**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**Form10-QSB**

**x  Quarterly report under section 13or 15(d) of the Securities Exchange Act of 1934**

**for the quarterly period ended  June 30, 2006**

**o  Transitionreport under section 13 or 15(d) of the Securities Exchange Act of 1934 for thetransition period from                       to                       .**

**Commission File Number 0-15982**

**NATIONAL MERCANTILE BANCORP**

**(Exactname of small business issuer in its charter)**

| **California**                            |   | **95-3819685**                        |
|-------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of          |   | (I.R.S. Employer  Identification No.) |
| incorporation or  organization)           |   |                                  |
|                                      |   |                                  |
| **1880  Century Park East**               |   |                                  |
| **Los  Angeles, California**              |   | **90067**                             |
| (Address to  principal executive offices) |   | (Zip Code)                            |

 

**Issuer’stelephone number, including area code: (310) 277-2265**

Check whether theissuer:  (1) filed all reports requiredto be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the past12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.       o    Yes    x    No

Indicated by checkmarkwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). o    Yes    x    No

The number of shares ofCommon Stock, no par value, of the issuer outstanding as of  September 18, 2006 was 5,550,767.

TransitionalSmall Business Disclosure Format (Check one):        o    Yes    x    No

 

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PART I – FINANCIALINFORMATION

*Item1.  Financial Statements*

Presented are theunaudited consolidated financial statements of National Mercantile Bancorp (“NationalMercantile” on a parent-only basis, and the ‘‘Company’’ on a consolidatedbasis) and its wholly-owned subsidiaries, Mercantile National Bank (“Mercantile”)and South Bay Bank, N.A. (“South Bay”), (collectively, the “Banks”).

2

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**NATIONALMERCANTILE BANCORP AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

(Unaudited)
|                                                                                                                                                                                                                       | ** ** | **June 30,**                    | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                            | ** ** | **2006**                             | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                                                                            | ** ** | **(Dollars in thousands)** | ** ** |
| ASSETS                                                                                                                                                                                                                |       |                                 |       |                  |       |
| Cash and due from  banks-demand                                                                                                                                                                                       |       | $                                    | 15,002     |                  | $          | 13,507 |   |
| Due from banks-interest  bearing                                                                                                                                                                                      |       | 2,263                                |       | 2,000                 |       |
| Federal funds sold                                                                                                                                                                                                    |       | 600                                  |       | 685                   |       |
| Cash and cash  equivalents                                                                                                                                                                                            |       | 17,865                               |       | 16,192                |       |
| Securities  available-for-sale, at fair value; aggregate amortized cost of $104,577 and 

$72,428 at June  30, 2006 and December 31, 2005, respectively                                                               |       | 101,701                              |       | 71,758                |       |
| Securities  held-to-maturity, at amortized cost; aggregate fair value of $2,177 and 

$2,572 at June  30, 2006 and December 31, 2005, respectively                                                                    |       | 2,269                                |       | 2,612                 |       |
| Federal Reserve Bank  and other stock                                                                                                                                                                                 |       | 3,682                                |       | 3,809                 |       |
| Loans receivable                                                                                                                                                                                                      |       | 351,229                              |       | 338,558               |       |
| Allowance for  credit losses                                                                                                                                                                                          |       | (4,648                               | )          | (4,468                | )          |
| Net loans  receivable                                                                                                                                                                                                 |       | 346,581                              |       | 334,090               |       |
|                                                                                                                                                                                                                  |       |                                 |       |                  |       |
| Premises and equipment,  net                                                                                                                                                                                          |       | 5,902                                |       | 5,861                 |       |
| Other real estate owned                                                                                                                                                                                               |       | —                               |       | 1,056                 |       |
| Deferred tax asset, net                                                                                                                                                                                               |       | 4,198                                |       | 4,442                 |       |
| Goodwill                                                                                                                                                                                                              |       | 3,225                                |       | 3,225                 |       |
| Intangible assets, net                                                                                                                                                                                                |       | 1,295                                |       | 1,407                 |       |
| Accrued interest  receivable and other assets                                                                                                                                                                         |       | 4,684                                |       | 4,007                 |       |
| Total assets                                                                                                                                                                                                          |       | $                                    | 491,402    |                  | $          | 448,459 |   |
|                                                                                                                                                                                                                  |       |                                 |       |                  |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                                                                                                                            |       |                                 |       |                  |       |
| Deposits:                                                                                                                                                                                                             |       |                                 |       |                  |       |
| Noninterest-bearing  demand                                                                                                                                                                                           |       | $                                    | 115,650    |                  | $          | 115,924 |   |
| Interest-bearing  demand                                                                                                                                                                                              |       | 30,973                               |       | 36,018                |       |
| Money market                                                                                                                                                                                                          |       | 97,578                               |       | 76,334                |       |
| Savings                                                                                                                                                                                                               |       | 24,103                               |       | 28,208                |       |
| Time  certificates of deposit:                                                                                                                                                                                        |       |                                 |       |                  |       |
| $100,000 or more                                                                                                                                                                                                      |       | 86,756                               |       | 87,468                |       |
| Under $100,000                                                                                                                                                                                                        |       | 17,516                               |       | 19,256                |       |
| Total deposits                                                                                                                                                                                                        |       | 372,576                              |       | 363,208               |       |
|                                                                                                                                                                                                                  |       |                                 |       |                  |       |
| Securities sold under  agreement to repurchase                                                                                                                                                                        |       | 45,000                               |       | —                |       |
| Other borrowings                                                                                                                                                                                                      |       | 12,250                               |       | 28,337                |       |
| Junior subordinated  deferrable interest debentures                                                                                                                                                                   |       | 15,464                               |       | 15,464                |       |
| Accrued interest  payable and other liabilities                                                                                                                                                                       |       | 7,076                                |       | 3,288                 |       |
| Total  liabilities                                                                                                                                                                                                    |       | 452,366                              |       | 410,297               |       |
|                                                                                                                                                                                                                  |       |                                 |       |                  |       |
| Shareholders’ equity:                                                                                                                                                                                            |       |                                 |       |                  |       |
| Preferred stock,  no par value-authorized 1,000,000 shares: Series B non-cumulative convertible  perpetual preferred stock; authorized 1,000 shares; outstanding 1,000 shares at  June 30, 2006 and December 31, 2005 |       | 1,000                                |       | 1,000                 |       |
| Common stock, no  par value-authorized 10,000,000 shares: outstanding 5,543,891 shares and  5,503,780 shares at June 30, 2006 and December 31, 2005, respectively                                                     |       | 46,177                               |       | 45,697                |       |
| Accumulated  deficit                                                                                                                                                                                                  |       | (5,178                               | )          | (7,381                | )          |
| Accumulated  other comprehensive loss                                                                                                                                                                                 |       | (2,963                               | )          | (1,154                | )          |
| Total  shareholders’ equity                                                                                                                                                                                      |       | 39,036                               |       | 38,162                |       |
| Total liabilities and  shareholders’ equity                                                                                                                                                                      |       | $                                    | 491,402    |                  | $          | 448,459 |   |

 

See accompanyingnotes to consolidated financial statements.

3

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**NATIONALMERCANTILE BANCORP AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

 
|                                                                             | ** ** | **For the Three Months Ended** | ** ** | **For the Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                  | ** ** | **June 30,**                                  | ** ** | **June 30,**                                | ** ** |
| ** **                                                                  | ** ** | **2006**                                           | ** ** | **2005**                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                  | ** ** | **(Dollars in thousands,**               | ** ** |
| ** **                                                                  | ** ** | **except per share data)**          | ** ** |
| Interest income:                                                            |       |                                               |       |                                             |       |   |   |   |   |
| Loans, including  fees                                                      |       | $                                                  | 7,551      |                                             | $          | 5,675 |   | $ | 14,591 |   | $ | 11,118 |   |
| Securities                                                                  |       | 1,319                                              |       | 377                                              |       | 2,304 |   | 745 |   |
| Due from banks -  interest bearing                                          |       | 30                                                 |       | 18                                               |       | 51 |   | 34 |   |
| Federal funds  sold and securities purchased under agreements to resell     |       | 13                                                 |       | 19                                               |       | 18 |   | 29 |   |
| Total interest  income                                                      |       | 8,913                                              |       | 6,089                                            |       | 16,964 |   | 11,926 |   |
| Interest expense:                                                           |       |                                               |       |                                             |       |   |   |   |   |
| Deposits:                                                                   |       |                                               |       |                                             |       |   |   |   |   |
| Interest-bearing  demand                                                    |       | 60                                                 |       | 35                                               |       | 102 |   | 67 |   |
| Money market and  savings                                                   |       | 797                                                |       | 234                                              |       | 1,381 |   | 454 |   |
| Time  certificates of deposit:                                              |       |                                               |       |                                             |       |   |   |   |   |
| $100,000 or more                                                            |       | 991                                                |       | 259                                              |       | 1,759 |   | 467 |   |
| Under $100,000                                                              |       | 196                                                |       | 152                                              |       | 372 |   | 294 |   |
| Total interest  expense on deposits                                         |       | 2,044                                              |       | 680                                              |       | 3,614 |   | 1,282 |   |
| Federal funds  purchased and securities sold under agreements to repurchase |       | 367                                                |       | —                                           |       | 512 |   | — |   |
| Junior  subordinated deferrable interest debentures                         |       | 397                                                |       | 397                                              |       | 793 |   | 793 |   |
| Other borrowings                                                            |       | 139                                                |       | 39                                               |       | 363 |   | 133 |   |
| Total interest  expense                                                     |       | 2,947                                              |       | 1,116                                            |       | 5,282 |   | 2,208 |   |
| Net interest  income before provision for credit losses                     |       | 5,966                                              |       | 4,973                                            |       | 11,682 |   | 9,718 |   |
| Provision for loan  losses                                                  |       | 40                                                 |       | —                                           |       | 72 |   | 89 |   |
| Net interest  income after provision for credit losses                      |       | 5,926                                              |       | 4,973                                            |       | 11,610 |   | 9,629 |   |
| Other operating income  (loss) :                                            |       |                                               |       |                                             |       |   |   |   |   |
| Trading gain  (loss) on economic derivatives                                |       | (369                                               | )          | 582                                              |       | (817 | ) | 378 |   |
| Deposit-related  and other customer services                                |       | 234                                                |       | 269                                              |       | 466 |   | 566 |   |
| Other  non-interest income                                                  |       | 59                                                 |       | 130                                              |       | 145 |   | 271 |   |
| Gain (loss) on  sale of OREO/fixed assets                                   |       | —                                             |       | —                                           |       | 47 |   | — |   |
| Total other  operating income (loss)                                        |       | (76                                                | )          | 981                                              |       | (159 | ) | 1,215 |   |
| Other operating  expenses:                                                  |       |                                               |       |                                             |       |   |   |   |   |
| Salaries and  related benefits                                              |       | 2,193                                              |       | 1,848                                            |       | 4,282 |   | 3,686 |   |
| Net occupancy                                                               |       | 253                                                |       | 239                                              |       | 514 |   | 485 |   |
| Furniture and  equipment                                                    |       | 141                                                |       | 124                                              |       | 274 |   | 251 |   |
| Printing and  communications                                                |       | 150                                                |       | 119                                              |       | 316 |   | 264 |   |
| Insurance and  regulatory assessments                                       |       | 93                                                 |       | 105                                              |       | 192 |   | 213 |   |
| Client services                                                             |       | 168                                                |       | 147                                              |       | 310 |   | 319 |   |
| Computer data  processing                                                   |       | 209                                                |       | 218                                              |       | 426 |   | 450 |   |
| Legal services                                                              |       | 20                                                 |       | 308                                              |       | 94 |   | 456 |   |
| Other  professional services                                                |       | 350                                                |       | 285                                              |       | 654 |   | 539 |   |
| Other expenses                                                              |       | 242                                                |       | 206                                              |       | 489 |   | 422 |   |
| Total other  operating expenses                                             |       | 3,819                                              |       | 3,599                                            |       | 7,551 |   | 7,085 |   |
| Income before income  tax provision                                         |       | 2,031                                              |       | 2,355                                            |       | 3,900 |   | 3,759 |   |
| Income tax provision                                                        |       | 885                                                |       | 977                                              |       | 1,698 |   | 1,560 |   |
| Net income                                                                  |       | $                                                  | 1,146      |                                             | $          | 1,378 |   | $ | 2,202 |   | $ | 2,199 |   |
| Earnings per share:                                                         |       | $                                                  | 0.21       |                                             | $          | 0.35 |   | $ | 0.40 |   | $ | 0.58 |   |
| Basic                                                                       |       | $                                                  | 0.19       |                                             | $          | 0.23 |   | $ | 0.37 |   | $ | 0.38 |   |
| Diluted                                                                     |       |                                               |       |                                             |       |   |   |   |   |

 

Seeaccompanying notes to consolidated financial statements.

