10KSB

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-KSB

ý Annual report under section 13 or 15(d) of the Securities Exchange Act of 1934

for the fiscal year ended December 31, 2003

o  Transition report under section 13 or 15(d) of the Securities Exchange Act of 1934

for the transition period from        to       .

Commission File Number 0-15982

NATIONAL MERCANTILE BANCORP

(Exact name of small business issuer in its charter)

California	95-3819685
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
1880 Century Park East Los Angeles, California	90067
(Address to principal executive offices)	(Zip Code)
Issuer’s telephone number, including area code:  (310) 277-2265 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act:
Common Stock, No Par Value Series A Noncumulative Convertible Perpetual Preferred Stock (Title of Class)

Check whether the issuer:  (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.      ý Yes         o   No

Check if there is no disclosure of delinquent filers to Item 405 of Regulation S-B contained herein, and no disclosure will be contained, to the registrant’s knowledge, in definitive in response or information statements incorporated by reference in Part III of this Form 10-KSB. o

The issuer’s revenues for its most recent fiscal year:  $18.5 million.

The aggregate market value of the voting common equity held by nonaffiliates of the registrant, based upon the closing sale price of its Common Stock as reported by the National Association of Securities Dealers Automated Quotation System on March 19, 2004, was approximately $28.3 million.

The number of shares of Common Stock, no par value, of the issuer outstanding as of March 19, 2004 was 2,900,003.

DOCUMENTS INCORPORATED BY REFERENCE:

Certain portions of the Company’s Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Rule 14a-6 under the Securities Exchange Act of 1934 in connection with the Company’s 2004 Annual Meeting of Shareholders are incorporated by reference in Part III, Items 9-12 and 14 and is of this Annual Report on Form 10-KSB.

Transitional Small Business Disclosure Format (Check one):      o Yes   ý    No

NATIONAL MERCANTILE BANCORP

Table of Contents

Form 10-KSB

For the Fiscal Year Ended December 31, 2003

PART I
Item 1.	Description of Business
Item 2.	Description of Property
Item 3.	Legal Proceedings
Item 4.	Submission Of Matters to a Vote of Security Holders
PART II
Item 5.	Market for Common Equity and Related Shareholder Matters
Item 6.	Management’s Discussion and Analysis
Item 7.	Financial Statements
Item 8.	Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
PART III
Item 9.	Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Exchange Act
Item 10.	Executive Compensation
Item 11.	Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
Item 12.	Certain Relationships and Related Transactions
Item 13.	Exhibits and Reports on Form 8-K
Item 14.	Principal Accountant Fees and Services
Signatures
Financial Statements
Index to Exhibits

ANNUAL REPORT ON FORM 10-K

Certain matters discussed in this Form 10-KSB may constitute forward-looking statements within the meaning of the Securities Exchange Act of 1934 (the “Exchange Act”) and as such may involve risks and uncertainties.  These forward-looking statements relate to, among other things, expectations of the business environment in which National Mercantile Bancorp (referred to as “we” or “our” when such reference includes National Mercantile Bancorp and its subsidiaries, collectively, “National Mercantile” when referring only to the parent company and “the Banks” when referring only to National Mercantile’s banking subsidiaries, Mercantile National Bank and South Bay Bank, N.A.) operates, projections of future performance, perceived opportunities in the market and statements regarding our mission and vision.  Our actual results, performance, or achievements may differ significantly from the results, performance, or achievements expressed or implied in such forward-looking statements.  Statements regarding policies and procedures are not intended to imply, and should not be interpreted to mean, that we will conduct our business in accordance with such policies for any particular period of time, as we may at any time and from time to time amend or repeal such policies and adopt new policies.  For discussion of the factors that might cause such a difference, see “Item 6.  Management’s Discussion and Analysis of Financial Condition and Results of Operations— Factors Which May Affect Future Operating Results”.

PART I

ITEM 1.   BUSINESS

CRITICAL ACCOUNTING POLICIES

National Mercantile is a bank holding company whose principal assets are the capital stock of two bank subsidiaries: Mercantile National Bank (“Mercantile”) and South Bay Bank, N.A.  (“South Bay”).  National Mercantile has been authorized by the Federal Reserve Bank of San Francisco to engage in lending activities separate from the Banks but to date has not done so.

Our present business strategy is to attract individual and small- to mid-sized business borrowers in specific market niches located in our primary service areas by offering a variety of loan products and a full range of banking services coupled with highly personalized service.  Our lending products include revolving lines of credit, term loans, commercial real estate loans, construction loans and consumer and home equity loans, which often contain terms and conditions tailored to meet the specific demands of the market niche in which the borrower operates.  Additionally, we provide a wide array of deposit and investment products that are also designed to meet specific customer needs.

We operate throughout the west side of Los Angeles County including the South Bay, Century City and San Fernando Valley with banking offices in Century City, Torrance, Encino and El Segundo and a loan production office in Beverly Hills.  Additionally, we target Orange County businesses through our loan production office in Costa Mesa, California.  Our targeted market niches for businesses include the entertainment industry, the healthcare industry, professional services providers, the real estate escrow industry, property managers and community-based nonprofit organizations.    Entertainment industry customers include television, music and film production companies, talent agencies, individual performers, directors and producers (whom we attract by establishing relationships with business management firms) and others affiliated with the entertainment industry.  Healthcare organizations include primarily outpatient healthcare providers such as physician medical groups, independent practice associations and surgery centers.  Professional service customers include legal, accounting, insurance, advertising firms and their individual directors, officers, partners and shareholders.  Additionally, we target developers of small commercial real estate properties and residential properties – including small home tracks and luxury homes for resale.  Furthermore, we provide loans for the purchase or refinance of commercial properties including owner-occupied business facilities and retail properties.

In order to grow and expand our array of products and services, we may from time to time open de novo branch banking offices or acquire other financial service-related companies including “in-market” acquisitions with banks of similar size and market presence.  No assurance can be made that we will identify a company which can be acquired on terms and conditions acceptable to us or that we could obtain the necessary regulatory approvals for such an acquisition.

We believe that banking clients value doing business with locally managed institutions that can provide a full service commercial banking relationship through an understanding of the clients’ financial needs and the flexibility to deliver customized solutions through our menu of products and services.  We also believe that our subsidiary Banks are better able to build successful client relationships as the holding company provides cost effective administrative support services while promoting bank autonomy and flexibility in serving client needs.

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To implement this philosophy, we operate each of our Bank subsidiaries by retaining their independent names.  Our banking subsidiaries have established strong client followings in their market areas through attention to client service and an understanding of client needs.

In an effort to capitalize on the identities and reputations of the Banks, we intend to continue to market our services under each Bank’s name, primarily through each Bank’s relationship managers.  The primary focus for the Banks’ relationship managers is to cultivate and nurture their client relationships.  Relationship managers are assigned to each borrowing client to provide continuity in the relationship.  This emphasis on personalized relationships requires that all of the relationship managers maintain close ties to the communities or industry niche in which they serve, so they are able to capitalize on their efforts through expanded business opportunities for the Banks.

Client service decisions and day-to-day operations are maintained at the Banks.  National Mercantile offers the advantages of affiliation with a multi-bank holding company by providing expanded client support services, such as increased client lending capacity, business cash management, and centralized administrative functions, including client services, support in credit policy formulation and review, investment management, data processing, accounting, loan servicing and other specialized support functions.  All of these centralized services are designed to enhance the ability of the relationship manager to expand their client relationship base.

At December 31, 2003, we had total assets of $355.2 million, total loans, net, of $256.6 million and total deposits of $298.7 million.

Corporate History

Mercantile was organized in 1981 as a national banking association and commenced operations through an office in Century City in 1982.  In 1983 National Mercantile was organized under the laws of the State of California and registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the ‘‘BHCA’’), to serve as a holding company for Mercantile.

In March 2001, Mercantile opened a regional office in Encino, California which expanded our client-focused niche banking services to the San Fernando Valley area of Los Angeles.  In January 2004, Mercantile opened a loan production office in Beverly Hills, California to focus on providing banking services to those affiliated with the healthcare industry.

In December 2001, National Mercantile acquired South Bay, which had offices in Torrance and El Segundo.   In January 2004, South Bay opened a loan production office in Costa Mesa, California to expand our lending services to the Orange County area of Southern California.

Competition

The banking and financial services industry in California generally, and in the Banks’ market areas specifically, is highly competitive.  The increasingly competitive environment is primarily a result of changes in regulation, changes in technology and product delivery systems, and the accelerating pace of consolidation among financial services providers.  Our primary service area is dominated by a relatively small number of major banks that have many offices operating over a wide geographical area.  We compete for loans, deposits, and customers with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market funds, credit unions, and other nonbank financial service providers.  Many of these competitors are much larger in total assets and capitalization, have greater access to capital markets and offer a broader range of financial services than us.  Nondepository institutions can be expected to increase the extent to which they act as financial intermediaries.  Large institutional users and sources of credit may also increase the extent to which they interact directly, meeting business credit needs outside the banking system.  Furthermore, the geographic constraints on portions of the financial services industry can be expected to erode.  In addition, many of the major commercial banks operating in our primary service area offer services, such as trust services, which are not offered directly by us and, by virtue of their greater total capitalization, such banks have substantially higher lending limits.

To compete with other financial institutions in our primary service area, we rely principally upon personal contact by our officers, directors and employees and providing, through third parties, specialized services such as messenger, accounting and other related services.  For clients whose loan demands exceed our legal lending limit, we arrange for such loans on a participation basis with other banks.  We also assist clients requiring other services not offered by us in obtaining such services from other providers.

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Economic Conditions and Government Policies

Our profitability, like most financial institutions, is primarily dependent on interest rate differentials.  In general, the difference between the interest rates paid by us on our interest-bearing liabilities, such as deposits and other borrowings, and the interest rates received by us on our interest-earning assets, such as loans and investment securities, comprise the major portion of our earnings.  These rates are highly sensitive to many factors that are beyond our control, such as inflation, recession and unemployment, and the impact which future changes in domestic and foreign economic con ditions might have on us cannot be predicted.

The monetary and fiscal policies of the federal government and the policies of regulatory agencies, particularly the Board of Governors of the Federal Reserve System (the “Federal Reserve”), influence our business.  The Federal Reserve implements national monetary policies (with objectives such as curbing inflation and combating recession) through its open-market operations in U.S.  Government securities by adjusting the required level of reserves for depository institutions subject to its reserve requirements, and by varying the target federal funds and discount rates applicable to borrowings by depository institutions.  The actions of the Federal Reserve in these areas influence t he growth of bank loans, investments, and deposits and also affect interest rates earned on interest-earning assets and paid on interest-bearing liabilities.  We cannot fully predict the nature and impact on us of any future changes in monetary and fiscal policies.

Supervision and Regulation

General

Banking is a highly regulated industry.  Congress and the states have enacted numerous laws that govern banks, bank holding companies and the financial services industry, and have created several largely autonomous regulatory agencies which have authority to examine and supervise banks and bank holding companies, and to adopt regulations furthering the purpose of the statutes.  The primary goals of the regulatory scheme are to maintain a safe and sound banking system, to protect depositors and the Federal Deposit Insurance Corporation (“FDIC”) insurance fund, and to facilitate the conduct of sound monetary policy; they were not adopted for the benefit of shareholders of the Company.  As a result, the Company’s financial condition, results of operations, ability to grow and engage in various business activities can be affected not only by management decisions and general economic conditions, but the requirements of applicable federal and state laws, regulations and the policies of the various regulatory authorities.

Further, these laws, regulations and policies are reviewed often by Congress, state legislatures and federal and state regulatory agencies.  Changes in laws, regulations and policies can materially increase in the cost of doing business, limit certain business activities, require additional capital, or materially adversely affect competition between banks and other financial intermediaries.  While it can be predicted that significant changes will occur, what changes, when they will occur, and how they will impact the Company cannot be predicted.

Set forth below is a summary description of certain of the material laws and regulations that relate to the operations of National Mercantile and the Banks.  The description does not purport to be a complete description of these laws and regulations and is qualified in its entirety by reference to the applicable laws and regulations.

National Mercantile

As a registered bank holding company, National Mercantile and its subsidiaries are subject to the Federal Reserve’s supervision, regulation and examination under the Bank Holding Company Act.

National Mercantile is required to obtain the Federal Reserve’s prior approval before acquiring ownership or control of more than 5% of the outstanding shares of any class of voting securities, or substantially all the assets, of any company, including a bank or bank holding company.  Further, National Mercantile is generally allowed to engage, directly or indirectly, only in banking and other activities that the Federal Reserve deems to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.

Under Federal Reserve regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner.  In addition, it is the Federal Reserve’s policy that in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary ban ks.  A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve’s regulations or both.

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The Banks

Both Banks are national banks and members of the Federal Reserve System.  The Banks are subject to primary supervision, examination, and regulation by the Office of the Comptroller of the Currency (the “OCC”) and are also subject to regulations of the Federal Deposit Insurance Corporation (“FDIC”) and the Federal Reserve.  The Banks are subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and limitations on the types of investments that may be made and services that may be offered.  Various consumer laws and regulations also affect the Banks’ operations.  These laws primarily protect depositors and other customers of the Banks, rather than National Mercantile and its shareholders.

The OCC and the Federal Reserve have various remedies if they should determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of a bank’s operations are unsatisfactory or that a bank or its management is violating or has violated any law or regulation.  These remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the bank, to assess civil monetary penalties, to remove officers and directors, and ultimately to terminate the bank’s deposit insurance.

Memorandum of Understanding

In October 2002, Mercantile executed an informal non-binding memorandum of understanding with the OCC relating to its interest rate risk management.  The memorandum provided for Mercantile to take certain actions that the OCC believed would strengthen Mercantile’s interest rate risk management process, including the review of its interest rate risk limits and interest rate risk modeling assumptions and the retention of an independent consultant to conduct a review of Mercantile’s interest rate risk management processes.  Mercantile substantially completed the actions provided in the MOU and was notified by the OCC that the MOU was terminated.

USA Patriot Act of 2001

The USA Patriot Act of 2001 (“Patriot Act”) is intended to strengthen the U.S law enforcement and the intelligence communities’ abilities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including: (i) due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-US persons; (ii) standards for verifying customer identification at account opening; (iii) rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; and (iv) reports by non-financial trades and businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000, and filing of suspicious activities reports by securities brokers and dealers if they believe a customer may be violating U.S. laws and regulations.

On April 30, 2003, the U.S. Treasury issued final regulations to implement section 326 of the Patriot Act requiring institutions to incorporate into their written money laundering plans a customer identification program implementing reasonable procedures for: (i) verifying the identity of any person seeking to open an account, to the extent reasonable and practicable; (ii) maintaining records of the information used to verify the person’s identity; and (iii) determining whether the person appears on any list of known or suspected terrorists or terrorist organizations.  We have established policies and procedures implementing the requirements of the Patriot Act.

Privacy

Federal banking rules limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. Pursuant to these rules, financial institutions must provide: (i) initial notices to customers about their privacy policies, describing the conditions under which they may disclose nonpublic personal information to nonaffiliated third parties and affiliates; (ii) annual notices of their privacy policies to current customers; and (iii) a reasonable method for customers to “opt out” of disclosures to nonaffiliated third parties.

These privacy provisions affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors. We have implemented our privacy policies in accordance with the law.

In recent years, a number of states have implemented their own versions of privacy laws. For example, in 2003, California adopted standards that are more restrictive than federal law, allowing bank customers the opportunity to bar financial companies from sharing information with their affiliates.

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Interagency Guidance on Response Programs to Protect Against Identity Theft

On August 12, 2003, the Federal bank and thrift regulatory agencies requested public comment on proposed guidance that would require financial institutions to develop programs to respond to incidents of unauthorized access to customer information, including procedures for notifying customers under certain circumstances. The proposed guidance: (i) interprets previously issued interagency customer information security guidelines that require financial institutions to implement information security programs designed to protect their customers’ information; and (ii) describes the components of a response program and sets a standard for providing notice to customers affected by unauthorized access to or use of customer information that could result in substantial harm or inconvenience to those customers, thereby reducing the risk of losses due to fraud or identity theft.

FDIC

The Banks are subject to examination and regulation by the FDIC under the Federal Deposit Insurance Act because their deposit accounts are insured by the FDIC under the Bank Insurance Fund (“BIF”).

Under FDIC regulations, each insured depository institution is assigned to one of three capital groups for insurance premium purposes — “well capitalized,” “adequately capitalized” and “undercapitalized” — which are defined in the same manner as under prompt corrective action rules, as discussed under “Capital Adequacy Requirements” below.  These three groups are then divided into subgroups which are based on supervisory evaluations by the institution’s primary federal regulator, resulting in nine assessment classifications.  Currently, assessment rates for BIF-insured banks range from 0% of insured deposits for well-capitalized banks with minor supervisory concerns to 0.027% of insured deposits for undercapitalized banks with substantial supervisory concerns.  The FDIC may increase or decrease the assessment rate schedule semiannually.

The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices which, as with the OCC’s enforcement authority, are not limited to cases of capital inadequacy, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation or order or any condition imposed in writing by the FDIC.  In addition, FDIC regulations provide that any insured institution that falls below a 2% minimum leverage ratio (see below) will be subject to FDIC deposit insurance termination proceedings unless it has submitted, and is in compliance with, a capital plan with its primary federal regulator and the FDIC.  The FDIC may also suspend deposit insurance temporarily during the hearing process if the institution has no tangible capital.  The FDIC is additionally authorized by statute to appoint itself as conservator or receiver of an insured depository institution (in addition to the powers of the institution’s primary federal regulatory authority) in cases, among others and upon compliance with certain procedures, of unsafe or unsound conditions or practices or willful violations of cease and desist orders.

All FDIC-insured depository institutions must pay an annual assessment to provide funds for the payment of interest on bonds issued by the Financing Corporation ( “FICO”), a federal corporation chartered under the authority of the Federal Housing Finance Board.  The bonds, commonly referred to as FICO bonds, were issued to capitalize the Federal Savings and Loan Insurance Corporation.  The FICO has established assessment rates effective for the first quarter of 2004 at approximately $.0154 per $100 annually for assessable deposits. The FICO assessments are adjusted quarterly to reflect changes in the assessment bases of the FDIC’s insurance funds and do not vary depending on a depository institution’s capitalization or supervisory evaluations.

Dividends and Capital Distributions

Dividends and capital distributions from the Banks constitute the principal ongoing source of cash to National Mercantile.  National Mercantile is a legal entity separate and distinct from the Banks, and as such has separate and distinct financial obligations including debt service and operating expenses.  The Banks are subject to various statutory and regulatory restrictions on their ability to pay dividends and capital distributions to National Mercantile.

OCC approval is required for a national bank to pay a dividend if the total of all dividends declared in any calendar year exceeds the total of the bank’s net profits (as defined) for that year combined with its retained net profits for the preceding two calendar years, less any required transfer to surplus or a fund for the retirement of any preferred stock.  A national bank may not pay any dividend that exceeds its retained net earnings, as defined by the OCC.   The OCC and the Federal Reserve have also issued banking circulars emphasizing that the level of cash dividends should bear a direct correlation to the level of a national bank’s current and expected earnings stream, the bank’s need to maintain an adequate capital base and other factors.

National banks that are not in compliance with regulatory capital requirements generally are not permitted to pay dividends.  The OCC also can prohibit a national bank from engaging in an unsafe or unsound practice in its business.  Depending on the bank’s financial condition, payment of dividends could be deemed to constitute an unsafe or unsound practice.  Except under certain circumstances, and with prior regulatory approval, a bank may not pay a dividend if, after so doing, it would be undercapitalized.  The

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Banks’ ability to pay dividends in the future is, and could be, further influenced by regulatory policies or agreements and by capital guidelines.

Mercantile has a substantial accumulated deficit and does not anticipate having positive retained earnings for the foreseeable future.  South Bay has an accumulated surplus of $130,000 as of December 31, 2003.  Mercantile and South Bay may from time to time be permitted to make capital distributions to National Mercantile with the consent of the OCC.  It is not anticipated that such consent could be obtained unless the distributing bank were to remain “well capitalized” following such distribution.

The payment of dividends by National Mercantile is limited by the terms of the Trust Preferred Securities indenture.  National Mercantile may not declare or pay any dividends or other distributions on its common stock or preferred stock if it is in default under the terms of the indenture or if it has elected to defer payments of interest on the Trust Preferred Securities.

Transactions with Affiliates

The Banks are subject to certain restrictions imposed by federal law on any extensions of credit to, or the issuance of a guarantee or letter of credit on behalf of, National Mercantile or other affiliates, the purchase of, or investments in, stock or other securities thereof, the taking of such securities as collateral for loans, and the purchase of assets of National Mercantile or other affiliates.  Such restrictions prevent National Mercantile and such other affiliates from borrowing from the Banks unless the loans are secured by marketable obligations of designated amounts.  Further, such secured loans and investments by the Banks to or in National Mercantile or to or in any other affiliate are limited, individually, to 10% of the respective Bank’s capital and surplus (as defined by federal regulations), and such secured loans and investments are limited, in the aggregate, to 20% of the respective Bank’s capital and surplus (as defined by federal regulations).

Capital Adequacy Requirements

Both the Federal Reserve and the OCC have adopted similar, but not identical, “risk-based” and “leverage” capital adequacy guidelines for bank holding companies and national banks, respectively.  Under the risk-based capital guidelines, different categories of assets are assigned different risk weights, ranging from zero percent for assets considered risk-free (e.g., cash) to 100% for assets considered relatively high-risk (e.g., commercial loans).  These risk weights are multiplied by corresponding asset balances to determine a risk-adjusted asset base.  Certain off-balance sheet items (e.g., standby letters of credit) are added to the risk-adjusted asset base.  The minimum required ratio of total capital to risk-weighted assets for both bank holding companies and national banks is presently 8%.  At least half of the total capital is required to be “Tier 1 capital,” consisting principally of common shareholders’ equity, a limited amount of perpetual preferred stock and minority interests in the equity, less goodwill, intangible assets and certain other items.  The remainder (Tier 2 capital) may consist of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, preferred stock and a limited amount of the general loan-loss allowance.

The minimum Tier 1 leverage ratio (Tier 1 capital to average adjusted total assets) is 3% for bank holding companies and national banks that have the highest regulatory examination rating and are not contemplating significant growth or expansion.  All other bank holding companies and national banks are expected to maintain a ratio of at least 1% to 2% or more above the stated minimum.

Prompt Corrective Action Rules

The OCC has adopted regulations establishing capital categories for national banks and prompt corrective actions for undercapitalized institutions.  The regulations create five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.  A bank may be reclassified by the OCC to the next level below that determined by its regulatory capital if the OCC finds that it is in an unsafe or unsound condition or if it has received a less-than-satisfactory rating for any of the categories of asset quality, management, earnings or liquidity in its most recent examination and the deficiency has not been corrected, except that a bank cannot be reclassified as critically undercapitalized for such reasons.

The OCC may subject national banks which are not at least “adequately capitalized” to a broad range of restrictions and regulatory requirements.  An undercapitalized bank may not pay management fees to any person having control of the institution, nor, except under certain circumstances and with prior regulatory approval, make any capital distribution.  Undercapitalized banks are subject to increased monitoring by the OCC, are restricted in their asset growth, must obtain regulatory approval for certain corporate activities, such as acquisitions, new branches and new lines of business, and, in most cases, must submit to the OCC a plan to bring their capital levels to the minimum required in order to be classified as adequately capitalized.  The OCC may not approve a capital restoration plan unless each company that controls the bank guarantees that the bank will comply with it.  Under Federal Reserve policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to commit resources to support each such bank.  In addition, a bank holding company is required to guarantee that its subsidiary bank will comply with any capital restoration plan.  The amount of such a guarantee is limited to the lesser of (i) 5% of the bank’s total assets at the time it became

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undercapitalized, or (ii) the amount which is necessary (or would have been necessary) to bring the bank into compliance with all applicable capital standards as of the time the bank fails to comply with the capital restoration plan.  A holding company guarantee of a capital restoration plan results in a priority claim to the holding company’s assets ahead of its other unsecured creditors and shareholders that is enforceable even in the event of the holding company’s bankruptcy or the subsidiary bank’s insolvency.

If any one or more of a bank’s ratios are below the minimum ratios required to be classified as undercapitalized, it will be classified as significantly undercapitalized provided that if its ratio of tangible equity to total assets is 2% or less, it will be classified as critically undercapitalized.  Significantly and critically undercapitalized banks are subject to additional mandatory and discretionary restrictions and, in the case of critically undercapitalized institutions, must be placed into conservatorship or receivership unless the OCC and the FDIC agree otherwise.

As a condition to the approval of National Mercantile’s acquisition of South Bay, National Mercantile agreed with the Federal Reserve that it would maintain its and each of the Bank’s regulatory capital ratios in the well capitalized category for the three years following the closing date of the acquisition, December 14, 2001.  At December 31, 2003, each of the Banks and National Mercantile exceeded the required ratios for classification as well capitalized.

Safety and Soundness Standards

  ;

The federal banking agencies have adopted guidelines designed to assist the federal banking agencies in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) asset growth; (v) earnings; and (vi) compensation, fees and benefits.

In addition, the federal banking agencies have also adopted safety and soundness guidelines with respect to asset quality and earnings standards.  These guidelines provide six standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating.  Under these standards, an insured depository institution should (i) conduct periodic asset quality reviews to identify problem assets; (ii) estimate the inherent losses in problem assets and establish reserves that are sufficient to absorb estimated losses; (iii) compare problem asset totals to capital; (iv) take appropriate corrective action to resolve problem assets; (v) consider the size and potential risks of material asset concentrations; and (vi) provide periodic asset quality reports with adequate information for management and the board of directors to assess the level of asset risk.

These new guidelines also set forth standards for evaluating and monitoring earnings and for ensuring that earnings are sufficient for the maintenance of adequate capital and reserves.

Cross Guarantees

The Banks are also subject to cross-guaranty liability under federal law.  This means that if one FDIC-insured depository institution subsidiary of a multi-institution bank holding company fails or requires FDIC assistance, the FDIC may assess commonly controlled depository institutions for the estimated losses suffered by the FDIC.  Such a liability could have a material adverse effect on the financial condition of any assessed subsidiary institution and on National Mercantile as the common parent.  While the FDIC’s cross-guaranty claim is generally junior to the claim of depositors, holders of secured liabilities, general creditors and subordinated creditors, it is generally superior to the claims of shareholders and affiliates.

< p style="margin:0in 0in .0001pt .2in;">Community Reinvestment Act and Fair Lending

The Banks are subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act (“CRA”) activities.  A bank may be subject to substantial penalties and corrective measures for a violation of certain fair lending laws.  The CRA requires the Banks to ascertain and meet the credit needs of the communities it serves, including low- and moderate-income neighborhoods.  The Banks’ compliance with the CRA is reviewed and evaluated by the OCC, which assigns the Banks a publicly available CRA rating at t he conclusion of the examination.

The CRA regulations emphasize measurements of performance in the area of lending (specifically, a bank’s home mortgage, small business, small farm and community development loans), investment (a bank’s community development investments) and service (a bank’s community development services and the availability of its retail banking services), although examiners are still given a degree of flexibility in taking into account unique characteristics and needs of a bank’s community and its capacity and constraints in meeting such needs.  The regulations also require certain levels of collection and reporting of data regarding certain kinds of loans.

