which could lead to higher levels of loan defaults or a declinein the value of collateral for our loans. In addition, an unfavorable economy could reduce the demand for ourloans and other products and services.

** **

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

 

AtJune 30, 2002, approximately 68% of our loans outstanding were collateralizedby properties located in California. Because of this concentration in California, our financial position andresults of operations have been and are expected to continue to be influencedby general trends in the California economy and its real estate market.  Real estate market declines may adverselyaffect the values of the properties collateralizing loans.  If the principal balances of our loans,together with any primary financing on the mortgaged properties, equal orexceed the value of the mortgaged properties, we could incur higher losses onsales of properties collateralizing foreclosed loans.  In addition, California historically has been vulnerable tocertain natural disaster risks, such as earthquakes and erosion-causedmudslides, which are not typically covered by the standard hazard insurancepolicies maintained by borrowers. Uninsured disasters may adversely impact our ability to recover losseson properties affected by such disasters and adversely impact our results ofoperations.

 

Inaddition, California is undergoing an energy crisis and expected to worsenduring the summer months, including the threat of rolling power outages or“blackouts” which have occurred during the past year.  Such outages could disrupt our operations, increase our operatingcosts and reduce the productivity of staff and operations. Power outages couldalso cause delays in processing banking transactions. Unscheduled power outagescould result in the shut down of information systems 

 

24

----

 

that could cause financialdata to be lost. The Company has developed contingency plans to deal with suchpower outages, including the review of plans and procedures of major vendorswho provide processing services.

 

TheCompany has extensions of credit to borrowers that are exposed to the poweroutages.  Likewise, such outages coulddisrupt their operations, increase their operating costs, and reduce theproductivity of staff and operations impacting their ability to meet their debtobligations to the Company.  The Companycannot predict the frequency or duration of the power outages that may occur.

** **

**Ourbusiness is very competitive**.

 

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

** **

**Ourbusiness is heavily regulated**.

 

BothNational Mercantile Bancorp, as a bank holding company, and Mercantile andSouth Bay, as national banks, are subject to significant governmentalsupervision and regulation, which is intended primarily for the protection ofdepositors.  Statutes and regulationsaffecting us may be changed at any time, and the interpretation of thesestatutes and regulations by examining authorities also may change.  We cannot assure you that future changes inapplicable statutes and regulations or in their interpretation will notadversely affect our business.

 

25

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**PARTII—OTHER INFORMATION**

 

***Item 1.       LEGAL PROCEEDINGS***

 

None.

 

***Item 2.       CHANGES INSECURITIES***

 

None.

 

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

 

None.

 

***Item 4.       SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDER***

 

         (a) OnJune 6, 2002, the Company held its annual meeting of shareholders.

 

         (b) Atthe annual meeting, the following directors were elected: Donald E. Benson,Joseph N. Cohen, Robert E. Gipson, Antoinette Hubenette, M.D, Scott A.Montgomery , Dion G. Morrow, Carl R. Terzian and Robert E. Thomson.

 

         (c) The following proposals wereconsidered at the annual meeting and the number of shares voting for or againstsuch proposals are listed below.

 

Election of Directors

 

| **Name**                    |   | **Votes For** |   | **Votes   Withheld** |   |
|-----------------------------|--------|---------------|--------|----------------------|--------|
|                        |   |          |   |                 |   |
| Donald E. Benson            |   | 2,074,609     |   | 118,497              |   |
|                        |   |          |   |                 |   |
| Joseph N. Cohen             |   | 2,076,109     |   | 116,997              |   |
|                        |   |          |   |                 |   |
| Robert E. Gipson            |   | 2,074,609     |   | 118,479              |   |
|                        |   |          |   |                 |   |
| Antoinette  Hubenette, M.D. |   | 2,076,219     |   | 116,887              |   |
|                        |   |          |   |                 |   |
| Scott A.  Montgomery        |   | 2,074,389     |   | 118,717              |   |
|                        |   |          |   |                 |   |
| Dion G. Morrow              |   | 2,075,999     |   | 117,107              |   |
|                        |   |          |   |                 |   |
| Carl R. Terzian             |   | 2,075,889     |   | 117,217              |   |
|                        |   |          |   |                 |   |
| Robert E.  Thomson          |   | 2,074,389     |   | 118,717              |   |

 

26

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Approval of Amendment of Section5 of the 1996 Stock Incentive Plan to increase the number of common sharesavailable for grant under the Plan from 448,510 shares to 548,510 shares.

 

| **Votes For** |   | **Votes  Against** |   | **Abstentions** |   | **Broker  Non-votes** |   |
|---------------|--------|--------------------|--------|-----------------|--------|-----------------------|--------|
| 1,413,670     |   | 167,264            |   | 6,794           |   | 605,378               |   |

 

***Item 5.       OTHERINFORMATION***

 

None

 

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

 

(a)          *Exhibits.*

99.1  CERTIFICATIONPURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO

SECTION906 OF THE SARBANES-OXLEY ACT OF 2002

 

99.1  CERTIFICATIONPURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO

SECTION906 OF THE SARBANES-OXLEY ACT OF 2002

 

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

 

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

 

Form 8-K Filed June 13, 2002 (Item 5).

 

Form 8-K Filed August 6, 2002 (Item 4).

 

**SIGNATURES**

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 
|   |            | **NATIONAL  MERCANTILE BANCORP** |
|--------|-----------------|----------------------------------|
|   |            | (Registrant)                     |
|   |            |                             |
|   |            |                             |
|   |            |                             |
| DATE:  | August 14, 2002 | /s/  Scott A. Montgomery    |
|   |            | **SCOTT  A. MONTGOMERY**         |
|   |            | Chief Executive Officer          |
|   |            |                             |
| DATE:  | August 14, 2002 | /s/   DAVID R. BROWN        |
|   |            | **DAVID  R. BROWN**              |
|   |            | Chief Financial Officer          |

 

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