4

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**NATIONALMERCANTILE BANCORP AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

(Unaudited)
|                                                                                                          | ** ** | **For the Six Months Ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2006**                                                            | ** ** | **2005** | ** ** |
| ** **                                                                                               | ** ** | **(Dollars in thousands)**                                | ** ** |
| Cash flows from  operating activities:                                                                   |       |                                                                |       |   |   |
| Net income                                                                                               |       | $                                                                   | 2,202      |   | $ | 2,199 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:                       |       |                                                                |       |   |   |
| Depreciation and  amortization                                                                           |       | 239                                                                 |       | 207 |   |
| Provision for  credit losses                                                                             |       | 72                                                                  |       | 89 |   |
| Stock  compensation cost                                                                                 |       | 185                                                                 |       | — |   |
| Gain on sale of  other real estate owned                                                                 |       | (48                                                                 | )          | — |   |
| Net amortization  of premium (discount) on securities available-for-sale                                 |       | (104                                                                | )          | 37 |   |
| Net amortization  of premium on securities held-to-maturity                                              |       | 10                                                                  |       | 16 |   |
| Net amortization  of core deposit intangible                                                             |       | 112                                                                 |       | 112 |   |
| Net amortization  of premium on loans purchased                                                          |       | 64                                                                  |       | 83 |   |
| Utilization of  deferred tax assets                                                                      |       | 1,692                                                               |       | 424 |   |
| Trading (gain)  loss on economic derivatives                                                             |       | 817                                                                 |       | (378 | ) |
| Decrease  (increase) in accrued interest receivable and other assets                                     |       | (2,083                                                              | )          | 64 |   |
| Increase  (decrease) in accrued interest payable and other liabilities                                   |       | 3,897                                                               |       | (256 | ) |
| Net cash  provided by operating activities                                                               |       | 7,055                                                               |       | 2,597 |   |
| Cash flows from  investing activities:                                                                   |       |                                                                |       |   |   |
| Purchase of  securities available-for-sale                                                               |       | (48,055                                                             | )          | (9,410 | ) |
| Proceeds from  repayments and maturities of securities available-for-sale                                |       | 16,011                                                              |       | 2,278 |   |
| Proceeds from  repayments and maturities of securities held-to-maturity                                  |       | 333                                                                 |       | 443 |   |
| Loan  originations and principal collections, net                                                        |       | (12,736                                                             | )          | 5,995 |   |
| Proceeds from  sale of other real estate owned                                                           |       | 1,104                                                               |       | — |   |
| Purchase of  Federal Reserve stock and other stocks                                                      |       | (336                                                                | )          | (87 | ) |
| Purchases of  premises and equipment                                                                     |       | (280                                                                | )          | (255 | ) |
| Net cash used in  investing activities                                                                   |       | (43,959                                                             | )          | (1,036 | ) |
| Cash flows from  financing activities:                                                                   |       |                                                                |       |   |   |
| Net increase in  demand deposits, money market and savings accounts                                      |       | 11,820                                                              |       | 23,287 |   |
| Net increase (decrease)  in time certificates of deposit                                                 |       | (2,452                                                              | )          | 13,481 |   |
| Net increase in  securities sold under agreements to repurchase and federal funds purchased              |       | 45,000                                                              |       | — |   |
| Net decrease in  other borrowings                                                                        |       | (16,087                                                             | )          | (25,900 | ) |
| Net proceeds  from exercise of stock options                                                             |       | 296                                                                 |       | 222 |   |
| Cash paid in lieu  of fraction shares from 5 for 4 stock split effected in the form of a stock  dividend |       | (1                                                                  | )          | — |   |
| Net cash  provided by financing activities                                                               |       | 38,576                                                              |       | 11,090 |   |
| Net increase in cash  and cash equivalents                                                               |       | 1,672                                                               |       | 12,651 |   |
| Cash and cash  equivalents, January 1                                                                    |       | 16,192                                                              |       | 16,915 |   |
| Cash and cash  equivalents, June 30                                                                      |       | $                                                                   | 17,864     |   | $ | 29,566 |   |
|                                                                                                     |       |                                                                |       |   |   |
| Supplemental  disclosures of cash flow information:                                                      |       |                                                                |       |   |   |
| Cash paid for  interest                                                                                  |       | $                                                                   | 4,324      |   | $ | 1,857 |   |
| Cash paid for  income taxes                                                                              |       | 730                                                                 |       | 800 |   |
| Unrealized loss  on securities available-for-sale, net of tax effect                                     |       | 1,290                                                               |       | 20 |   |
| Unrealized gain  (loss) on cash flow hedges, net of tax effect                                           |       | $                                                                   | (519       | ) | $ | 44 |   |
|                                                                                                     |       |                                                                |       |   |   |

 

See accompanyingnotes to consolidated financial statements.

5

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**NATIONALMERCANTILE BANCORP AND SUBSIDIARIES**

###### **NOTES TO THE CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

NOTE 1—BASIS OFPRESENTATION AND MANAGEMENT REPRESENTATIONS

The unauditedconsolidated financial statements include the accounts of National MercantileBancorp (“National Mercantile” on a parent-only basis, and the ‘‘Company’’ on aconsolidated basis) and its wholly-owned subsidiaries, Mercantile National Bankand South Bay Bank, N.A., (collectively, the “Banks”). The unauditedconsolidated financial statements of the Company 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 six months ended June 30, 2006 are not necessarilyindicative of the results expected for any subsequent period or for the fullyear ending December 31, 2006. The unaudited consolidated financial statementsshould be read in conjunction with the audited consolidated financialstatements included in the Company’s Annual Report on Form 10-KSB for the yearended December 31, 2005.

The financialstatements, and other financial information, as of December 31, 2005 and forthe three months and six months ended June 30, 2005 have been restated. Therestatement corrected errors in the originally filed Annual Report on Form10-KSB and Quarterly Report on Form 10-QSB related to the Company’s accountingunder Statement of Financial Accounting Standards 133, Accounting for Derivative Instruments and Hedging Activities, asamended (“SFAS 133”), for interest rate swap agreements entered into inconnection with certain debentures related to trust preferred securities andsubordinated debt (“Debt Transactions”). See Note 11.

NOTE 2—EARNINGS PER SHARE

Basicearnings per share are computed using the weighted average number of commonshares outstanding during the period. The number of shares has been adjustedfor the five-for-four stock split effected in the form of a stock dividend paidApril 14, 2006 and reflects the conversion of the Series A Preferred Stock inJune 2005.

The following table is a reconciliationof income and shares used in the computation of basic and diluted earnings pershare:

6

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|                                                            | ** ** | **Earnings**                                                                         | ** ** | **Weighted** | ** ** | ** **         | ** ** |
|------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|--------------|------------|--------------------|------------|
| ** **                                                 | ** ** | **available to**                                                                | ** ** | **Average**  | ** ** | **Per share** | ** ** |
| ** **                                                 | ** ** | **shareholders**                                                                     | ** ** | **Shares**   | ** ** | **amount**         | ** ** |
| ** **                                                 | ** ** | **(in thousands)**                                                              | ** ** | ** **   | ** ** | ** **         | ** ** |
| ** **                                                 | ** ** | ** **                                                                           | ** ** | ** **   | ** ** | ** **         | ** ** |
| *For the three months ended June  30, 2006:*               |       |                                                                                 |       |         |       |               |       |
| Basic EPS                                                  |       | $                                                                                    | 1,146      |         | 5,542,441  |               | $          | 0.21 |   |
|                                                       |       |                                                                                 |       |         |       |               |       |
| Effect of  dilutive securities:                            |       |                                                                                 |       |         |       |               |       |
| Options                                                    |       |                                                                                 |       | 250,679      |       |               |       |
| Convertible  preferred stock                               |       |                                                                                 |       | 242,406      |       |               |       |
| Diluted earnings  per share                                |       | $                                                                                    | 1,146      |         | 6,035,527  |               | $          | 0.19 |   |
|                                                       |       |                                                                                 |       |         |       |               |       |
| *For the three months ended June  30, 2005 (as restated):* |       |                                                                                 |       |         |       |               |       |
| Basic and  diluted loss per share                          |       | $                                                                                    | 1,378      |         | 3,908,376  |               | $          | 0.35 |   |
|                                                       |       |                                                                                 |       |         |       |               |       |
| Effect of  dilutive securities:                            |       |                                                                                 |       |         |       |               |       |
| Options                                                    |       |                                                                                 |       | 250,103      |       |               |       |
| Convertible  preferred stock                               |       |                                                                                 |       | 1,720,875    |       |               |       |
| Diluted earnings  per share                                |       | 1,378                                                                                |       | 5,879,355    |       | $                  | 0.23       |   |
|                                                       |       |                                                                                 |       |         |       |               |       |
| *For the six months ended June  30, 2006:*                 |       |                                                                                 |       |         |       |               |       |
| Basic EPS                                                  |       | $                                                                                    | 2,202      |         | 5,530,479  |               | $          | 0.40 |   |
|                                                       |       |                                                                                 |       |         |       |               |       |
| Effect of  dilutive securities:                            |       |                                                                                 |       |         |       |               |       |
| Options                                                    |       |                                                                                 |       | 259,047      |       |               |       |
| Convertible  preferred stock                               |       |                                                                                 |       | 229,535      |       |               |       |
| Diluted earnings  per share                                |       | $                                                                                    | 2,202      |         | 6,019,060  |               | $          | 0.37 |   |
|                                                       |       |                                                                                 |       |         |       |               |       |
| *For the six months ended June  30, 2005 (as restated):*   |       |                                                                                 |       |         |       |               |       |
| Basic EPS                                                  |       | $                                                                                    | 2,199      |         | 3,812,796  |               | $          | 0.58 |   |
|                                                       |       |                                                                                 |       |         |       |               |       |
| Effect of  dilutive securities:                            |       |                                                                                 |       |         |       |               |       |
| Options                                                    |       |                                                                                 |       | 248,186      |       |               |       |
| Convertible  preferred stock                               |       |                                                                                 |       | 1,800,579    |       |               |       |
| Diluted earnings per  share                                |       | $             2,199 |       | $            | 5,861,561  |               | 0.38       |   |
|                                                            |            |                                                                                      |            |              |            |                    |            |  |  |  |

 

NOTE 3—CASH ANDCASH EQUIVALENTS

For purposes of reporting cash flows, cash andcash equivalents include cash, due from banks-interest-bearing and federalfunds sold.

7

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NOTE 4—ALLOWANCEFOR LOAN AND LEASE LOSSES 

The allowance for loan and lease losses is avaluation adjustment used to recognize impairment of the recorded investment inthe Company’s loans receivable on its balance sheet before losses have beenconfirmed resulting in a subsequent charge-off or write-down.

Provisions for credit losses charged (orcredited) to operations reflect management’s judgment of the adequacy of theallowance for loan and lease losses and are determined through periodicanalysis of the loan portfolio.  Thisanalysis includes a systematic and detailed review of the classification andcategorization of problem loans; an assessment of the overall quality andcollectibility of the portfolio; and consideration of the loan loss experience,trends in problem loans, concentrations of credit risk, as well as currenteconomic conditions (particularly Southern California).  Management performs a periodic risk andcredit analysis, the results of which are reported to the Board of Directors.

During the second quarter 2006, the Companycharged off no loans and recovered no loans previously charged off.  Pursuant to management’s evaluation of theallowance for loan and lease losses at June 30, 2006, a provision for creditlosses of $40,000 and $72,000 was recorded for the three months and six monthsended June 30, 2006, respectively.  Therewas no provision for credit losses during the second quarter 2005 and $89,000for the six months ended June 30, 2005.

The following table sets forth information concerningthe Company’s allowance for credit losses for the periods indicated.
|                                                                           | ** ** | **Six Months ended June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| ** **                                                                | ** ** | **(Dollars in thousands)**              | ** ** |
| ** **                                                                | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Balance, beginning of  period                                             |       | $                                                 | 4,468      |   | $ | 3,511 |   |
| Total loans  charged-off                                                  |       | 1                                                 |       | 6 |   |
| Total recoveries  of loans previously charged off                         |       | —                                            |       | 135 |   |
| Net charge-offs                                                           |       | 1                                                 |       | (129 | ) |
| Provision for  credit losses                                              |       | 72                                                |       | 89 |   |
| Transfer (to)  from reserve for contingent losses on unfunded commitments |       | 109                                               |       | (60 | ) |
| Balance, end of period                                                    |       | $                                                 | 4,648      |   | $ | 3,669 |   |

 

Credit quality is affected by many factorsbeyond the control of the Company, including local and national economies, andfacts may exist which are not known to the Company that adversely affect thelikelihood of repayment of various loans in the loan portfolio and realizationof collateral upon a default. Accordingly, no assurance can be given that the Company will not sustainloan losses materially in excess of the allowance for credit losses. Inaddition,

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theOffice of the Comptroller of the Currency (“OCC”), as an integral part of itsexamination process, periodically reviews the allowance for credit losses andcould require additional provisions for credit losses.

NOTE5—GOODWILL AND CORE DEPOSIT INTANGIBLES

As of June 30, 2006 and December 31, 2005, theCompany had goodwill of $3.2 million, and net core deposit intangibles of $1.3million and $1.4 million, respectively, from its acquisition of South Bay Bankin December 2001.  The gross carryingamount of core deposit intangibles was $2.3 million at June 30, 2006 andDecember 31, 2005, and accumulated amortization was $1.0 million and $900,000,respectively, at such dates.  The coredeposit intangibles are estimated to have a life of 10 years and 4 months.  Amortization of intangibles for 2006 and eachof the next four years is estimated to be $223,000 per year.  In accordance with SFAS No. 142 goodwill isnot amortized.  The Company has no otherrecorded indefinite-lived intangible assets. Goodwill and other intangible assets are reviewed and assessed annuallyfor impairment or more frequently if conditions suggest impairment may exist.

NOTE6—REPURCHASE AGREEMENTS

At June 30, 2006, the Company had $45.0 millionof securities sold under agreement to repurchase (“Repurchase Agreements”).  At December 31, 2005, there were noRepurchase Agreements.  The RepurchaseAgreements are adjustable, indexed to LIBOR, and contain embedded interest ratefloors with various strike rates for terms ranging two  to three years and were utilized tofacilitate the Company’s liquidity and interest rate risk managementobjectives.  In the event of a sustaineddecline in interest rates, upon reaching the strike rate, the cost of theRepurchase Agreements will decline at double the difference between the indexrate and the strike rate, but in any event, not below zero.

The embedded interest rate floors have not beenseparated from the Repurchase Agreements and accounted for as a derivativeinstrument because (i) the strike rate was below the LIBOR index at issuance ofthe Repurchase Agreements and it is clearly and closely related to the economiccharacteristics and risks of the Repurchase Agreements, and (ii) the RepurchaseAgreements are not remeasured at fair value under otherwise applicablegenerally accepted accounting principles with changes in fair value reported inearnings.

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NOTE7—INCOME TAXES

Income tax provisions of $885,000 and $977,000were recorded for the three months ended June 30, 2006 and 2005,respectively.   Income tax provisions of$1,698,000 and $1,560,000 were recorded for the six months ended June 30, 2006and 2005, respectively.

At June 30, 2006, the Company had: (i) federalnet operating loss carry forwards (“NOLS”) of approximately $402,000, whichbegin to expire in the year 2009; and (ii) federal alternative minimum tax (“AMT”)credits of $637,000.  The AMT creditscarry forward indefinitely.

Management believes that it is more likely thannot that the deferred tax asset, a portion of which is comprised of the NOLS,will be realized.  Accordingly, novaluation allowance has been established against the deferred tax asset.

NOTE8—SHARE-BASED PAYMENTS

At June 30, 2006, the Company had one stockincentive plan pursuant to which up to a total of 312,000 shares of commonstock may be issued.  Under this plan,the Company may grant to directors, officers, employees and consultantsstock-based incentive compensation in a variety of forms, including withoutlimitation nonqualified options, incentive options, sales and bonuses of commonstock and stock appreciation rights, on such terms and conditions as the Boardof Directors of the Company determines. The term of the stock option may not exceed 10 years.  Employee stock option grants generally vestover one year or ratable over two years. Director stock options vest in one year. All stock options have vesting conditions that include only serviceconditions; none of the grants contains performance or market vestingconditions.