Further, the federal banking agencies may take compliance with such laws and CRA obligations into account when regulating and supervising other activities.  An assessment of CRA compliance is required in connection with applications for OCC approval of

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certain activities, including establishing or relocating a branch office that accepts deposits or merging or consolidating with, or acquiring the assets or assuming the liabilities of, a federally regulated financial institution.  An unfavorable rating may be the basis for OCC denial of such an application, or approval may be conditioned upon improvement of the applicant’s CRA record.  In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the Federal Reserve will assess the CRA record of each subsidiary bank of the applicant, and such records may be the basis for denying the application.  The federal banking agencies have established annual reporting and public disclosure requirements for certain written agreements that are entered into between insured depository institutions or their affiliates and nongovernmental entities or persons th at are made pursuant to, or in connection with, the fulfillment of the CRA.

In connection with its assessment of CRA performance, the appropriate bank regulatory agency assigns a rating of “outstanding”, “satisfactory”, “needs to improve” or “substantial noncompliance”.  Each of the Banks received a “satisfactory” rating in its most recent exam.

Employees

At December 31, 2003, we had 95 full-time equivalent employees.  None of the employees is covered by a collective bargaining agreement.  We consider our employee relations to be satisfactory.

ITEM 2.  PROPERTIES.

National Mercantile leases approximately 14,000 square feet in an office building at 1880 Century Park East, Los Angeles, California, which serves as its administrative headquarters.  The rent for the period January 2004 to April 2014 is $2.23 per square foot or $30,952 per month, subject to an annual CPI adjustment and for changes in property taxes and operating costs.  The lease for the former administrative offices at 1840 Century Park East was scheduled to expire in October 2004, however, the lease was terminated in January 2004 by agreement with the landlord.

Mercantile’s principal banking office is located in 7,715 square feet in an office building at 1840 Century Park East, Los Angeles, California.  The effective rent is $3.00 per s quare foot or $23,145 per month.  The lease expires in October 2004.  We have entered into a lease for approximately 1,800 square feet at 1880 Century Park East, Los Angeles, California in which we will relocate Mercantile’s principal banking office anticipated in June 2004.

Mercantile also leases an approximately 1,650 square foot facility in Encino, California for the primary purpose of providing branch banking operations in the San Fernando Valley.  The lease expires in May 2004 and we are currently negotiating a renewal of the lease.

South Bay owns a two-story stand alone office building at 2200 Sepulveda Boulevard, Torrance, California, which serves as its principal banking office.  South Bay also leases an approximately 1,500 square foot facility in El Segundo, California for the primary purpose of providing branch banking operations in the Los Angeles airport area.  The El Segundo lease expires in June 2004 and we are currently negotiating for another office space in the area.

We believe our present facilities are adequate for our present needs but anticipate the need for additional facilities as we continue to grow.  We believe that, if necessary, we could secure suitable alternative fa cilities on similar terms without adversely affecting operations.

ITEM 3.  LEGAL PROCEEDINGS.

From time to time, we are involved in certain legal proceedings arising in the normal course of our business.  We believe that the outcome of these matters existing as of December 31, 2003 will not have a material adverse effect on us.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

There was no submission of matters to a vote of shareholders during the quarter ended December 31, 2003.

PART II

ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

The Common Stock and Series A Noncumulative Convertible Perpetual Preferred Stock (the “Series A Preferred”) of National Mercantile are traded on the Nasdaq SmallCap Market, under the symbols MBLA and MBLAP, respectively.  The following table

10

shows the high and low trade prices of the Common Stock and Series A Preferred for each quarter of 2002 and 2003 as reported by the Nasdaq. Additionally, there may have been transactions at prices other than those shown during that time.

	Common Stock				Series A Preferred
Quarter Ended:	High		Low		High		Low
March 31, 2002	$	6.90	$	5.45	$	13.03	$	11.90
June 30, 2002	6.75		5.16		13.05		12.50
September 30, 2002	6.20		5.01		11.90		10.00
December 31, 2002	7.00		5.81		14.40		12.00
March 31, 2003	7.45		6.52		15.75		12.00
June 30, 2003	7.35		6.57		14.60		13.00
September 30, 2003	8.39		7.09		16.50		14.25
December 31, 2003	12.32		7.45		25.50		16.00

At March 19, 2004, National Mercantile had 150 shareholders of record for its Common Stock and 16 shareholders of record for its Series A Preferred.  The number of beneficial owners for the Common Stock and Series A Preferred is higher as many people hold their shares in “street” name.  At March 19, 2004, approximately 41% and 20% of the Common Stock and Series A Preferred, respectively, were held in street name.

National Mercantile has not paid a cash dividend on the Common Stock since July 1990, and has never paid a cash dividend on the Series A Preferred.  The Series A Preferred is entitled to a noncumulative cash dividend at a rate of 6.5% of its liquidation preference quarterly on the first day of January, April, July and October of each year, before any dividend may be declared upon or paid upon the Common Stock.  As a California corporation, under the California General Corporation Law, generally National Mercantile may not pay dividends in cash or property except (ii) out of positive retained earnings or (ii) if, after giving effect to the distribution, National Mercantile’s assets would be at least 1.25 times its liabilities and its current assets would exceed its current liabilities (determined on a consolidated basis under generally accepted accounting principles).  At December 31, 2003, National Mercantile had an accumulated deficit of $13.9 million.  Further, it is unlikely that its assets will ever be at least 1.25 times its liabilities.  Accordingly, National Mercantile must generate net income in excess of $13.9 million before it can pay a dividend in cash or property.

In addition, National Mercantile may not pay dividends on its capital stock if it is in default or has elected to defer payments of interest under its trust preferred securities.

Outstanding Awards Under All Equity Compensation Plans.  The following table sets forth as of December 31, 2003 information regarding outstanding options under all of our equity compensation plans and the number of shares available for future option grants under equity compensation plans currently in effect.

	(a)	(b)		(c)
Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights	Weighted-average exercise price of outstanding options, warrants and rights		Number of securities remaining available for issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plans approved by security holders (1)	495,883	$	6.84	105,584

(1) Includes the 1996 Stock Incentive Plan and two stock option plans which have been terminated but under which there remain outstanding options to purchase an aggregate of 50,779 shares of our Common Stock.

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ITEM 6.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

EXECUTIVE LEVEL OVERVIEW

We recorded  net income of $207,000 for 2003 compared to a net loss of $253,000 for 2002.  On a per share basis, in 2003 we recorded a basic earnings per share of $0.08 and fully-diluted earnings per share of $0.05 compared to basic and fully-diluted loss of  $0.15 per share for 2002.  The increase in net earnings was primarily due to a  $660,000 decrease in provision for loan losses as well as a $627,000 decrease in interest expense on the Junior Subordinated Debentures partially offset by a $510,000 decrease in net interest income (excluding interest relating to the Junior Subordinated Debentures) and a $435,000 increase in operating expenses.   (The comparison of interest expense and net interest income considers the reclassification of the trust preferred securities discussed below in which interest on the trust preferred securities after June 30, 2003 is reflected in interest expense rather than as previously reported as minority interest in the Company’s income of the Junior Subordinated Debentures.)

Total assets at December 31, 2003 were $355.2 million compared to $355.4 million at year end 2002.  While total assets were nearly unchanged, the composition of assets at the year ends reflects a $12.1 million decrease in loans receivable and a $8.7 million decrease in federal funds sold offset by a $5.7 million increase in cash and due from banks – demand, a $4.4 million increase in due from banks – time.   Securities available-for-sale and securities held-to-maturity increased $4.7 million and $4.6 million, respectively at December 31, 2003 compared to the prior year end.  During the 2003 year, particularly in the third quarter,  we experienced a more rapid repayment of construction loans than funding of newly originated loans.  Due to the nature of construction loans, the outstanding balance of newly originated loans increases gradually during the life of the loan and repays in a lump sum.  The proceeds from loan repayments were redeployed into investment securities and interest-bearing balances at other banks.

The allowance for credit losses at December 31, 2003 was $3.6 million compared to $4.8 million at December 31, 2002.  The decrease is due to net charge-offs of $2.5 million partially offset by provisions to the allowance during the year of $1.3 million.

Total deposits at December 31, 2003 were $298.7 million unchanged from year-end 2002.  The composition of deposits at December 31, 2003, however,  reflects a $12.4 million increase in noninterest-bearing demand deposits and a $12.3 million increase in money market accounts offset by a $15.7 million decrease and a $4.6 million decrease in time certificates of deposit $100,000 and over, and under $100,000, respectively.  The change in the composition of deposits reflects management’s emphasis on business banking at South Bay generating lower cost transaction deposit accounts combined with more aggressive pricing of the higher cost time certificates of deposit.

In July 2001, National Mercantile formed National Mercantile Capital Trust (the “Trust”) as a Delaware statutory business trust for the exclusive purpose of issuing and selling trust preferred securities (the “Trust Preferred Securities”).  The trust utilized the proceeds from the issuance of the Trust Preferred Securities to purchase National Mercantile’s junior subordinated interest debentures (the “Junior Subordinated Debentures”).  Through June 30, 2003, the Company’s financial statements reflected the Trust as a consolidated subsidiary, with its Trust Preferred Securities reflected on the consolidated balance sheet as mezzanine equity, shown as guaranteed preferred beneficial interests in the Company’s Junior Subordinated Debentures, net, and payments on the Trust Preferred Securities set forth as expenses and classified as minority interest in the Company’s income of the guaranteed preferred beneficial interest in the Junior Subordinated Debentures.

The Company implemented FASB Interpretation No. 46 (“FIN 46”) Consolidation of Variable Interest Entities effective July 1, 2003 resulting in the Trust no longer being a consolidated subsidiary of the Company for financial reporting purposes.  As a result: (i) the Company’s balance sheets as of dates on or after July 1, 2003 no longer reflect the Trust Preferred Securities as mezzanine equity but instead reflect the Junior Subordinated Debentures as liabilities, and (ii) the Company’s statements of operations incorporating periods on or after July 1, 2003, no longer reflect interest payments on the Junior Subordinated Debentures for periods on or after July 1, 2003 as expenses classified as minority interest  in the Company’s income of the guaranteed preferred beneficial interest in the Company’s Junior Subordinated Debentures but rather as interest expense.  As discussed below, this has a significant effect on comparisons of net interest income for periods prior to July 1, 2003 and after implementation.

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Table 1

Operations Summary

	Year Ended December 31, 2003							Year Ended December 31, 2002
			Increase (Decrease)
			Amount			%
	(Dollars in thousands)
Interest income	$	17,124	$	(2,448	)	(12.5	)%	$	19,572
Interest expense	3,180		(1,484		)	(31.8	)%	4,664
Net interest income	13,944		(964		)	(6.5	)%	14,908
Provision for credit losses	1,265		(660		)	(34.3	)%	1,925
Other operating income	1,376		(126		)	(8.4	)%	1,502
Other operating expense	13,296		435			3.4	%	12,861
Minority interest in the Company’s income of the:
Guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debenture-net	456		(1,081		)	(70.3	)%	1,537
Series A Preferred Stock of South Bay Bank, N.A.	—		(213		)	N/A		213
Income before income taxes	303		429			(340.5	)%	(126		)
Income taxes	96		(31		)	(24.4	)%	127
Net income (loss)	$	207	$	460		(181.8	)%	$	(253	)

CRITICAL ACCOUNTING POLICIES

Our accounting policies are integral to understanding the results reported. Accounting policies are described in detail in Note 1 of the Notes to Consolidated Financial Statements.  Our most complex accounting policies require management’s judgment to ascertain the valuation of assets, liabilities, commitments and contingencies.  We have established detailed policies and control procedures that are intended to ensure valuation methods are well controlled and applied consistently from period to period.  In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner.  The following is a brief description of our current accounting policies involving significant management valuation judgments.

Allowance for Credit Losses

The allowance for credit losses represents management’s best estimate of losses inherent in the existing loan portfolio. The allowance for credit losses is increased by the provision for credit losses charged to expense and reduced by loans charged off, net of recoveries. The allowance for credit losses is determined based on management’s assessment of several factors: (i) reviews and evaluation of individual loans including underlying cash flow and collateral values, (ii) the level of and changes in classified and nonperforming loans, (iii) historical loan loss experiences, (iv) changes in the nature and volume of the loan portfolio, and (v) current economic conditions and the related impact on specific borrowers and industry groups.

We review and manage the credit quality of the loan portfolio through a process that includes a risk grading system, uniform underwriting criteria, early identification of problem credits, regular monitoring of any classified assets graded as ‘‘criticized’’ by our internal grading system, and an independent loan review process.  The calculation of the adequacy of the allowance for credit losses is based on this internal risk grading system as well as other factors including loan grade migration trends and collateral values.

The internal risk grading utilizes an 10-level grading system – six pass grades for unclassified loans based upon our assessment of the borrower’s ability to service the loan and the quality of the collateral and four classification grades for “criticized” loans depending on the severity of the underwriting weakness and liklihood of loss.  We use a statistical grading migration analysis as part of our allowance for credit losses evaluation for unclassified loans which is a method by which the types and gradings of historical loans charged-off are related to the current loan portfolio.  This analysis attempts to use historical trends in loan risk grading, nonperforming assets and concentrations that are characteristic to our portfolio and consider other factors affecting loan losses that are specific to our marketplace and customer demographic.

An allowance based upon the migration analysis is established for various loan types and unclassified grades ranging from zero for loans secured by cash or marketable securities to 1.0% for unsecured commercial loans.  This methodology assumes, among other things, (i) consistency in underwriting standards and internal risk grading between the current loan portfolio and the historical sample, (ii) that the factors that resulted in historical loans charged-off, such as industry economic condition, will be the same factors that cause future loans to be charged-off, and (iii) the economic environment experienced during the period of historical loans charged-off is similar to the future economic environment.

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Generally, the allowance for credit losses established for classified loans that are collateral-dependent is based on the net realizable value of the collateral.  In measuring the net realizable value of the collateral, management uses current appraisals that, among other techniques, observe market transactions of similar property and adjust for differences.  Changes in the financial condition of individual borrowers, in economic conditions, in historical loss experience and in the condition of the various markets in which collateral may be sold may all affect the required level of the allowance for credit losses and the associated provision for credit losses.

On a periodic basis -twice in 2003- we engage an outside loan review firm to review our loan portfolio, risk grade accuracy and the reasonableness of loan evaluations.  Annually, this outside loan review team analyzes our methodology for calculating the allowance for credit losses based on our loss histories and policies.

Each Bank’s board of directors reviews the adequacy of that Bank’s allowance for credit losses on a quarterly basis.  We utilize our judgment to determine the provision for credit losses and establish the allowance for credit losses.  We believe, based on information known to management, that the allowance for credit losses at December 31, 2003 was adequate to absorb inherent losses in the existing loan portfolio.  However, credit quality is affected by many factors beyond our control, including local and national economies, and facts may exist which are not known to us that adversely affect the likelihood of repayment of various loans in the loan portfolio and realization of collateral upon a default.  Accordingly, no assurance can be given that we will not sustain loan losses materially in excess of the allowance for credit losses.  In addition, the OCC, as an integral part of its examination process, periodically reviews the allowance for credit losses and could require additional provisions for credit losses.

Goodwill and Other Intangible Assets

As discussed in Note 2 of the Notes to Consolidated Financial Statements, we must assess goodwill and other intangible assets each year, or more frequently upon the occurrence of certain events, for impairment.  Impairment is the condition that exists when the carrying amount of the asset exceeds its implied fair value.

The goodwill impairment test involves comparing the fair value of South Bay with its carrying amount, including goodwill.  We retained an independent valuation consultant to evaluate the goodwill as of October 1, 2003.  The valuation consultant conducted the analysis utilizing two valuation methods – the income approach and the market approach.

The income approach measures the present worth of anticipated future net cash flows generated by South Bay.  Net cash flow forecasts require analysis of the significant variables influencing revenues, expenses, working capital and capital investment as well as residual value and cost of capital.  Our forecasts were for a three-year period reflecting average annual asset growth of 12.8%, an average loan to deposit ratio of 97.5%, an average net interest margin of 5.1%, and average annual return on assets of 1.0%.  A 10.8% cost of capital and a $29.1 million residual value was utilized in the analysis to discount the projected cash flows.

The market approach derives a valuation by analyzing the prices at which shares of capital stock of reasonably similar companies are trading in the public market, or the transaction price at which similar companies have been acquired.  The analysis identified ten transactions during the period from January 2001 through September 2003 involving seller companies with similarities to South Bay in size and operating characteristics.  Transaction multiples were considered for purchase price to (i) earnings, and (ii) total assets.  The purchase price to earnings multiple for the South Bay acquisition was 11.38 compared to a range from 8.03 to 33.37 with an average of 17.62% for the transactions studied.  The South Bay transaction purchase price to total assets multiple was 0.15 compared to a range of 0.08 to 0.33 with an average of 0.20 for the comparable transactions.

The consultant also analyzed our stock price as part of their market approach analysis.  This analysis involved applying price multiples based on our stock price at or near the valuation date to the performance measures of South Bay.  Additionally, the consultants considered guideline companies operating in the same market segment as South Bay.  The stock trading values of similar companies was not considered reliable due to the small volume of trading activity, however, the results were not inconsistent with those of the transaction method.

The fair value indications derived from the income approach was $28.2 million and from the two market approaches, transaction and stock price analysis, $26.8 million and $22.1 million, respectively.  The fair value of South Bay under both approaches exceeds the carrying value at October 1, 2003 of $20.3 million, therefore, goodwill is not considered impaired.  The testing of goodwill and other intangible assets for impairment requires re-measurement of fair values.  If the future fair values were materially less than the recorded value, we would be required to take a charge against earnings to write down the goodwill and other intangible assets to the lower value.

Deferred Tax Assets

At December 31, 2003 we had total deferred tax assets of $7.0 million of which $6.9 million is represented by (i) federal NOLs of $18.9 million, which begin to expire in 2009; (ii) California NOLs of $766,000 which will expire in 2004.  In order to utilize the benefit of the deferred tax assets related to the NOLs, we must generate aggregate taxable income equal to the amount of the NOLs during the period prior to their expiration.

If future taxable income should prove non-existent or less than the amount of the deferred tax assets within the tax years to which they may be applied, the asset may not be realized.  A valuation allowance may be established to reduce the deferred tax asset to its realizable value.  Any adjustment required to the valuation allowance is coupled with a related entry to income tax expense.  A charge to earnings will be made in the event that we determine that a valuation allowance to the deferred tax asset is necessary.  Our deferred tax assets are described further in Note 6 of the Notes to Consolidated Financial Statements.

We use estimates of future taxable income to evaluate if it is more likely than not that the benefit of our deferred tax assets will be realized.  Our analysis utilizes alternative scenarios reflecting a range of assumptions for asset growth rates, loan to deposit ratios, interest rates and inflation rates.  The results of the analysis support our position that it is more likely than not that our deferred tax assets will be realized.

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OPERATIONS SUMMARY ANALYSIS

Net Interest Income

Our earnings depend largely upon the difference between the income earned on our loans and other investments and the interest paid on our deposits and borrowed funds.  This difference is net interest income.  Our ability to generate net interest income is largely dependent on our ability to maintain sound asset quality and appropriate levels of capital and liquidity.  Our inability to maintain strong asset quality, capital or liquidity may adversely affect (i) the ability to accommodate desirable borrowing customers, thereby inhibiting growth in quality higher-yielding earning assets; (ii) the ability to attract comparatively stable, lower-cost deposits; and (iii) the costs of wholesale funding sources.

Net interest income decreased $1.0 million to $13.9 million during 2003 compared to $14.9 million during 2002. The decrease was attributable to the reclassification of Trust Preferred Securities, discussed above, and lower yields on earning assets, partially offset by a greater volume of average earning assets, a greater volume of noninterest-bearing liabilities, a lower volume of average interest-bearing liabilities and a lower cost of interest-bearing liabilities.  The reclassification of Trust Preferred Securities resulted in the $454,000 of payments on the Junior Subordinated Debentures being classified as interest in 2003, while no interest expense was recorded in 2003 on the Trust Preferred Securities.  The net yield on earning assets in 2003 declined to 4.29% for 2003 from 4.73% for 2002 (the net yield on earning assets in 2003 would have been 4.43% without the reclassification  of the Trust Preferred Securities).

Average earning assets increased $9.5 million to $324.8 million during 2003 compared to 2002 while the average yield on earning assets declined 0.94 % from 6.21% to 5.27%.  Total interest income decreased $2.4 million signficantly due to the lower yields on earning assets offset only slightly by the greater  average earning assets.  The lower yields are due to the sustained decline in interest rates over the past three years impacting the yields on adjustable rate earning assets as well as newly originated fixed rate loans and existing fixed rate loans upon renewal at maturity.

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Interest income from loans decreased $1.7 million during 2003 due to a 81 basis point (one basis point is equal to .01%) decline in yield, partially offset by a $6.3 million increase in average loans receivable.  The average amount of securities available-for-sale decreased $7.4 million while the average yield declined 144 basis points resulting in a $741,000 decrease in interest income.  Interest income from federal funds sold decreased approximately $73,000 despite $7.3 million greater average volume due to a 57% decrease in average yield.

Average interest-bearing liabilities decreased $7.1 million to $205.3 million during 2003 compared to $212.4 million during 2002.  Interest expense decreased  $1.5 million  for 2003 compared to 2002 due to the lower average volume of interest bearing liabilities and a 65 basis point decline in the average cost of funds for 2003.  Average interest-bearing liabilities decreased $14.8 million and interest expense declined $1.9 million without the reclass of the Trust Preferred Securities into liabilities.  The decrease in the cost of funds was due to the overall lower interest rate environment during 2003 and a change in the composition of interest-bearing liabilities to lower cost funds.  Relatively high-cost other borrowings, consisting primarily of advances from the Federal Home Loan Bank, averaged $7.5 million in 2003 compared to $11.3 million in 2002.  The average amount of moderate-cost time certificates of deposit decreased $21.9 million while lower-cost money market and savings deposits and interest-bearing demand deposits increased $12.3 million and $0.2 million, respectively.

Noninterest-bearing demand deposits averaged $119.8 million during 2003 compared to $102.2 million in 2002.  Shareholders’ equity averaged $31.6 million during 2003 compared to $25.9 million during the prior year primarily due to the sale and issuance of $7.7 million common shares in December 2002.

While Mercantile and South Bay had similar volumes of interest earning assets, a significant difference existed in the composition of South Bay’s interest earning assets and the related yields.  Accordingly, the acquisition of South Bay in December 2001 has affected the net interest spread during the 2002 and 2003 periods as compared to 2001.  During 2003 average loans receivable of South Bay were $22.4 million, or 19%, greater than Mercantile’s average loans receivable while lower-yielding Federal funds sold and investment securities at South Bay were $25.8 million less than Mercantile.  The greater relative volume of higher yielding earning assets at South Bay than Mercantile increased the yield of our total interest earning assets approximately 0.42% in 2003.

Significant differences in the composition and related costs of funding liabilities between Mercantile and South Bay also affected our net interest spread and net yield on earning assets for the 2003 periods.  Average noninterest bearing deposits at Mercantile for the year ended December 31, 2003 were $56.8 million greater than South Bay while average interest bearing liabilities at Mercantile were $41.8 million less than South Bay.  During 2003, time certificates of deposit averaged $19.5 million and $44.8 million at Mercantile and South Bay, respectively, with rates of 1.49% and 2.34%, respectively.  The greater relative volume of higher costing funding liabilities at South Bay than Mercantile has increased the rate on our total interest bearing liabilities approximately 0.58% in 2003.

In 2003 we replaced higher costing liabilities at South Bay with Federal funds purchased from Mercantile in order to lower our overall cost of funds.  Additionally, we allocated greater resources to South Bay, primarily in salaries, to increase its emphasis on business banking.  Management expects this emphasis to result in further diversification of the loan portfolio through growth of commercial loans, in additional to growth of lower cost funds, particularly noninterest bearing.

Table 2

Ratios to Average Assets

	2003		2002
Net interest income	3.82	%	4.15	%
Other operating income	0.38	%	0.42	%
Provision for credit losses	(0.35	)%	(0.54	)%
Other operating expense	(3.64	)%	(3.58	)%
Minority interest in the Company’s junior subordinated deferrable interest debenture-net	(0.12	)%	(0.43	)%
Income before income taxes	0.09	%	0.02	%
Net income	0.06	%	(0.07	)%

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Interest Rate Spread and Net Interest Margin

We analyze earnings performance using, among other measures, the interest rate spread and net interest margin.  The interest rate spread represents the difference between the weighted average yield received on interest earning assets and the weighted average rate paid on interest bearing liabilities.  Net interest margin (also called the net yield on interest earning assets) is net interest income expressed as a percentage of average total interest earning assets.  Our net interest margin is affected by changes in the yields earned on assets and rates paid on liabilities, referred to as rate changes, and changes to the relative amount of interest earning assets and interest bearing liabilities.  Interest rates charged on our loans are affected principally by the demand for such loans, the supply of money available for lending purposes, and other competitive factors.  These factors are in turn affected by general economic conditions and other factors beyond our control, such as federal economic policies, the general supply of money in the economy, legislative tax policies, governmental budgetary matters, and actions of the Federal Reserve Board.  Table 3 presents information concerning the change in interest income and interest expense attributable to changes in average volume and average rate.  Table 4 presents the weighted average yield on each category of interest earning assets, the weighted average rate paid on each category of interest bearing liabilities, and the resulting interest rate spread and net yield on interest earning assets for 2003, 2002 and 2001.  We had no tax exempt interest income for 2003, 2002 or 2001.

Our net interest margin remains high in comparison with the interest rate spread due to the continued significance of noninterest-bearing demand deposits relative to total funding sources.  Average noninterest bearing demand deposits totaled $119.8 million, representing 38.7% of average deposits, during 2003, compared to $102.2 million, representing 34.0% of average deposits, during 2002.  Of these noninterest bearing demand deposits during 2003, $27.0 million or 22.5% of average noninterest bearing deposits were represented by real estate title and escrow company deposits, compared to $23.9 million or 23.4% of average noninterest bearing deposits during 2002.  While these deposits are noninterest bearing, they are not cost free funds.  Customer service expenses, primarily costs related to external accounting and data processing services provided to title and escrow company depositors are incurred by us to the extent that such depositors maintain certain average noninterest bearing deposits.  Customer service expense is classified as other operating expense.  If customer service expenses related to escrow customers had been classified as interest expense, our reported net interest income for 2003 and 2002, would have been reduced by $132,000 and $206,000, respectively, and the net interest margin for 2003 and 2002 would have decreased 6 basis points and 7 basis points, respectively.  Similarly, this would create identical reductions in other operating expense.     The expense associated with these deposits declined in 2003 from 2002 despite the increase in volume because we reduced the amount of third-party customer services provided for these depositors.

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Table 3

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

Average Volume and Average Rate (1)

	2003 vs 2002												2002 vs 2001
									Net Increase (Decrease)												Net Increase (Decrease)
	Increase (decrease) due to:												Increase (decrease) due to:
	Volume				Rate								Volume				Rate
	(Dollars in thousands)
Interest Income:
Federal funds sold and securities purchased under agreement to resell	$	119		$		(192	)	$		(73	)	$		192		$		(572	)	$		(380	)
Due from banks - interest bearing	5			—				5				—				—				—
Securities available-for-sale	(370		)	(371			)	(741			)	(1,164			)	(420			)	(1,584			)
Securities held-to-maturity	38			—				38				—				—				—
Loans receivable (2)	435			(2,112			)	(1,677			)	12,075				(4,342			)	7,733
Total interest-earning assets	227			(2,675			)	(2,448			)	11,103				(5,334			)	5,769
Interest Expense:
Interest-bearing deposits:
Demand	$	3		$		(199	)	$		(196	)	$		178		$		52		$		230
Money market and savings	203			(724			)	(521			)	1,162				(755			)	407
Time certificates of deposit:
$100,000 or more	(307		)	(3			)	(310			)	619				(1,183			)	(564			)
Under $100,000	(200		)	(476			)	(676			)	1,397				(246			)	1,151
Total time certificates of deposit	(507		)	(479			)	(986			)	2,016				(1,429			)	587
Total interest-bearing deposits	(301		)	(1,402			)	(1,703			)	3,356				(2,132			)	1,224
Other borrowings	(161		)	44				(117			)	(463			)	(70			)	(533			)
Junior subordinated debentures (3)	454			—				454				—				—				—
Federal funds purchased and securities sold under agreements to repurchase	(98		)	(20			)	(118			)	79				18				97
Total interest-bearing liabilities	(106		)	(1,378			)	(1,484			)	2,972				(2,184			)	788
Net interest income	$	333		$		(1,297	)	$		(964	)	$		8,131		$		(3,150	)	$		4,981

(1)The change in interest income or interest expense that is attributable to both changes in average balance and average rate has been allocated to the changes due to ‘(i) average balance and (ii) average rate in proportion to the relationship of the absolute amounts of changes in each.