The Company issues new shares upon the exerciseof stock options.  All of the share-basedpayment awards qualify for classification as equity.  At June 30, 2006, the only outstanding awardsunder this plan were stock options, and at that date 192,213 shares wereavailable for future awards.  At June 30,2006, there were also outstanding options granted under two prior stockincentive plans.  The activity of stockoptions for the six months ended June 30, 2006 is as shown:

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| ** **                      | ** ** | **No. of Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic Value (In  thousands)** | ** ** |
|---------------------------------|------------|-----------------------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------------|------------|
| Outstanding,  December 31, 2005 |       | 519,358                     |       | $                                      | 9.62       |                                                |       |                                                     |       |   |
| Granted                         |       | 6,975                       |       | 15.00                                  |       |                                                |       |                                                     |       |
| Exercised                       |       | (32,439                     | )          | 7.45                                   |       |                                                |       |                                                     |       |
| Forefeited                      |       | (6,750                      | )          | 12.40                                  |       |                                                |       |                                                     |       |
| Expired                         |       | —                      |       | —                                 |       |                                                |       |                                                     |       |
| Five-for-four stock split       |       | 121,490                     |       | n/a                                    |       |                                                |       |                                                     |       |
| Outstanding,  June 30, 2006     |       | 608,634                     |       | $                                      | 7.81       |                                                | 5.8        |                                                     | $          | 3,288 |   |
|                            |       |                        |       |                                   |       |                                                |       |                                                     |       |
| Exercisable,June 30,  2006      |       | 396,625                     |       | $                                      | 6.51       |                                                | 4.3        |                                                     | $          | 2,682 |   |

 

 

The Financial Accounting Standards Board issuedStatement of Financial Accounting Standards No. 123R, “Share-Based Payment”(SFAS 123R) which eliminated the ability to account for share-basedcompensation transactions, including grants of employee and director stockoptions, using Accounting Principles Board Opinion No. 25, “Accounting forStock Issued to Employees” (APB 25), and generally requires that suchtransactions be accounted for using a fair value-based method with theresulting compensation cost recognized over the period that the employee ordirector is required to provide service in order to receive their compensation.  The Company adopted SFAS 123R as of January1, 2006 utilizing the modified prospective application.  Under this method, the provisions of SFAS123R are applied to new awards and to awards modified, repurchased or canceledafter December 31, 2005 and to awards outstanding on December 31, 2005 forwhich the requisite service has not yet been rendered.  Prior to December 31, 2005, the Companyaccounted for its stock options using the intrinsic value method, as prescribedby APB 25, and accordingly, no expense for stock options was recorded inperiods ending on or prior to December 31, 2005.

For the three months and six months ended June30, 2006, share-based compensation expense was $100,000 and $185,000respectively, resulting in similar charges to net income before income tax andnet income for the periods.****Theshare-based compensation expense decreased both basic and diluted earnings pershare by $0.02 for the quarter ended June 30, 2006 and $0.03 for the six monthsended June 30, 2006.  The income taxbenefit for the six months ended June 30, 2006 was immaterial as nearly allunvested stock options were qualified incentive stock options.  For the six months ended June 30, 2006, therewas no impact to cash flow from financing activities as there were no taxdeductions that exceeded the compensation cost for share-based payments.

The reported net income and earnings per sharefor the three months and  six monthsended June 30, 2005 are presented below to reflect the impact had the Companybeen required to recognize compensation expense based on SFAS 123R:

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|                                                                                                                | ** ** | **Three Months  Ended  June 30,  2005**            | ** ** | **Six Months  Ended  June 30,  2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                                                     | ** ** | **(Dollars in thousands)**                                   | ** ** |
|                                                                                                           |       |                                                         |       |                                            |       |
| Reported net income                                                                                            |       | $                                                            | 1,378      |                                            | $          | 2,199 |   |
| Deduct: Toal  share-based compensation expense determined using fair value method, net of  related tax effects |       | 41                                                           |       | 78                                              |       |
|                                                                                                           |       | $         1,337 |       | $                                               | 2,121      |   |
|                                                                                                           |       |                                                         |       |                                            |       |
| Basic earnings per  share:                                                                                     |       |                                                         |       |                                            |       |
| As reported                                                                                                    |       | $                                                            | 0.35       |                                            | $          | 0.58 |   |
| Pro forma                                                                                                      |       | $                                                            | 0.34       |                                            | $          | 0.56 |   |
|                                                                                                           |       |                                                         |       |                                            |       |
| Diluted earnings per  share:                                                                                   |       |                                                         |       |                                            |       |
| As reported                                                                                                    |       | $                                                            | 0.23       |                                            | $          | 0.38 |   |
| Pro forma                                                                                                      |       | $                                                            | 0.23       |                                            | $          | 0.36 |   |

 

The estimated per share weighted average fairvalue of options granted in the six months ended June 30, 2006 and 2005 was$5.99 and $9.59, respectively.  The totalintrinsic value of options exercised during the six months ended June 30, 2006was $268,000.  As of June 30, 2006, totalunrecognized compensation cost related to stock options issued but unvested was$340,000 that will be recognized through 2008.

Under the fair value method, stock optioncompensation expense is measured on the date of grant using an option-pricingmodel.  Upon adoption of SFAS 123R, thefair values of the stock options were estimated using a lattice option pricingmodel.   Previously, the fair values ofstock options were estimated using the Black-Scholes option-pricing model.  Due to longer contractual terms of theCompany’s stock options than traded options, suboptimal exercise patterns andrisk-free interest rates and dividend rates that may be expected to differ overthe option term from the grant date, the lattice option pricing model betterreflects the substantive characteristics of the Company’s stock options.  The effect of the change to the latticeoption pricing model did not have a material impact on the current period.

The lattice option pricing models requirecertain assumptions.  For the six monthsended June 30, 2006, the expected volatility assumption of 32.0% is based uponthe weekly historical volatility of the Company’s stock price for the periodJanuary 1, 2000 through December 31, 2005 using a blend of the unweightedstandard deviation of closing price with a weighted mean reversionformula.  The risk-free interest rateassumption ranged from 4.46% to 4.60% for the expected term of the share optionsand is based upon the U.S. Treasury implied forward yield curve at the time ofthe grant.  The dividend yield assumptionranged from 0 to 2.5% during the expected term of the options and is based uponthe Company’s capital planning model. The assumptions used with the Black-Sholes option pricing

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model,for the six months ended June 30, 2006, are as follows: expected volatility43%; expected term 10 years; risk-free interest rate 5.0%; and dividend yield0%.

NOTE9—COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) is the change in equityduring a period from transactions and other events and circumstances fromnonowner sources.  The accumulatedbalance of other comprehensive income (loss) is required to be displayedseparately from retained earnings in the consolidated balance sheet.  Total comprehensive income (loss) was asfollows:
|                                                                              | ** ** | **Three Months ended June 30,** | ** ** | **Six Months ended June 30,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                   | ** ** | **(Dollars in thousands)**                | ** ** | **(Dollars in thousands)**              | ** ** |
|                                                                         |       |                                                |       |                                              |       |   |   |   |   |
| Net income                                                                   |       | $                                                   | 1,146      |                                              | $          | 1,378 |   | $ | 2,202 |   | $ | 2,199 |   |
| Unrealized gain  (loss) on interest rate swaps used in cash flow hedges      |       | (317                                                | )          | 712                                               |       | (821 | ) | (370 | ) |
| Unrealized loss  on interest rate floors used in cash flow hedges            |       | (24                                                 | )          | (26                                               | )          | (248 | ) | (26 | ) |
| Unrealized gain  (loss) on securities available for sale                     |       | (1,409                                              | )          | 260                                               |       | (2,205 | ) | (34 | ) |
|                                                                         |       |                                                |       |                                              |       |   |   |   |   |
| Other  comprehensive income (loss), before tax                               |       | (1,750                                              | )          | 946                                               |       | (3,274 | ) | (430 | ) |
| Income tax benefit  (expense) related to items of other comprehensive income |       | 705                                                 |       | (388                                              | )          | 1,149 |   | 179 |   |
| Other  comprehensive income (loss)                                           |       | (1,045                                              | )          | 558                                               |       | (2,125 | ) | (251 | ) |
| Total comprehensive  income                                                  |       | $                                                   | 101        |                                              | $          | 1,936 |   | $ | 77 |   | $ | 1,948 |   |

 

NOTE10—DERIVATIVE FINANCIAL INSTRUMENTS

The Company holds fixed rate and variable ratefinancial assets that are funded by fixed rate and variable rateliabilities.  Consequently, they aresubject to the effects of changes in interest rates.  In response to this, the Company hasdeveloped an interest rate risk management policy with the objective ofmitigating financial exposure to changing interest rates.  These exposures are managed, in part, withthe use of derivatives but only to the extent necessary to meet the overallgoal of minimizing interest rate risk.

Derivatives are accounted for according to SFASNo. 133, Accounting for Derivative Instruments and Hedging Activities, asamended. This standard requires that all derivative instruments be recognizedin the financial statements and measured at fair value regardless of thepurpose or intent for holding them.  Toqualify for hedge accounting, the details of the hedging relationship must beformally documented at inception of the arrangement, including the riskmanagement objective, hedging strategy, hedged item, specific risks that arebeing hedged, the derivative instrument and how effectiveness is beingassessed.  The derivative must be highlyeffective in offsetting either changes in fair value or cash flows, asappropriate, for the risk being hedged. Effectiveness is evaluated on a retrospective and prospective basis. Ifa hedge relationship becomes ineffective, it no longer qualifies as a hedge.Any excess gains or

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lossesattributable to such ineffectiveness, as well as subsequent changes in the fairvalue of the derivative, are recognized in earnings.

The following is a summary of our derivativefinancial instruments and the related fair values:

|                              | ** ** | **June 30, 2006**          | ** ** | **December 31, 2005** | ** ** |
|------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                   | ** ** | **Notional  Amount**                 | ** ** | **Fair Value**             | ** ** | **Notional  Amount** | ** ** | **Fair Value** | ** ** |
| ** **                   | ** ** | **(Dollars in thousands)** | ** ** |
| Fair value hedges:           |       |                                 |       |                            |       |   |   |   |   |
| Interest rate  swaps         |       | $                                    | 50,000     |                            | $          | (132 | ) | $ | 20,000 |   | $ | (23 | ) |
|                         |       |                                 |       |                            |       |   |   |   |   |
| Cash flow hedges:            |       |                                 |       |                            |       |   |   |   |   |
| Interest rate  swaps         |       | $                                    | 50,000     |                            | $          | (1,872 | ) | $ | 50,000 |   | $ | (1,034 | ) |
| Interest rate floors         |       | $                                    | 50,000     |                            | $          | 21 |   | $ | 50,000 |   | $ | 268 |   |
|                         |       |                                 |       |                            |       |   |   |   |   |
| Other economic  derivatives: |       |                                 |       |                            |       |   |   |   |   |
| Interest rate  floors        |       | $                                    | —     |                            | $          | — |   | $ | 150,000 |   | $ | — |   |
| Interest rate swaps          |       | $                                    | 15,000     |                            | $          | (1,393 | ) | $ | 15,000 |   | $ | (575 | ) |

 

Fair value hedges minimize the risk of changesin the fair values of assets, liabilities and certain types of firmcommitments.  The Company uses interestrate swaps to hedge the changes in the fair values of its brokered certificatesof deposit.  The interest rate swapsresult in the Company paying or receiving the difference between the fixed andfloating rates at specified intervals calculated on the notional amounts.  The differential paid or received on suchinterest rate swaps are recognized as an adjustment to interest expense.  The net change in fair value of thederivatives and the hedged items is reported in earnings.  The fair value hedges are highly effectiveand therefore no ineffectiveness was recognized in current earnings related tothis swap.

Cash flow hedges use simple derivatives tooffset the variability of expected future cash flows.  The Company’s cash flow hedges includecertain interest rate swaps and interest rate floors used to manage theinterest rate risk associated with its significant volume of adjustable rateloans.  At June 30, 2006, a loss of $1.1million was recorded in accumulated other comprehensive income and noineffectiveness was recorded to earnings for the six months ended June 30, 2006related to these cash flow hedges.  Thepremiums paid for the interest rate floors are amortized over the life of thefloors.

Other economic derivatives not designated ashedges are interest rate swaps and interest rate floors that do not meet thestrict criteria for hedge accounting treatment. The Company does not utilize derivatives for purely speculativepurposes.  The Company uses derivativesto hedge exposures when it makes economic sense to do so, includingcircumstances in which the hedging relationship does not qualify for hedgeaccounting.  The Company uses

14

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aninterest rate swap to hedge the change in fair value of its junior subordinateddeferrable interest debentures, however, at June 30, 2006 and 2005 this swapwas not designated as a fair value hedge. Derivatives not designated as hedges are marked-to-market throughearnings as a trading gain or loss on economic derivatives.  The following table reflects the effect ofthe trading gains and losses on economic derivatives for the periods shown:
| ** **                                                       | ** ** | **Three Months ended** | ** ** | **Six Months ended** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                       | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **                                                       | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                       | ** ** | **(Dollars in thousands)**       | ** ** |
| Trading gain (loss) on  economic derivatives, gross              |       | $                                | (369       | )                              | $          | 582 |   | $ | (817 | ) | $ | 378 |   |
| Income tax benefit  (expense) related to economic derivatives    |       | (153                             | )          | 242                            |       | (339 | ) | 157 |   |
| Trading gain (loss) on economic derivatives, net of income taxes |       | $                                | (216       | )                              | $          | 340 |   | $ | (478 | ) | $ | 221 |   |

 

Thevalue of the swap is largely influenced by the level of current interest ratesand market participants’ expectations for the levels of future rates.  Accordingly, the value of the swap, and therelated trading gains or losses on economic derivatives can be expected tofluctuate from period to period, and the results in any period are notindicative of the results that can be expected in any future period.

NOTE11—RESTATEMENT

The financial statements as of December 31, 2005and June 30, 2005, and for the six months then ended, have been restated.  The restatement corrects errors in thefinancial statements related to the Company’s accounting under SFAS 133, forthe interest rate swap agreement entered into in connection with certaindebentures related to trust preferred securities and the related subordinateddebt (“Debt Transactions”).

In August 2006, the Company became aware that,in light of recent informal technical interpretations, its application of hedgeaccounting under paragraph 68 of SFAS No. 133 (commonly referred to as the“short-cut” method) for the interest rate swap on its Debt Transactions may notbe correct. After further examination and discussions with its auditors, the Companyconcluded that the swap transaction did not qualify for the short-cut method ofhedge accounting because of the interest deferral feature of the trustpreferred securities.  SFAS 133 does notallow for application of the “long-haul” method retrospectively.  Consequently, the swap did not qualify forhedge accounting and was marked-to-market from its inception, with the resultthat changes in the market value of the interest rate swap has been recordedthrough the income statement. There is no effect on cash flows from theserevisions.

The following table shows the effect of therestatement as of December 31, 2005:

15

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|                                               | ** ** | **December 31, 2005**      | ** ** |
|-----------------------------------------------|------------|--------------------------------------|------------|
| ** **                                    | ** ** | **As  Originally  Reported**         | ** ** | **As Restated** | ** ** |
| ** **                                    | ** ** | **(Dollars in thousands)** | ** ** |
| Deferred tax asset, net                       |       | $                                    | 4,203      |   | $ | 4,442 |   |
| Accrued interest  receivable and other assets |       | 4,583                                |       | 4,007 |   |
| Total assets                                  |       | 448,796                              |       | 448,459 |   |
|                                          |       |                                 |       |   |   |
| Accumulated deficit                           |       | (7,044                               | )          | (7,381 | ) |
| Total shareholders’ equity               |       | 38,499                               |       | 38,162 |   |
|                                               |            |                                      |            |  |  |  |  |

 

The following table shows the effect of therestatement for the periods shown:
|                                                                                           | ** ** | **Three Months Ended**     | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                | ** ** | **June 30, 2005**          | ** ** | **June 30, 2005**    | ** ** |
| ** **                                                                                | ** ** | **As  Originally  Reported**         | ** ** | **As Restated**           | ** ** | **As  Originally  Reported** | ** ** | **As Restated** | ** ** |
| ** **                                                                                | ** ** | **(Dollars in thousands)** | ** ** |
| Net interest income before provision for credit losses | ** ** | $                                    | 5,073      |                           | $          | 5,073 |   | $ | 9,934 |   | $ | 9,934 | ** ** |
|                                                                                      |       |                                 |       |                           |       |   |   |   |   |
| Net cash settlement of  interest rate swap derivative                                     |       | —                               |       | (100                           | )          | — |   | (216 | ) |
| Total net  interest income                                                                |       | 5,073                                |       | 4,973                          |       | 9,934 |   | 9,718 |   |
| Provision (benefit) for  credit losses                                                    |       | —                               |       | —                         |       | 89 |   | 89 |   |
| Net interest  income after provision for credit losses                                    |       | 5,073                                |       | 4,973                          |       | 9,845 |   | 9,629 |   |
| Total other operating  income                                                             |       | 299                                  |       | 299                            |       | 621 |   | 621 |   |
| Net cash  settlement of interest rate swap derivative                                     |       | —                               |       | 100                            |       | — |   | 216 |   |
| Change in fair  value of interest rate swap derivative                                    |       | —                               |       | 582                            |       | — |   | 378 |   |
| Total non-interest  income                                                                |       | 299                                  |       | 981                            |       | 621 |   | 1,215 |   |
| Total other operating  expenses                                                           |       | 3,599                                |       | 3,599                          |       | 7,085 |   | 7,085 |   |
| Income before  taxes                                                                      |       | 1,773                                |       | 2,355                          |       | 3,381 |   | 3,759 |   |
| Income tax expense                                                                        |       | 736                                  |       | 736                            |       | 1,403 |   | 1,403 |   |
| Income tax  effect on restatement                                                         |       | —                               |       | 241                            |       | — |   | 157 |   |
| Total income tax  expense                                                                 |       | 736                                  |       | 977                            |       | 1,403 |   | 1,560 |   |
| Net income                                                                                |       | $                                    | 1,037      |                           | $          | 1,378 |   | $ | 1,978 |   | $ | 2,199 |   |
|                                                                                      |       |                                 |       |                           |       |   |   |   |   |
| Net income per share –  Basic                                                        |       | $                                    | 0.27       |                           | $          | 0.35 |   | $ | 0.52 |   | $ | 0.58 |   |
| Net income per share – Diluted                                                       |       | $                                    | 0.18       |                           | $          | 0.23 |   | $ | 0.34 |   | $ | 0.38 |   |

 

NOTE 12—AGREEMENTAND PLAN OF MERGER

On June 15, 2006, National Mercantileentered into an Agreement and Plan of Merger (the “Merger Agreement”) with FCBBancorp, a California corporation (“FCB”), and First California FinancialGroup, Inc. (“FCFG”), a new Delaware corporation formed by NationalMercantile for the purpose of the merger transactions.  The Merger Agreement provides for thereincorporation merger of National Mercantile into FCFG immediately followed bythe merger of FCB into FCFG (together, the “Mergers”).

Consummation of the Mergers is subject to anumber of closing conditions, including approval by the shareholders of bothNational Mercantile and FCB and regulatory approval.

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NOTE13—RECLASSIFICATIONS

Certain prior year data has been reclassified toconform to the current year presentation.

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***Item2.******       MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS***

National MercantileBancorp (“National Mercantile” on a parent-only basis, and the ‘‘Company’’ or “we”on a consolidated basis) is the holding company for two subsidiary banks,Mercantile National Bank (“Mercantile”) and South Bay Bank, N.A. (“South Bay”)(collectively, “the Banks”).  NationalMercantile’s principal assets are the capital stock of Mercantile and SouthBay.  The per share data reflects thefive-for-four stock split paid April 14, 2006 to shareholders of record March31, 2006 as well as the conversion of the Series A Preferred stock to commonstock in June 2005.

The financial statementsfor each of the years ended 2003, 2004, 2005, and each of the quarters endedMarch 31, June 30, September 30, 2005 and March 31, 2006 have beenrestated.  The restatement correctserrors in the financial statements related to the Company’s accounting underSFAS 133, for the interest rate swap agreement entered into in connection withcertain debentures related to trust preferred securities and the relatedsubordinated debt (“Debt Transactions”). We determined that the interest rateswap did not qualify for short-cut hedge accounting treatment under SFAS 133,and consequently, was marked-to-market from its inception, with the result thatchanges in the market value of the interest rate swap has been recorded throughthe income statement

**RESULTSOF OPERATIONS OVERVIEW**

We recorded net incomeof $1.1 million, or $0.21 basic earnings per share and $0.19 diluted earningsper share, for the three months ended June 30, 2006 compared to net income of$1.4 million, or $0.35 basic earnings per share and $0.23 diluted earnings pershare, for the same period of 2005. The decrease in net income for the secondquarter of 2006 was due to a $369,000 of trading losses on economic derivativesrelated to an interest rate swap not designated as a hedge as compared to a$582,000 gain for the three months ended June 30, 2005, or a change of $951,000.  Net interest income before provision forcredit losses increase by $993,000 primarily due to increases in the prime ratelending index, and a greater volume of interest earning assets, particularlyhigher-yielding loans receivable and securities available-for-sale. Noninterestexpense for the second quarter of 2006 increased $220,000.  The Company adopted Statement of FinancialAccounting Standards No. 123R, Stock-Based Payments (SFAS 123R), January 1,2006 resulting in the recognition of compensation expense for unvested stockoptions and an after-tax charge of $100,000 to earnings for the three monthsended June 30, 2006.

We recorded net incomeof $2.2 million for both the six month periods ended June 30, 2006 and2005.  This represented $0.40 basic earningsper share and $0.37 diluted earnings per share, for the six months ended June30,

18

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2006 compared $0.58 basic earnings pershare and $0.38 diluted earnings per share for the same period of 2005.  While earnings were nearly unchanged for theperiods, there were significant changes in the composition of earnings.  The earnings for the 2006 period includes an$817,000 charge for trading losses on economic derivatives compared to a$378,000 trading gain for the 2005 period.   Also, for the six months ended June 30, 2006 net interest income beforethe provision for credit losses increased $2.0 million resulting from increasesin the prime rate lending index, and a greater volume of interest earningassets, particularly higher-yielding loans receivable and securitiesavailable-for-sale.  Noninterest expensefor the six months ended June 30, 2006 increased $466,000 over the same periodin 2005.  The compensation expense forunvested stock options under SFAS 123R resulted in an after-tax charge of$185,000 to earnings for the six months ended June 30, 2006.

Return on average assetsduring the second quarter and first half of 2006 was 0.94% and 0.93%,respectively, compared to 1.44% and 1.13% during the second quarter and firsthalf of 2005, respectively.  Return onaverage equity during the second quarter and first half of 2006 was 11.63% and11.17%, respectively, compared to 15.43% and 12.38% during the second quarterand first half of 2005.

NET INTEREST INCOME

Net interest incomebefore provision for loan losses increased $993,000 to $6.0 million for thethree months ended June 30, 2006 compared to $5.0 million for the same quarterof 2005 due to a $2.8 million increase in interest income offset by a $1.8million increase in interest expense.

Loan interest incomeincreased $1.9 million due to $48.5 million greater average volume of loansreceivable and a 110 basis point increase in yield, primarily due to increasesin the prime rate lending index.  During2005, the Federal Reserve Bank increased interest rates 200 basis points oneight occasions and, continuing into the first half of 2006, another 100 basispoints on four occasions.  Approximately80% of our $351 million loans receivable at June 30, 2006, have adjustableinterest rates; consequently, rising interest rates positively affect interestincome.  Conversely, declining interestrate environments have the potential to negatively impact our net interestincome.  In order to reduce the negativeimpact in the event of a decline in the prime rate lending index, we haveentered into interest rate swaps, in which we exchanged an adjustable rateinterest payment based on the prime rate lending index for a fixed rate paymenton an aggregate notional amount of $50.0 million.  The higher yields earned on our loansreceivable during the second quarter of 2006 were partially offset by therising cost of the interest rate swaps.

Interest income fromsecurities available-for-sale increased $942,000 to $1.3 million during thesecond quarter of 2006 compared to $377,000 for the same period of 2005 due to$57.8 million greater average volume and a 186 basis 

19

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point increase in yield.  During the third and fourth quarter of 2005and continuing into 2006, we have steadily added newly purchased securities toour investment portfolio as part of a strategy to further reduce the exposureof net interest income to a declining interest rate environment.  The additions to securities have beeninstruments that we expect to have limited prepayment of principal in the eventof declining interest rates (and muted term extension in rising interestrates).  These investments, as well asloans receivable, have been largely financed with adjustable rate wholesalefunds that will decline in cost in a falling interest rate environment.  The more recently purchased securities, in aperiod of higher interest rates, and the maturity of lower yielding securitiesin the portfolio, resulted in an increase in the portfolio yield.

Overall,interest-earning assets averaged $104.6 million greater during the secondquarter 2006 compared to 2005 while the higher interest rates and favorablechange in composition to higher-yielding assets resulted in an 89 basis pointincrease in weighted average yield on interest-earning assets.

Interest expenseincreased $1.8 million during the second quarter of 2006 compared to the sameperiod in 2005 due to a $108.2 million increase in average interest-bearingliabilities and a 157 basis point increase in the weighted average cost ofinterest-bearing liabilities.  Interestexpense on deposits increased $1.4 million due to a 163 basis point rise inweighted average cost of interest-bearing deposits in addition to $45.4 milliongreater average volume than 2005.  Timecertificates of deposit $100,000 and over averaged $47.5 million greater duringthe second quarter 2006 than the same period in 2005 due to an increased volumeof brokered certificates of deposit (“Brokered CDs”).  The volume of money market and savingsdeposits increased $27.9 million during the second quarter of 2006 compared tosecond quarter of 2005 while time certificates of deposit under $100.000declined $2.1 million.

During the risinginterest rate environment experienced during the past eight quarters, westrategically elected to only moderately increase transaction deposit rates andto fund asset growth, and runoff of these deposits, with Brokered CDs.  Although this type of funding is typicallyhigher costing and exhibits higher interest rate sensitivity, the Brokered CDsfacilitate our liquidity and interest rate risk management that we utilize toreduce our net interest income exposure to possible declining interestrates.  The greater interest expense onthe incremental Brokered CDs needed to fund asset growth is less than theimpact of increasing rates on the significantly greater volume of transactionaccounts.  As market interest ratescontinue to rise, the cost of our deposits has been increasing more rapidly dueto more frequent exceptions to our posted interest rates granted to depositorsin order to prevent deposit withdrawals.

The cost of timecertificates of deposit $100,000 and over increased 199 basis points during thesecond quarter of 2006 compared to second quarter 2005.  The cost of money market and savings depositsincreased 159 basis points 

20

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while the cost of interest-bearing demanddeposits and time certificates of deposit under $100,000 increased 30 basispoints and 94 basis points, respectively.

The volume of otherborrowings averaged $10.9 million and $5.4 million during the second quarter of2006 and 2005, respectively.   Wecontinue to employ a liquidity strategy of maintaining relatively low levels ofshort-term assets and utilizing Federal Home Loan Bank overnight advances,against pledged loans and securities, to fund asset and depositfluctuations.  Minimizing short-termassets and increasing short-term liabilities furthers the interest rate riskmanagement of our asset sensitive balance sheet.  The cost of other borrowings was 5.14% and2.89% for 2006 and 2005 periods, respectively, representing an increase of  225 basis points for the second quarter of2006.

Securities sold underagreement to repurchase (“Repurchase Agreements”) averaged $28.4 million duringthe second quarter of 2006 with a cost of 5.18%.  The Repurchase Agreements, totaling $45million at June 30, 2006 with adjustable interest rate based upon the 3-monthLIBOR index and have embedded floors with varying strike rates ranging from4.00% to 4.75%, further our interest rate risk management objectives.  In the event that the LIBOR index declinesbelow the strike rate, the cost of the Repurchase Agreements will decline atdouble the difference between the LIBOR index and the strike rate.   We had no Repurchase Agreements during 2005.

Noninterest-bearingdemand deposits averaged $115.5 million during the second quarter 2006 or $10.9million less than during the same quarter in 2005.  Rising interest rates increase depositors’opportunity cost of noninterest-bearing deposits and their sensitivity tomaintaining such balances, resulting in the redeployment of their funds intohigher yielding deposits and alternative investments outside the Banks.

The net yield on interest earning assets (net interestmargin) was 5.26% and 5.69% during the second quarter in 2006 and 2005,respectively, while the net interest spread was 4.25% and 4.93%,respectively.  The net interest marginand net interest spread during the second quarter of 2006 have declined fromrecent quarters largely due to the securities leverage strategy – intermediate-termsecurity purchases financed with adjustable wholesale funds – executed toreduce our balance sheet asset sensitivity. While the strategy protects against a possible decline in interestrates, the current margin on such leverage is relatively thin.  Also, the second quarter of 2006 continued toexperience a flat or inverted yield curve in which short-term rates have risento or above the level of long-term interest rates.  A preponderance of our funding sources arecorrelated to the short-term rates. Additionally, the net interest spread has been effected by a decline innet earning assets due to a lower proportion of noninterest-bearing depositsfunding earning assets.

21

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Net interest incomeincreased $1.9 million to $11.7 million for the six months ended June 30, 2006compared to the same period of 2005 due to a $5.0 million increase in interestincome offset by a $3.1 million increase in interest expense.

Loan interest incomeincreased $3.5 million to $14.6 million due to $41.3 million greater averagevolume of loans receivable and a 114 basis point increase in yield, resultingprimarily from increases in the prime rate lending index.  The higher yields earned on our loansreceivable during the first half of 2006 were partially offset by the risingcost of the interest rate swaps.