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

(3)The implementation of FASB Interpretation No. 46, effective July 1, 2003 resulted in the reclassification of the Company’s Junior Subordinated Debentures from mezzanine equity to liabilities and the related interest to interest expense after June 30, 2003.

18

Table 4

Average Balance Sheet and

Analysis of Net Interest Income

	2003							2002							2001
	Average Amount			Interest Income/ Expense		Weighted Average Yield/ Rate		Average Amount			Interest Income/ Expense		Weighted Average Yield/ Rate		Average Amount			Interest Income/ Expense		Weighted Average Yield/ Rate
	(Dollars in thousands)
Assets:
Federal funds sold and securities purchased under agreements to resell	$	33,829		$	359	1.06	%	$	26,514		$	432	1.63	%	$	21,446		$	812	3.79	%
Due from banks - interest bearing	1,304			17		1.30	%	1,348			12		0.89	%	—			—		—
Securities available-for-sale	25,672			911		3.55	%	33,077			1,652		4.99	%	51,665			3,236		6.26	%
Securities held-to-maturity	3,254			38		1.17	%	—			—		—		—			—		—
Loans receivable (1) (2)	260,756			15,799		6.06	%	254,424			17,476		6.87	%	113,615			9,743		8.58	%
Total interest earning assets	324,815			$	17,124	5.27	%	315,363			$	19,572	6.21	%	186,726			$	13,791	7.39	%
Noninterest earning assets:
Cash and due from banks - demand	22,171							20,775							11,698
Other assets	21,859							28,348							4,900
Allowance for credit losses and net unrealized (loss) gain on sales of securities available-for-sale	(4,025		)					(5,652		)					(2,794		)
Total assets	$	364,820						$	358,834						$	200,530
Liabilities and shareholders’ equity:
Interest-bearing deposits:
Demand	$	28,269		$	126	0.45	%	$	28,024		$	322	1.15	%	$	9,562		$	92	0.96	%
Money market and savings	98,763			905		0.92	%	86,444			1,426		1.65	%	40,396			1,019		2.52	%
Time certificates of deposit:
$100,000 or more	29,150			535		1.84	%	45,770			845		1.85	%	31,807			1,409		4.43	%
Under $100,000	33,316			783		2.35	%	38,606			1,459		3.78	%	6,975			308		4.42	%
Total time certificates of deposit	62,466			1,318		2.11	%	84,376			2,304		2.73	%	38,782			1,717		4.43	%
Total interest-bearing deposits	189,498			2,349		1.24	%	198,844			4,052		2.04	%	88,740			2,828		3.19	%
Other borrowings	7,500			361		4.81	%	11,308			478		4.23	%	20,865			1,011		4.85	%
Junior subordinated debentures (3)	7,733			454		5.87	%	—			—		—		—			—		—
Federal funds purchased and securities sold under agreements to repurchase	609			16		2.63	%	2,294			134		5.84	%	733			37		5.05	%
Total interest-bearing liabilities	205,340			3,180		1.55	%	212,446			4,664		2.20	%	110,338			3,876		3.51	%
Noninterest-bearing liabilities:
Noninterest bearing demand deposits	119,789							102,213							58,883
Other liabilities	845							3,716							1,197
Guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures, net (3)	7,267							14,525							7,592
Shareholders’ equity	31,579							25,934							22,520
Total liabilities and shareholders’ equity	$	364,820						$	358,834						$	200,530
Net interest income (interest rate spread)				$	13,944	3.72	%				$	14,908	4.01	%				$	9,915	3.88	%
Net yield on earning assets (2)						4.29	%						4.73	%						5.31	%

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

(2)Yields and amounts earned on loans receivable include loan fees of $882,000, $645,000 and $403,000 for the years ended December 31, 2003, 2002 and 2001, respectively.

(3)The implementation of FASB Interpretation No. 46, effective July 1, 2003 resulted in the reclassification of the Company’s Junior Subordinated Debentures from mezzanine equity to liabilities and the related interest to interest expense after June 30, 2003.

19

Provision for Credit Losses

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

During 2003, we provided $1.3 million to the allowance for credit losses to maintain an adequate allowance after the charge-off of various loans.  In 2003 net charge-offs were $2.5 million compared to $3.6 million in 2002.  Management determined that a decrease in the allowance for credit losses was warranted due to the reduction in nonperforming loans.

Based on continued loan growth, the relative uncertainty regarding the state of the economy, the level of nonperforming loans and a relatively constant level of charge offs, it is anticipated that regular provisions for credit losses will be made during 2004.  Credit quality will be influenced by underlying trends in the economic cycle, particularly in Southern California, and other factors which are beyond management’s control.  Accordingly, no assurance can be given that we will not sustain loan losses that in any particular period are sizable in relation to the allowance for credit losses.  Subsequent evaluation of the loan portfolio, in light of factors then prevailing, by us and our regulators may indicate a requirement for increases in the allowance for credit losses through  additions to the provision for credit losses.

Other Operating Income

Other operating income was $1.4 million and $1.5 million in 2003 and 2002, respectively.  During 2003 we recorded a net gain of $51,000 on the sales of securities available-for-sale.  In 2002, there were no sales of securities and therefore, no gains nor losses on sales of securities.  Fee income related to international services was $44,000 in 2003 compared to $37,000 in 2002.  Investment services fees remained stable at $84,000 in 2003 compared to $82,000 in 2002.  Deposit related services were $1.3 million in 2003 as compared to $1.4 million in 2002.  In 2003 we recorded a loss of $136,000 on the sale or write-down of  OREO.

Other Operating Expenses

Other operating expense increased $435,000 to $13.3 million in 2003, compared to $12.9 million during 2002.  Salaries and related benefits increased $381,000 or 5.6 % to $7.2 million, primarily due to the addition of business development staff.  Other professional services expense increased 57.2 % to $833,000 due to costs associated with problem loan resolution, goodwill and intangible valuation and expanded internal audit reviews.  Legal expenses decreased 12.6 % to $473,000 during 2003 from $541,000 during 2002 largely due to decreased activity required for loan collections at both Banks.  During 2003, $223,000 was recorded for the amortization of core deposit intangibles associated with the South Bay acquisition.  Customer services expense declined $93,000 during 2003 due to the decline in interest rates resulting in the bank paying for fewer third-party services, such as accounting and bookkeeping services, for its escrow and title insurance depositors.

Income Taxes

Deferred tax assets and liabilities are recognized for the expected future tax consequences of existing differences between financial reporting and tax reporting bases of assets and liabilities, as well as for operating losses and tax credit carryforwards, using enacted tax laws and rates.  Deferred tax assets will be reduced through a valuation allowance whenever it becomes more likely than not that all or some portion will not be realized.  Deferred income tax expense (benefit) represents the net change in the deferred tax asset or liability balance during the year. This amount, together with income taxes currently payable or refundable in the current year, represents the total tax expense for the year.

At December 31, 2003, our deferred tax asset totaled $7.0 million, respectively, with no recorded valuation allowance.

For tax purposes at December 31, 2003, we had (i) federal net operation loss carryforwards (“NOLs”) of $18.9 million, which begin to expire in 2009; (ii) California NOLs of $766,000 which will expire in 2004; (iii) a federal alternative minimum tax (“AMT”) credit carryforward of $298,000, and (iv) a California AMT credit carryforward of $16,000.  The California NOL was scheduled to expire in 2002, however, the state legislature suspended NOL utilization and extended the related carryforward expiration.  The AMT credits carryforward indefinitely.

An income tax provision of $96,000 was recorded for 2003.  During 2002, a $127,000 income tax provision was recorded despite the net loss as taxable income was greater than the reported results of operations due to non-deductible expenses for tax purposes.

20

Federal and state income tax laws provide that following an ownership change of a corporation with NOLs, a net unrealized built-in loss or tax credit carryovers, the amount of annual post-ownership change taxable income that can be offset by pre-ownership change NOLs, built-in losses or tax credit carryovers generally cannot exceed a prescribed annual limitation.  The annual limitation generally equals the product of the fair market value of the corporation immediately before the ownership change (subject to certain adjustments) and the federal long-term tax-exempt rate prescribed monthly by the Internal Revenue Service.  If such limitations were to apply to us, our ability to reduce future taxable income by the NOLs could be severely limited.

Accumulated Other Comprehensive Income

Changes in the unrealized gain on available-for-sale securities, net of taxes is the only component of our other comprehensive income.  At December 31, 2003 the net unrealized gain on available-for-sale securities, net of taxes was $71,000 compared to $202,000 at December 31, 2002.  During 2003 there was a $131,000 net unrealized holding loss.

FINANCIAL CONDITION

Regulatory Capital

The following table sets forth the regulatory standards for well-capitalized banks and our regulatory capital ratios as of December 31, 2003 and 2002.

Table 5

Regulatory Capital Information

of the National Mercantile and Banks

	Minimum For Capital Adequacy Purposes		Well Capitalized Standards		December 31,
					2003		2002
National Mercantile Bancorp:
Tier 1 leverage	4.00	%	N/A		8.69	%	8.60	%
Tier 1 risk-based capital	4.00	%	N/A		11.02	%	10.57	%
Total risk-based capital	8.00	%	N/A		13.84	%	13.31	%
Mercantile National Bank:
Tier 1 leverage	4.00	%	5.00	%	8.13	%	7.20	%
Tier 1 risk-based capital	4.00	%	6.00	%	10.88	%	9.89	%
Total risk-based capital	8.00	%	10.00	%	12.13	%	11.15	%
South Bay Bank, NA:
Tier 1 leverage	4.00	%	5.00	%	9.44	%	9.38	%
Tier 1 risk-based capital	4.00	%	6.00	%	11.18	%	10.90	%
Total risk-based capital	8.00	%	10.00	%	12.37	%	12.15	%

Our Tier 1 capital, which is comprised of shareholders’ equity as modified by certain regulatory adjustments, was $31.2 million and $29.9 million at December 31, 2003 and 2002, respectively.  National Mercantile’s Tier 1 capital increased in 2003 as a result of retained earnings, exercised stock options and a reduction of disallowed deferred tax asset.  Federal Reserve capital rules allow trust preferred securities to represent 25% of Tier 1 capital with the balance treated as Tier 2 capital for the Total Risk-based Capital Ratio.  At December 31, 2003 and 2002, Trust Preferred Securities represented $10.6 million and $10.3 million, respectively, of National Mercantile’s Tier 1 capital, and $4.4 million and $4.7 million, respectively, of its Tier 2 capital.  Disallowed against National Mercantile’s Tier 1 capital is $3.2 million of goodwill recorded in the acquisition of South Bay, $1.9 million of other intangible assets and $5.9 million of deferred tax asset based upon estimated earnings.  A reduction in estimated earnings will increase the amount of the disallowed deferred tax asset and will have the effect of reducing our regulatory capital.

Mercantile’s Tier 1 capital was $15.7 million and $12.6 million at December 31, 2003 and 2002, respectively.  The increase in Tier 1 capital during 2003 was due to the decrease of the disallowed portion of the deferred tax asset related to the NOL.  Because the allowable portion of the deferred tax asset is based upon our estimated twelve-month’s earnings of the consolidated entity, as discussed above, an increase in estimated earnings will likewise increase Mercantile’s regulatory capital.

21

South Bay’s Tier 1 capital at December 31, 2003 was $15.4 million compared to $17.0 million at December 31, 2002.  The decrease is due to an increase in the goodwill disallowed for regulatory purposes.

Liquidity Management

The objective of liquidity management is to maintain cash flow adequate to fund our operations and meet obligations and other commitments on a timely and cost effective basis.  We manage to this objective primarily through the selection of asset and liability maturity mixes.  Our liquidity position is enhanced by the ability to raise additional funds as needed through available borrowings or accessing the wholesale deposit market.

Our deposit base provides the majority of funding requirements.  Average deposits, a relatively stable and low-cost source of funds has, along with shareholders’ equity, provided 84.8 % and 83.9 % of funding for average total assets during 2003 and 2002, respectively.  The other borrowings, specifically Federal Home Loan Bank (“FHLB”) advances, which averaged $7.5 million during 2003 compared to $11.3 million during 2002, and federal funds purchased and securities sold under agreements to repurchase, which averaged $609,000 in 2003 compared to $2.3 million in 2002, comprise the balance of the liability funding.  The decline in relatively high-cost other borrowings during 2002 was offset by deposits and capital sources of funding.

Liquidity is also provided by assets such as federal funds sold and securities purchased under resale agreements that may be immediately converted to cash at minimal cost. The aggregate of these assets averaged $33.8 million during 2003, as compared to $26.5 million during 2002.

The portfolio of available-for-sale securities is an additional source of liquidity, which averaged $25.7 million during 2003 compared to $33.1 million in 2002.  The securities available-for-sale increased in 2003 due to the deployment of funds into securities pending redeployment into loans.  The unpledged portion of investment securities at December 31, 2003 totaled $15.6 million and was available as collateral for borrowings.  At December 31, 2003 an additional $2.3 million borrowing capacity remained on pledged securities.  Maturing loans also provide liquidity, of which $79.9 million of the Banks’ loans are scheduled to mature in 2004.

Net cash provided by operating activities totaled $2.4 million in 2003 compared to $2.5 million in 2002.  The primary source of funds is net income from operations adjusted for provision for credit losses and depreciation and amortization.  Net cash used in investing activities totaled $426,000 in 2003 compared to $407,000 net cash provided by investing activities in 2002.  The decrease in cash provided by investing activities resulted from an increase in purchase of securities available-for-sale and securities held-to-maturity partially offset by an increase in the proceeds from sales and repayments of securities available-for-sale and a decrease in net loan originations.  Net cash used in financing activities was $581,000 in 2003 compared to $17.1 million provided by financing activities in 2002.  The decrease in 2003 resulted primarily from a decrease in other borrowed funds offset by an increase in demand, money market and savings deposits.

Interest Rate Risk Management

Interest rate risk management seeks to maintain a stable growth of income and manage the risk associated with changes in interest rates.  Net interest income, the primary source of earnings, is affected by interest rate movements.  Changes in interest rates have a lesser impact the more that assets and liabilities reprice in approximately equivalent amounts at basically the same time intervals.  Imbalances in these repricing opportunities at any point in time constitute interest sensitivity gaps, which is the difference between interest sensitive assets and interest sensitive liabilities.

Interest rate risk, including interest rate sensitivity and the repricing characteristics of assets and liabilities, is managed by the Interest Rate Risk Management Committee (“IRRMC”).  The principal objective of IRRMC is to maximize net interest income within acceptable levels of risk established by policy.

We manage interest rate sensitivity by matching the repricing opportunities on our earning assets to those on our funding liabilities.  We use various strategies to manage the repricing characteristics of our assets and liabilities to ensure that exposure to interest rate fluctuations is limited within guidelines of acceptable levels of risk-taking.  Hedging strategies, including the terms and pricing of loans and deposits, and managing the deployment of our securities are used to reduce mismatches in interest rate repricing opportunities of portfolio assets and their funding sources.  Interest rate risk 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 the results of any projected activity and are best used as early indicators of potential interest rate exposures.

An asset sensitive gap means an excess of interest sensitive assets over interest sensitive liabilities, whereas a liability sensitive gap means an excess of interest sensitive liabilities over interest sensitive assets.  In a changing rate environment, a mismatched gap

22

position generally indicates that changes in the income from interest earning assets will not be proportionate to changes in the cost of interest bearing liabilities, resulting in net interest income volatility.

Table 6 compares our interest rate gap position as of December 31, 2003 and 2002.  The gap report shows a cumulative one year interest rate asset sensitivity gap of $85.9 million at December 31, 2003, a change from an asset sensitivity gap of $36.7 million at December 31, 2002.  The increase in asset sensitivity was due to a $21.0 million increase in loans receivable maturing or repricing in less than one year , an increase of $13.7 in securities-available-for-sale maturing or repricing in less than one year and a reduction in time certificates of deposit of $25.6 million maturing in less than one year partially offset by an increase in immediately repricable interest-bearing demand, money market and savings deposits of $7.9 million ..  The greater volume of loans repricing within one year is due to the greater emphasis on growth in commercial loans which are typically adjustable rate loans.  The increase in interest-bearing demand, money market and savings deposits is due similarly to the emphasis on commercial borrowers as well as a change in mix from time certificates of deposit to savings deposits.  In the low interest rate environment, depositors have moved maturing time certificates of deposits to savings deposits.

Since interest rate changes do not affect all categories of assets and liabilities equally or simultaneously, a cumulative gap analysis alone cannot be used to evaluate the interest rate sensitivity position.  To supplement traditional gap analysis, interest rate sensitivities are also monitored through the use of simulation modeling techniques that apply alternative interest rate scenarios to periodic forecasts of future business activity and estimate the related impact on net interest income.  The use of simulation modeling assists management in its continuing efforts to achieve earnings growth in varying interest environments.

Key assumptions in the model include anticipated prepayments on mortgage-related instruments, contractual cash flow and maturities of all financial instruments, anticipated future business activity, deposit rate sensitivity and changes in market conditions.  These assumptions are inherently uncertain and, as a result, these models cannot  precisely estimate the impact that higher or lower rate environments will have on net interest income.  Actual results will differ from simulated results due to the timing, magnitude and frequency of interest rate changes, changes in cash flow patterns and market conditions, as well as changes in management’s strategies.  The model results are consistent with the gap analysis reflecting our asset sensitivity position.

Our asset sensitive position during a period of slowly declining interest rates is not expected to have a significant negative impact on net interest income since we have a large base of immediately adjustable interest bearing demand, savings and money market deposits.  However, since we are asset sensitive, in a period of rapidly declining interest rates, the rapid decline will have a negative effect on our net interest income as changes in the rates of interest bearing deposits historically have not changed proportionately with changes in market interest rates.  Additionally, in low and declinging interest rate environments, such as the environment experienced in 2003, the interest rates paid on funding liabilities may begin to reach floors preventing further downward adjustments while rates on earning assets continue to adjust downward.  This condition will likewise have a negative impact on our net interest income.

23

Table 6

Rate-Sensitive Assets and Liabilities

	December 31, 2003
	Maturing or repricing in
	Less than three months			After three months but within one year			After one year but within 5 years			After 5 years			Total
	(Dollars in thousands)
Rate-Sensitive Assets:
Federal funds sold and securities purchased under agreements to resell	$	10,000		$	—		$	—		$	—		$	10,000
Securities available-for-sale, at amortized cost	10,507			4,186			4,875			11,309			30,877
Securities held to maturity	—			—			—			4,597			4,597
Due from banks - time	—			4,728			—			—			4,728
FRB and other stock, at cost	—			—			—			1,872			1,872
Loans receivable (1)	221,578			6,647			27,973			4,341			260,539
Total rate-sensitive assets	242,085			15,561			32,848			22,119			312,613
Rate-Sensitive Liabilities:  (2)
Interest bearing deposits:
Demand, money market and savings	123,696			—			—			—			123,696
Time certificates of deposit	28,427			19,263			7,333			—			55,023
Other borrowings	—			399			—			—			399
Total rate-sensitive liabilities	152,123			19,662			7,333			0			179,118
Interest rate-sensitivity gap	89,962			(4,101		)	25,515			22,119			133,495
Cumulative interest rate-sensitivity gap	$	89,962		$	85,861		$	111,376		$	133,495
Cumulative ratio of rate sensitive assets to rate-sensitive liabilities	159		%	150		%	162		%	175		%

(1)Loans receivable excludes nonaccrual loans.

(2)Deposits which are subject to immediate withdrawal are presented as repricing within three months or less.

The distribution of other time deposits is based on scheduled maturities.

24

Table 6

Rate-Sensitive Assets and Liabilities

	December 31, 2002
	Maturing or repricing in
	Less than three months			After three months but within one year			After one year but within 5 years			After 5 years			Total
	(Dollars in thousands)
Rate-Sensitive Assets:
Federal funds sold and securities purchased under agreements to resell	$	18,700		$	—		$	—		$	—		$	18,700
Securities available-for-sale, at amortized cost	—			998			1,857			22,969			25,824
Due from banks - time	—			325			—			—			325
FRB and other stock, at cost	—			—			—			2,018			2,018
Loans receivable (1)	196,286			10,907			40,375			19,425			266,993
Total rate-sensitive assets	214,986			12,230			42,232			44,412			313,860
Rate-Sensitive Liabilities:  (2)
Interest bearing deposits:
Demand, money market and savings	115,781			—			—			—			115,781
Time certificates of deposit	41,381			31,865			6,617			—			79,863
Other borrowings	—			1,476			—			—			1,476
Total rate-sensitive liabilities	157,162			33,341			6,617			0			197,120
Interest rate-sensitivity gap	57,824			(21,111		)	35,615			44,412			116,740
Cumulative interest rate-sensitivity gap	$	57,824		$	36,713		$	72,328		$	116,740
Cumulative ratio of rate sensitive assets to rate-sensitive liabilities	137		%	119		%	137		%	159		%

(1)Loans receivable excludes nonaccrual loans.

(2)Deposits which are subject to immediate withdrawal are presented as repricing within three months or less.

The distribution of other time deposits is based on scheduled maturities.

Investment Securities

We invest in investment securities consisting primarily of mortgage-related securities to: (i) generate interest income pending the ability to deploy those funds in loans meeting our lending strategies; (ii) increase net interest income where the rates earned on such investments exceed the related cost of funds, consistent with the management of interest rate risk; and (iii) provide sufficient liquidity in order to maintain cash flow adequate to fund our operations and meet obligations and other commitments on a timely and cost efficient basis.

We generally classify our investment securities as available-for-sale except for investment securities we have the ability and the positive intent to hold to maturity which are classified as held-to-maturity securities.   There were no held-to-maturity securities at December 31, 2002.

Table 7 provides certain information regarding our investment securities.

25

Table 7

Estimated Fair Values of and Unrealized

Gains and Losses on Investment Securities

	December 31, 2003
	Total amortized cost		Gross unrealized gains		Gross unrealized loss		Estimated fair value
	(Dollars in thousands)
Available-For-Sale:
U.S. Treasury securities	$	600	$	—	$	1	$	599
GNMA-issued/guaranteed mortgage pass through certificates	351		12		—		363
Other U.S. government and federal agency securities	12,758		45		4		12,799
FHLMC/FNMA-issued mortgage pass through certificates	3,828		161		—		3,989
CMO’s and REMIC’s issued by U.S. government-sponsored  agencies	56		1		—		57
Mortgage mutual funds	10,000		—		98		9,902
Privately issued corporate bonds, CMO and REMIC securities	3,163		5		—		3,168
	$	30,756	$	224	$	103	$	30,877
FRB and other equity stocks	$	1,872	—		—		$	1,872

	December 31, 2003
	Total amortized cost		Gross unrealized gains		Gross unrealized loss		Estimated fair value
	(Dollars in thousands)
Held-to-Maturity:
FHLMC/FNMA-issued mortgage pass through certificates	$	4,597	$	43	$	—	$	4,640
	$	4,597	$	43	$	—	$	4,640

	December 31, 2002
	Total amortized cost		Gross unrealized gains		Gross unrealized loss		Estimated fair value
	(Dollars in thousands)
Available-For-Sale:
U.S. Treasury securities	$	998	$	—	$	1	$	997
GNMA-issued/guaranteed mortgage pass through certificates	2,409		73		—		2,482
FHLMC/FNMA-issued mortgage pass through certificates	12,370		506		—		12,876
CMO’s and REMIC’s issued by U.S. government-sponsored  agencies	4,544		44		—		4,588
Privately issued corporate bonds, CMO and REMIC securities	5,503		12		288		5,227
	$	25,824	$	635	$	289	$	26,170
FRB and other equity stocks	$	2,018	—		—		$	2,018

26

At December 31, 2003, we held no securities from any issuer other than by U.S. government agencies and corporations in which the aggregate book value exceeded 10% of our shareholders’ equity.

Our present strategy is to stagger the maturities of investment securities to meet our overall liquidity requirements.  Table 10 sets forth information concerning the contractual maturity of and weighted average yield of our investment securities at December 31, 2003.

Table 8

Maturities of and Weighted Average Yields on

Investment Securities

	Within one year				After one but within five years				After five but within ten years				After ten years						Weighted Average
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Total		Yield
	(Dollars in thousands)
Securities available-for-sale:
U.S Treasury securities	$	599	1.13	%	$	—	—		$	—	—		$	—	—		$	599	1.13	%
GNMA-issued/guaranteed  mortgage pass-through certificates	—		—		—		—		—		—		363		3.86	%	363		3.86	%
Other U.S. government and federal agencies	1,018		1.12	%	4,542		1.98	%	7,239		4.63	%	—		—		12,799		3.41	%
FHLMC/FNMA-issued mortgage pass-through certificates	6		7.10	%	276		5.81	%	1,019		3.33	%	2,688		5.09	%	3,989		4.69	%
CMO’s and REMIC’s issued by U.S. government-sponsored agencies	—		—		57		7.27	%	—		—		—		—		57		7.27	%
Mortgage mutual funds	9,902		3.10	%	—		—		—		—		—		—		9,902		3.10	%
Privately issued corporate bonds, CMO’s and REMIC’s securities	3,168		2.02	%	—		—		—		—		—		—		3,168		2.02	%
	$	14,693	2.65	%	$	4,875	2.26	%	$	8,258	4.47	%	$	3,051	4.94	%	$	30,877	3.30	%
Amortized Cost	$	14,299			$	5,344			$	8,204			$	2,909			$	30,756
FRB and other equity stocks	$	1,872	0.00	%	$	—	—		$	—	—		$	—	—		$	1,872	0.00	%
	Within one year				After one but within five years				After five but within ten years				After ten years						Weighted Average
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Total		Yield
	(Dollars in thousands)
Securities held-to-maturity:
FHLMC/FNMA-issued mortgage pass-through certificates	$	—	—		$	—	—		$	4,597	4.58	%	$	—	—		$	4,597	4.58	%
	$	—	—		$	—	—		$	4,597	4.58	%	$	—	—		$	4,597	4.58	%

Actual maturities may differ from contractual maturities to the extent that borrowers have the right to call or prepay obligations with or without call or repayment penalties.

Lending Activities

Through Mercantile and South Bay we engage in commercial banking, serving small to medium-sized businesses in the niche markets of entertainment, healthcare, business banking, and community-based nonprofit organizations, business executives, professionals and other individuals, providing commercial and residential real estate financing, real estate construction financing and commercial lending, consumer and home equity loans.  Our primary geographic focus is the Los Angeles basin of Los Angeles County, with four branch banking offices consisting of Mercantile Bank’s offices located in Century City and Encino, and South Bay Bank’s offices located in Torrance and El Segundo.  We offer a full range of loan, deposit and investment products which are designed to meet specific customer needs and are offered with highly personalized service.