Interest income fromsecurities available-for-sale increased $1.6 million to $2.3 million during thefirst half of 2006 compared to the same period of 2005 due to $47.9 milliongreater average volume and a 175 basis point increase in yield.  As discussed above, we have been steadilyadding to securities available-for-sale and the more recently purchasedsecurities, in a period of higher interest rates, resulted in an increase inthe portfolio yield.

Overall, interest-earningassets were $86.8 million greater during 2006 period than 2005 while the higherinterest rates and favorable change in composition to higher-yielding assetsresulted in a 96 basis point increase in weighted average yield oninterest-earning assets.

Interest expenseincreased $3.1 million during the first half of 2006 compared to the sameperiod in 2005 due to a $88.1 million increase in average interest-bearingliabilities and a 142 basis point increase in the weighted average cost ofinterest-bearing liabilities.  Interestexpense on deposits increased $2.3 million due to a 147 basis point rise inweighted average cost of interest-bearing deposits in addition to $62.6 milliongreater average volume than 2005.  Timecertificates of deposit $100,000 and over averaged $46.6 million greater duringthe 2006 period than 2005 due to an increased volume of Brokered CDs.  The average volume of money market andsavings deposits increased $17.9 million during the first half of 2006 comparedto first half of 2005.

The cost of timecertificates of deposit $100,000 and over increased 177 basis points during thefirst half of 2006 compared to first half 2005. The cost of money market and savings deposits increased 145 basis pointswhile the cost of certificates of deposit under $100,000 increased 91 basispoints.

The volume of otherborrowings averaged $15.3 million and $10.2 million during the first half of2006 and 2005, respectively.  The cost ofother borrowings was 4.78% and 2.62% for 2006 and 2005 periods, respectively,representing an increase of 216 basis points for the first half of 2006.

Repurchase Agreementsaveraged $20.4 million during the first half of 2006 with a cost of 5.06%.  We had no Repurchase Agreements during 2005.

22

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Noninterest-bearingdemand deposits averaged $114.4 million during the first half of 2006 or $9.5million less than during the same period in 2005.  Depositors have redeployed theirnoninterest-bearing demand deposits into higher yield, yet accessible, moneymarket deposits as short-term interest rates have risen.

The net yield on interest earning assets (net interestmargin) was 5.35% and 5.55% during the first half in 2006 and 2005,respectively, while the net interest spread was 4.39% and 4.85%,respectively.  Similar to the quarterly results,the net interest margin and net interest spread during the first half of 2006have declined from recent quarters due to (i) the securities leverage strategy,(ii) a more rapid rise in the cost of fund than in the yield on earnings assetsdue to the flat yield curve, (iii) a change in the mix of deposits to highercosting types, and (iv) a smaller proportion of noninterest bearing depositsfunding earning assets.

The following tablepresents the components of net interest income for the three months ended June30, 2006 and 2005.

23

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| ** **                                                                                     | ** ** | **Three Months ended**     | ** ** |
|------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                     | ** ** | **June 30, 2006**          | ** ** | **June 30, 2005** | ** ** |
| ** **                                                                                     | ** ** | ** **                           | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                                                                     | ** ** | ** **                           | ** ** | **Interest** | ** ** | **Average** | ** ** | ** ** | ** ** | **Interest** | ** ** | **Average** | ** ** |
| ** **                                                                                     | ** ** | **Average**                          | ** ** | **Income/** | ** ** | **Yield/** | ** ** | **Average** | ** ** | **Income/** | ** ** | **Yield/** | ** ** |
| ** **                                                                                     | ** ** | **Amount**                           | ** ** | **Expense** | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Expense** | ** ** | **Rate** | ** ** |
| ** **                                                                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Assets:                                                                                        |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Federal funds  sold and securities purchased under agreements to resell                        |       | $                                    | 1,211      |   | $ | 13 |   | 4.31 | % | $ | 2,526 |   | $ | 19 |   | 3.02 | % |
| Due from  banks-interest-bearing                                                               |       | 2,500                                |       | 30 |   | 4.81 | % | 2,032 |   | 18 |   | 3.55 | % |
| Securities  available-for-sale                                                                 |       | 98,047                               |       | 1,295 |   | 5.30 | % | 40,235 |   | 346 |   | 3.44 | % |
| Securities  held-to-maturity                                                                   |       | 2,372                                |       | 24 |   | 4.06 | % | 3,194 |   | 31 |   | 3.88 | % |
| Loans receivable  (1) (2)                                                                      |       | 350,878                              |       | 7,551 |   | 8.63 | % | 302,382 |   | 5,675 |   | 7.53 | % |
| Total interest earning assets                                                                  |       | 455,008                              |       | 8,913 |   | 7.86 | % | 350,369 |   | 6,089 |   | 6.97 | % |
|                                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Noninterest  earning assets:                                                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks - demand                                                               |       | 16,636                               |       |   |   |   |   | 16,352 |   |   |   |   |   |
| Other assets                                                                                   |       | 22,370                               |       |   |   |   |   | 20,881 |   |   |   |   |   |
| Allowance for credit losses and net unrealized gain  on sales of securities available-for-sale |       | (6,642                               | )          |   |   |   |   | (4,358 | ) |   |   |   |   |
| Total assets                                                                                   |       | $                                    | 487,372    |   |   |   |   |   | $ | 383,244 |   |   |   |   |   |
|                                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Liabilities and  shareholders’ equity:                                                    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  deposits:                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Demand                                                                                         |       | $                                    | 32,056     |   | 60 |   | 0.75 | % | $ | 30,865 |   | 35 |   | 0.45 | % |
| Money market and savings                                                                       |       | 125,394                              |       | 797 |   | 2.55 | % | 97,512 |   | 234 |   | 0.96 | % |
| Time certificates of deposit:                                                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| $100,000 or more                                                                               |       | 91,657                               |       | 991 |   | 4.34 | % | 44,198 |   | 259 |   | 2.35 | % |
| Under $100,000                                                                                 |       | 24,032                               |       | 196 |   | 3.27 | % | 26,175 |   | 152 |   | 2.33 | % |
| Total time certificates of deposit                                                             |       | 115,689                              |       | 1,187 |   | 4.12 | % | 70,373 |   | 411 |   | 2.34 | % |
| Total interest-bearing deposits                                                                |       | 273,139                              |       | 2,044 |   | 3.00 | % | 198,750 |   | 680 |   | 1.37 | % |
| Other borrowings                                                                               |       | 10,853                               |       | 139 |   | 5.14 | % | 5,404 |   | 39 |   | 2.89 | % |
| Junior  subordinated debentures                                                                |       | 15,464                               |       | 397 |   | 10.30 | % | 15,464 |   | 397 |   | 10.30 | % |
| Federal funds  purchased and securities sold under agreements to repurchase                    |       | 28,406                               |       | 367 |   | 5.18 | % | — |   | — |   | — |   |
| Total interest-bearing liabilities                                                             |       | 327,862                              |       | 2,947 |   | 3.61 | % | 219,618 |   | 1,116 |   | 2.04 | % |
|                                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities:                                                              |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing demand deposits                                                            |       | 115,474                              |       |   |   |   |   | 126,399 |   |   |   |   |   |
| Other liabilities                                                                              |       | 4,628                                |       |   |   |   |   | 1,497 |   |   |   |   |   |
| Shareholders’  equity                                                                     |       | 39,408                               |       |   |   |   |   | 35,730 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity                                               |       | $                                    | 487,372    |   |   |   |   |   | $ | 383,244 |   |   |   |   |   |
|                                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net interest income  (spread)                                                                  |       |                                 |       | $ | 5,966 |   | 4.25 | % |   |   | $ | 4,973 |   | 4.93 | % |
|                                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net yield on  earning assets (2)                                                               |       |                                 |       |   |   | 5.26 | % |   |   |   |   | 5.69 | % |

 

----

(1)   The average balance of nonperforming loans has been included in loansreceivable.

(2)   Yields and amounts earned on loans receivable include loan fees of$639,000 and $437,000 for the three months ended June 30, 2006 and 2005,respectively.

The following table presents thecomponents of net interest income for the six months ended June 30, 2006 and2005.

24

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| ** **                                                                                     | ** ** | **Six Months ended**       | ** ** |
|------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                     | ** ** | **June 30, 2006**          | ** ** | **June 30, 2005** | ** ** |
| ** **                                                                                     | ** ** | ** **                           | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                                                                     | ** ** | ** **                           | ** ** | **Interest** | ** ** | **Average** | ** ** | ** ** | ** ** | **Interest** | ** ** | **Average** | ** ** |
| ** **                                                                                     | ** ** | **Average**                          | ** ** | **Income/** | ** ** | **Yield/** | ** ** | **Average** | ** ** | **Income/** | ** ** | **Yield/** | ** ** |
| ** **                                                                                     | ** ** | **Amount**                           | ** ** | **Expense** | ** ** | **Rate** | ** ** | **Amount** | ** ** | **Expense** | ** ** | **Rate** | ** ** |
| ** **                                                                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Assets:                                                                                        |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Federal funds  sold and securities purchased under agreements to resell                        |       | $                                    | 829        |   | $ | 18 |   | 4.38 | % | $ | 2,098 |   | $ | 29 |   | 2.79 | % |
| Due from  banks-interest-bearing                                                               |       | 2,103                                |       | 51 |   | 4.89 | % | 2,378 |   | 34 |   | 2.88 | % |
| Securities  available-for-sale                                                                 |       | 87,950                               |       | 2,254 |   | 5.17 | % | 40,073 |   | 680 |   | 3.42 | % |
| Securities  held-to-maturity                                                                   |       | 2,459                                |       | 50 |   | 4.10 | % | 3,304 |   | 65 |   | 3.97 | % |
| Loans receivable  (1) (2)                                                                      |       | 346,831                              |       | 14,591 |   | 8.48 | % | 305,556 |   | 11,118 |   | 7.34 | % |
| Total interest earning assets                                                                  |       | 440,172                              |       | 16,964 |   | 7.77 | % | 353,409 |   | 11,926 |   | 6.81 | % |
|                                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Noninterest earning  assets:                                                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks - demand                                                               |       | 15,814                               |       |   |   |   |   | 17,736 |   |   |   |   |   |
| Other assets                                                                                   |       | 23,008                               |       |   |   |   |   | 20,726 |   |   |   |   |   |
| Allowance for credit losses and net unrealized gain  on sales of securities available-for-sale |       | (5,940                               | )          |   |   |   |   | (4,213 | ) |   |   |   |   |
| Total assets                                                                                   |       | $                                    | 473,054    |   |   |   |   |   | $ | 387,658 |   |   |   |   |   |
|                                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Liabilities and  shareholders’ equity:                                                    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  deposits:                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Demand                                                                                         |       | $                                    | 32,478     |   | 102 |   | 0.63 | % | $ | 31,448 |   | 67 |   | 0.43 | % |
| Money market and savings                                                                       |       | 118,180                              |       | 1,381 |   | 2.36 | % | 100,307 |   | 454 |   | 0.91 | % |
| Time certificates of deposit:                                                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| $100,000 or more                                                                               |       | 88,917                               |       | 1,759 |   | 3.99 | % | 42,352 |   | 467 |   | 2.22 | % |
| Under $100,000                                                                                 |       | 24,096                               |       | 372 |   | 3.11 | % | 26,973 |   | 294 |   | 2.20 | % |
| Total time certificates of deposit                                                             |       | 113,013                              |       | 2,131 |   | 3.80 | % | 69,325 |   | 761 |   | 2.21 | % |
| Total interest-bearing deposits                                                                |       | 263,671                              |       | 3,614 |   | 2.76 | % | 201,080 |   | 1,282 |   | 1.29 | % |
| Other borrowings                                                                               |       | 15,326                               |       | 363 |   | 4.78 | % | 10,244 |   | 133 |   | 2.62 | % |
| Junior  subordinated debentures                                                                |       | 15,464                               |       | 793 |   | 10.34 | % | 15,464 |   | 793 |   | 10.34 | % |
| Federal funds  purchased and securities sold under agreements to repurchase                    |       | 20,415                               |       | 512 |   | 5.06 | % | — |   | — |   | 0.00 | % |
| Total interest-bearing liabilities                                                             |       | 314,876                              |       | 5,282 |   | 3.38 | % | 226,788 |   | 2,208 |   | 1.96 | % |
|                                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities                                                               |       |                                 | :          |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing demand deposits                                                            |       | 114,428                              |       |   |   |   |   | 123,917 |   |   |   |   |   |
| Other liabilities                                                                              |       | 4,329                                |       |   |   |   |   | 1,423 |   |   |   |   |   |
| Shareholders’  equity                                                                     |       | 39,421                               |       |   |   |   |   | 35,530 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity                                               |       | $                                    | 473,054    |   |   |   |   |   | $ | 387,658 |   |   |   |   |   |
|                                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  income (spread)                                                                  |       |                                 |       | $ | 11,682 |   | 4.39 | % |   |   | $ | 9,718 |   | 4.85 | % |
|                                                                                           |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net yield on  earning assets (2)                                                               |       |                                 |       |   |   | 5.35 | % |   |   |   |   | 5.55 | % |

 

----

(1)   The average balance of nonperforming loans hasbeen included in loans receivable.

(2)   Yields and amounts earned on loans receivableinclude loan fees of $980,000 and $860,000 for the six months ended June 30,2006 and 2005, respectively.

 

The following table setsforth, for the periods indicated, the changes in interest earned and interestpaid resulting from changes in volume and changes in rates.  Average balances in all categories in eachreported period were used in the volume computations.  Average yields and rates in each reportedperiod were used in rate computations.

25

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**Increase (Decrease) in InterestIncome/Expense Due to Change in**

**AverageVolume and Average Rate (1)**

 

|                                                                             | ** ** | **Three Months ended June 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2006 vs 2005**                          | ** ** |
| ** **                                                                  | ** ** | ** **                                          | ** ** | ** ** | ** ** | **Net** | ** ** |
| ** **                                                                  | ** ** | **Increase (decrease) due to:**      | ** ** | **Increase** | ** ** |
| ** **                                                                  | ** ** | **Volume**                                          | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| ** **                                                                  | ** ** | **(Dollars in thousands)**                | ** ** |
| Interest Income:                                                            |       |                                                |       |   |   |   |   |
| Federal funds sold and securities purchased                                 |       |                                                |       |   |   |   |   |
| Federal funds sold                                                          |       | $                                                   | (10        | ) | $ | 4 |   | $ | (6 | ) |
| Interest-bearing deposits with other financial  institutions                |       | 4                                                   |       | 8 |   | 12 |   |
| Securities available-for-sale                                               |       | 496                                                 |       | 453 |   | 949 |   |
| Securities held-to-maturity                                                 |       | (8                                                  | )          | 1 |   | (7 | ) |
| Loans receivable (2)                                                        |       | 910                                                 |       | 966 |   | 1,876 |   |
| Total interest-earning assets                                               |       | 1,392                                               |       | 1,432 |   | 2,824 |   |
|                                                                        |       |                                                |       |   |   |   |   |
| Interest  Expense:                                                          |       |                                                |       |   |   |   |   |
| Interest-bearing deposits:                                                  |       |                                                |       |   |   |   |   |
| Demand                                                                      |       | $                                                   | 1          |   | $ | 24 |   | $ | 25 |   |
| Money market and savings                                                    |       | 67                                                  |       | 496 |   | 563 |   |
| Savings                                                                     |       |                                                |       |   |   |   |   |
| Time certificates of deposit:                                               |       |                                                |       |   |   |   |   |
| $100,000 or more                                                            |       | 278                                                 |       | 454 |   | 732 |   |
| Under $100,000                                                              |       | (12                                                 | )          | 56 |   | 44 |   |
| Total time certificates of deposit                                          |       | 266                                                 |       | 510 |   | 776 |   |
| Total interest-bearing deposits                                             |       | 334                                                 |       | 1,030 |   | 1,364 |   |
| Other borrowings                                                            |       | 39                                                  |       | 61 |   | (100 | ) |
| Junior subordinated debentures                                              |       | —                                              |       | — |   | — |   |
| Federal funds purchased and securities sold under  agreements to repurchase |       | 367                                                 |       | — |   | 367 |   |
| Total interest-bearing liabilities                                          |       | 740                                                 |       | 1,091 |   | 1,831 |   |
|                                                                        |       |                                                |       |   |   |   |   |
| Net interest income                                                         |       | $                                                   | 652        |   | $ | 341 |   | $ | 993 |   |

 

----

(1)   The change in interest income or interestexpense that is attributable to both changes in average balance, average rateand days in the quarter has been allocated to the changes due to (i) averagebalance and (ii) average rate in proportion to the rel

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

26

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| ** **                                                                  | ** ** | **Six Months ended June 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2006 vs 2005**                        | ** ** |
| ** **                                                                  | ** ** | ** **                                        | ** ** | ** ** | ** ** | **Net** | ** ** |
| ** **                                                                  | ** ** | **Increase (decrease) due to:**    | ** ** | **Increase** | ** ** |
| ** **                                                                  | ** ** | **Volume**                                        | ** ** | **Rate** | ** ** | **(Decrease)** | ** ** |
| ** **                                                                  | ** ** | **(Dollars in thousands)**              | ** ** |
|                                                                        |       |                                              |       |   |   |   |   |
| Interest Income:                                                            |       |                                              |       |   |   |   |   |
| Federal funds sold                                                          |       | $                                                 | (18        | ) | $ | 7 |   | $ | (11 | ) |
| Interest-bearing deposits with other financial  institutions                |       | (4                                                | )          | 21 |   | 17 |   |
| Securities available-for-sale                                               |       | 812                                               |       | 762 |   | 1,574 |   |
| Securities held-to-maturity                                                 |       | (17                                               | )          | 2 |   | (15 | ) |
| Loans receivable (2)                                                        |       | 1,502                                             |       | 1,971 |   | 3,473 |   |
| Total interest-earning assets                                               |       | 2,275                                             |       | 2,763 |   | 5,038 |   |
|                                                                        |       |                                              |       |   |   |   |   |
| Interest  Expense:                                                          |       |                                              |       |   |   |   |   |
| Interest-bearing deposits:                                                  |       |                                              |       |   |   |   |   |
| Demand                                                                      |       | $                                                 | 2          |   | $ | 33 |   | $ | 35 |   |
| Money market and savings                                                    |       | 81                                                |       | 846 |   | 927 |   |
| Time certificates of deposit:                                               |       |                                              |       |   |   |   |   |
| $100,000 or more                                                            |       | 513                                               |       | 779 |   | 1,292 |   |
| Under $100,000                                                              |       | (31                                               | )          | 109 |   | 78 |   |
| Total time certificates of deposit                                          |       | 482                                               |       | 888 |   | 1,370 |   |
| Total interest-bearing deposits                                             |       | 565                                               |       | 1,767 |   | 2,332 |   |
| Other borrowings                                                            |       | 66                                                |       | 164 |   | 230 |   |
| Junior subordinated debentures                                              |       | —                                            |       | — |   | — |   |
| Federal funds purchased and securities sold under  agreements to repurchase |       | 512                                               |       | — |   | 512 |   |
| Total interest-bearing liabilities                                          |       | 1,143                                             |       | 1,931 |   | 3,074 |   |
|                                                                        |       |                                              |       |   |   |   |   |
| Net interest income                                                         |       | $                                                 | 1,132      |   | $ | 832 |   | $ | 1,964 |   |

 

----

(1)   The change in interest income or interestexpense that is attributable to both changes in average balance, average rateand days in the quarter has been allocated to the changes due to (i) averagebalance and (ii) average rate in proportion to the rel

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

 

PROVISION FOR CREDIT LOSSES

We recorded provisionsfor credit losses of $40,000 for the second quarter 2006 and $72,000 for thesix months ended June 30, 2006, reflecting (i) the growth in loans receivablepartially offset by a decrease in unfunded loan commitments, and (ii) a changein portfolio credit migration, compared to no provision for the second quarter2005 and $89,000 for the six months ended June 30, 2005.  During the first half of 2006, we charged offloans receivable of $1,000, compared to $6,000 for the same period 2005.

27

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OTHER OPERATING INCOME (LOSS)

During the three monthsand six months ended June 30, 2006 we recorded other operating losses of$76,000 and $159,000, respectively, compared to other operating income of$981,000 and $1.2 million for the three months and six months ended June 30,2005.  The change between the 2006 and2005 quarters was due to a $369,000 charge for trading losses on economicderivatives in 2006 compared to a $582,000 credit in 2005.  Similarly the 2006 first half included an$817,000 charge compared to $378,000 credit in 2005.

Deposit-related feesdecreased in 2006 compared to 2005 due to higher compensating balance rates andchanges in fee structure.  Otheroperating income includes the net settlement payments on the interest rate swapnot designated as a hedge.  The 2006periods reflect a decline in net settlement payments under this swap due torising interest rates.

Other operating incomefor the first half of 2006 included a $47,000 gain on the sale of other realestate owned acquired through foreclosure and an increase in internationalservices fees.

OTHER OPERATINGEXPENSES

Otheroperating expenses were $3.8 million for the three months ended June 30, 2006compared to $3.6 million for the same period of 2005. Significant varianceswithin operating expenses were: (i) salaries and related benefits expenseincreased $345,000 or 18.7% due to the adoption of SFAS 123R requiring stockoptions to be expensed, the addition of business development staff andincreased incentive expense; (ii) legal services expense decreased $288,000 or93.5% primarily due to fewer problem assets and the decline in related legalactivity; and (iii) other professional services expense increased $65,000 or22.8% due to increased costs for audit services, recruiting fees and directors’fees.

Otheroperating expenses were $7.5 million for the six months ended June 30, 2006compared to $7.1 million for the same period of 2005. Significant varianceswithin operating expenses were, similar to the quarterly results, (i) salariesand related benefits expense increased $596,000 or 16.2% due to the adoption ofSFAS 123R, which accounted for $185,000 of this increase, and the addition ofbusiness development staff and increased incentive expense; (ii) legal servicesexpense decreased $362,000 or 79.4% primarily due to fewer problem assets andthe decline in related legal activity; and (iii) other professional servicesexpense increased $115,000 or 21.3% due to increased costs for audit services,recruiting fees and directors’ fees.

28

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***BALANCE SHEET ANALYSIS***

 

INVESTMENT SECURITIES

 

The following comparativeperiod-end table sets forth certain information concerning the estimated fairvalues and unrealized gains and losses of securities available-for-sale andsecurities held-to-maturity.

29

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**EstimatedFair Values of and Unrealized**

**Gainsand Losses on Securities**
| ** **                                                                | ** ** | **June 30, 2006**          | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                | ** ** | **Total**                            | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                                                | ** ** | **amortized**                        | ** ** | **unrealized** | ** ** | **unrealized** | ** ** | **fair** | ** ** |
| ** **                                                                | ** ** | **cost**                             | ** ** | **gains** | ** ** | **loss** | ** ** | **value** | ** ** |
| ** **                                                                | ** ** | **(Dollars in thousands)** | ** ** |
| **Available-for-Sale:**                                                   |       |                                 |       |   |   |   |   |   |   |
| U.S. Treasury  securities                                                 |       | $                                    | 599        |   | $ | — |   | $ | 7 |   | $ | 592 |   |
| GNMA-issued/guaranteed  mortgage pass through certificates                |       | 83                                   |       | — |   | — |   | 83 |   |
| Other U.S. Government  and federal agency securities                      |       | 10,183                               |       | — |   | 184 |   | 9,999 |   |
| FHLMC/FNMA-issued  mortgage pass through certificates                     |       | 56,086                               |       | 22 |   | 1,990 |   | 54,118 |   |
| CMO’s and REMIC’s  issued by U.S. government-sponsored agencies |       | 8,373                                |       | — |   | 67 |   | 8,306 |   |
| Privately issued  corporate bonds, CMO and REMIC securities               |       | 29,253                               |       | 13 |   | 663 |   | 28,603 |   |
|                                                                      |       | $                                    | 104,577    |   | $ | 35 |   | $ | 2,911 |   | $ | 101,701 |   |
|                                                                      |       |                                 |       |   |   |   |   |   |   |
| FRB and other equity stocks                                               |       | $                                    | 3,682      |   | — |   | — |   | $ | 3,682 |   |

 
| ** **                                            | ** ** | **June 30, 2006**          | ** ** |
|-------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                            | ** ** | **Total**                            | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                            | ** ** | **amortized**                        | ** ** | **unrealized** | ** ** | **unrealized** | ** ** | **fair** | ** ** |
| ** **                                            | ** ** | **cost**                             | ** ** | **gains** | ** ** | **loss** | ** ** | **value** | ** ** |
| ** **                                            | ** ** | **(Dollars in thousands)** | ** ** |
| **Held-to-Maturity:**                                 |       |                                 |       |   |   |   |   |   |   |
| FHLMC/FNMA-issued  mortgage pass through certificates |       | $                                    | 2,269      |   | $ | — |   | $ | 92 |   | $ | 2,177 |   |
|                                                  |       |                                 |       |   |   |   |   |   |   |
|                                                  |       | $                                    | 2,269      |   | $ | — |   | $ | 92 |   | $ | 2,177 |   |

 
| ** **                                                                | ** ** | **December 31, 2005**      | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                | ** ** | **Total**                            | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                                                | ** ** | **amortized**                        | ** ** | **unrealized** | ** ** | **unrealized** | ** ** | **fair** | ** ** |
| ** **                                                                | ** ** | **cost**                             | ** ** | **gains** | ** ** | **loss** | ** ** | **value** | ** ** |
| ** **                                                                | ** ** | **(Dollars in thousands)** | ** ** |
| **Available-For-Sale:**                                                   |       |                                 |       |   |   |   |   |   |   |
| U.S. Treasury  securities                                                 |       | $                                    | 599        |   | $ | — |   | $ | — |   | $ | 599 |   |
| GNMA-issued/guaranteed  mortgage pass through certificates                |       | 98                                   |       | 2 |   | — |   | 100 |   |
| Other U.S. government  and federal agency securities                      |       | 17,931                               |       | — |   | 152 |   | 17,779 |   |
| FHLMC/FNMA-issued mortgage  pass through certificates                     |       | 33,982                               |       | 47 |   | 366 |   | 33,663 |   |
| CMO’s and REMIC’s  issued by U.S. government-sponsored agencies |       | 2,528                                |       | 13 |   | — |   | 2,541 |   |
| Privately issued  corporate bonds, CMO and REMIC securities               |       | 17,290                               |       | 3 |   | 217 |   | 17,076 |   |
|                                                                      |       | $                                    | 72,428     |   | $ | 65 |   | $ | 735 |   | $ | 71,758 |   |
|                                                                      |       |                                 |       |   |   |   |   |   |   |
| FRB and other equity stocks                                               |       | $                                    | 3,809      |   | — |   | — |   | $ | 3,809 |   |

 
| ** **                                            | ** ** | **December 31, 2005**      | ** ** |
|-------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                            | ** ** | **Total**                            | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                            | ** ** | **amortized**                        | ** ** | **unrealized** | ** ** | **unrealized** | ** ** | **fair** | ** ** |
| ** **                                            | ** ** | **cost**                             | ** ** | **gains** | ** ** | **loss** | ** ** | **value** | ** ** |
| ** **                                            | ** ** | **(Dollars in thousands)** | ** ** |
|                                                  |       |                                 |       |   |   |   |   |   |   |
| **Held-to-Maturity:**                                 |       |                                 |       |   |   |   |   |   |   |
| FHLMC/FNMA-issued  mortgage pass through certificates |       | $                                    | 2,612      |   | $ | — |   | $ | 40 |   | $ | 2,572 |   |
|                                                  |       |                                 |       |   |   |   |   |   |   |
|                                                  |       | $                                    | 2,612      |   | $ | — |   | $ | 40 |   | $ | 2,572 |   |

 

30

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As of June 30,2006, we did not hold securities of any issuer, other than U.S.government-chartered agencies, the aggregate book value of which exceeded 10%of our shareholders’ equity.  At June 30,2006 and December 31, 2005, we had no securities determined to beother-than-temporarily impaired.