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Loan products include commercial real estate loans, construction financing, revolving lines of credit, term loans and consumer and home equity loans, along with an array of deposits and investment accounts that often contain terms and conditions tailored to meet the specific demands of the market niche in which the borrower operates, including the ability to evaluate the revenue streams and other sources of repayment supporting the loan.  In order to provide the personalized service required by these customers, we use a team approach to customer service combining an experienced relationship management officer with operations support personnel.

Our targeted market niches have included the entertainment industry, professional services providers, healthcare and community-based nonprofit organizations.  Entertainment industry customers include television, music and film production companies, talent agencies, individual performers, directors and producers (whom we attract by establishing relationships with business management firms), and others affiliated with the entertainment industry.   Professional service customers include legal, accounting, insurance, advertising firms and their individual directors, officers, partners and shareholders.  Healthcare organizations include primarily outpatient healthcare providers such as physician medical groups, independent practice associations and surgery centers.

Loan Portfolio

The following table sets forth the composition of our loan portfolio at the dates indicated:

Table 9

Loan Portfolio Composition

	December 31,
	2003					2002					2001					2000					1999
	Amount			Percent		Amount			Percent		Amount (1)			Percent		Amount			Percent		Amount			Percent
	(Dollars in thousands)
Real Estate loans:
Secured by one to four family residential properties	$	8,167		3	%	$	10,797		4	%	$	27,069		10	%	$	6,578		6	%	$	4,405		6	%
Secured by multifamily residential properties	13,071			5		12,596			5		8,492			3		3,765			3		5,355			7
Secured by commercial real properties	132,320			52		119,872			44		95,142			36		40,540			37		28,233			38
Real estate construction and land development	27,210			10		37,934			14		30,811			12		1,890			2		6			—
Commercial loans:
Other - secured and unsecured	76,699			29		86,015			32		85,292			33		53,433			48		33,221			45
Consumer installment, home equity and unsecured loans to individuals	3,510			1		5,566			1		15,306			6		4,373			4		2,863			4
Total loans outstanding	260,977			100	%	272,780			100	%	262,112			100	%	110,579			100	%	74,083			100	%
Deferred net loan origination fees and purchased loan discount	(728		)			(458		)			(144		)			(331		)			(240		)
Loans receivable, net	$	260,249				$	272,322				$	261,968				$	110,248				$	73,843

(1)Increase in loans receivable commencing in 2001 reflects the acquisition of South Bay in December, 2001.

Most of the our commercial loans are generally within $100,000 to $3.0 million and our consumer and home equity loans generally are less than $100,000.  The Banks may not make any loan, with certain limited exceptions, in excess of their loan to one borrower limit under applicable regulations ($2.7 million for Mercantile and $2.6 million for South Bay at December 31, 2003).  If a Bank’s borrower requests a loan in excess of these amounts we may originate the loan with the participation of the other Bank or other lenders.  At December 31, 2003 we had $10.5 million in loans originated and service by other banks in which we purchased a non-recourse participation.

Commercial Loans Secured by Real Estate.  We offer adjustable and fixed rate secured loans to finance the purchase or holding of commercial real estate, one to four family residences and multi-family residences.  These loans generally have maturities ranging from three to fifteen years and payments based on a 15 to 25 years schedule.  The original principal amount of a real estate loan generally does not exceed 65% to 75% of the appraised value of the property (or the lesser of the appraised value or the purchase price for the property if the loan is made to finance the purchase of the property).

Other Secured and Unsecured Commercial Loans.  We offer adjustable and fixed rate secured and unsecured commercial loans for working capital, the purchase of assets and other business purposes.  We underwrite these loans primarily on the basis of the

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borrower’s ability to service the debt from cash flow without reliance on the liquidation of the underlying collateral, where applicable.  These loans generally have maturity terms of 12 months and are typically renewed.

Collateral for commercial loans may include commercial or residential real property, accounts receivable, inventory, equipment, marketable securities or other assets.  Unsecured commercial loans include short-term term loans and lines of credit. Our underwriting guidelines for these loans generally require that the borrower have low levels of existing debt, working capital sufficient to cover the loan and a history of earnings and cash flow. Typically, unsecured lines of credit must be unused for a continuous 30-day period within each year to demonstrate the borrower’s ability to have sufficient funds to operate without the credit line.

Real Estate Construction and Land Development Loans.  Real estate construction and land development loans are short-term secured loans made to finance the construction of commercial, one to four-family and multifamily residential properties or for improvements to raw land.  These loans include financing for developers for the construction of residential tract homes and custom homes.  Our real estate construction and loan development loans are primarily for properties located in Southern California.  These loans typically have adjustable rates with terms of twelve to fifteen months.  We monitor the progress of the construction and disburse the loan proceeds directly to the various contractors during stages of improvement.  Generally, the amount of a construction loan generally does not exceed 65% of the appraised completion value and the borrower’s funds are disbursed prior to disbursement of the construction loan.

Consumer Installment Loans and Home Equity Lines of Credit.  We offer consumer loans and home equity lines of credit. Home equity lines of credit provide the borrower with a line of credit in an amount which generally does not exceed 80% of the appraised value of the borrower’s residence net of senior mortgages.  Consumer loans are primarily adjustable rate open ended unsecured loans (such as credit card loans) but also include fixed rate term loans (generally under five years) to purchase personal property which are secured by that personal property. These loans (other than purchase money loans) generally provide for monthly payments of interest and a portion of the outstanding principal balance.

Loan Concentrations

We provide banking services to the entertainment industry in Southern California.  Table 10 below presents information about the loans outstanding to entertainment related customers at December 31, 2003 and 2002.

Table 10

Industry Concentrations of Loans

	December 31,
	2003			2002
	(Dollars in thousands)
Entertainment industry-related loans:
Loans for single productions of motion picture and television feature films	$	9,218		$	6,652
Other loans to entertainment-related enterprises, such as television, music, film and talent agencies	15,508			19,620
Loans to individuals involved primarily in the entertainment industry	1,796			4,868
Total entertainment industry-related loans	$	26,522		$	31,140
Percent of total loans outstanding	10.2		%	11.4		%

Loan Rate Composition and Maturities

Of our total loans outstanding, excluding loans on nonaccrual, 81.7% and 68.7% had adjustable rates at December 31, 2003 and 2002, respectively.  Adjustable rate loans generally have interest rates tied to the prime rate and adjust with changes in the rate on a daily, monthly or quarterly basis.

Of our total loans outstanding, excluding nonaccrual loans, at December 31, 2003, 30.7% were due in one year or less, 46.8% were due in 1-5 years and 22.5% were due after 5 years.   As is customary in the banking industry, loans can be renewed by mutual agreement between the borrower and us.  Because we are unable to estimate the extent to which its borrowers will renew their loans, Table 11 is based on contractual maturities.

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Table 11

Loan Maturities

	December 31, 2003
	Interest rates are floating or adjustable		Interest rates are fixed or predetermined		Total
	(Dollars in thousands)
Aggregate maturities of total loans outstanding:
Commercial secured by real estate
In one year or less	$	31,776	$	8,546	$	40,322
After one year but within five years	30,869		2,964		33,833
After five years	2,251		3,083		5,334
Commercial other secured and unsecured
In one year or less	12,706		2,299		15,005
After one year but within five years	43,659		22,571		66,230
After five years	46,702		403		47,105
Real estate construction and land development
In one year or less	7,229		1,893		9,122
After one year but within five years	10,320		2,164		12,484
After five years	5,005		309		5,314
Consumer installment, home equity lines of credit and unsecured loans to individuals
In one year or less	12,398		3,043		15,441
After one year but within five years	9,086		274		9,360
After five years	989		—		989
Total loans outstanding (1)	$	212,990	$	47,549	$	260,539

(1)Excluding nonaccrual loans

Loan Commitments

Off-Balance Sheet Credit Commitments and Contingent Obligations

We are a party to financial instruments with off-balance sheet credit risk in the normal course of business to meet the financing needs of our customers.  In addition to undisbursed commitments to extend credit under loan facilities, these instruments include conditional obligations under standby and commercial letters of credit.  Our  exposure to credit loss in the event of nonperformance by customers is represented by the contractual amount of the instruments.

Loan commitments are agreements to lend to a customer a specified amount subject to certain conditions.  Loan commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  We had outstanding loan commitments aggregating $64.5 million at December 31, 2003, substantially all of which were for real estate contruction and commercial lines of credit.

Standby letters of credit are conditional commitments issued by us to secure the financial performance of a customer to a third party and are primarily issued to support private borrowing arrangements. The credit risk involved in issuing a letter of credit for a customer is essentially the same as that involved in extending a loan to that customer. We use the same credit underwriting policies in accepting such contingent obligations as it does for loans. When deemed necessary, we hold appropriate collateral supporting those commitments. The nature of collateral obtained varies and may include deposits held in financial institutions and real properties.  At December 31, 2003 letters of credit amounted to $1.3 million.

Many of these commitments are expected to expire without being drawn upon and, as such, the total commitment amounts do not necessarily represent future cash requirements.

Asset Quality and Credit Risk Management

We assess and manage credit risk on an ongoing basis through diversification guidelines, lending limits, credit review and approval policies and internal monitoring.  As part of the control process, an independent credit review firm regularly examines our

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loan portfolio, related products, including unused commitments and letters of credit, and other credit processes.  In addition to this credit review process, our loan portfolio is subject to examination by external regulators in the normal course of business.  Underlying trends in the economic and business cycle will influence credit quality.  We seek to manage and control credit risk through diversification of the portfolio by type of loan, industry concentration and type of borrower.

Nonperforming Assets

Nonperforming assets consist of nonperforming loans and other real estate owned.  Nonperforming loans are (i) loans which have been placed on nonaccrual status, (ii) troubled debt restructurings (“TDR’s”), or (iii) loans which are contractually past due ninety days or more with respect to principal or interest, and have not been restructured or placed on nonaccrual status, and are accruing interest as described below.  Other real estate owned consists of real properties securing loans of which we have taken title in partial or complete satisfaction of the loan.  Other than loans included in nonperforming assets at December 31, 2003, we had no loans that cause management to have serious doubts about the ability of the borrower to comply with the present loan repayment terms and we had no other interest earning assets that were considered impaired at December 31, 2003.  Information about nonperforming assets is presented in Table 12.

Table 12

Nonperforming Assets

	December 31,
	2003			2002			2001			2000			1999
	(Dollars in thousands)
Nonaccrual loans	$	438		$	5,787		$	7,807		$	683		$	932
Troubled debt restructurings	—			—			953			—			—
Loans contractually past due ninety or more days with respect to either principal or interest and still accruing interest	—			209			642			—			—
Nonperforming loans	438			5,996			9,402			683			932
Other real estate owned	925			1,000			—			—			382
Other assets-SBA guaranteed loan	—			—			—			—			150
Total nonperforming assets	$	1,363		$	6,996		$	9,402		$	683		$	1,464
Allowance for credit losses as a percent of nonaccrual loans	829.9		%	83.7		%	83.8		%	380.2		%	203.4		%
Allowance for credit losses as a percent of nonperforming loans	829.9		%	80.8		%	69.6		%	380.2		%	203.4		%
Total nonperforming assets as a percent of loans receivable	0.5		%	2.6		%	3.6		%	0.6		%	2.0		%
Total nonperforming assets as a percent of total shareholders’ equity	4.3		%	22.4		%	36.9		%	3.3		%	12.6		%

Nonaccrual Loans. Nonaccrual loans are those loans for which management has discontinued accrual of interest because there exists reasonable doubt as to the full and timely collection of either principal or interest.  Our policy is to place a loan on nonaccrual status if either principal or interest payments are past due in excess of ninety days unless the loan is both well secured and in process of collection, or if full collection of interest or principal becomes uncertain, regardless of the time period involved.

When a loan is placed on nonaccrual status, all interest previously accrued but uncollected is reversed against current period operating results. Income on such loans is then recognized only to the extent that cash is received, and, where the ultimate collection of the carrying amount of the loan is probable, after giving consideration to the borrower’s current financial condition, historical repayment performance and other factors. Accrual of interest is resumed only when (i) principal and interest are brought fully current, and (ii) such loans are either considered, in management’s judgment, to be fully collectible or otherwise become well secured and in the process of collection. (See ‘‘Net Interest Income’’ for a discussion of the effects on operating results of nonperforming loans.)

Nonaccrual loans decreased to $438,000 at December 31, 2003, from $5.8 million at December 31, 2002.  The decrease was primarily due to the charge off and collection of nonaccrual loans partially offset by the newly classified loans.  Nonaccrual loans at December 31, 2003 were comprised primarily of secured commercial loans.  The value of the collateral securing these loans may not be adequate to avoid a charge off of a portion of the credit.  The additional interest income that would have been recorded from nonaccrual loans, if the loans had not been on nonaccrual status, was $48,000 and $388,000 for 2003 and 2002, respectively.  Interest payments received on nonaccrual loans are applied to principal unless there is no doubt as to ultimate full repayment of principal, in

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which case, the interest payment is recognized as interest income.  Interest income not recognized on nonaccrual loans reduced the net yield on earning assets by 1 basis point and 12 basis points for 2003 and 2002, respectively.

Troubled Debt Restructurings. A TDR is a loan for which we have, for economic or legal reasons related to a borrower’s financial difficulties, granted a concession to the borrower we would not otherwise consider, including modifications of loan terms to alleviate the burden of the borrower’s near-term cash flow requirements in order to help the borrower to improve its financial condition and eventual ability to repay the loan.  At December 31, 2003 and 2002 and for the years then ended we had no TDRs, accordingly, no interest income was recorded in 2003 and 2002 on TDRs.

Loans Contractually Past Due 90 or More Days. Loans contractually past due 90 or more days are those loans which have become contractually past due at least ninety days with respect to principal or interest. Interest accruals may be continued on these loans when such loans are well secured and in the process of collection and, accordingly, management has determined such loans to be fully collectible as to both principal and interest.

For this purpose, a loan is considered well secured if the collateral has a realizable value in excess of the amount of principal and accrued interest outstanding and/or is guaranteed by a financially capable party. A loan is considered to be in the process of collection if collection of the loan is proceeding in due course either through legal action or through other collection efforts which management reasonably expects to result in repayment of the loan or its restoration to a current status in the near future.

There were no loans contractually past due and still accruing interest at December 31, 2003.  Loans contractually past due and still accruing interest totalled $209,000 at December 31, 2002.

Other Real Estate Owned. We carry OREO at the lesser of our recorded investment or the fair value less estimated costs to sell. We periodically revalue OREO properties and charge other expenses for any further write-downs.  At December 31, 2003 we had $925,000 recorded as OREO and at December 31, 2002 we had $1.0 million recorded as OREO.

Impaired Loans.  Due to the size and nature of the our loan portfolio, impaired loans are determined by a periodic evaluation on an individual loan basis.  At December 31, 2003 we had classified $408,000 of our loans as impaired for which $408,000 of specific reserves were allocated.  At December 31, 2002 we had classified $4.2 million of our loans as impaired for which $1.7 million of specific reserves were allocated.  The impaired loans are included in nonaccrual loans.  The average recorded investment in impaired loans during the year ended December 31, 2003, was $1.7 million and no interest income was recognized on these loans.

Foregone interest income attributable to nonperforming loans amounted to $48,000 in 2003 and $388,000 in 2002.  This resulted in a reduction in yield on average loans receivable of 2 basis points and 12 basis points for the years ended December 31, 2003 and 2002, respectively.

Allowance for Credit Losses

The calculation of the adequacy of the allowance for credit losses is based on a variety of factors (see Allowance for Credit Losses under Critical Accounting Policies).  Table 13 presents, at December 31, 2003 and the prior four years, the composition of our allocation of the allowance for credit losses to specific loan categories.  Our current practice is to make specific allocations of the allowance for credit losses to criticized and classified loans, and unspecified allocations to each loan category based on our risk assessment.  This allocation should not be interpreted as an indication that loan charge-offs will occur in the future in these amounts or proportions, or as an indication of future charge-off trends.  In addition, the portion of the allowance for credit losses allocated to each loan category does not represent the total amount available for future losses that may occur within such categories, since the total allowance for credit losses is applicable to the entire portfolio.

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Table 13

Allocation of Allowance For Credit Losses

	December 31,
	2003			%(1)		2002		%(1)		2001		%(1)		2000		%(1)		1999		%(1)
	(Dollars in thousands)
Commercial loans:
Secured by one to four family residential properties	$		114	3	%	$	192	4	%	$	675	10	%	$	155	6	%	$	102	6	%
Secured by multifamily residential properties	182			5		224		5		212		3		73		3		103		7
Secured by commercial real properties	1,843			51		2,129		44		2,376		36		842		37		659		38
Other - secured and unsecured	1,068			29		1,528		31		2,128		33		1,355		48		938		45
Real estate construction and land development	379			11		674		14		769		12		47		2		—		—
Consumer installment, home equity lines of credit and unsecured loans to individuals (1)	49			1		99		2		381		6		125		4		94		4
Allowance allocable to loans receivable	$	3,635		100	%	$	4,846	100	%	$	6,541	100	%	$	2,597	100	%	$	1,896	100	%

(1)Percentage of loans in each category to total loans.

The allowance for credit losses at December 31, 2003 was $3.6 million compared to $4.8 million at December 31, 2002.  The decrease is due to net charge-offs of $2.5 million partially offset by  $1.3 million provision for credit losses.  Total loans charged-off in 2003 was $2.9 million.

The additional provisions to the allowance were recorded based upon our analysis of the adequacy of allowance for credit losses.  The allowance for credit losses for classified loans graded as “criticized” by our internal grading system that are collateral-dependent is based upon the net realizable value of the collateral that we periodically evaluate.  The allowance for unsecured classified loans is based upon the severity of the credit weakness ranging from 3.0% for “special mention”, 15.0% for “substandard” to 50% for “doubtful”.  The volume of more severely classified loans – “substandard” and “doubtful” - declined to $690,000 at December 31, 2003 million from $8.7 million at year end 2002.

Table 14 presents an analysis of changes in the allowance for credit losses during the periods indicated:

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Table 14

Analysis of Changes in Allowance for Credit Losses

	December 31,
	2003			2002
	(Dollars in thousands)
Balance, beginning of period	$	4,846		$	6,542
Loans charged off:
Real Estate loans:
Secured by one to four family residential properties	38			—
Secured by multifamily residential properties	—			—
Secured by commercial real properties	75			44
Real estate construction and land development	—			31
Commercial loans:
Other - secured and unsecured	2,697			3,849
Consumer installment, home equity lines of credit and unsecured loans to individuals	41			138
Total loans charged-off	2,851			4,062
Recoveries of loans previously charged off:
Real Estate loans:
Secured by one to four family residential properties	1			—
Secured by multifamily residential properties	—			—
Secured by commercial real properties	13			—
Real estate construction and land development	—			191
Commercial Loans
Other - secured and unsecured	291			189
Consumer installment, home equity lines of credit and unsecured loans to individuals	70			61
Total recoveries of loans previously charged off	375			441
Net (recoveries) charge-offs	2,476			3,621
Provision for credit losses	1,265			1,925
Allowance acquired in acquisition of South Bay Bank, N.A	—			—
Balance, end of period	$	3,635		$	4,846
Net loans (recoveries) charged-off as a percentage of allowance for credit losses	68.12		%	74.72		%
Net loans (recoveries) charged-off as a percentage of average gross loans outstanding during the period	0.95		%	1.42		%
Recoveries of loans previously charged off as a percentage of loans charged off in the previous year	9.23		%	89.82		%

Deposits

While South Bay historically has had a greater portion of its deposits from retail banking customers, we emphasize developing business client relationships at both Banks in order to increase our core deposit base.  We offer internet-based cash management services, and for many business customers, provide regular courier service between their business locations and our banking offices.  Additionally, we attract deposits in serving the specific market niches of escrow and title companies and nonprofit community organizations.  Each Bank offers its own rates in order to compete in its specific markets.  In 2002 we suspended the money desk operation for the generation of new deposits in order to reduce these higher cost deposits.

We experienced a 2.7% increase in average total deposits during 2003 compared to 2002. This increase in deposits occurred primarily as a result of growth of $17.6 million in non interest-bearing demand and $12.3 million increase in money market and savings accounts partially offset by a $21.9 million decrease in time certificates of deposit.

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Table 15

Average Deposit Composition

	December 31,
	2003				2002				2001
	Amount		Percent		Amount		Percent		Amount		Percent
	(Dollars in thousands)
Noninterest-bearing demand deposits:
Real estate title and escrow company customers	$	26,989	9	%	$	26,104	9	%	$	19,746	13	%
Other noninterest-bearing demand	92,799		30	%	76,109		25	%	39,137		28	%
Interest-bearing demand	28,269		9	%	28,024		9	%	9,562		6	%
Money market and savings	98,764		32	%	86,444		29	%	40,396		27	%
Time certificates of deposit:
Money desk	—		0	%	2,558		1	%	3,461		2	%
Other:
$100,000 or more	29,150		9	%	43,212		14	%	26,021		18	%
Under $100,000	33,316		11	%	38,606		13	%	9,300		6	%
Total time certificates of deposit	62,466		20	%	84,376		28	%	38,782		26	%
Total deposits	$	309,287	100	%	$	301,057	100	%	$	147,623	100	%

Table 16

Maturities of Time Certificates of Deposit

$100,000 or more

	December 31, 2003
	Money Desk		All Other		Total
	(Dollars in thousands)
Time certificates of deposit maturing:
In three months or less	$	—	$	15,494	$	15,494
After three months but within six months	—		4,176		4,176
After six months but within twelve months	—		5,570		5,570
After twelve months	—		2,068		2,068
Total time certificates of deposit $100,000 or more	$	—	$	27,308	$	27,308
	December 31, 2002
	Money Desk		All Other		Total
	(Dollars in thousands)
Time certificates of deposit maturing:
In three months or less	$	400	$	26,656	$	27,056
After three months but within six months	100		4,722		4,822
After six months but within twelve months	—		9,396		9,396
After twelve months	100		1,632		1,732
Total time certificates of deposit $100,000 or more	$	600	$	42,406	$	43,006

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Borrowed Funds

Borrowed funds and related weighted average rates are summarized below in Table 17.

Table 17

Borrowed Funds

	2003								2002								2001
	Year-end				Average				Year-end				Average				Year-end				Average
	Balance		Rate		Balance		Rate		Balance		Rate		Balance		Rate		Balance		Rate		Balance		Rate
	(Dollars in thousands)
Federal funds purchased and securities sold under repurchase agreements	$	399	2.20	%	$	609	2.63	%	$	1,476	4.65	%	$	2,294	5.84	%	$	3,096	4.77	%	$	733	5.05	%
Other borrowings	7,500		4.70	%	7,500		4.81	%	7,500		4.70	%	11,308		4.23	%	17,500		4.25	%	20,865		4.85	%

The maximum amount of securities sold with agreements to repurchase at any month end was $800,000, $11.7 million and $5.0 million during 2003, 2002 and 2001, respectively.

The maximum amount of other borrowings at any month end was $7.5 million during 2003 and $17.5 million during 2002.

At December 31, 2003,  $5.5 million of borrowed funds were scheduled to mature during 2004, and $2.0 million were scheduled to mature during 2005.

Junior Subordinated Debentures/Trust Preferred Securities

In 2001, National Mercantile, through National Mercantile Capital Trust I (the “Trust”), issued 15,000 of 10.25% fixed rate securities (the “Trust Preferred Securities”), with an aggregate liquidation amount of $15.0 million due July 25, 2031.  The Trust Preferred Securities represent undivided beneficial interests in the assets of the Trust and are unconditionally guaranteed by National Mercantile with respect to distributions and payments upon liquidation, redemption and otherwise pursuant to the terms of a Guarantee Agreement. The Company issued the Trust Preferred Securities to generate regulatory capital at a relatively low cost (as payments of interest are deductible for income tax purposes).

The primary assets of the Trust are $15.5 million aggregate principal amount of National Mercantile 10.25% fixed rate junior subordinated deferrable interest debentures due July 25, 2031 (“Junior Subordinated Debentures”) that pay interest each January 26 and July 26.  The interest is deferrable, at National Mercantile’s option, for a period up to ten consecutive semi-annual payments, but in any event not beyond June 25, 2031.  The debentures are redeemable, in whole or in part, at National Mercantile’s option on or after five years from issuance at declining premiums to maturity.

The Company adopted FASB Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46) as of July 1, 2003 resulting in the deconsolidation of the Trust.  Accordingly, the Junior Subordinated Debentures have been classified in liabilities at December 31, 2003 and the related interest was classified as interest expense for the six months then ended.  For dates and periods prior to the adoption of FIN 46, the Trust Preferred Securities, net of the cost of issuance, were recorded as a minority interest – guaranteed preferred beneficial interests in the Company’s Junior Subordinated Debentures, net - and the related interest was recorded as a minority interest in the Company’s income.  The recorded balance of Junior Subordinated Debentures was $15.5 million at December 31, 2003.  For the year ended December 31, 2003, interest expense associated with the Junior Subordinated Debentures was $454,000 for the six month period following adoption of FIN 46 and the minority interest in the Company’s income of the trust subsidiary was $456,000 for the six months ended June 30, 2003 prior to adoption of FIN 46.  Minority interest in the Company’s income of the trust subsidiary was $1.6 million for the year ended December 31, 2002.

In January 2003, National Mercantile entered into a interest rate swap agreement pursuant to which it exchanged a fixed rate payment obligation of 10.25% on a notional principal amount of $15.0 million for a floating rate interest based on the six-month London InterBank Offerred Rate plus 458 basis points for a 29-year period ending July 25, 2031.  The interest rate swap agreement results in the company paying or receiving the difference between the fixed and floating rates at specified intervals calculated based on the notional amounts.  The differential paid or received on the interest rate swap is recognized as an adjustment to interest expense.  At

36

December 31, 2003, we were paying an interest rate of 5.75% under the terms of the swap.  The counter party to the swap has the option to call the swap under a declining premium schedule beginning July 2006.

The interest rate swap reduces the adverse impact of our 10.25% fixed rate Trust Preferred Securities in a low interest rate environment.  The Company does not utilize derivatives for speculative purposes.  Under Statement of Financial Accounting Standards No. 133 this swap transaction is designated as a fair value hedge.  Accordingly, the effective portion of the change in the fair value of the swap transaction is recorded each period in current income.  The terms of the swap are symmetrical with the terms of the Trust Preferred Securities, including the payment deferral terms, and considered highly effective in offsetting changes in fair value of the Trust Preferred Securities.  Accordingly, no ineffectiveness will be recorded to current earnings related to the interest rate swap.

Contractual Obligations

The following table provides the amounts due under specified contractual obligations for the periods indicated as of December 31, 2003.

Table 18

Contractual Obligations

	Payments Due
	Twelve months and less		After one year but within three years		After three years but within five years		After five years		Total
	(Dollars in thousands)
Commitment to fund loans	$	64,540	$	—	$	—	$	—	$	64,540
Commitments under letters of credit	1,310		—		—		—		1,310
Deposits	291,384		6,954		379		—		298,717
Borrowings	5,899		2,000		—		15,464		23,363
Interest expense	1,777		3,192		3,170		43,721		51,861
Operating lease obligations	313		539		779		2,448		4,079
Purchase obligations	119		—		—		—		119
Other liabilities	1,405		—		—		—		1,405
Total	$	366,747	$	12,685	$	4,328	$	45,595	$	429,355

The obligations are categorized by their contractual due dates.  Approximately $21.8 million of the commitments to fund loans relate to real estate contruction and are expected to fund within the next 12 months.  The balance of the commitments to fund loans is primarily revolving lines of credit or other commercial loans, and many of these commitments are expected to expire without being drawn upon.  Additionally, payments due for deposits reflect the contractual terms with our depositors to withdraw deposits, however, we do not anticipate the withdrawl of these deposits.  Total contractual obligations, therefore, do not necessarily represent future cash requirements.  We may, at our option, prepay certain borrowings prior to their maturity date.  Furthermore, the actual payment of certain current liabilities may be deferred into future periods.