LOAN PORTFOLIO

Thefollowing comparative period-end table sets forth certain informationconcerning the composition of the loan portfolio.
|                                                                       | ** ** | **June 30,**                    | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                                                            | ** ** | **2006**                             | ** ** | **2005**              | ** ** |
| ** **                                                            | ** ** | **Amount**                           | ** ** | **Percent**           | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                                                            | ** ** | **(Dollars in thousands)** | ** ** |
| Commercial loans  - secured and unsecured                             |       | $                                    | 91,485     |                  | 26         | % | $ | 89,474 |   | 26 | % |
| Real estate  loans:                                                   |       |                                 |       |                  |       |   |   |   |   |
| Secured by commercial real properties.                                |       | 137,177                              |       | 39                    | %          | 121,641 |   | 36 | % |
| Secured by one to four family residential properties                  |       | 8,431                                |       | 2                     | %          | 10,498 |   | 3 | % |
| Secured by multifamily residential properties                         |       | 18,786                               |       | 5                     | %          | 18,663 |   | 6 | % |
| Total real estate loans                                               |       | 164,394                              |       | 47                    | %          | 150,802 |   | 45 | % |
| Construction and  land development                                    |       | 88,717                               |       | 25                    | %          | 92,077 |   | 27 | % |
| Consumer  installment, home equity and unsecured loans to individuals |       | 7,686                                |       | 2                     | %          | 7,239 |   | 2 | % |
| Total loans outstanding                                               |       | 352,282                              |       | 100                   | %          | 339,592 |   | 100 | % |
|                                                                  |       |                                 |       |                  |       |   |   |   |   |
| Deferred net  loan origination fees                                   |       | (1,053                               | )          |                  |       | (1,034 | ) |   |   |
| Loans receivable, net                                                 |       | $                                    | 351,229    |                  |       |   | $ | 338,558 |   |   |   |

 

Loansreceivable increased $12.7 million to $351.2 million at June 30, 2006 comparedto $338.6 million at December 31, 2005 primarily due to increased funding of commercialreal estate loans and to a lesser extent, secured and unsecured commercialloans.  We have increased funding ofintermediate-term fixed rate commercial real estate loans as part of ourinterest rate risk management strategy. The balance of construction loansdeclined at June 30, 2006 from year end 2005 due to a greater volume of payoffsof outstanding loans than additional funding of loan commitments and newlygenerated loans.  Commitments to fund loansat June 30, 2006 totaled $95.0 million compared to $116.7 million at December31, 2005.

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NONPERFORMINGASSETS

Thefollowing comparative period-end table sets forth certain informationconcerning nonperforming assets.  
|                                                                                                                             | ** ** | **June 30,**                    | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                  | ** ** | **2006**                             | ** ** | **2005**              | ** ** |
| ** **                                                                                                                  | ** ** | **(Dollars in thousands)** | ** ** |
|                                                                                                                        |       |                                 |       |                  |       |
| Nonaccrual loans                                                                                                            |       | $                                    | 343        |                  | $          | 319 |   |
| Troubled debt  restructurings                                                                                               |       | —                               |       | —                |       |
| Loans  contractually past due ninety or more days with respect to either principal  or interest and still accruing interest |       | —                               |       | —                |       |
| Nonperforming  loans                                                                                                        |       | 343                                  |       | 319                   |       |
| Other real  estate owned                                                                                                    |       | —                               |       | 1,056                 |       |
| Other  nonperforming assets                                                                                                 |       | —                               |       | —                |       |
| Total  nonperforming assets                                                                                                 |       | $                                    | 343        |                  | $          | 1,375 |   |
|                                                                                                                        |       |                                 |       |                  |       |
| Allowance for  credit losses as a percent of nonaccrual loans                                                               |       | 1355.1                               | %          | -1400.6               | %          |
| Allowance for  credit losses as a percent of nonperforming loans                                                            |       | 1355.1                               | %          | 1400.6                | %          |
| Total  nonperforming assets as a percent of loans receivable                                                                |       | 0.1                                  | %          | 0.4                   | %          |
| Total nonperforming  assets as a percent of total shareholders’ equity                                                 |       | 0.9                                  | %          | 3.6                   | %          |

 

Duringthe six months ended June 30, 2006, we sold other real estate owned recording a$47,000 gain on sale during the first quarter of 2006.  A single secured commercial loan was onnonaccrual status due to borrower financial weakness and uncertaintysurrounding collateral value.  The loanwas originated as part of a settlement of a legal dispute and is current by wayof advances from an interest reserve, typical for this type of financing.  The borrower’s ability to repay our loan ishighly dependent upon its success in marketing certain distribution rights.

ALLOWANCE FORCREDIT LOSSES

Theadequacy of the allowance for credit losses is determined through periodicanalysis of the loan portfolio.  Thisanalysis includes a systematic and detailed review of the classification and categorizationof problem loans; an assessment of the overall quality and collectibility ofthe portfolio; and consideration of the loan loss experience, trends in problemloans, concentrations of credit risk, as well as current economic conditions(particularly Southern California). Management performs a periodic risk and credit analysis, the results ofwhich are reported to the Board of Directors.

Therewere no recoveries of loans previously charged off during the second quarter of2006 compared to $132,000 during the second quarter of 2005.  Pursuant to our evaluation of the allowancefor credit losses at June 30, 2006, we recorded a provision for credit lossesof $40,000 for the second quarter 2006.

Wecharged off $1,000 of loans during the six months ended June 30, 2006 comparedto $6,000 of loans charged off during the same period of 2005.   There were no recoveries of loans previouslycharged off during the six months

32

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ended June 30,2006 compared to $135,000 during the same period of 2005.  We recorded a provision for credit losses of 72,000for the six months June 30, 2006.

Thefollowing table reflects the balances and activity in the allowance for loanlosses for the dates shown:
|                                                                                | ** ** | **Six Months ended June 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2006**                                          | ** ** | **2005** | ** ** |
| ** **                                                                     | ** ** | **(Dollars in thousands)**                        | ** ** |
|                                                                           |       |                                              |       |   |   |
| Balance,  beginning of period                                                  |       | $                                                 | 4,468      |   | $ | 3,511 |   |
| Total loans charged-off                                                        |       | 1                                                 |       | 6 |   |
| Total recoveries of loans previously charged off                               |       | —                                            |       | 135 |   |
| Net charge-offs                                                                |       | 1                                                 |       | (129 | ) |
| Provision for credit losses                                                    |       | 72                                                |       | 89 |   |
| Transfer (to) from reserve for contingent losses on unfunded  commitments |       | 109                                               |       | (60 | ) |
| Balance, end of period                                                         |       | $                                                 | 4,648      |   | $ | 3,669 |   |

 

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

DEPOSITS

Totaldeposits were $372.6 million and $363.2 million at June 30, 2006 and December31, 2005, respectively. Noninterest-bearing demand deposits were nearly flat at $115.7 millionat June 30, 2006 compared to $115.9 million at December 31, 2005.  Money market deposits and savings depositswere $97.6 million and $24.1 million, respectively, at June 30, 2006 comparedto $76.3 million and $28.2 million, respectively, at December 31, 2005.  Interest-bearing demand deposits, which forthe most part are limited to individuals, decreased to $30.9 million at June 30,2006 from $36.0 million at December 31, 2005. Time certificates of deposit decreased to $104.3 million at June 30,2006 from $106.7 million at December 31, 2005. Our Brokered CDs increased to $50.0 million at June 30, 2006 compared to$37.5 million at December 31, 2005.  TheBrokered CDs are typically 1-year terms and have been swapped to adjustablerate.  We utilize the brokered CDs aspart of our interest rate risk management and liquidity management strategies.

Additionally,although we have priced our retail certificates of deposit to encourage runoffduring the past several years, in the rising rate environment experiencedduring the past 8 quarters, we have elected to only moderately

33

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increase rates on ourimmediately repriceable base of deposits – interest-bearing demand deposits,and savings and money market deposits – and price new time certificates ofdeposit to generate growth.

In asustained rising interest rate environment, increases in deposit interest rateswill be required to prevent net deposit withdrawals.  Additionally, in order to generate newdeposit growth, we have paid significantly higher rates than that paid onexisting deposits.  Also, we have beenmaking more frequent exceptions to our posted rates in order to generate andretain deposits.

SECURITIES SOLDUNDER AGREEMENTS TO REPURCHASE

RepurchaseAgreements totaled $45.0 million at June 30, 2006.  We entered into the Repurchase Agreements to furtherour liquidity and interest rate sensitivity objectives.  The Repurchase Agreements are adjustable rateand contain embedded interest rate floors that will result in an exponentialdecline in cost in the event of a sustained decline in interest rates.  The embedded interest rate floors are clearlyand closely related to the economic characteristics and risks of the underlyingRepurchase Agreements and accordingly are not separated and accounted for asderivative instruments.   We had norepurchase agreements at December 31, 2005.

JUNIOR SUBORDINATED DEBENTURES

Therecorded balance of Junior Subordinated Debentures was $15.5 million at June30, 2006 and December 31, 2005.  TheJunior Subordinated Debentures have a 10.25% fixed rate and are dueJuly 25, 2031. The interest is deferrable, at the Company’s option, for aperiod up to ten consecutive semi-annual payments, but in any event not beyondJune 25, 2031.  The debentures areredeemable, in whole or in part, at the Company’s option on or after five yearsfrom issuance at declining premiums to maturity.

OTHER BORROWINGS

There were $12.3 million ofother borrowings, consisting of overnight advances from the Federal Home LoanBank, at June 30, 2006 compared to $28.3 million at December 31, 2005.   The decline in other borrowings reflectedrepayment with alternative wholesale funding sources, including brokered timecertificates of deposit and Repurchase Agreements.

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SHAREHOLDERS’ EQUITY

Shareholders’equity increased from $38.2 million at December 31, 2005 to $39.0 million at June30, 2006 due to the retained earnings for the six months ended June 30, 2006 partiallyoffset by a decrease in market value of cash flow hedge derivatives andsecurities available-for-sale.

***CAPITALADEQUACY REQUIREMENTS***

At June30, 2006, National Mercantile and the Banks were in compliance with allapplicable regulatory capital requirements and the Banks were “well capitalized”under the Prompt Corrective Action rules of the OCC.  The following table sets forth the regulatorycapital standards for well-capitalized institutions and the capital ratios for NationalMercantile and the Banks, as of   June 30, 2006 and December 31, 2005.

**Regulatory Capital Informationof the National Mercantile Bancorp and Banks**
|                                   | ** ** | **Minimum**          | ** ** | ** **      | ** ** | ** **        | ** ** | ** **            | ** ** |
|-----------------------------------|------------|----------------------|------------|-----------------|------------|-------------------|------------|-----------------------|------------|
| ** **                        | ** ** | **For Capital** | ** ** | **Well**        | ** ** | ** **        | ** ** | ** **            | ** ** |
| ** **                        | ** ** | **Adequacy**         | ** ** | **Capitalized** | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
| ** **                        | ** ** | **Purposes**         | ** ** | **Standards**   | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| **National  Mercantile Bancorp:** |       |                 |       |            |       |              |       |                  |       |
| Tier 1 leverage                   |       | 4.00                 | %          | N/A             |       | 11.72             | %          | 10.84                 | %          |
| Tier 1  risk-based capital        |       | 4.00                 | %          | N/A             |       | 12.68             | %          | 12.10                 | %          |
| Total risk-based  capital         |       | 8.00                 | %          | N/A             |       | 14.05             | %          | 13.81                 | %          |
|                              |       |                 |       |            |       |              |       |                  |       |
| **Mercantile  National Bank:**    |       |                 |       |            |       |              |       |                  |       |
| Tier 1 leverage                   |       | 4.00                 | %          | 5.00            | %          | 9.11              | %          | 10.49                 | %          |
| Tier 1  risk-based capital        |       | 4.00                 | %          | 6.00            | %          | 11.95             | %          | 13.59                 | %          |
| Total risk-based  capital         |       | 8.00                 | %          | 10.00           | %          | 13.20             | %          | 14.84                 | %          |
|                              |       |                 |       |            |       |              |       |                  |       |
| **South  Bay Bank, NA:**          |       |                 |       |            |       |              |       |                  |       |
| Tier 1 leverage                   |       | 4.00                 | %          | 5.00            | %          | 10.06             | %          | 9.04                  | %          |
| Tier 1  risk-based capital        |       | 4.00                 | %          | 6.00            | %          | 10.29             | %          | 9.00                  | %          |
| Total risk-based  capital         |       | 8.00                 | %          | 10.00           | %          | 11.46             | %          | 10.22                 | %          |

 

***LIQUIDITY***

Wemanage our liquidity through a combination of core deposits, Federal fundspurchased, Repurchase Agreements, collateralized borrowing lines, and aportfolio of securities available for sale. Liquidity is also provided by interest and principal payments on securitiesand loans.

Our cash and due from banks - demand was $15.0 millionon June 30, 2006 compared to $13.5 million on December 31, 2005.  Due from banks-interest-bearing was $2.3million at June 30, 2006 and $2.0 million at December 31, 2005.  There was $600,000 in Federal funds sold at June30, 2006 compared to $685,000 at December 31, 2005.

35

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Mercantilehad $12.5 million and South Bay had $10.0 million in Federal funds borrowing lineswith correspondent banks as of June 30, 2006.  Additionally, at June 30, 2006 we had $42.1million remaining borrowing capacity at the FHLB against pledged loans andsecurities.

NationalMercantile is a legal entity separate and distinct from the Banks and,therefore, it must provide for its own liquidity.  National Mercantile’s principal sources of fundsare proceeds from the sales of securities and dividends or capitaldistributions from the Banks.  Inaddition to funding its own operating expenses, National Mercantile isresponsible for the payment of the interest on the outstanding JuniorSubordinated Debentures.  The semiannualinterest payments on the Junior Subordinated Debentures are deferrable atNational Mercantile’s option, for a period up to ten consecutive semiannualpayments, but in any event not beyond June 25, 2031.   National Mercantile has not deferred anyinterest payments.

NationalMercantile’s cash, including interest-bearing deposits, was $1.1 million on June30, 2006.

Dividends and capital distributions from the Banksconstitute the principal ongoing source of cash to National Mercantile.  The Banks are subject to various statutoryand regulatory restrictions on their ability to pay dividends and capitaldistributions to National Mercantile.

OCC approval is required for a national bank to pay adividend if the total of all dividends declared in any calendar year exceedsthe total of the bank’s net profits (as defined) for that year combined withits retained net profits for the preceding two calendar years, less anyrequired transfer to surplus or a fund for the retirement of any preferredstock.  A national bank may not pay anydividend that exceeds its retained net earnings, as defined by the OCC.  The OCC and the Federal Reserve have alsoissued banking circulars emphasizing that the level of cash dividends shouldbear a direct correlation to the level of a national bank’s current andexpected earnings stream, the bank’s need to maintain an adequate capital baseand other factors.

National banks that are not in compliance withregulatory capital requirements generally are not permitted to paydividends.  The OCC also can prohibit anational bank from engaging in an unsafe or unsound practice in itsbusiness.  Depending on the bank’sfinancial condition, payment of dividends could be deemed to constitute anunsafe or unsound practice. Except under certain circumstances, and with priorregulatory approval, a bank may not pay a dividend if, after so doing, it wouldbe undercapitalized.  A bank’s ability topay dividends in the future is, and could be, further influenced by regulatorypolicies or agreements and by capital guidelines.

Mercantile has an accumulated deficit and does notanticipate having positive cumulative retained earnings until 2008 at thecurrent rate of earnings.  South Bay hadcumulative retained earnings of $4.7 million as of June 30, 2006.  Mercantile and South Bay may from time totime be permitted to make capital distributions to National Mercantile

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withthe consent of the OCC.  It is likelythat such consent could not be obtained unless the distributing bank remained “wellcapitalized” following such distribution.