Selected Financial Ratios

The following Table 19 sets forth selected financial ratios:

Table 19

Selected Performance Ratios

	For the Year Ended December 31,
	2003		2002		2001
Return on average assets	0.06	%	-0.07	%	0.59	%
Return on average shareholders’ equity	0.66	%	-0.98	%	5.13	%
Average shareholders’ equity to average assets	8.66	%	7.23	%	11.23	%

37

Recent Accounting Pronouncements

See Recent Accounting Pronouncements in Note 1-Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.

FACTORS, WHICH MAY AFFECT FUTURE OPERATING RESULTS

We face risk from changes in interest rates.

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

38

•Our ability to originate loans;

•The ability of our borrowers to make payments on their loans;

•The value of our interest-earning assets and our ability to realize gains from the sale of these assets;

•The average life of our interest-earning assets;

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

•Our ability to access the wholesale funding market.

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

We face risk from possible declines in the quality of our assets.

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

Our allowances for credit losses may be inadequate.

We establish allowances for credit losses against each segment of our loan portfolio.  At December 31, 2003, our allowance for credit losses equaled 1.40% of loans receivable and 829.9% of nonperforming loans.  Although we believed that we had established adequate allowances for credit losses as of December 31, 2003, the credit quality or our assets is affected by many factors beyond our control, including local and national economic conditions, and the possible existence of facts which are not known to us which adversely affect the likelihood of repayment of various loans in our loan portfolio and realization of the collateral upon a default.  Accordingly, we can give no assurance that we will not sustain loan losses materially in excess of the allowance for credit losses.  In addition, the Office of the Comptroller of the Currency, as an integral part of its examination process, periodically reviews our allowance for credit losses and could require additional provisions for credit losses.  Material future additions to the allowance for credit losses may also be necessary due to increases in the size and changes in the composition of our loan portfolio.  Increases in our provisions for credit losses would adversely affect our results of operations.

Economic conditions may worsen.

Our business is strongly influenced by economic conditions in our market area (principally, the Greater Los Angeles metropolitan area) as well as regional and national economic conditions and in our niche markets, including the real estate and entertainment industries in Southern California.  During the past several years economic conditions, particularly in the real estate industry, have been favorable.  Should the economic condition in this market area deteriorate, the financial condition of our borrowers could weaken, which could lead to higher levels of loan defaults or a decline in the value of collateral for our loans.  In addition, an unfavorable economy could reduce the demand for our loans and other products and services.

Because a significant amount of the loans we make are to borrowers in California, our operations could suffer as a result of local recession or natural disasters in California.

At December 31, 2003, almost all of our loans outstanding were collateralized by real properties located in California.  Because of this concentration in California, our financial position and results of operations have been and are expected to continue to be influenced by general trends in the California economy and its real estate market.  Real estate market declines may adversely affect the values of the properties collateralizing loans.  If the principal balances of our loans, together with any primary financing on the mortgaged properties, equal or exceed the value of the mortgaged properties, we could incur higher losses on sales of properties collateralizing foreclosed loans.  In addition, California historically has been vulnerable to certain natural disaster risks, such as earthquakes and erosion-caused mudslides, which are not typically covered by the standard hazard insurance policies maintained by borrowers.  Uninsured disasters may adversely impact our ability to recover losses on properties affected by such disasters and adversely impact our results of operations.

Our business is very competitive.

There is intense competition in Southern California and elsewhere in the United States for banking customers.  We experience competition for deposits from many sources, including credit unions, insurance companies and money market and other mutual funds, as well as other commercial banks and savings institutions.  We compete for loans and deposits primarily with other commercial banks,

39

mortgage companies, commercial finance companies and savings institutions.  In recent years out-of-state financial institutions have entered the California market, which has also increased competition.  Many of our competitors have greater financial strength, marketing capability and name recognition than we do, and operate on a statewide or nationwide basis.  In addition, recent developments in technology and mass marketing have permitted larger companies to market loans more aggressively to our small business customers.  Such advantages may give our competitors opportunities to realize greater efficiencies and economies of scale than we can.  We can provide no assurance that we will be able to compete effectively against our competition.

Our business is heavily regulated.

Both National Mercantile, as a bank holding company, and the Banks, are subject to significant governmental supervision and regulation, which is intended primarily for the protection of depositors.  Statutes and regulations affecting us may be changed at any time, and the interpretation of these statutes and regulations by examining authorities also may change.  We cannot assure you that future changes in applicable statutes and regulations or in their interpretation will not adversely affect our business.

Recent accounting changes may give rise to a future regulatory capital event that would reduce our consolidated capital ratios.

In accordance with the provisions of Financial Accounting Standard Board (“FASB”) Interpretation No. (“FIN”) 46, “Consolidation of Variable Interest Entities” (“FIN 46”), we have deconsolidated the subsidiary trust which issued Trust Preferred Securities for National Mercantile, and effective July 1, 2003 its financial position and results of operations are not included in our consolidated financial position and results of operations.  Accordingly, the Trust Preferred Securities which had previously been reported as a minority interest have been replaced by the subordinated debt issued by National Mercantile to the trusts and are reported as a liability.

Under applicable regulatory guidelines, a portion of the Trust Preferred Securities qualifies as Tier I capital, and the remaining portion will qualifies as Tier II capital.  On July 2, 2003, the Federal Reserve Board issued Supervisory Letter (SR 03-13) affirming the historical capital treatment of trust preferred securities as Tier I capital despite the deconsolidation of the trusts holding the securities. SR 03-13 remained in effect at December 31, 2003, and we continue to include these securities in our Tier I capital. There remains the potential that this determination by the Federal Reserve Board may change at a later date.

If Tier I capital treatment for our Trust Preferred Securities were disallowed, there would be a reduction in our consolidated capital ratios. The following table shows as of December 31, 2003 (i) National Mercantile’s current capital position, (ii) our pro forma capital position if the Federal Reserve Board granted Tier II status to our Trust Preferred Securities, (iii) our pro forma capital position if the Federal Reserve Board excludes entirely our Trust Preferred Securities from capital, and (iv) the minimum regulatory capital requirements for well-capitalized status.

	Leverage ratio		Tier I risk-based capital ratio		Total risk-based capital ratio
(i) National Mercantile Bancorp	8.69	%	11.02	%	13.84	%
(ii) Assuming Trust Preferred Securities only qualified as Tier II capital	5.75	%	7.26	%	13.91	%
(iii) Assuming Trust Preferred Securities are excluded entirely from capital	5.75	%	7.26	%	8.52	%
(iv) Minimum regulatory requirements for Capital Adequacy Purposes	4.00	%	4.00	%	8.00	%

As the table shows, in the event that the Federal Reserve elected to change its position with regards to the capital treatment of Trust Preferred Securities we would remain above minimums for Federal Reserve capital adequacy guidelines.

Our ability to use our net operating losses may be limited.

As of December 31, 2003, we had net operating loss carryforwards of $18.5 million and $766,000 for federal and state tax purposes, respectively.  Our federal net operating loss carryforward begins to expire in 2009.  Our state net operating loss carryforwards continue to expire but remain available in reducing amounts through 2004.  Our ability to use these carryforwards in the future would be significantly limited if we experience an “ownership change” within the meaning of Section 382 of the Internal

40

Revenue Code.  If our use of these carryforwards is limited, we would be required to pay taxes on our taxable income to the extent our taxable income exceeded the limited amounts which could be offset, and our net income would be lower.

A significant portion of our loan portfolio consists of construction loans which have greater risks than loans secured by completed real properties

At December 31, 2003, we had outstanding construction loans in the amount of $27.2 million, representing 10.4% of our loan portfolio.  These types of loans generally have greater risks than loans on completed homes, multifamily and commercial properties.  A construction loan generally does not cover the full amount of the construction costs, so the borrower must have adequate funds to pay for the balance of the project.  Price increases, delays and unanticipated difficulties can materially increase these costs.  Further, even if completed, there is no assurance that the borrower will be able to sell the project on a timely or profitable basis, as these are closely related to real estate market conditions, which can fluctuate substantially between the start and completion of the project.  If the borrower defaults prior to completion of the project, the value of the project will likely be less than the outstanding loan, and we could be required to complete construction with our own funds to minimize losses on the project.

We have goodwill from the acquisition of South Bay, which must be evaluated regularly for impairment

In connection with the acquisition of South Bay in December 2001, we recorded goodwill in the amount of $2.2 million.  We must evaluate the goodwill regularly for impairment. We had an unaffiliated consultant conduct goodwill impairment testing in the fourth quarter of 2003, and we determined that this goodwill was not impaired.  If in the future we determine that the goodwill is impaired, we would be required to write-off some or all of the goodwill, which could have a material adverse effect on our financial condition and results of operations.

We have a significant deferred tax asset and our ability to realize that asset depends in part on the certainty of future earnings

At December 31, 2003, we had a deferred tax asset of $7.0 million relating primarily to our NOLs.  If future taxable income should be less than the amount of the NOLs within the tax years to which it may be applied, the deferred tax asset may not be realized.  To support our position that the benefits of this asset will be realized, we must estimate future earnings.  These estimates are based on many factors, including prior periods results.  If we are unable to generate future earnings in an amount sufficient to support the asset, we would have to establish a valuation allowance and corresponding charge to earnings to reduce the deferred tax asset to its realizable value.  A material valuation allowance on this asset would have a material adverse effect on our results of operations and financial condition.

ITEM 7.FINANCIAL STATEMENTS

The consolidated financial statements required by this Item are included herewith as a separate section of this Report as follows:

1.Financial Statements

ITEM 8.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

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ITEM 8A.  CONTROLS AND PROCEDURES

Our management, including the Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934, as amended, within 90 days of the filing of this annual report.  Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer believe that our disclosure controls and procedures were effective in ensuring that information required to be disclosed by the Company in this quarterly report has been made known to them in a timely manner.

During the quarter ended December 31, 2003, there were no significant changes in our internal controls or in other factors that could significantly affect those controls.

PART III

ITEM 9.DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

The information required by this item will appear under the captions “Election of Directors,’’ ‘‘ Executive Officers,’’ and ‘‘Compliance with Section 16(a) Beneficial Ownership Reporting’’ in the Company’s proxy statement for the 2004 Annual Meeting of Shareholders (the ‘‘2004 Proxy Statement’’), and such information shall be deemed to be incorporated herein by reference to that portion of the 2004 Proxy Statement, if filed with the Securities and Exchange Commission not later than 120 days after the end of  our most recently completed fiscal year.

ITEM 10.EXECUTIVE COMPENSATION

The information required by this item will appear under the captions “Compensation of Executive Officers,” “Compensation of Directors,’’ ‘‘Summary Compensation Table,’’ ‘‘Report on Executive Compensation for 2003,’’ ‘‘2003 Option Exercises and Year-End Option Values” and “Compensation Committee Interlocks and Insider Participation’’ in the 2004 Proxy Statement, and such information shall be deemed to be incorporated herein by reference to those portions of the 2004 Proxy Statement, if filed with the Securities and Exchange Commission not later than 120 days after the end of our most recently completed fiscal year.

ITEM 11.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS

The information required by this item will appear under the caption ‘‘Security Ownership of Principal Shareholders and Management’’ in the 2004 Proxy Statement, and such information either shall be deemed to be incorporated herein by reference to that portion of the 2004 Proxy Statement, if filed with the Securities and Exchange Commission not later than 120 days after the end of our most recently completed fiscal year.

ITEM 12.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item will appear under the caption ‘‘Certain Relationships and Related Transactions’’ in the 2004 Proxy Statement, and such information shall be deemed to be incorporated herein by reference to that portion of the 2004 Proxy Statement, if filed with the Securities and Exchange Commission not later than 120 days after the end of our most recently completed fiscal year.

ITEM 13.EXHIBITS AND REPORTS ON FORM 8-K

(c) Exhibits

See Index to Exhibits on page 66 of this Report on Form 10-KSB

(b) Reports on Form 8-K

On October 31, 2003, the Company filed a report on Form 8-K reporting under Item 5 the Company’s press release regarding third quarter 2003 operating results.

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ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item will appear under the caption “Independent Public Accountants” in the 2004 Proxy Statement, and such information shall be deemed to be incorporated herein by reference to that portion of the 2004 Proxy Statement, if filed with the Securities and Exchange Commission not later than 120 days after the end of our most recently completed fiscal year.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	NATIONAL MERCANTILE BANCORP
	(Registrant)
	By	/s/  SCOTT A. MONTGOMERY
		Scott A. Montgomery
Date: March 29, 2004		Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature		Title	Date
/s/	ROBERT E. GIPSON
	Robert E. Gipson	Chairman of the Board	March 29, 2004
/s/	ROBERT E. THOMSON
	Robert E. Thomson	Vice Chair	March 29, 2004
/s/	DONALD E. BENSON
	Donald E. Benson	Director	March 29, 2004
/s/	JOSEPH N. COHEN
	Joseph N. Cohen	Director	March 29, 2004
/s/	W. DOUGLAS HILE
	W. Douglas Hile	Director	March 29, 2004
/s/	ANTOINETTE HUBENETTE, M.D.
	Antoinette Hubenette, M.D.	Director	March 29, 2004
/s/	SCOTT A. MONTGOMERY
	Scott A. Montgomery	Director, Chief Executive Officer	March 29, 2004
/s/	DION G. MORROW
	Dion G. Morrow	Director	March 29, 2004
/s/	CARL R. TERZIAN
	Carl R. Terzian	Director	March 29, 2004
/s/	DAVID R. BROWN
	David R. Brown	Principal Financial and Principal Accounting Officer	March 29, 2004

43

REPORT OF INDEPENDENT AUDITORS

To the Shareholders and the Board of Directors
of National Mercantile Bancorp and Subsidiaries:

We have audited the consolidated balance sheet of National Mercantile Bancorp (a California corporation) and Subsidiaries (collectively the “Company”) as of December 31, 2003, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the two years in the period ended December 31, 2003. These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States.  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financialposition of National Mercantile Bancorp and Subsidiaries at December 31, 2003, and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States.

As are further described in Note 1 to the consolidated financial statements, at July 1, 2003 the Company adopted FASB Interpretation No. (FIN) 46, Consolidation of Variable Interest Entities, as revised, which required the deconsolidation of its trust subsidiaries that had issued its mandatorily redeemable preferred securities and to which the Company had issued its junior subordinated debentures.

	Ernst & Young LLP
Los Angeles, California
February 13, 2004

44

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

	December 31, 2003
	(Dollars in thousands)
ASSETS
Cash and due from banks-demand	$	24,556
Due from banks-interest bearing	4,728
Federal funds sold and securities purchased under agreements to resell	10,000
Cash and cash equivalents	39,284
Securities available-for-sale, at fair value; aggregate amortized cost of $30,756	30,877
Securities held-to-maturity, at amortized cost	4,597
FRB and other stock, at cost	1,872
Loans receivable	260,249
Allowance for credit losses	(3,635		)
Net loans receivable	256,614
Premises and equipment, net	5,444
Other real estate owned	925
Deferred tax asset	6,950
Goodwill	3,225
Intangible assets, net	1,854
Accrued interest receivable and other assets	3,564
Total assets	$	355,206
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest-bearing demand	$	119,998
Interest-bearing demand	29,349
Money market	55,422
Savings	38,925
Time certificates of deposit:
$100,000 or more	27,308
Under $100,000	27,715
Total deposits	298,717
Federal funds purchased and securities sold under agreements to repurchase	399
Other borrowings	7,500
Junior subordinated deferrable interest debentures	15,464
Accrued interest payable and other liabilities	1,405
Total liabilities	323,485
Shareholders’ equity:
Preferred stock, no par value - authorized 1,000,000 shares:
Series A non-cumulative convertible perpetual preferred stock; authorized 990,000 shares; outstanding 729,585 shares	5,959
Series B non-cumulative convertible perpetual preferred stock; authorized 1,000 shares; outstanding 1,000 shares	1,000
Common stock, no par value; authorized 10,000,000 shares; outstanding 2,772,279 shares	38,602
Accumulated deficit	(13,911		)
Accumulated other comprehensive income	71
Total shareholders’ equity	31,721
Total liabilities and shareholders’ equity	$	355,206

See accompanying notes to consolidated financial statements.

45

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

	For The Year Ended December 31,
	2003			2002
	(Dollars in thousands, except per share data)
Interest income:
Loans, including fees	$	15,799		$	17,488
Securities	949			1,652
Due from banks - interest bearing	17			—
Federal funds sold and securities purchased under agreements to resell	359			432
Total interest income	17,124			19,572
Interest expense:
Interest-bearing demand	126			322
Money market and savings	905			1,426
Time certificates of deposit:
$100,000 or more	535			845
Under $100,000	783			1,459
Total interest expense on deposits	2,349			4,052
Federal funds purchased and securities sold under agreements to repurchase	16			134
Junior subordinated deferrable interest debentures	454			—
Other borrowings	361			478
Total interest expense	3,180			4,664
Net interest income before provision for credit losses	13,944			14,908
Provision for credit losses	1,265			1,925
Net interest income after provision for credit losses	12,679			12,983
Other operating income:
Net gain on sale of securities available-for-sale	51			—
International services	44			37
Investment division	84			82
Deposit-related and other customer services	1,333			1,383
Loss on sale of other real estate owned	(136		)	—
Total other operating income	1,376			1,502
Other operating expenses:
Salaries and related benefits	7,157			6,776
Net occupancy	1,329			1,368
Furniture and equipment	464			418
Printing and communications	504			562
Insurance and regulatory assessments	381			358
Client services	563			656
Computer data processing	994			953
Legal services	473			541
Other professional services	833			530
Amortization of core deposit intangible	223			223
Promotion and other expenses	375			476
Total other operating expenses	13,296			12,861
Income before income tax provision and minority interests	759			1,624
Minority interest in the Company’s income of the:
Guaranteed preferred beneficial interests in the Company’s junior subordinated deferrable interest debentures, net	456			1,537
Series A Preferred Stock of South Bay Bank, N.A	—			213
Income (loss) before income tax provision	303			(126		)
Income tax provision	96			127
Net income (loss)	$	207		$	(253	)
Earnings (loss) per share:
Basic	$	0.08		$	(0.15	)
Diluted	$	0.05		$	(0.15	)

See accompanying notes to consolidated financial statements.

46

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

	Preferred Stock Series A					Preferred Stock Series B			Common Stock			Additional Paid-in			Accumulated			Accumulated Other Comprehensive
	Shares		Amount			Shares	Amount		Shares	Amount		Capital			Deficit			Income			Total
	(Dollars in thousands except share data)
Balance at December 31, 2001	750,580		$	6,131		1,000	$	1,000	1,623,467	$	30,268	$	1,824		$	(13,802	)	$	56		$	25,477
Preferred stock converted into common stock on a 2:1 basis	(15,595	)	(128		)				31,190	128											—
Common stock issued									1,006,287	7,572											7,572
Stock options exercised									18,600	86											86
Redemption of beneficial conversion rights of subsidiary preferred stock												(1,824		)							(1,824		)
Comprehensive income (loss):
Unrealized holding gain during the period, net																		146			146
Net loss															(253		)				(253		)
Comprehensive loss																					(107		)
Balance at December 31, 2002	734,985		$	6,003		1,000	$	1,000	2,679,544	$	38,054	$	—		$	(14,055	)	$	202		$	31,204
Preferred stock converted into common stock on a 2:1 basis	(5,400	)	(44		)				10,800	44											—
Stock options exercised									81,935	504											504
Cumulative effect of change in accounting principal (Note 1)															(63		)				(63		)
Comprehensive income (loss):
Unrealized holding loss during the period, net																		(131		)	(131		)
Net income															207						207
Comprehensive income																					76
Balance at December 31, 2003	729,585		$	5,959		1,000	$	1,000	2,772,279	$	38,602	$	—		$	(13,911	)	$	71		$	31,721

See accompanying notes to consolidated financial statements.

47

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

	For the Year Ended December 31,
	2003			2002
	(Dollars in thousands)
Cash flows from operating activities:
Net income (loss)	$	207		$	(253	)
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization	479			693
Provision for credit losses	1,265			1,925
Valuation allowance for OREO	75			—
Gain on sale of securities available for sale	(51		)	—
Loss on sales of OREO	61			—
Net amortization of premium on securities available-for-sale	239			238
Net amortization of premium on securities held-to-maturity	24			—
Net amortization of core deposit intangible	223			—
Net amortization of premium on loans purchased	281			348
Decrease in accrued interest receivable and other assets	132			1,340
Decrease in accrued interest payable and other liabilities	(545		)	(1,800		)
Net cash provided by operating activities	2,390			2,491
Cash flows from investing activities:
Purchase of securities available-for-sale	(33,339		)	(8,002		)
Proceeds from sales of securities available-for-sale	2,545			—
Proceeds from repayments and maturities of securities available-for-sale	25,674			23,367
Purchase of securities held-to-maturity	(5,021		)	—
Proceeds from repayments and maturities of securities held-to-maturity	400			—
Proceeds from sales of OREO	474			—
Loan originations and principal collections, net	8,782			(15,324		)
Redemption of Federal Reserve stock and other stocks	146			534
Purchases of premises and equipment	(87		)	(168		)
Net cash provided by (used in) investing activities	(426		)	407
Cash flows from financing activities:
Net increase in demand deposits, money market and savings accounts	20,333			14,074
Net decrease in time certificates of deposit	(20,341		)	(24,489		)
Net decrease in securities sold under agreements to repurchase and federal funds purchased	(1,077		)	(1,620		)
Net decrease in other borrowings	—			(10,000		)
Redemption of South Bay Bank preferred stock.	—			(2,500		)
Net proceeds from issuance of common stock	—			7,572
Dividends paid on subsidiary preferred stock	—			(213		)
Net proceeds from exercise of stock options	504			86
Net cash used in financing activities	(581		)	(17,090		)
Net increase (decrease) in cash and cash equivalents	1,383			(14,192		)
Cash and cash equivalents, January 1	37,901			52,093
Cash and cash equivalents, December 31	$	39,284		$	37,901
Supplemental disclosures of cash flow information:
Cash paid for Interest	$	3,885		$	5,852
Cash paid for Income taxes, net	—			—
Unrealized gain on securitites available-for-sale, net of tax effect	71			146
Transfers to OREO from loans receivable, net	$	535		$	1,000

See accompanying notes to consolidated financial statements.

48

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1—Summary of Significant Accounting Policies

Basis of Presentation

The consolidated financial statements include the accounts of National Mercantile Bancorp (“National Mercantile” when referring only to the parent company or the “Company” when such reference includes National Mercantile Bancorp and its subsidiaries, collectively) and of its wholly owned subsidiaries, Mercantile National Bank (“Mercantile”) and South Bay Bank, N.A. (“South Bay”) (and collectively, the “Banks”).  All intercompany transactions and balances have been eliminated.  Certain prior year amounts have been reclassified to conform to the current year presentation.

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States and to prevailing practices within the banking industry.  The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, and disclosure of contingent assets and liabilities at the date of consolidated financial statements and the reported amounts of revenues and expenses during reported periods.  Actual results could differ from those estimates.

The Company, through the Banks, engages in commercial banking in the Los Angeles area providing commercial and residential real estate financing, real estate construction financing and commercial lending serving niche markets represented by professional service providers, entertainment, healthcare and community-based nonprofit borrowers, and associated individuals with commercial banking and personal banking needs.

Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks-demand, due from banks – interest bearing, federal funds sold and securities purchased under agreements to resell.

Securities

Securities available-for-sale are carried at fair value.  Unrealized gains or losses on available-for-sale securities are excluded from earnings and reported as accumulated other comprehensive income, net of deferred income taxes, in a separate component of shareholders’ equity until realized.  Realized gains or losses on sales available-for-sale securities are recorded using the specific identification method.

Securities held-to-maturity are debt instruments in which management has the positive intent and ability to hold to maturity and are carried at amortized cost.

Premiums or discounts on available-for-sale and held-to-maturity securities are amortized or accreted into income using the effective interest method.

Loans

Loans are generally carried at principal amounts outstanding less unearned income.  Unearned income includes deferred unamortized fees net of direct incremental loan origination costs.

Interest income is accrued as earned.  Net deferred fees are accreted into interest income using the effective interest method.

Loans are placed on nonaccrual status when a loan becomes 90 days past due as to interest or principal unless the loan is both well secured and in process of collection.  Loans are also placed on nonaccrual status when the full collection of interest or principal becomes uncertain.  When a loan is placed on nonaccrual status, the accrued and unpaid interest receivable is reversed and the accretion of deferred loan fees is ceased.  Thereafter, interest collected on the loan is accounted for on the cash collection or cost recovery method until qualifying for return to accrual status.  Generally, a loan may be returned to accrual status when all delinquent principal and interest are brought current in accordance with the terms of the loan agreement and certain performance criteria have been met.

The Company considers a loan to be impaired when it is probable that it will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Once a loan is determined to be impaired, the impairment is measured based on the present

49

value of the expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, the impairment is measured by using the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.

When the measurement of the impaired loan is less than the recorded amount of the loan, impairment is recognized by creating a valuation allowance with a corresponding charge to the provision for credit losses or by adjusting an existing valuation allowance for the impaired loan with a corresponding charge or credit to the provision for credit losses.

The Company’s policy is to record cash receipts received on impaired and nonaccrual loans first as reductions to principal and then to interest income.

Allowance for Credit Losses

The provisions for credit losses charged to operations reflect management’s judgment of the adequacy of the allowance for credit losses and are determined through periodic analysis of the loan portfolio, problem loans and consideration of such other factors as the Company’s loan loss experience, trends in problem loans, concentrations of credit risk, and economic conditions (particularly Southern California), as well as the results of the Company’s ongoing examination process and its regulatory examinations.

The calculation of the adequacy of the allowance for credit losses is based on a variety of factors, including loan classifications, migration trends and underlying cash flow and collateral values.  On a periodic basis, management engages an outside loan review firm to review the Company’s loan portfolio, risk grade accuracy and the reasonableness of loan evaluations.  Annually, this outside loan review team analyzes the Company’s methodology for calculating the allowance for credit losses based on the Company’s loss histories and policies.  The Company uses a migration analysis as part of its allowance for credit losses evaluation which is a method by which specific charge-offs are related to the prior life of the same loan compared to the total loan pools in which the loan was graded.  This method allows for management to use historical trends that are relative to the Company’s portfolio rather than use outside factors that may not take into consideration trends relative to the specific loan portfolio.  In addition, this analysis takes into consideration other trends that are qualitative relative to the Company’s marketplace, demographic trends, amount and trends in nonperforming assets and concentration factors.

Premises and Equipment, Net

Premises and equipment are presented at cost less accumulated amortization and depreciation.  Depreciation of furniture, fixtures and equipment is determined using the straight-line method over the estimated useful lives (3 years to 5 years) of each type of asset.  Leasehold improvements are amortized using the straight-line method over the term of the related leases or the service lives (10 years to 20 years) of the improvements, whichever is shorter.  Gains and losses on dispositions are reflected in current operations.  Maintenance and repairs are charged to other operating expenses as incurred.