***ASSETLIABILITY MANAGEMENT***

Wemanage interest rate sensitivity by matching the repricing opportunities on ourearning assets to those on our funding liabilities.  Various strategies are used to manage the repricingcharacteristics of assets and liabilities to ensure that exposure to interestrate fluctuations is limited within guidelines of acceptable levels ofrisk-taking.  Hedging strategies,including the terms and pricing of loans and deposits, the use of derivativefinancial instruments (see Note 10 of the Notes to the Consolidated FinancialStatements) and managing the deployment of securities are used to reducemismatches in interest rate repricing opportunities of portfolio assets andtheir funding sources.  Interest raterisk is measured using financial modeling techniques, including stress tests,to measure the impact of changes in interest rates on future earnings.  These static measurements do not reflect theresults of any projected activity and are best used as early indicators ofpotential interest rate exposures.

Throughvarious interest rate risk management strategies, we believe that our balancesheet is nearly neutral and that changes in interest rates will have a limitedimpact upon our net interest income. These strategies have included securitiesleverage in which purchases of intermediate term investment securities whichwere funded by short-term  or adjustablewholesale liabilities.  Some of thewholesale liabilities are adjustable Repurchase Agreements with embedded floorsthat, in a declining interest rate environment, will decline at an exponentialrate to the decline in the underlying index. Additionally, the Company hasentered into interest rate swap agreements and has purchased interest ratefloors at various strike prices and terms that have the effect of furtherreducing its exposure to declining interest rates.

Sinceinterest rates began increasing in June 2004, the Company’s deposit fundingcosts have lagged the increase in earning asset yields.  This lag in funding costs could narrow futurenet interest margins in the event that rates paid on deposits begin rising morerapidly due to increased funding needs or competitive pressures

# **FACTORS WHICH MAY AFFECT FUTURE OPERATING RESULTS**

The Company’s results ofoperations and financial condition are affected by many factors, including thefollowing:

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**Risk fromchanges in interest rates.**

The success of theCompany’s business depends, to a large extent, on its net interest income.  Changes in market interest rates can affectnet interest income by affecting the spread between interest-earning assets andinterest-bearing liabilities.  This maybe due to the different maturities of interest-earning assets andinterest-bearing liabilities, as well as an increase in the general level ofinterest rates.  Changes in marketinterest rates also affect, among other things:

·                  The Company’sability to originate loans;

·                  The abilityof borrowers to make payments on their loans;

·                  The value ofinterest-earning assets and ability to realize gains from the sale of theseassets;

·                  The averagelife of interest-earning assets;

·                  The abilityto generate deposits instead of other available funding alternatives; and

·                  The abilityto access the wholesale funding market.

Interest rates are highlysensitive to many factors, including governmental monetary policies, domesticand international economic and political conditions and other factors beyond theCompany’s control.

**Risk frompossible declines in the quality of the Company’s assets.**

The Company’s financialcondition depends significantly on the quality of its assets.  While its has developed and implementedunderwriting policies and procedures to guide management in the making ofloans, compliance with these policies and procedures in making loans does notguarantee repayment of the loans.  If thelevel of non-performing assets rises, the results of operations and financialcondition will be affected.  A borrower’sability to pay its loan in accordance with its terms can be adversely affectedby a number of factors, such as a decrease in the borrower’s revenues and cashflows due to adverse changes in economic conditions or a decline in the demandfor the borrower’s products and/or services.

**Allowancesfor credit losses may be inadequate.**

Allowances forcredit losses are established against each segment of the loan portfolio.  At June 30, 2006, the allowance for creditlosses equaled 1.32% of loans receivable and 1355.1% of nonperformingloans.  Although management believes thatit has established adequate allowances for credit losses as of June 30, 2006,the credit quality of the Company’s assets is affected by many factors beyond itscontrol, including local and national economic conditions, and the possibleexistence of facts which are not currently known which adversely affect thelikelihood of repayment of various loans in the loan portfolio and realizationof the collateral upon a default. Accordingly, there is

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no assurance that the Company will not sustain loanlosses materially in excess of the allowance for credit losses.  In addition, the Office of the Comptroller ofthe Currency, as an integral part of its examination process, periodicallyreviews the allowance for credit losses and could require additional provisionsfor credit losses.  Material futureadditions to the allowance for credit losses may also be necessary due toincreases in the size and changes in the composition of the loanportfolio.  Increases in the provisionsfor credit losses would adversely affect the Company’s results of operations.

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**Economicconditions may worsen.**

The Company’sbusiness is strongly influenced by economic conditions in its market area(principally, the greater Los Angeles metropolitan area) as well as regionaland national economic conditions and in its niche markets, including theentertainment industry in Southern California. Should the economic condition in these areas worsen, the financialcondition of its borrowers could weaken, which could lead to higher levels ofloan defaults or a decline in the value of collateral for its loans.  In addition, an unfavorable economy couldreduce the demand for its loans and other products and services.

**Because asignificant amount of the loans are made to borrowers in Southern California, theCompany’s operations could suffer as a result of local recession or naturaldisasters in California.**

At June 30, 2006, a large majority of the loansoutstanding were collateralized by real properties located in California.  Because of this concentration in Southern California,the Company’s financial position and results of operations have been and areexpected to continue to be influenced by general trends in the Californiaeconomy and its real estate market.  Realestate market declines may adversely affect the values of the properties collateralizingloans.  If the principal balances of theloans, together with any primary financing on the mortgaged properties, equalor exceed the value of the mortgaged properties, the Company could incur higherlosses on sales of properties collateralizing foreclosed loans.  In addition, California historically has beenvulnerable to certain natural disaster risks, such as earthquakes anderosion-caused mudslides, which are not typically covered by the standardhazard insurance policies maintained by borrowers.  Uninsured disasters may adversely impact theability to recover losses on properties affected by such disasters andadversely impact the Company’s results of operations.

**TheCompany’s business is very competitive.**

There is intensecompetition in Southern California and elsewhere in the United States forbanking customers.  The Companyexperiences competition for deposits from many sources, including creditunions, insurance companies and money market and other mutual funds, as well asother commercial banks and savings institutions.  The Company competes for loans and depositsprimarily with other commercial banks, mortgage companies, commercial financecompanies and savings institutions.  Inrecent years out-of-state financial institutions have entered the Californiamarket, which has also increased competition. Many of the competitors have greater financial strength, marketing capabilityand name recognition, and operate on a statewide or nationwide basis.  In addition, recent developments in technologyand mass marketing have permitted larger companies to market loans moreaggressively to small business

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customers.  Suchadvantages may give the competitors opportunities to realize greaterefficiencies and economies of scale than the Company can.  There is no assurance that the Company willbe able to compete effectively against its competition.

**TheCompany’s business is heavily regulated.**

Both National Mercantileas a bank holding company, and Mercantile and South Bay, as national banks, aresubject to significant governmental supervision and regulation, which isintended primarily for the protection of depositors.  Statutes and regulations affecting theCompany may be changed at any time, and the interpretation of these statutesand regulations by examining authorities also may change.  There is no assurance that future changes inapplicable statutes and regulations or in their interpretation will notadversely affect the Company’s business.

**Goodwillis evaluated annually and any impairment must be recorded as a charge toearnings**.

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

The Company has goodwillof $3.2 million in connection with the South Bay acquisition in December2001.  During the fourth quarter of 2005,the required impairment tests of goodwill were completed.  The tests determined that goodwill was notconsidered impaired.  No assurance can begiven that goodwill will not become impaired in the future.

CAUTIONARY NOTE REGARDING FORWARD-LOOKINGSTATEMENTS

Thisreport contains forward-looking statements about the Company.  Forward-looking statements consist ofdescription of plans or objectives for future operations, products or services,forecasts of revenues, earnings or other measures of economic performance andassumptions underlying or relating to any of the foregoing.  Because forward-looking statements discussfuture events or conditions and not historical facts, they often include wordssuch as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,”“target,” “can,” “could,” “may,” “should” or similar expressions.   Do not rely unduly on forward-lookingstatements.  They give the Company’sexpectations about the future and are not guarantees or predictions of futuresevents, conditions or results.  Forward-lookingstatements

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speak only as of the datethey are made, and the Company does not undertake to update them to reflectchanges that occur after that date.

Manyfactors, most beyond the Company’s control, could cause actual results todiffer significantly from the Company’s expectations   These include, among other things, changesin interest rates which reduce interest margins, impact funding sources ordiminish loan demand; increased competitive pressures; adverse changes innational and local economic conditions, and in real estate markets inCalifornia; changes in fiscal policy, monetary policy; legislative orregulatory environments, requirements or changes which adversely affect theCompany; and declines in the credit quality of the Company’s loanportfolio.  See “Factors Which May AffectFuture Operating Results.”

***ITEM 3.  CONTROLS ANDPROCEDURES***

The Company maintainsdisclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e))that are designed to assure that information required to be disclosed in itsExchange Act reports is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’s rules andforms, and that such information is accumulated and communicated to management,including the Chief Executive Officer and Chief Financial Officer, asappropriate, to allow timely decisions regarding required disclosures.

In designing andevaluating the disclosure controls and procedures, management recognizes thatany controls and procedures, no matter how well designed and operated, canprovide reasonable assurance only of achieving the desired control objectives,and management necessarily is required to apply its judgment in weighting thecosts and benefits of possible new or different controls and procedures.  Limitations are inherent in all controlsysytems, so no evaluation of controls can provide absolute assurance that allcontrol issues and any fraud within the company have been detected.

As required by ExchangeAct Rule 13a-15(b), as of the end of the period covered by this report theCompany, under  the supervision and withthe participation of our Chief Executive Officer and Chief Financial Officer,evaluated the effectiveness of the Company’s disclosure controls and procedures.  Based on this evaluation, our Chief ExecutiveOfficer and Chief financial Officer concluded that the Company’s disclosurecontrols and procedures were effective as of that date.

There was no change inthe Company’s internal control over financial reporting during the Company’smost recently completed fiscal quarter that has materially affected, or isreasonably likely to materially affect, the Company’s internal control overfinancial reporting.

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**PARTII—OTHER INFORMATION**

***Item 1.       LEGALPROCEEDINGS***

None.

***Item 2.       UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS***

None.

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

None.

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

The Annual Meeting of Shareholders of the Company was held on May 18,2006 to elect the members of the Company’s Board of Directors and vote on twoadditional proposals.  The number ofvotes for each nominee is set forth below:

|                             | ** ** | ** **         | ** ** | **Votes**    | ** ** |
|-----------------------------|------------|--------------------|------------|--------------|------------|
| **Name**                    | ** ** | **Votes For** | ** ** | **Withheld** | ** ** |
|                        |       |               |       |         |       |
| Donald E. Benson            |       | 4,127,357          |       | 96,515       |       |
|                        |       |               |       |         |       |
| Joseph N. Cohen             |       | 2,514,198          |       | 176,577      |       |
|                        |       |               |       |         |       |
| Robert E. Gipson            |       | 2,553,394          |       | 111,844      |       |
|                        |       |               |       |         |       |
| W. Douglas Hile             |       | 4,127,857          |       | 96,015       |       |
|                        |       |               |       |         |       |
| Antoinette  Hubenette, M.D. |       | 4,127,957          |       | 96,015       |       |
|                        |       |               |       |         |       |
| Scott A.  Montgomery        |       | 4,127,357          |       | 95,915       |       |
|                        |       |               |       |         |       |
| Dion G. Morrow              |       | 4,127,357          |       | 96,515       |       |
|                        |       |               |       |         |       |
| Carl R. Terzian             |       | 4,127,857          |       | 97,015       |       |
|                        |       |               |       |         |       |
| Robert E. Thomson           |       | 4,126,776          |       | 97,106       |       |

 

In addition, thefollowing proposals were voted on at the annual meeting:

Proposal to approve anamendment to Article XIII of the Company’s Amended and Restate Articles ofIncorporation to extend the termination date of that Article from July 2, 1006to July 1, 2009.
| For       | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker Non-Vote** | ** ** |
|-----------|------------|-------------|------------|-------------|------------|--------------------------|------------|
|      |       |        |       |        |       |                     |       |
| 3,630,778 |       | 146,147     |       | 16,090      |       | 430,857                  |       |

 

***Item 5.       OTHER INFORMATION***

None.

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***Item 6.       EXHIBITS***
|   | 2.1  | Agreement and Plan of  Merger, dated as of June 15, 2006, among National Mercantile Bancorp,  FCB Bancorp, and First California Financial Group, Inc. (1) |
|--------|------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 3.1  | Certificate of Amendment of the Amended and Restated  Articles of Incorporation of National Mercantile Bancorp                                                      |
|   | 10.1 | Letter dated June 15, 2006, between Scott A.  Montgomery and National Mercantile Bancorp.(2)                                                                   |
|   | 10.2 | Second Amended and Restated Severance Agreement,  dated as of June 15, 2006, between National Mercantile Bancorp and  Robert W. Bartlett.(2)                   |
|   | 10.3 | Second Amended and Restated Severance Agreement,  dated as of June 15, 2006, between National Mercantile Bancorp and David  R. Brown.(2)                       |
|   | 10.4 | Employment Agreement, dated as of June 15,  2006, between C.G. Kum and First California Financial Group, Inc. (1)                                         |
|   | 31.1 | Certification of Scott A. Montgomery on disclosure  controls                                                                                                        |
|   | 31.2 | Certification of David R. Brown on disclosure  controls                                                                                                             |
|   | 32.1 | Certification of Scott A. Montgomery pursuant to  section 906 of the Sarbanes-Oxley Act of 2002                                                                     |
|   | 32.2 | Certification of David R. Brown pursuant to section  906 of the Sarbanes-Oxley Act of 2002                                                                          |

 

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(1)   Incorporated by reference tothe Current Report on Form 8-K filed by FCB Bancorp on June 21, 2006

(2)   Filed as an exhibit to National MercantileBancorp’s Current Report on Form 8-K dated June 21, 2006

**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
| ** ** |   |            |   | **NATIONAL MERCANTILE  BANCORP**                      |                     |
|------------|--------|-----------------|--------|-------------------------------------------------------|--------------------------|
|       |   |            |   | (Registrant)                                          |
|       |   |            |   |                                                  |                     |   |
| DATE:      |   | October 4, 2006 |   |                                                  | /s/ Scott A.  Montgomery |   |
| ** ** |   |            |   | **Scott A. Montgomery**                               |
|       |   |            |   | Chief Executive Officer                               |
|       |   |            |   |                                                  |                     |   |
| DATE:      |   | October 4, 2006 |   |                                                  | /s/ David R.  Brown      |   |
| ** ** |   |            |   | **David R. Brown**                                    |
|       |   |            |   | Principal Financial and Principal  Accounting Officer |
|            |        |                 |        |                                                       |                          |  |  |  |  |

 

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