Other Real Estate Owned

Other Real Estate Owned (‘‘OREO’’) is comprised of real estate acquired in satisfaction of loans.  Properties acquired by foreclosure or deed in lieu of foreclosure are transferred to OREO and are initially recorded at the lower of the loan balance or fair value at the date of transfer of the property, establishing a new cost basis.  Subsequently, OREO is carried at the lower of cost or fair value less costs to sell.  The fair value of the OREO property is based upon a current appraisal.  Losses that result from the ongoing periodic valuation of these properties are charged to other operating expenses in the period in which they are identified.  Expenses for holding costs are charged to other operating expenses as incurred.

Income Taxes

The Company and the Banks file consolidated federal income tax returns and combined state income tax returns.

Deferred tax assets and liabilities are recognized for the expected future tax consequences of existing differences between financial reporting and tax reporting bases of assets and liabilities, as well as for operating losses and tax credit carryforwards, using enacted tax laws and rates.  Deferred tax assets will be reduced through a valuation allowance whenever it becomes more likely than not that all or some portion will not be realized.  Deferred income taxes (benefit) represents the net change in deferred tax asset or liability balance during the year.  This amount, together with income taxes currently payable or refundable in the current year, represents the total tax expense (benefit) for the year.

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Comprehensive Income

Comprehensive income is defined as the change in equity during a period from transactions and other events and circumstances from nonowner sources.  The accumulated balance of other comprehensive income is required to be displayed separately from retained earnings in the consolidated balance sheet.

The components of other comprehensive income together with total comprehensive income are reported in the consolidated statements of changes in shareholders’ equity.  The accumulated balance of other comprehensive income is reported as a net amount after taxes.

Earnings per Share

Basic earnings per share is computed using the weighted average number of common shares outstanding during the period.  The weighted average number of common shares outstanding used in computing basic earnings per share for the years ended December 31, 2003 and 2002 was 2,707,931 and 1,650,997, respectively.  Diluted earnings per share for the year ended December 31, 2003 was $0.05.  The weighted average number of common shares and common share equivalents outstanding used in computing diluted earnings per share for the year ended December 31, 2003 was 4,410,394.  The following table is a reconciliation of net income and shares used in the computation of basic and diluted earnings per share:

	Earnings available to shareholders			Weighted Average Shares	Per share amount
	(in thousands)
For the year ended December 31, 2003:
Basic EPS	$	207		2,707,931	$	0.08
Effect of dilutive securities:
Options				76,294
Convertible preferred stock				1,626,169
Diluted earnings per share	207			4,410,394	$	0.05
For the year ended December 31, 2002:
Basic and diluted loss per share	$	(253	)	1,650,997	$	(0.15	)

Fair Value of Financial Instruments

Estimated fair value amounts have been determined using available market information and appropriate valuation methodologies.  Considerable judgment is required to interpret market data and to develop the estimates of fair value.  Accordingly, the estimates of fair value in the financial statements are not necessarily indicative of the amounts the Company could realize in a current market exchange.  The use of different market assumptions and estimation methodologies may have a material effect on the estimated fair value amounts.

Stock Options

The Company applies Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for the stock incentive plans.  SFAS No. 123, ‘‘Accounting for Stock-Based Compensation,’’ encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. Compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price.  All options were granted at current market prices, accordingly, no compensation cost has been recognized for the plans.  Pro forma net income and pro forma earnings per share

51

disclosures for employee stock option grants are based on recognition as expense, over the vesting period, the fair value on the date of grant of all stock-based awards made during 2003 and 2002.

Recent Accounting Pronouncements

In January 2003, the FASB issued Statement of Financial Accounting Standards No. 148 “Accounting for Stock-Based Compensation” (“SFAS No. 148”). SFAS No. 148 amends Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation” (“SFAS No. 123”), to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. If awards of stock-based employee compensation were outstanding and accounted for under the intrinsic value method of Accounting Principles Board Opinion No. 25 “Accounting for Stock” (“APB No. 25”) issued to employees, certain disclosures have to be made for any period for which an income statement is presented.

SFAS No. 148 is effective for financial statements for fiscal years ending after December 15, 2002.  We continue to apply APB No. 25 in accounting for stock based compensation and have adopted the disclosure requirements of SFAS No. 123 and SFAS No. 148.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS No. 149”). The changes in SFAS No. 149 improve financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. In particular, SFAS No. 149 (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative discussed in paragraph 6(b) of SFAS No. 133 and No. 138, (2) clarifies when a derivative contains a financing component, (3) amends the definition of an underlying to conform it to language used in FIN 45, and (4) amends certain other existing pronouncements. One point of clarification in SFAS No. 149 was that loan commitments that relate to the origination of mortgage loans that will be held for sale shall be accounted for as derivative instruments by the issuer of the loan commitment. We have no such commitments at December 31, 2003. Those changes will result in more consistent reporting of contracts as either derivatives or hybrid instruments.

SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The adoption of SFAS No. 149 did not have a material impact on our financial condition or operating results.

In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS 150).  SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.  It requires than an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances).  Many of those instruments were previously classified as equity.

The Company adopted SFAS 150 effective July 1, 2003, which had no effect on the Company’s financial statements.

In January 2003, the FASB issued Financial Accounting Standards Board Interpretation No. 46 “Consolidation of Variable Interest Entities” (“FIN 46”).  FIN 46 changes the consolidation requirements by requiring a variable interest entity to be consolidated by a company if that company is subject to the majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both.  In addition, FIN No. 46 requires disclosures about variable interest entities that the company is not required to consolidate but in which it has a significant variable interest.  The consolidation requirements of FIN No. 46 apply to variable interest entities created after January 31, 2003 and apply to existing variable interest entities no later than the end of the first interim or annual reporting period ending after March 15, 2004.

FIN 46 may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated.  The Company adopted FIN 46 effective July 1, 2003 and accordingly recorded a cumulative-effect adjustment as of that date and reclassified the Junior Subordinated Debentures as other liabilities and the related interest as other interest expense.

FIN 46 may have an impact on the treatment of the Trust Preferred Securities we have issued and ability for those instruments to provide us with Tier I capital. FIN 46 required us to deconsolidate the trust entities that issued these Trust Preferred Securities. The Federal Reserve has issued regulations that allow for the inclusion of these instruments in Tier I capital regardless of the impact of FIN 46 on the consolidation of the trusts. There remains the potential that this determination by the Federal Reserve may be changed at a later date. We do not expect FIN 46 to have any other material impact on our financial condition or operating results.

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Note 2—Goodwill and Other Intangible Assets

As of December 31, 2003, the Company had goodwill of $3.2 million and core deposit intangibles of $1.9 million from the South Bay acquisition.  In accordance with SFAS No. 142 goodwill is not amortized.  SFAS No. 142 also requires an analysis of impairment of goodwill annually or more frequently upon the occurrence of certain events.  During 2003, the required impairment tests of goodwill were conducted, and based upon these evaluations, the Company’s goodwill was not impaired at December 31, 2003.  The Company has no other indefinite-lived intangible assets.  The core deposit intangibles were estimated to have an original life of 10 years and 4 months. Amortization for intangibles for 2003 and each of the next five years is estimated to be $223,000 per year.

Note 3—Investment Securities

The following is a summary of amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair values of the Company’s investment securities available-for-sale and held-to-maturity at December 31, 2003:

	December 31, 2003
	Total amortized cost		Gross unrealized gains		Gross unrealized loss		Estimated fair value
	(Dollars in thousands)
Available-For-Sale
U.S. Treasury securities	$	600	$	—	$	1	$	599
GNMA-issued/guaranteed  mortgage pass through certificates	351		12		—		363
Other U.S. government and federal agency securities	12,758		45		4		12,799
FHLMC/FNMA-issued mortgage pass through certificates	3,828		161		—		3,989
CMO’s and REMIC’s issued by U.S. government-sponsored  agencies	56		1		—		57
Mortgage mutual funds	10,000		—		98		9,902
Privately issued corporate bonds, CMO’s and REMIC’s securities	3,163		5		—		3,168
	$	30,756	$	224	$	103	$	30,877
FRB and other equity stocks	$	1,872	$	—	$	—	$	1,872
	December 31, 2003
	Total amortized cost		Gross unrealized gains		Gross unrealized loss		Estimated fair value
	(Dollars in thousands)
Held-to-Maturity
FHLMC/FNMA-issued mortgage pass through certificates	$	4,597	$	43	$	—	$	4,640
	$	4,597	$	43	$	—	$	4,640

The Company had gross proceeds and gross realized gains related to the sale of investment securities of $2.5 million and $100,000, respectively, and gross realized losses related to a valuation reserve of $49,000 established on other-than-temporarily impaired securities, for the year ended December 31, 2003.  The Company had no sales of investment securities for the year ended December 31, 2002.

The estimated fair value and amortized cost of securities available-for-sale and held-to-maturity at December 31, 2003 by contractual maturity, are shown below:

53

Maturities of and Weighted Average Yields on

Investment Securities

	Within one year				After one but within five years				After five but within ten years				After ten years						Weighted Average
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Total		Yield
	(Dollars in thousands)
Securities available-for-sale:
U.S Treasury securities	$	599	1.13	%	$	—	—		$	—	—		$	—	—		$	599	1.13	%
GNMA-issued/guaranteed  mortgage pass-through certificates	—		—		—		—		—		—		363		3.86	%	363		3.86	%
Other U.S. government and federal agencies	1,018		1.12	%	4,542		1.98	%	7,239		4.63	%	—		—		12,799		3.41	%
FHLMC/FNMA-issued mortgage pass-through certificates	6		7.10	%	276		5.81	%	1,019		3.33	%	2,688		5.09	%	3,989		4.69	%
CMO’s and REMIC’s issued by U.S. government-sponsored agencies	—		—		57		7.27	%	—		—		—		—		57		7.27	%
Mortgage mutual funds	9,902		3.10	%	—		—		—		—		—		—		9,902		3.10	%
Privately issued Corporate bonds, CMO’s and REMIC’s securities	3,168		2.02	%	—		—		—		—		—		—		3,168		2.02	%
	$	14,693	2.65	%	$	4,875	2.26	%	$	8,258	4.47	%	$	3,051	4.94	%	$	30,877	3.30	%
Amortized Cost	$	14,299			$	5,344			$	8,204			$	2,909			$	30,756
FRB and other equity stocks.	$	1,872	0.00	%	$	—	—		$	—	—		$	—	—		$	1,872	0.00	%
	Within one year				After one but within five years				After five but within ten years				After ten years						Weighted Average
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Total		Yield
	(Dollars in thousands)
Securities held-to-maturity:
FHLMC/FNMA-issued mortgage pass-through certificates	$	—	—		$	—	—		$	4,597	4.58	%	$	—	—		$	4,597	4.58	%
	$	—	—		$	—	—		$	4,597	4.58	%	$	—	—		$	4,597	4.58	%

Actual maturities may differ from contractual maturities to the extent that borrowers have the right to call or prepay obligations with or without call or repayment penalties.

Investment securities totaling $8.5 million were pledged to secure government tax deposits, bankruptcy deposits, or for other purposes required or permitted by law at December 31, 2003.

Impaired Securities

In November 2003, the FASB’s Emerging Issues Task Force (“EITF”) reached a consensus requiring certain disclosures for impaired securities as described in EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. Any security for which the current fair value is less than the carrying value is considered impaired. On a quarterly basis, impaired securities are evaluated to determine if the impairments are other-than-temporary. For those securities that are identified as having an other-than-temporary impairment, the loss is reported as a reduction in current period income. For all other temporary impairments, the current period unrealized losses are recorded to other comprehensive income.

As of December 31, 2003, temporarily impaired securities had a fair value of $14.5 million and unrealized losses of $103,000.  Securities that were not impaired had a fair value of $22.8 million and unrealized gains of $267,000 at December 31, 2003.  The following table shows fair value and unrealized loss positions of temporarily impaired securities, categorized by whether the securities have been impaired for less than twelve months or if they have been impaired for twelve months or more as of December 31, 2003.

54

	Less than 12 months				12 months or longer				Total
	Fair value		Unrealized losses		Fair value		Unrealized losses		Fair value		Unrealized losses
	(Dollars in thousands)
U.S. Treasury obligations	$	599	$	1	$	—	$	—	$	599	$	1
Other U.S. government and federal agency securities	4,038		4		—		—		4,038		4
Mortgage mutual funds	9,902		98		—		—		9,902		98
Total temporarily impaired securities	$	14,539	$	103	$	—	$	—	$	14,539	$	103

The U.S. Treasury obligations and other U.S. government and federal agency securities are impaired due to declines in fair values resulting from increases in market interest rates from the time of purchase.  In total, there are three impaired securities.  None of the securities has exhibited a decline in value as a result of changes in credit risk.  As such, management does not consider the impairments on these securities to be other-than-temporary.

The impaired mortgage mutual fund is a fund holding primarily short duration fixed rate and adjustable rate mortgage securities that is valued at its closing net asset value.  The Company believes that the primary reason for the impairment of these securities is due to the volatility of interest rates.  The Company does not believe that the decline in the net asset value of these securities has given rise to an other than-temporary-impairment and furthermore, and it has the intent and ability to hold these securities for the foreseeable future, and therefore does not expect to realize a loss on the mutual fund investment.  As such, the Company does not consider the impairment on this security to be other-than-temporary.

Note 4—Loans Receivable and Allowance for Credit Losses

The following is a summary of the major categories of loans receivable outstanding at December 31, 2003:

	2003
	(Dollars in thousands)
Real Estate loans:
Secured by one-to-four family residential properties	$	8,167
Secured by multifamily residential properties	13,071
Secured by commercial real properties	132,320
Real estate construction and land development	27,210
Commercial loans
Other, secured and unsecured	76,699
Home equity lines of credit	—
Consumer installment and unsecured loans to individuals	3,510
	260,977
Unearned income	(728		)
	$	260,249
Weighted average yield for loans at December 31	6.99		%

At December 31, 2003, the Company had identified impaired loans with recorded investments of  $408,000.  At December 31, 2003, specific allowances for credit losses totaling $408,000 were established for these loans.  The average recorded investment of impaired loans was $1.7 million and $4.3 million during 2003 and 2002, respectively.  No interest income was recognized on impaired loans during the years ended December 31, 2003 and 2002.

In the normal course of business, the Banks may make loans to officers and directors as well as loans to companies and individuals affiliated with or guaranteed by officers and directors of the Company and the Banks.  Such loans are made in the ordinary course of

55

business at rates and terms no more favorable than those offered to other customers with a similar credit standing.  The outstanding principal balance of these loans was $5.9 million at December 31, 2003 and $4.5 million at December 31, 2002.  During 2003 there were $1.7 million of advances and $1.2 million  of repayments.  Interest income recognized on these loans amounted to $322,000 and $374,000 during 2003 and 2002, respectively.  At December 31, 2003, none of these loans were on nonaccrual status. Based on analysis of information presently known to management about the loans to officers and directors and their affiliates, management believes all have the ability to comply with the present loan repayment terms.

The following is a summary of activity in the allowance for credit losses for the year ended December 31, 2003:

	2003
	(Dollars in thousands)
Balance, beginning of year	$	4,846
Provision for credit losses	1,265
Loans charged off	(2,851		)
Recoveries of loans previously charged off	375
Balance, end of year	$	3,635

Total loans charged-off in 2003 was $2.9 million.  The additional provision for credit losses was recorded based upon the analysis of the adequacy of allowance for credit losses.  The allowance for credit losses for classified loans graded as “criticized” by the Company’s internal grading system that are collateral-dependent is based upon the net realizable value of the collateral that is periodically evaluate.  The allowance for unsecured classified loans is based upon the severity of the credit weakness.

The following is a summary of nonperforming loans at December 31, 2003:

	2003
	(Dollars in thousands)
Nonaccrual loans	$	438
Troubled debt restructurings	—
Loans contractually past due ninety or more days with respect to either principal or interest and still accruing interest	—
	$	438

Interest foregone on nonperforming loans outstanding at December 31, 2003 and 2002 was $47,000 and $388,000, respectively.  Foregone interest on nonperforming loans does not include interest forgone on loans on nonperforming status that were restored to performing status prior to year end, or subsequent to either being charged off prior to year end or transferred to OREO prior to year end.

The ability of the Company’s borrowers to honor their loan agreements is substantially dependent upon economic conditions and real estate market values throughout the Company’s market area. At December 31, 2003, loans aggregating $180.8 million were collateralized by liens on residential and commercial real properties.  While the Company’s loan portfolio is generally diversified with regard to the industries represented, at December 31, 2003, the Company’s loans to businesses and individuals engaged in entertainment industry related activities amounted to $26.5 million.

Troubled Debt Restructurings. A TDR is a loan for which the Company has, for economic or legal reasons related to a borrower’s financial difficulties, granted a concession to the borrower it would not otherwise consider, including modifications of loan terms to alleviate the burden of the borrower’s near-term cash flow requirements in order to help the borrower to improve its financial condition and eventual ability to repay the loan.  At December 31, 2003 and 2002, the Company had no TDRs.

Note 5—Premises and Equipment and Lease Commitments

The following is a summary of the major components of premises and equipment at December 31, 2003:

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	2003
	(Dollars in thousands)
Land	$	1,392
Buildings	3,870
Leasehold improvements	1,464
Furniture, fixtures and equipment	5,499
	12,225
Less accumulated amortization and depreciation	(6,781		)
	$	5,444

Depreciation and amortization expense was $479,000 in 2003 and $456,000 in 2002.  Rental expense on operating leases included in occupancy expense in the Consolidated Statements of Operations was $808,000 in 2003 and $915,000 in 2002.

The future minimum annual rental commitments at December 31, 2003 are summarized below.

	(Dollars in thousands)
For the year ended December 31,
2004	$	313
2005	280
2006	259
2007	260
2008	519
Thereafter	2,448
	$	4,079

Note 6—Income Taxes

A deferred federal and state income tax provision of $96,000 and $127,000 was recognized during 2003 and 2002, respectively.

A reconciliation of the amounts computed by applying the federal statutory rate of 34% for 2003 and 2002 to the income and the effective tax rate are as follows:

	2003			2002
	(Dollars in thousands)			(Dollars in thousands)
Tax provision (benefit) at statuory rate	$	103		$	(43	)
Increase (reduction) in taxes resulting from:
Book deductions without tax benefit	(22		)	151
Permanent differences	15			19
	$	96		$	127

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The major components of the net deferred tax asset at December 31, 2003 are as follows:

(Dollars in thousands)	2003
Deferred tax assets:
Net operating losses	$	6,879
Accrued expenses	146
Alternative minimum tax credits	314
Nonaccrual interest	138
Loan fees	170
Bad debt expense	334
Core deposits	58
Other.	2
Total deferred tax assets.	8,041
Deferred tax liabilities:
Depreciation	(777		)
Securities available for sale	(50		)
FHLB stock dividend	(39		)
Loan premium amortization	(225		)
Total deferred tax liabilities	(1,091		)
Net deferred tax asset	$	6,950

For tax purposes at December 31, 2003, the Company had (i) federal NOLs of $18.9 million, which begin to expire in 2009; (ii) California NOLs of $766,000 which begin to expire in 2004; (iii) a federal AMT credit carryforward of $298,000; and (iv) a California AMT credit carryforward of $16,000.  The AMT credits carryforward indefinitely.

The Company believes that it is more likely than not that the deferred tax asset will be realized.  Accordingly, no valuation allowance has been established against the deferred tax asset.

Note 7—Benefit Plans

Stock Incentive Plans.  At December 31, 2003, the Company had in effect one stock incentive plan pursuant to which up to a total of 668,510 shares of common stock may be issued.  Under this plan, the Company may grant to directors, officers, employees and consultants stock-based incentive compensation in a variety of forms, including without limitation nonqualified options, incentive options, sales and bonuses of common stock and stock appreciation rights, on such terms and conditions as the Board committee determines. However, the exercise price of options granted to nonemployee directors may not be less than the fair market value of the common stock on the date of grant.  At December 31, 2003, the only outstanding awards under this plan were stock options, and at that date 105,584 shares were available for future awards.

At December 31, 2003, there were also outstanding options and tandem stock appreciation rights granted under two prior stock incentive plans.

The following summarizes option grants, cancellations and exercises under the stock incentive plans for the periods indicated .

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			Option Price Range Per Share
Outstanding, December 31, 2001	457,289		$	4.31	-	$	8.52
Granted	12,500		5.26		-	6.70
Cancelled	(30,346	)	4.59		-	8.52
Exercised	(18,600	)	4.50		-	6.60
Outstanding, December 31, 2002	420,843		$	4.31	-	$	8.52
Granted	165,200		6.75		-	11.50
Cancelled	(10,800	)	5.75		-	8.52
Exercised	(81,935	)	4.47		-	8.52
Outstanding, December 31, 2003	493,308		$	4.31	-	$	11.50

Of the outstanding options at December 31, 2003:  (i) options to purchase 330,483 shares were vested and exercisable; and (ii) the remaining options become exercisable as follows: 2004  — 96,750 and 2005 — 68,650.

The estimated per share weighted average fair value of options granted was $7.81 and $4.08 during 2003 and 2002.  The Company applies Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for the stock incentive plans.  SFAS No. 123, ‘‘Accounting for Stock-Based Compensation,’’ encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value.  Accordingly, no compensation cost has been recognized for the plans.  Had compensation cost for the options granted been determined based on the fair value at the grant dates for awards under the plans consistent with the method of SFAS No. 123, the Company’s net earnings for 2003 would have been decreased by $121,000 and the net loss for 2002 would have increased by $92,000.  Basic and diluted earnings per share would have decreased by $0.04 and  $0.03 for 2003, respectively.  Basic and diluted loss per share would have increased by $0.06 for 2002.

The fair values of options granted during 2003 and 2002 were estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used: 2003— no dividend yield, expected volatility of 62%, risk-free interest rate of 4.28%, and an expected life of 10 years; 2002— no dividend yield, expected volatility of 59%, risk-free interest rate of 4.06%, and an expected life of 10 years.

Defined Contribution Retirement Plan. The Company maintains a defined contribution retirement plan under section 401(k) of the Internal Revenue Code. Employees are eligible to participate followingsix months of continuous employment. Under the plan, the Company has partially matched employee contributions since May 1, 2001.  Such matching contributions become fully vested when the employee reaches three years of service.  The Company’s matching contributions for 2003 and 2002 were $89,000 and $90,000, respectively.

Note 8—Borrowed Funds

The following summarizes borrowed funds and weighted average rates.

	2003
	Year-end				Average
	Balance		Weighted Average Rate		Balance		Weighted Average Rate
	(Dollars in thousands)
Federal funds purchased and securities sold under repurchase agreements	$	399	2.20	%	$	609	2.63	%
Other borrowings	7,500		4.70	%	7,500		4.81	%

The maximum amount of federal funds purchased and securities sold under agreements to repurchase at any month-end was $792,000 during 2003.

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Other borrowings are primarily comprised of Federal Home Loan Bank (“FHLB”) advances.  At December 31, 2003 FHLB advances included: (i) a $2.5 million putable borrowing with a fixed rate of 5.93%, with puts commencing July 2002 and continuing every three months thereafter, through July 2004; (ii) fixed rate borrowings of $3.0 million maturing April 2004 with a rate of 3.85%; (iii) fixed rate borrowings of $2.0 million maturing April 2005 with a rate of 4.45%.  The maximum amount of other borrowings outstanding at any month-end was $7.5 million during 2003.

The Banks had $2.3 million of unused borrowing capacity from the FHLB at December 31, 2003 based upon pledged securities.

Note 9—Junior Subordinated Deferrable Interest Debentures

The Company formed National Mercantile Capital Trust I (the “Trust”), a statutory business trust under the Delaware Business Trust Act, pursuant to a Declaration of Trust dated as of June 27, 2001, for the sole purpose of issuing and selling certain securities representing undivided beneficial interests in the assets of the Trust and investing the proceeds thereof in certain debentures of the Company.

On July 16, 2001 the Trust issued and sold to the Company 464 common securities (liquidation amount of $1,000 per common security) of the Trust (the “Common Securities”), representing common beneficial interests in the assets of the Trust.

Also, on July 16, 2001 the Trust issued 15,000 of 10.25% fixed rate securities (the “Trust Preferred Securities”), with a liquidation amount of $1,000 per Trust Preferred Security and an aggregate liquidation amount of $15.0 million due July 25, 2031.  The Trust Preferred Securities are unconditionally guaranteed by the Company with respect to distributions and payments upon liquidation, redemption and otherwise to the extent provided in and pursuant to the terms of a Guarantee Agreement.

The Trust used the proceeds from the issuance and the sale of the Trust Preferred Securities and the Common Securities to purchase $15.5 million aggregate principal amount of the Company’s 10.25% fixed rate junior subordinated deferrable interest debentures due July 25, 2031 (“Junior Subordinated Debentures’) that pay interest each January 26 and July 26.  The interest is deferrable, at the Company’s option, for a period up to ten consecutive semi-annual payments, but in any event not beyond June 25, 2031.  The debentures are redeemable, in whole or in part, at the Company’s option on or after five years from issuance at declining premiums to maturity.  The debentures are the primary assets of the Trust.

The recorded balance of Junior Subordinated Debentures was $15.5 million at December 31, 2003.

Note 10—Availability to National Mercantile of Funds from Banks; Restrictions on Cash Balances; Regulatory Capital

National Mercantile is a legal entity separate and distinct from the Banks, and as such has separate and distinct financial obligations including deferrable debt service of $1.5 million on the Junior Subordinated Debenture and other modest operating expenses.  While National Mercantile from time to time holds short-term investments,  its assets primarily consist of the common shares of the Banks and it has historically not engaged in any other business activity.  Accordingly, dividends and capital distributions from the Banks constitute the principal source of cash to the Company.  The Banks are subject to various statutory and regulatory restrictions on their ability to pay dividends to the Company.

OCC approval is required for a national bank to pay a dividend if the total of all dividends declared in any calendar year exceeds the total of the bank’s net profits (as defined) for that year combined with its retained net profits for the preceding two calendar years, less any required transfer to surplus or a fund for the retirement of any preferred stock.  A national bank may not pay any dividend that exceeds its retained net earnings, as defined by the OCC.  The OCC and the Federal Reserve Board have also issued banking circulars emphasizing that the level of cash dividends should bear a direct correlation to the level of a national bank’s current and expected earnings stream, the bank’s need to maintain an adequate capital base and other factors.

National banks that are not in compliance with regulatory capital requirements generally are not permitted to pay dividends.  The OCC also can prohibit a national bank from engaging in an unsafe or unsound practice in its business.  Depending on the bank’s financial condition, payment of dividends could be deemed to constitute an unsafe or unsound practice.  Except under certain circumstances, and with prior regulatory approval, a bank may not pay a dividend if, after so doing, it would be undercapitalized.  The Banks’ ability to pay dividends in the future is, and could be, further influenced by regulatory policies or agreements and by capital guidelines.

Mercantile has no retained earnings, and therefore is presently unable to pay dividends.  Mercantile has a substantial accumulated deficit and does not anticipate having positive retained earnings for the foreseeable future.  South Bay has retained earnings of $130,000 as of December 31, 2003.  Mercantile and South Bay may from time to time be permitted to make capital distributions to

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National Mercantile with the consent of the OCC.  It is not anticipated that such consent could be obtained unless the distributing bank were to remain “well capitalized” following such distribution.

Federal law restricts the Banks’ extension of credit to, the issuance of a guarantee or letter of credit on behalf of, investments in or taking as collateral stock or other securities of National Mercantile.  Restrictions prevent National Mercantile from borrowing from the Banks unless the loans are secured by designated amounts of marketable obligations.  Further, secured loans to and investments in National Mercantile or its affiliates by a bank are limited to 10% of  the bank’s capital stock and surplus (as defined by federal regulations) and are limited, in the aggregate, to 20% of the bank’s contributed capital (as defined by federal regulations).

Federal Reserve Board regulations require the Banks to maintain certain minimum reserve balances.  Cash balances maintained to meet reserve requirements are not available for use by the Banks or National Mercantile.  During 2003 and 2002, the average reserve balances for the Banks were approximately $6.2 million and $4.6 million, respectively.  Neither National Mercantile nor the Banks is required to maintain compensating balances to assure credit availability under existing borrowing arrangements.

National Mercantile and the Banks are subject to various capital requirements administered by the federal banking regulatory agencies. Failure to meet minimum capital requirements can initiate certain mandatory—and possibly additional discretionary—actions by regulators that, if undertaken, could have a direct material effect on National Mercantile’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, National Mercantile and Banks must meet specific capital guidelines that involve quantitative measures of National Mercantile’s and the Banks’ assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. National Mercantile’s and the Banks’ capital amounts and classification are also subject to qualitative judgment by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require National Mercantile and the Banks to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined).  Management believes, as of December 31, 2003, National Mercantile and Banks meet all capital adequacy requirements to which they are subject.

At December 31, 2003, each Bank was categorized as well capitalized under the regulatory framework for prompt corrective action.  To be categorized as well capitalized under the prompt corrective action rules, each Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table.  There are no conditions or events since the most recent notification which management believes have changed the Banks’ category.

The following table presents, at the dates indicated, certain information regarding the regulatory capital of National Mercantile and the Banks and the required amounts of regulatory capital for National Mercantile and the Banks to meet applicable regulatory capital requirements and, in the case of the Banks, to be well capitalized under the prompt corrective action rules.

	Actual				For Capital Adequacy Purposes				To be Categorized as Well Capitalized under Prompt Corrective Action Rules
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in thousands)
As of December 31, 2003
Total Capital to Risk Weighted Assets
National Mercantile Bancorp	$	39,163	13.84	%	$	22,653	>=8.0	%	N/A		>=10.0	%
Mercantile National Bank	17,484		12.13	%	11,528		>=8.0	%	$	14,410	>=10.0	%
South Bay Bank, N.A.	17,031		12.37	%	11,015		>=8.0	%	$	13,769	>=10.0	%
Tier 1 Capital to Risk Weighted Assets
National Mercantile Bancorp	31,195		11.02	%	11,326		>=4.0	%	N/A		>=6.0	%
Mercantile National Bank	15,680		10.88	%	5,764		>=4.0	%	8,646		>=6.0	%
South Bay Bank, N.A.	15,400		11.18	%	5,508		>=4.0	%	8,262		>=6.0	%
Tier 1 Capital to Average Assets
National Mercantile Bancorp	31,195		8.69	%	14,365		>=4.0	%	N/A		>=5.0	%
Mercantile National Bank	15,680		8.13	%	7,711		>=4.0	%	9,639		>=5.0	%
South Bay Bank, N.A.	15,400		9.44	%	6,526		>=4.0	%	8,158		>=5.0	%

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Note 11—Commitments and Contingencies

In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk.  These financial instruments include commitments to extend credit, letters of credit and financial guarantees.  These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount reflected in the consolidated balance sheet.

Exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, letters of credit and financial guarantees written, is represented by the contractual notional amount of those instruments.  The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

The Company had outstanding loan commitments aggregating $64.5 million at December 31, 2003, substantially all of which were for adjustable rate commercial loans.  In addition, the Company had $1.3 million outstanding letters of credit at December 31, 2003.

Loan commitments are agreements to lend to a customer a specified amount subject to certain conditions.  Loan commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since portions of the commitments are expected to expire without being drawn upon, the total amount of commitments does not necessarily represent future cash requirements.

The Company from time to time is party to lawsuits, which arise in the normal course of business. The Company does not believe that any pending lawsuit at December 31, 2003 will have a material adverse effect on the financial position or results of operations of the Company.

Note 12—Disclosures about the Fair Value of Financial Instruments

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practical to estimate that value.

Cash, cash equivalents and interest bearing deposits:  For these short-term investments, the carrying amount is a reasonable estimation of fair value.

Securities available-for-sale and securities held-to-maturity:  For securities classified as available-for-sale, fair value equals quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Federal Reserve Bank (FRB) and other stock:  FRB and other stock may be redeemed at the carrying amount, therefore, the carrying amount is a reasonable estimation of fair value.

Loans:  Variable rate loans have carrying amounts that approximate fair value. The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. In establishing the credit risk component of the fair value calculations for loans, the Company concluded the allowance for credit losses represented a reasonable estimate of credit risk component of the fair value at December 31, 2003.

Interest rate swap:  The fair value of the interest rate swap is based upon an estimate derived from broker quotations or proprietary broker models that consider the relevant characteristics of the instrument.

Deposits:  The fair value of demand and interest checking deposits, money market accounts and savings deposits is the amount payable on demand at the reporting date.  The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar maturities.

Federal funds purchased and securities sold under agreements to repurchase:  The fair value of fixed-rate securities sold under agreements to repurchase is estimated by discounting the future cash flows using the rates currently offered for instruments of similar maturities.

Junior subordinated debentures:  The fair value of the junior subordinated debentures is based upon the reciprocal change in value of the interest rate swap as the terms of the swap are symmetrical with the terms of the debentures.

Other borrowings:  The fair value of fixed-rate borrowings is estimated by discounting the future cash flows using the rates currently offered for borrowings of similar maturities.  Borrowings with maturities greater than one year bear interest at variable rates and approximate fair value.

The estimated fair values of financial instruments are presented below.

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	December 31, 2003
	Carrying Amount		Fair Value
	(Dollars in thousands)
Financial Assets:
Cash, cash equivalents and deposit with other financial institutions	$	39,284	$	39,284
Securities available-for-sale	30,877		30,877
Securities held-to-maturity	4,597		4,640
FRB and other stock	1,872		1,872
Loans, net of allowance for credit losses	256,614		393,253
Interest rate swap	—		409
Financial Liabilities:
Demand deposits, money market and savings	243,694		243,694
Time certificates of deposit	55,023		43,176
Federal funds purchased and securities sold under agreements to repurchase	399		399
Junior subordinated debentures	15,464		15,585
Other borrowings	7,500		7,649

Note 13—Derivatives

In January 2003, National Mercantile entered into a interest rate swap agreement pursuant to which it exchanged a fixed rate payment obligation of 10.25% on a notional principal amount of $15.0 million for a floating rate interest based on the six-month London InterBank Offerred Rate plus 458 basis points for a 29-year period ending July 25, 2031.  The interest rate swap agreement results in the company paying or receiving the difference between the fixed and floating rates at specified intervals calculated based on the notional amounts.  The differential paid or received on the interest rate swap is recognized as an adjustment to interest expense.  At December 31, 2003, the Company was paying an interest rate of 5.75% under the terms of the swap.  The counter party to the swap has the option to call the swap under a declining premium schedule beginning July 2006.

The interest rate swap reduces the adverse impact of the Company’s 10.25% Junior Subordinated Debentures in a declining interest rate environment.  The Company does not utilize derivatives for speculative purposes.  Under Statement of Financial Accounting Standards No. 133 this swap transaction is designated as a fair value hedge.  Accordingly, the effective portion of the change in the fair value of the swap transaction is recorded each period in current income.  The terms of the swap are symmetrical with the terms of the Trust Preferred Securities, including the payment deferral terms, and considered highly effective in offsetting changes in fair value of the Trust Preferred Securities.  Accordingly, no ineffectiveness will be recorded to current earnings related to the interest rate swap.

Note 14—Parent Company Information

The following financial information presents the condensed balance sheet of the Company on a parent-only basis as of December 31, 2003, and the related condensed statements of operations and cash flows for each of the years in the two-year period ended December 31, 2003.

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Balance Sheet

	December 31, 2003
	(Dollars in thousands)
Cash with Banks	$	1,158
Due from banks - time	1,004
Securities available-for-sale	1,550
Investment in the Banks	42,393
Other assets	2,068
Total assets	$	48,173
Junior subordinated deferrable interest debentures	$	15,464
Other liabilities	988
Total liabilities	16,452
Shareholders’ equity:
Preferred stock	6,986
Common stock	38,576
Accumulated deficit	(13,912		)
Accumulated other comprehensive income	71
Total shareholders’ equity	31,721
Total liabilities and shareholders’ equity	$	48,173

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Statements of Operations

	Year ended December 31,
	2003			2002
	(Dollars in thousands)
Interest income	$	42		$	6
Interest expense	934			1,585
Net interest income	(892		)	(1,579		)
Other operating income	14			38
Other operating expense	290			228
Income before equity in undistributed net income of the Bank	(1,168		)	(1,769		)
Equity in undistributed net income of subsidiaries	944			791
Income before income tax benefit	(224		)	(978		)
Income tax benefit	479			725
Net income (loss)	$	255		$	(253	)

Statements of Cash Flow

	Year ended December 31,
	2003			2002
	(Dollars in thousands)
Cash flows from operating activities:
Net income (loss)	$	255		$	(253	)
Adjustment to reconcile net income to net cash provided by operating activities.:
Equity in undistributed net income of subsidiaries, net	(944		)	(791		)
Net increase in other assets and other liabilities	(687		)	(780		)
Net cash provided by (used in) operations	(1,376		)	(1,824		)
Cash flows from investing activities:
Investment in South Bay Bank, N.A.	—			(3,000		)
Dividends from South Bay Bank, N.A.	—			800
Net cash used in purchase of South Bay Bank, N.A.	—			—
Purchase of available-for-sale securities	(1,586		)	—
Purchase of time deposits at banks	—			—
Loans purchased and principal collections, net	—			879
Net cash used in investing activities	(1,586		)	(1,321		)
Cash flows from financing activities:
Net proceeds from issuance of debentures	—			—
Net proceeds from issuance of preferred stock	—			—
Net proceeds from common stock offering	—			7,572
Proceeds from stock options exercised	504			86
Net cash provided by financing activities	504			7,658
Net (decrease) increase in cash and cash equivalents	(2,458		)	4,513
Cash and cash equivalents, beginning of the year	4,620			107
Cash and cash equivalents, end of the year	$	2,162		$	4,620
Supplemental disclosures of cash flow information:
Cash paid for Interest	$	1,328		$	1,528
Cash paid for Income taxes, net	$	—		$	—

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INDEX TO EXHIBITS

Exhibit
3.1	Amended and Restated Articles of Incorporation, dated June 20, 1997 (1); Certificate of Amendment of the Articles of Incorporation, filed May 4, 2000 (6); Certificate of Determination of Rights, Preferences and Privileges of Series B Convertible Perpetual Preferred Stock filed December 14, 2001(8)
3.2	Bylaws of the Company, as amended, restated as of December 18, 1992 (2)
4.1	Indenture for Junior Subordinated Debt Securities dated as of July 16, 2001  (7)
10.1	Employment Agreement dated January 1, 1999 between Mercantile National Bank and Scott A. Montgomery (3); Assignment, Assumption — Amendment of Employment Agreement among National Mercantile Bancorp, Mercantile National Bank and Scott A. Montgomery
10.2	Form of Indemnity Agreement between the Company and its directors (4)
10.3	First Floor Lease at 1840 Century Park East, Los Angeles, California, dated as of December 21, 1982 between Northrop Corporation and Mercantile National Bank (2)
10.4	National Mercantile Bancorp Amended 1996 Stock Incentive Plan (10)
10.5	Registration Rights Agreement between the Company and Conrad Company (5)
10.6	Amended and Restated Declaration of Trust of National Mercantile Capital Trust I, dated as of June 27, 2001 (7)
10.7	Guarantee Agreement of National Mercantile Bancorp for trust preferred securities dated July 16, 2001 (7)
10.8	Severence Agreement dated November 14, 2002 between National Mercantile Bancorp and David Brown (9)
10.9	Severence Agreement dated September 26, 2003 between National Mercantile Bancorp and Robert Bartlett
10.10	Eighth floor lease at 1880 Century Park East, Los Angeles, California, dated as of November 12, 2003 between Century Park and Mercantile National Bank
11.	Statement regarding computation of per share earnings (see ‘‘Note 1-Summary of Significant Accounting Policies-Earnings (Loss) Per Share’’—of the ‘‘Notes to the Consolidated Financial Statements’’ in “Item 7. Financial Statements” in this Annual Report on Form 10-KSB)
21.	Subsidiaries of the Registrant
23.	Consent of Ernst & Young LLP
31.1	Certification of Scott A. Montgomery under Section 302 of Sarbanes-Oxley Act
31.2	Certification of David R. Brown under Section 302 of Sarbanes-Oxley Act
32.1	Certification of Scott A. Montgomery under Section 906 of Sarbanes-Oxley Act
32.2	Certification of David R. Brown under Section 906 of Sarbanes-Oxley Act

(1)Filed as an exhibit to the Company’s Annual Report on Form 10-K for the year ended December 31, 1997.

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(2)Filed as an exhibit to the Company’s Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference.

(3)Filed as an exhibit to the Company’s Report on Form 10-Q for the quarter ended March 31, 1999 and incorporated herein by reference.

(4)Filed as an exhibit to Company’s Annual Report on Form 10-K for the year ended December 31, 1990 and incorporated herein by reference.

(5)Filed as an exhibit to the Company’s Registration Statement on Form S-2 dated February 10, 1997 and amendments thereto and incorporated herein by reference.

(6)Filed as an exhibit to the Company’s Annual Report on Form 10-K for the year ended December 21, 2000 and incorporated herein by reference.

(7)Filed as an exhibit to the Company’s Report on Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference.

(8)Filed as an exhibit to the Company’s Annual Report on Form 10-K for the year ended December 21, 2001 and incorporated herein by reference.

(9)Filed as an exhibit to the Company’s Annual Report on Form 10-K for the year ended December 21, 2002 and incorporated herein by reference.

(10)  Filed as an exhibit to the Company's Registration Statement on Form S-8 dated June 20, 2003 and incorporated herein by reference.

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EX-10.1

Exhibit 10.1

Assignment, Assumption and Amendment
of
EMPLOYMENT AGREEMENT

This Assignment, Assumption and Amendment (the “Amendment”) of Employment Agreement is made effective as of January 1, 2002 by and among MERCANTILE NATIONAL BANK, a national banking association organized and existing under the laws of the United States (“Bank”), National Mercantile Bancorp, a California corporation (“Bancorp”), and SCOTT A. MONTGOMERY (“Montgomery”), with reference to the following facts:

A.            In 1996, Bank and Montgomery entered into an employment agreement pursuant to which Bank employed Montgomery as President and Chief Executive Officer of Bank.

B.            The Employment Agreement was amended and restated as of January 1, 1999 (the “Employment Agreement”).

C.            Since 1997 Montgomery has also served as President and Chief Executive Officer of Bancorp, the parent corporation of Bank.

D.            In December 2001, Bancorp acquired South Bay Bank, N.A.(“South Bay”), at which time Montgomery became the President and Chief Executive Officer of South Bay.

E.             The parties desire that Bancorp assume the obligations of Bank under the Agreement and to effect certain amendments to the Employment Agreement.

NOW, THEREFORE, with reference to the foregoing facts and in consideration of mutual promises of the parties set forth in this Amendment, Bank, Bancorp and Montgomery hereby agree as follows:

1.             Assignment and Assumption.  Bank hereby assigns to Bancorp all of its rights and obligations under the Employment Agreement, and Bancorp hereby assumes such rights and obligations, but in each case excluding the indemnification obligations of Bank under Paragraph 4 of the Employment Agreement.  Montgomery hereby consents to such assignment and assumption, and agrees that Bank is released from its obligations under the Employment Agreement except for its indemnification obligations under Paragraph 4 of the Agreement.  As a result, all references to the “Bank” in the Employment Agreement shall be changed to “Bancorp” except: (i) under Paragraph 4 of the Employment Agreement; (ii) in connection with references to employee benefit plans, insurance and similar matters which are maintained by Bank and not Bancorp (and for only so long as such plans, insurance and other matters are so maintained by Bank); (iii) under Paragraphs 6.1, 10.11 and 10.12 of the Employment Agreement; and (iv) where used in this Amendment.

2.             Paragraphs 1.2 and 1.3—Employment and Directorships.  Paragraphs 1.2 and 1.3 of the Agreement are amended in their entirety to read as follows:

1.2.          Performance of Duties for Subsidiaries.  Montgomery agrees to serve as chief executive officer of such direct and indirect

subsidiaries of National Mercantile Bancorp (“Bancorp”) as the Board of Directors of Bancorp may from time to time request.

1.3           Directorships.  During the term of his employment, Montgomery shall serve as a director of Bancorp and such direct and indirect subsidiaries of Bancorp as the Board of Directors may from time to time request, but shall receive no director’s fees or other remuneration for his services as a member of said Boards of Directors.

3.             Paragraph 2—Term.  Paragraph 2 of the Employment Agreement is amended in its entirety to read as follows:

2.  Term.  Montgomery’s employment under this Agreement shall commence on January 1, 1999 and shall expire on March 31, 2007; unless terminated sooner as hereinafter provided (the “term” or “term of employment”).  This Agreement supersedes and replaces the Employment Agreement dated June 21, 1996.

4.             Paragraph 3.1—Base Salary.  Paragraph 3.1 of the Agreement is amended in its entirety to read as follows:

3.1           Base Salary.  From January 1, 1999 until December 31, 2001, Bancorp shall pay Montgomery a semi-monthly salary at an annualized rate of $250,000, less applicable withholding.  From January 1, 2002 until March 31, 2007, Bancorp shall pay Montgomery a semi-monthly salary at the annualized rate of $310,000 (“Base Salary”), less applicable withholding.  On December 1, 2002 and each December 1 thereafter, the Base Salary shall be adjusted by multiplying the Base Salary times the percentage increase, if any in the Consumer Price Index for All Urban Consumers (“CPI–U”) for the Los Angeles - Riverside - Orange County, California area as reported by the United States Department of Labor, Bureau of Labor Statistics for the most recent 12-month period for which statistics are available (“CPI increase”) and then adding the product to the then existing Base Salary (and such adjusted salary shall as of the succeeding January 1 become the “Base Salary); provided, however, that in no event shall the increase in Base Salary in any year exceed five percent (5%).  A decline in the CPI-U shall not result in a reduction in the Base Salary; provided, however, the same CPI increase shall not be the basis of an additional adjustment to the Base Salary.

5.             Paragraph 3.2—Incentive Compensation.  Paragraph 3.2 of the Agreement is amended in its entirety to read as follows:

3.2           Incentive Compensation

3.2.1  If Bancorp has positive net income before income tax provision (a “Pretax Profit”) during any calendar year commencing 1999

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through and including 2001, Montgomery shall receive an incentive bonus in an amount equivalent to five percent (5%) of such Pretax Profit for that calendar year, less applicable withholding.  Such incentive bonus shall be paid, if earned, on or before April 1 of the year following the year during which the applicable Pretax Profit was earned.  Additionally, in the event the Bancorp has a Pretax Profit and a return ratio of at least one and one-half percent (1.5%) of Pretax Profit to assets during a calendar year, the Board of Directors shall award Montgomery an additional incentive bonus in an amount equivalent to two percent (2%) of such Pretax Profit for that calendar year, less applicable withholding.  Such additional incentive bonus shall be paid, if earned, on or before April 1 of the year following the year during which the applicable Pretax Profit was earned.

3.2.2  If Bancorp has positive “Pretax Profit” during any calendar year during the term of Montgomery’s employment commencing with calendar year 2002, Montgomery shall receive an incentive bonus in an amount equal to 3% of the first $3 million of such Pretax Profit, plus 4% of the next $2 million of Pretax Profit, plus 5% of any Pretax Profit in excess of $5 million; provided, however, the incentive bonus in any year shall not exceed Montgomery’s Base Salary for such year.

3.2.3  Montgomery understands and agrees that nothing in this Agreement is intended to create or imply any right on his part to receive, or duty on the part of Bancorp to pay, a bonus or incentive compensation for any calendar year in which Bancorp fails to achieve a Pretax Profit; provided, however, that if Bancorp fails to achieve a positive Pretax Profit during any calendar year during the term of Montgomery’s employment, Bancorp’s Board of Directors may, in its sole and absolute discretion, award Montgomery a discretionary incentive bonus in an amount it deems appropriate under the circumstances, taking into account such factors as Montgomery’s performance of his duties, the operating results and financial condition of Bancorp, and the economic climate within which Bancorp operated during the year.

6.             Paragraph 8.2.2.  Paragraph 8.2.2 is amended in its entirety to read as follows:

8.2.2  Bancorp may terminate Montgomery’s employment hereunder at any time for cause.  For purposes of this Agreement, the term “cause” shall mean, (a) any act of dishonesty, unauthorized disclosure of confidential information or fraud by Montgomery in the performance of his duties hereunder; (b) the commission of a felony involving theft or fraud of any kind; (c) the commission of a fraud or misappropriation or embezzlement of property of the Bancorp Group or any customer of the Bancorp Group; (d) a willful and material breach by Montgomery of obligations under this Agreement, all (a, b, c and d) with or without prosecution or conviction; (e) the inability of any member of the Bancorp Group to secure a bond for the services of Montgomery, or Montgomery

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engaging in conduct that would preclude any member of the Bancorp Group’s ability to bond Montgomery; or (f) a written order or directive from the Office of the Comptroller of the Currency or the Board of Governors of the Federal Reserve System ordering the removal of Montgomery as an executive officer or director of any member of the Bancorp Group.  For purposes of this Agreement, the “Bancorp Group” shall mean Bancorp and any direct or indirect subsidiary depository institution of Bancorp.

7.             Paragraph 8.3.3.  With respect to the clause “the Bank [now Bancorp] substantially and adversely changes Montgomery’s status, title, position or responsibilities,” it is understood that this refers to Montgomery’s status, title, position and responsibilities as Chief Executive Officer and President of Bancorp and not any subsidiary or subsidiaries of Bancorp.

8.             Paragraph 8.3.4.  Paragraph 8.3.4 of the Employment Agreement is amended to add the words “or Paragraph 8.5.2 below” immediately after the words “Paragraph 8.3.3 above.”

9.             Paragraph 8.3.7.  A new Paragraph 8.3.7 is added to the Employment Agreement to read as follows:

8.3.7        If Montgomery’s employment is terminated pursuant to Paragraph 8.1, by Bancorp under Paragraphs 8.2.1 or 8.2.3, or by Montgomery under the circumstances described in Paragraph 8.3.3, and Bancorp has a positive Pre-tax Profit for the calendar year in which his termination of employment occurs, Montgomery shall be entitled to additional severance compensation in an amount equal to: (a) the amount of incentive compensation he would have earned under Paragraph 3.2.2 had he been employed for the full calendar year, multiplied by (b) a fraction, the numerator of which is the number of days during the calendar year during which he was employed by Bancorp and the denominator of which is the number of days in the calendar year.  Such additional severance shall be paid, if earned, on or before April 1 of the year following the calendar year in which Montgomery’s employment terminates.

10.           Paragraph 11—Change of Control Payment.  A new Paragraph 11 is added to the Employment Agreement to read as follows:

11.           Change of Control

11.1         For the purposes of this Agreement, the following terms shall have the meanings set forth below:

11.1.1 “Affiliate” shall mean, with respect to any Person, any Person that, directly or indirectly, controls, is controlled by or is under common control with such Person.  For the purposes of this definition, “control” (including, with correlative meanings, the terms “controlled by” and “under common control with”) shall

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mean the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities or voting equity interests.

11.1.2 A “Change of Control” shall be deemed to have occurred in any of the following instances:

(i)The sale by Bancorp of all or substantially all of its assets to any Person, but not a sale to the Existing Shareholder Group if the purchaser assumes all of the obligations of Bancorp under this Agreement (with the effect that Montgomery becomes the Chief Executive Officer of the purchaser);

(ii)A merger or consolidation of Bancorp with any other Person if the shareholders of Bancorp immediately prior to such merger or consolidation beneficially own shares representing less than 50% of the voting power in the election of directors of the surviving entity immediately following such merger or consolidation, but excluding a merger or consolidation with an entity which is a member of the Existing Shareholder Group; or

(iii)A Person other than the Existing Shareholder Group acquires beneficial ownership of shares representing 35% or more of the voting power in the election of directors of Bancorp or its successor or, if Bancorp or its successor is involved in a reorganization in which it becomes a subsidiary of another corporation, the ultimate parent corporation of Bancorp or its successor; or

(iv)any other transaction, although in a different form, accomplishes substantially the same result as (i), (ii) or (iii).

11.1.3 “Change of Control Payment” shall mean a lump-sum payment equal to 18 months salary at the Base Salary in effect on the date of termination of Montgomery’s employment.

11.1.4 “Exchange Act” shall mean the Securities Exchange Act of 1934, as amended, or any successor statute.

11.1.5 “Existing Shareholder Group” shall mean (i) Carl R. Pohlad, Eloise O. Pohlad, James O. Pohlad, Robert C. Pohlad and William M. Pohlad; (ii) members of the immediate family of the

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Persons in subparagraph (i); and (iii) Affiliates of Persons listed in subparagraphs (i) or (ii).

11.1.6 “Person” shall have the meaning ascribed to such term in Section 3(a)(9) of the Exchange Act, which definition shall include a “person” within the meaning of Section 13(d)(3) of the Exchange Act.

11.2         If the Company terminates Montgomery’s employment without cause and within 12 months thereafter a Change of Control occurs, within 30 days following such Change of Control, Bancorp shall pay to Montgomery a lump sum amount equal to amount to which Montgomery would thereafter be entitled under Paragraph 8.3.3 of this Agreement; in other words, the remaining obligation of Bancorp under Paragraph 8.3.3. shall be accelerated (and Bancorp shall have no obligation under Paragraph 8.3.3 of this Agreement for payments accruing after the Change of Control).

11.3         If a Change of Control occurs and within 12 months thereafter Montgomery’s employment is terminated without cause, within 30 days following such termination, Bancorp shall pay to Montgomery the Change of Control Payment (and while the Change of Control Payment shall be without reduction for salary and other compensation accruing following the Change of Control and prior to termination of employment, Bancorp shall have no obligation to make any payment under Paragraph 8.3.3 of this Agreement).

11.4         If a Change of Control occurs, Montgomery shall have the right to terminate his employment with Bancorp at any time after six months and prior to 12 months following the Change of Control.  If Montgomery so terminates his employment, within 30 days thereafter, Bancorp shall pay to Montgomery the Change of Control Payment (and Bancorp shall have no obligation to make any payment under Paragraph 8.3.3).

11.5         In the event Montgomery is entitled to a Change of Control Payment under Paragraph 11.2, 11.3 or 11.4 of this Agreement, Bancorp shall also pay to Montgomery: (a) at the time of the Change of Control Payment: (i) any bonus which had previously been awarded to Montgomery under Paragraph 3.2.3 of this Agreement but which had not been paid; and (ii) amount sufficient to pay for all employee benefits to which Montgomery may be entitled under COBRA for a period of twelve months following such termination; and (b) by April 1 of the year following year in which Montgomery’s employment terminates,

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additional severance compensation in the amount determined in accordance with Paragraph 8.3.7 of this Agreement.

11.           Paragraph 10.7.  Paragraph 10.7 shall be amended in its entirety to read as follows:

10.7  Acknowledgment – Montgomery hereby acknowledges that this Agreement is, from the outset, without liability to, or recourse against, any officer or director of any member of the Bancorp Group or any subsidiary thereof and that, except with respect to Bank’s indemnity under Paragraph 4, his sole recourse under this Agreement shall be against Bancorp.

12.           Except as amended pursuant to this Agreement, all other terms, conditions, promises and undertakings set forth in the Agreement are hereby ratified and shall remain in full force and effect until the termination of the Agreement as provided therein.

IN WITNESS WHEREOF, Bank and Bancorp have caused this Amendment to be executed by its duly authorized officers, and Montgomery has duly executed this Agreement, to be effective as of January 1, 2002.

MERCANTILE NATIONAL BANK	NATIONAL MERCANTILE BANCORP
By:	By:
Title:	Title:
/s/ SCOTT A. MONTGOMERY
SCOTT A. MONTGOMERY

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EX-10.9

Exhibit 10.9

SEVERANCE AGREEMENT

THIS SEVERANCE AGREEMENT (this “Agreement”) is made and entered into as of September 26, 2003, by and between National Mercantile Bancorp, a California corporation (the “Company”), and Robert Bartlett (“Officer”) with reference to the following facts:

A.            Officer is an officer of the Company and/or one or more subsidiaries of the Company; and

B.            In order to induce Officer to remain employed by the Company and/or its subsidiaries, the Company is willing to agree to pay severance to Officer under certain circumstances.

NOW, THEREFORE, in consideration of the foregoing and of the respective covenants and agreements of the parties herein contained, it is agreed as follows:

1.             Definitions.  For purposes of this Agreement, the following terms when used in this Agreement shall have the meanings set forth below:

1.1           “Board” shall mean the Board of Directors of the Company.

1.2           “Cause” shall mean Officer, after the date of this Agreement, (i) has been convicted by a court of competent jurisdiction of any felony or any criminal offense involving dishonesty, breach of trust or misappropriation, or has entered a plea of nolo contendere to such an offense; or (ii) has committed an act of fraud, embezzlement, theft, dishonesty or any act which would cause termination of coverage under the Company’s Banker’s Blanket Bond as to Officer (as distinguished from termination of coverage as to the Company as a whole); or (iii) has committed a willful violation of the Code of Conduct of any member of the Company Group or any law, rule or regulation governing the operation of the Company Group which the Board determines in good faith will likely have or has had a material adverse effect on the business, interests or reputation of the Company Group or any Member thereof; or (iv) has willfully refused to perform the duties assigned to him; or (v) has committed a willful and unauthorized disclosure of material confidential information regarding the Company Group, which disclosure the Board determines in good faith will likely have or has had a material adverse effect on the Company Group or any member thereof.

1.3           “Change of Control” shall mean any transaction or series of related transactions as a result of which

(i)            the Company consummates a reorganization, merger or consolidation, or sale or other disposition of all or substantially all of its assets (each a “Business Combination”), in each case unless immediately following the consummation of

such Business Combination all of the following conditions are satisfied:  (x) Persons, who, immediately prior to such Business Combination, were the beneficial owners of the Outstanding Voting Securities of the Company, beneficially own (within the meaning of Rule 13d-3 promulgated under the Exchange Act, directly or indirectly, more than one-third of the combined voting power of the then Outstanding Voting Securities of the entity (the “Resulting Entity”) resulting from such Business Combination (including, without limitation, an entity which as a result of such transaction owns the Company or all or substantially all of the Company’s assets either directly or through one or more subsidiaries); (y) no Person, other than the Existing Shareholder Group, beneficially owns (within the meaning of Rule l3d-3), directly or indirectly, more than 20% of the then outstanding combined voting power of the Outstanding Voting Securities of the Resulting Entity, except to the extent that such Person’s beneficial ownership of the Company immediately prior to the Business Combination exceeded such threshold; and (z) at least one-half of the members of the board of directors of the Resulting Entity were members of the Board at the time the Board authorized the Company to enter into the definitive agreement providing for such Business Combination; or

(ii)           any Person acquires beneficial ownership (within the meaning of Rule 13d-3) of more than 20% of the combined voting power (calculated as provided in Rule l3d-3 in the case of rights to acquire securities) of the then Outstanding Voting Securities of the Company; provided, however, that for purposes of this clause, the following acquisitions shall not constitute a Change of Control:  (x) any acquisition directly from the Company, (y) any acquisition by the Company, (z) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any entity controlled by the Company; or (zz) any acquisition by the Existing Shareholder Group.

1.4           “Company Group” shall mean at any time the Company and each subsidiary of the Company at such time which is consolidated with the Company for financial reporting purposes.

1.5           “Disability of Officer” shall mean if Officer is Disabled and such disability continues for a period of any six months out of a one-year period.  “Disabled” shall mean Officer’s inability, through physical or mental illness or other cause, to perform normal and customary duties which Officer is required to perform for the Company.  In determining whether Officer is Disabled, the Company may rely upon the written statement provided by a licensed physician acceptable to the Company.  Officer shall allow examination from time to time by any licensed physician selected by the Company and agreed to by Officer.  All such examinations will be conducted within a reasonable time period.

1.6           “Exchange Act” shall mean the Securities Exchange Act of 1934, as amended, or any successor statute.

1.7           “Existing Shareholder Group” shall mean Carl R. Pohlad, members of the immediate family of Carl R. Pohlad, and any affiliated Person of Carl R. Pohlad or any member of his immediate family.

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1.8           “Good Reason” shall mean with respect to Officer (i) Officer being delegated or assigned material duties by the Board or the Chief Executive Officer of the Company, by a communication in writing, which are substantially inconsistent with the position and status held by Officer immediately prior to the effective date of the Change of Control; or (ii) Officer having had removed by the Board or the Chief Executive Officer of the Company by a communication in writing such authority and responsibility which is necessary to carry out the duties of the position held by Officer immediately prior to the effective date of the Change of Control; or (iii) Officer having a substantial and adverse alteration in the nature, status, or prestige of Officer’s responsibilities due to the action of the Board or the Chief Executive Officer, which is verifiable by tangible evidence; or (iv) Officer being forced to relocate permanently to an office more than 25 miles from the location of the Company’s executive offices as in effect immediately prior to the effective date of the Change of Control; or (v) Officer having his or her base compensation reduced by 10% or more from such base compensation in effect on the date immediately preceding the effective date of the Change of Control.  Notwithstanding the foregoing, the loss of one or more titles, and corresponding responsibility(ies), shall not be deemed to be “Good Reason” under (i), (ii) or (iii) above provided that the Officer retains at least one title no less senior than Executive Vice President at the Company or at least one subsidiary bank of the Company.

1.9           “Outstanding Voting Securities” of any Person means the outstanding securities of such Person entitling the holders thereof to vote generally in the election of directors of such Person.

1.10         “Person” shall have the meaning ascribed to such term in Section 3(a)(9) of the Exchange Act, which definition shall include a “person” within the meaning of Section 13(d)(3) of the Exchange Act.

1.11         “Without Cause” shall mean any termination of Officer’s employment by the Company except for a termination (i) for Cause, (ii) as a result of the death of Officer, or (iii) as a result of the Disability of Officer.

2.             Severance Payment.

2.1           Except as provided in Section 2.2, if (i) Good Reason exists within one year following a Change of Control, and Officer gives written notice to the Company within 90 days after the occurrence of such Good Reason that Officer is terminating his or her employment with the Company for Good Reason, or (ii) the Company terminates Officer’s employment Without Cause within one year following a Change of Control, the Company will pay Officer in a lump sum an amount (the “Severance Payment”) equal to six times Officer’s base monthly salary as in effect at the time of termination or, if greater, immediately prior to the effective date of the Change of Control.  The Severance Payment shall be reduced by required deductions for applicable taxes and other withholdings and for any outstanding obligations owed by Officer to the Company that are then due and payable, which deductions and withholdings are specifically authorized by Officer.  The Severance Payment shall be in lieu of any other severance payments to which Officer would be entitled under the plans or policies of the Company and any of its subsidiaries.  The Severance Payment will be paid at the time of termination of the Officer’s employment with the Company.  Each Change of

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Control and each Good Reason following a Change of Control shall give Officer a separate right to give the notice set forth in the first sentence of this Section 2.

2.2           Notwithstanding any other provision of this Agreement, the Company shall have no obligations to make the Severance Payment if such Severance Payment is prohibited by applicable federal or state law, including without limitation Part 359 of the regulations of the Federal Deposit Insurance Corporation (12 CFR § 359 et seq.) or any successor provision.

2.3           As a condition to the obligation of the Company to pay the Severance Payment, the Officer must execute and deliver a release in form and substance satisfactory to the Company releasing the Company Group and its directors, officers, employees and agents (“Released Parties”) from any and all claims the Officer may have against the Released Parties, whether such claims are known or unknown, absolute or contingent, other than claims under this Agreement, claims for salary and other compensation and benefits accrued prior to termination, and rights under employee benefit plans.

3.             IRC Provisions.  Notwithstanding any other provision of this Agreement, if the Company reasonably determines that the payment of the Severance Payment to Officer would be nondeductible by the Company for federal income tax purposes because of Section 280G of the Internal Revenue Code of 1986, as amended (the “Code”), the Severance Payment shall be reduced to an amount which maximizes the Severance Payment without causing any portion of the same to be nondeductible by the Company because of Section 280G of the Code.  Any such reduction shall be applied to the Severance Payment or the other amounts due to Officer in such manner as Officer may reasonably specify within 30 days following notice from the Company of the need for such reduction or, if Officer fails to so specify timely, as determined by the Company.

4.             Employee Benefits.  All employee benefits provided by the Company shall cease upon termination of Officer’s employment, whether for Good Reason, Without Cause, or for any other reason, and the Company shall have no further responsibility with respect thereto after such termination; provided, however, that: (a) nothing contained in this Agreement shall affect any right Officer may have pursuant to the federal entitlement to continued group health care coverage as provided in the Consolidated Omnibus Budget Reconciliation Act of 1985 (“COBRA”) or any successor legislation or comparable state law; (b) if Officer is entitled to receive a Severance Payment pursuant to Section 2 hereof, and if Officer elects under COBRA to continue to receive any benefits thereunder, the Company shall reimburse Officer for the amount of such Officer’s COBRA payments for the first six months after such termination; and (c) nothing shall alter or modify the post termination rights of Officer under any employee benefit plan (such as the right to exercise vested options for a specified period under the Stock Incentive Plan).

5.             Term.  The Agreement shall commence on the date set forth above and shall terminate upon 12 months’ prior written notice to the Officer.

6.             Employment “At Will”.  Neither this Agreement nor the Severance Payment payable hereunder shall be deemed to limit, replace or otherwise affect the “at will” nature of

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Officer’s employment with the Company Group.  Officer’s employment with any member of the Company Group continues to be for an unspecified term and may be terminated at will at any time with or without cause or notice by such member of the Company Group or by Officer (but in the case of Officer, without the written consent of the Company Officer must terminate his employment with all members of the Company Group).  This employment “at-will” relationship cannot be changed absent an express intent as set forth in an individualized written employment contract signed by both Officer and the Chief Executive Officer of the Company.

7.             Mitigation.  Officer shall have no obligation to mitigate damages based upon Officer’s termination pursuant to Section 2 of this Agreement, and the Severance Payment shall not be reduced as a result of Officer obtaining other employment within nine months of Officer’s termination.

8.             Counterparts.  This Agreement may be executed in any number of counterparts, each of which shall be deemed an original, and all of which, together, shall constitute one and the same instrument.

9.             Partial Invalidity.  Any provision of this Agreement which shall prove to be invalid, void or illegal shall in no way affect, impair or invalidate any other provision hereof, and such other provisions shall remain in full force and effect.

10.           Governing Law.  The terms and provisions of this Agreement shall be governed and construed pursuant to the laws of the State of California except to the extent governed by federal law.

11.           Construction.  Headings at the beginning of each section are solely for the convenience of the parties and are not a part of this Agreement.  Whenever required by the context of this Agreement, the singular shall include the plural and the masculine shall include the feminine and vice versa.  This Agreement shall not be construed as if it had been prepared by one of the parties, but rather as if both parties had prepared the same.  Unless otherwise indicated, all references to sections are to this Agreement.

12.           Integration.  This Agreement represents the entire and integrated agreement between the Company and Officer regarding the subject matter hereof and supersedes all prior negotiations, representations or agreements, either written or oral.

13.           Successors and Assigns.  The terms, covenants and conditions herein contained shall be binding upon and shall inure to the benefit of the heirs, successors and assigns of the parties hereto.

14.           No Waiver.  No waiver by either party of any breach or default hereunder shall be deemed a waiver of any other breach or default, and no delay or forbearance by either party hereunder in enforcing any of its rights or remedies shall be deemed a waiver of any such rights or remedies, unless such waiver is embodied in a writing signed by the authorized representative of the party to be bound.

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IN WITNESS WHEREOF, this Agreement has been executed effective on the day and year hereinabove set forth.

THE “COMPANY”	NATIONAL MERCANTILE BANCORP
	By:	/s/ SCOTT A. MONTGOMERY
		Scott A. Montgomery
		Chief Executive Officer
“OFFICER”	/s/ ROBERT BARTLETT
	Robert Bartlett

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EX-10.10

Exhibit 10.10

LEASE

THIS LEASE (“Lease”), dated for reference purposes only as of November 12, 2003, is made by and between Century Park, a California Limited Partnership (“Landlord”) and Mercantile National Bank, N.A., a national bank (“Tenant”), upon the following terms and conditions:

1.Premises and Basic Lease Information

1.1.Landlord hereby leases to Tenant and Tenant hereby leases from Landlord, upon the terms and conditions set forth in this Lease, those certain premises (the “Premises”) described in Article 1.1.1 below and diagrammed in Exhibit “A” attached hereto and hereby made a part hereof, as well as the right to use, in common with others, the Common Areas (as hereinafter defined).  The Premises are situated in that certain office building (the “Building”) located at 1880 Century Park East, Los Angeles, California 90067.  The land upon which the Building is located together with the Building and related facilities and appurtenances and Common Areas shall hereinafter be referred to as the “Project.”  The terms and conditions of this Lease include, without limitation, the following:

1.1.1Premises:Suite 800 consisting of approximately 13,880 rentable square feet on the 8th floor of the Building (see the attached Exhibit “A”).  The exact area of the Premises shall be determined by applying the BOMA method of measurement (ANSI Z65.1-1996) to calculate the square footage per the final space plan for the Premises.  Should the square footage measured from the space plan vary from that set forth in this Article 1.1.1, Landlord shall revise all figures in this Lease that are affected by the square footage, and Landlord and Tenant shall amend this Lease accordingly.  Landlord may re-measure the Premises once within twenty (20) days of the Commencement Date of the Initial Term.  Landlord may re-measure the Premises thereafter; provided, however that such re-measurement does affect the economics specified in Article 1.1.4 or Article 1.1.7 herein.

1.1.2Lease Term:Except for Tenant’s occupancy of the Temporary Space pursuant to the terms and conditions of this Lease as set forth in Article 41 of the Lease Addendum, the term of this Lease (the “Lease Term” or “Term”) shall begin on the later of the following dates (the “Commencement Date”): (a) April 1, 2004 (the “Scheduled Commencement Date”) or, where applicable, (b) upon Substantial Completion of the Tenant Improvements, as defined in the construction agreement attached hereto as Exhibit “B” and herein incorporated by reference, and, unless terminated pursuant to Article 42 in the Lease Addendum, shall expire on the last day of the month that is one hundred twenty (120) months after the first day of the month after the Commencement Date, unless sooner terminated pursuant to this Lease.

1.1.3Holding Over.If Tenant, with or without Landlord’s written consent, remains in possession of all or any portion of the Premises after the expiration or sooner termination of the Lease, such holding over (“Holdover”) shall constitute and be construed as a tenancy from month-to-month only, subject to such terms and conditions contained herein as may reasonably and logically be construed to apply to the Holdover, and any and all options or other preferential rights of Tenant shall be deemed to have lapsed and to be of no further force or effect.  Either party may terminate such month-to-month tenancy by giving the other party at least thirty (30) days written notice thereof.  During such Holdover, Base Rent (as defined below) shall be one hundred fifty percent (150%) of the Base Rent in effect immediately prior to such Holdover.  Acceptance by Landlord of any Rent after the expiration or termination of the Lease shall not be deemed to constitute Landlord’s consent to such Holdover.

1.1.4Base Rent:The base rent (“Base Rent”) for the Premises shall be $2.23 per rentable square foot ($30,952.40) per month, subject to an annual CPI adjustment (see Article 3.2; see also Article 41 relating to the payment of rent in the Temporary Space.).

1.1.5Additional Rent: Amounts which are due as Additional Rent by reason of increases in Estimated Pass-through Costs (as both capitalized terms are defined in Article 4 below) and all other amounts payable by Tenant pursuant to the provisions of this Lease.

1.1.6Base Year:2004 is the Base Year.

1.1.7Tenant’s Percentage Share:   4.45% “Tenant’s Percentage Share” shall be a fraction, the numerator of which shall be the rentable square footage of the Premises and the denominator of which shall be 311,400 approximate rentable square feet for the Building.

1.1.8Security Deposit:None

1.1.9Permitted Use:General offices and uses related thereto that do not conflict with the Building’s certificate of occupancy, that comply with all applicable codes and statutes, and that are uses commonly found in similar office buildings in the Project vicinity.

1.1.10Address For Notices:

Tenant (prior to Commencement Date)	Tenant (after Commencement Date)
Mercantile National Bank	Mercantile National Bank
1840 Century Park East	1880 Century Park East, Suite 800
Los Angeles, CA  90067	Los Angeles, CA 90067
Contact: Mr. Scott A. Montgomery	Contact: Mr. Scott A. Montgomery
Phone:  310/282-6778	Phone: 310/ 282-6778
	With a Copy to:
	Ted Simpson
	Cushman & Wakefield
	601 Figueroa Street, Suite 4700
	Los Angeles, CA 90017
	Telephone:  213/955-5100

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LandlordCentury Park, a California limited partnership, c/o Held Properties, Inc., 1880 Century Park East, Suite 500, Los Angeles, CA 90067.  See also Article 25 of this Lease.

1.1.11Parking Rights:Two and One-Half automobile spaces per 1,000 rentable square feet, currently calculated as Thirty-Five (35) automobile spaces at the Building’s prevailing parking rates.  See also Article 31 herein.  See also Article 46 of the Lease Addendum.

1.1.12Guarantor(s):N/A

1.1.13Broker: Cushman & Wakefield of California, Inc.

1.2Common Areas.The term “Common Area(s)” as used in this Lease shall mean all areas and facilities in the Project which are provided and designated from time to time by Landlord for the general use and convenience of Tenant and other tenants of the Project and their respective employees and invitees. Common Areas include, without limitation, the lobby areas, walkways, parking facilities, landscaped areas, sidewalks, corridors, washrooms (if not part of the Premises), stairways, elevators, walls, common telephone and electrical closets, loading docks, plazas, service areas, and all other areas of the Project intended for common use.  Floors wholly occupied by Tenant or any other tenant shall not have any facilities which shall be used in common with other tenants, except for elevators, fire stairs, shafts, utility and service closets, and similar installations.  Tenant, its employees and invitees shall have a nonexclusive right to use the Common Areas, subject to Landlord’s rights and duties as hereinafter set forth.  Without Tenant’s consent and without liability to Tenant, so long as Tenant’s access to the Premises and parking area or Tenant’s ability to conduct business therefrom is not materially impaired and provided that Landlord uses reasonable effort (including performing such work after normal business hours, if reasonably required) to minimize any interference with Tenant’s use and access of the Premises and parking areas during normal business hours, Landlord shall have the right to do the following:

1.2.1Establish and enforce in a nondiscriminatory, consistently applied manner, reasonable rules and regulations concerning the maintenance, management, use and operation of the Common Areas;

1.2.2Temporarily close any Common Area for maintenance, alterations or improvements;

1.2.3Select, appoint and/or contract with any person or entity for the purpose of operating and maintaining the Common Areas; and

1.2.4Change, except for the number and location of parking spaces, the size, use, shape or nature of the Common Area provided that doing so does not materially affect the existing ingress and egress to the Building, or change the character of the Building to less than a first class office building.

2.Commencement Date; Early Entry

2.1Except as set forth in Article 42, this Lease shall not be void or voidable, nor shall Landlord be subject to any liability as a result of any delay in the Commencement Date for any reason.  Except for Tenant Delays, as defined in the Construction Agreement, payment of rent shall not commence until the Premises are available for occupancy by Tenant with all work to be performed pursuant to the Construction Agreement substantially completed and the Department of Building and Safety has signed the permit card, indicating that occupancy is permitted.

2.2Within thirty (30) business days after Tenant’s occupancy of the Premises, or as soon thereafter as possible, the Landlord shall draft a statement, and the parties hereto shall execute a written statement setting forth the Commencement Date and the date of expiration of this Lease; provided, however, the enforceability of this Lease and the Commencement Date shall not be affected should either party fail or refuse to execute such statement.

2.3Provided that Tenant or Tenant’s agents do not interfere with or delay the Substantial Completion of Landlord’s Work in the Premises, or otherwise cause additional cost or expense to Landlord, Tenant and Tenant’s agents shall be permitted to enter the Premises up to fourteen (14) days prior to the Commencement Date for the purpose of installing telephones, cabling, fixtures and equipment.  Such early entry shall be subject to all the terms of such permission and all the provisions of this Lease which could be reasonably and logically construed as applying thereto, except that Tenant shall not be required to pay Rent.

3.Base Rent; Adjustments; General Rent Provisions.

3.1Tenant shall pay to Landlord as Base Rent for the Premises, without prior notice or demand, the amount specified in Article 1.1.4, in advance, on or before the first day of each and every calendar month during the Lease Term.  All payments received by Landlord from Tenant shall be applied to the oldest payment obligation owed by Tenant to Landlord.

3.2Base Rent as set forth in Section 1.1.4 above shall be increased effective as of each anniversary of the Commencement Date during the term (“Adjustment Date”) to an amount which shall be determined by adding to the Base Rent an amount equal to the Base Rent multiplied by the percentage of increase, if any, of the “Consumer Price Index for All Urban Consumers, Los Angeles-Anaheim-Riverside, California, Subgroup All Items (1982-1984=100)”, published by the United States Department of Labor, Bureau of Labor Statistics (the “CPI”) for the calendar month which is four (4) months immediately preceding the month in which the Adjustment Date occurs (the “Adjustment Index”) as compared with the CPI for the calendar month which is four (4) months immediately preceding the Commencement Date (the “Base Index”); provided, however, that in no event shall the adjusted and then current rent be decreased.

For example, if (i) the Base Rent as of the Commencement Date is $1,000; (ii) the Base Index is 300; (iii) the Adjustment Index for the first Adjustment Date is 315; (iv) the Adjustment Index for the Second Adjustment Date is 327; and (v) the Adjustment Index for the third Adjustment Date is 330; the Base Rent shall be increased as follows:

A)	As of the first Adjustment Date –  315/300 = 1.05 x $1,000 = $1,050
B)	As of the second Adjustment Date – 327/300 = 1.09 x $1,000 = $1,090
C)	As of the third Adjustment Date – 330/300 = 1.10 x $1,000 = $1,100

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If the Adjustment Index is unavailable on the date on which the first installment of Base Rent as adjusted shall become due, Tenant shall continue to pay the then effective Rent payable by Tenant until the Adjustment Index is available, and the adjustment, if any, shall be paid retroactively with Base Rent for the first month in which the Adjustment Index is available.  If the Bureau of Labor Statistics ceases to use the 1982-1984 base of 100 as the basis of calculation for the CPI, then the Base Index and the Adjustment Index shall be adjusted in accordance with the conversion formula published by the Bureau of Labor Statistics.  If, at any time required for the determination of the amount of any adjustment in Base Rent, the CPI is no longer published or issued, Landlord shall reasonably select a reliable governmental or other non-partisan publication evaluating the information theretofore used in determining the CPI.

3.3For any period during the Lease Term which is less than one (1) month, Base Rent, Additional Rent (defined in Article 4.1), and any other sums which are payable by Tenant under the Lease (all of which shall be deemed “Rent”) shall be prorated based upon a thirty (30) day month.

3.4Rent under this Lease shall be paid to Landlord, without deduction, offset or abatement (except as otherwise may be specifically set forth in this Lease) at Landlord’s address as specified in Article 1.1.10 above. Landlord shall have the right to accept all payments of Rent and other payments, whether full or partial, and to negotiate checks in payment thereof without any waiver of its rights, irrespective of any conditions to the contrary sought to be imposed by Tenant.  Rent paid by check shall not be deemed paid to Landlord until funds clear and the check is honored.  If any noncash payment is not paid by the bank or other financial institution on which it is drawn, Landlord shall have the right to require Tenant to make future payments by certified funds.

4.Additional Rent.

4.1Computation of Additional Rent  During each December of the Lease Term, or as soon thereafter as reasonably practical, Landlord shall provide Tenant with its good faith written estimate of the amount, if any, by which the Tax Costs (as defined in Article 4.3 below) and/or the Operating Costs (as defined in Article 4.4 below) for the coming calendar year are projected to exceed those of the Base Year (collectively referred to as “Estimated Pass-through Costs”).  On or before the first day of each month during the ensuing calendar year, Tenant shall pay to Landlord as additional rent (“Additional Rent”), in addition to and at the time provided for payment of Base Rent, one-twelfth (1/12^th) of the amount computed by multiplying Tenant’s Percentage Share by the amount of the Estimated Pass-through Costs for Taxes and/or one-twelfth (1/12^th) of the amount computed separately with respect to Operating Costs.  In the event that Landlord does not provide Tenant with such written estimate in December, Tenant shall continue to make monthly payments of Additional Rent on the basis of the prior year’s Estimated Pass-through Costs until the first day of the month after Landlord provides such written estimate to Tenant, at which time Tenant shall commence making monthly Additional Rent payments based upon the revised Estimated Pass-through Costs, and additionally shall pay to Landlord a one-time retroactive sum for each month that has elapsed since December the amount by which the Additional Rent payable pursuant to the revised Estimated Pass-through Costs exceeds the amount Tenant paid based on the prior year’s Estimated Pass-through Costs.  Landlord shall use its commercially best efforts to deliver its written estimate within six (6) months of the end of the calendar year.  Under no circumstances shall the provisions of this Article 4 cause the Base Rent to be reduced.  Neither Landlord’s failure to deliver, nor the late delivery of such statement or statements shall constitute a default by Landlord hereunder, nor a waiver of Landlord’s right to receive any Additional Rent or to later collect Additional Rent accrued as provided hereinabove.  The Tax Costs and Operating Costs for the Base Year shall be deemed to constitute Landlord’s agreed contribution to Operating Costs and Tax Costs and is neither a representation nor a warranty that such Base Year costs will reflect actual Operating Costs or Tax Costs for any succeeding year.  If, during any calendar year including the Base Year, the Building is less than ninety-five percent (95%) occupied, then for the purpose of computing Additional Rent due hereunder, the variable components of the Operating Costs and Tax Costs actually incurred during such calendar year shall be increased to approximate the amounts which would have been payable if the Building had been ninety-five percent (95%) occupied.

4.2Reconciliation of Estimated Pass-through Costs to Actual  By July 1^st of each year, Landlord shall furnish to Tenant a written statement of reconciliation (the “Reconciliation”), showing Landlord’s actual Operating Costs and Taxes for the preceding calendar year, together with a statement of adjustments necessary to reconcile any sums paid by Tenant hereunder during such calendar year pursuant to Article 4.1 with those sums actually payable and due hereunder for such calendar year.  Any reference to Landlord’s “actual” Operating Costs or Tax Costs in this Article 4 shall be deemed to include an allowance for adjustment to reflect the level of occupancy of the Building to the extent provided above.  If the Reconciliation shows that Tenant owes additional sums hereunder, Tenant shall pay such sums to Landlord within thirty (30) days after receipt of the Reconciliation.  If the Reconciliation shows that Tenant overpaid Additional Rent, such overpayment shall be refunded or credited to Tenant within thirty (30) days after Tenant’s receipt of the Reconciliation. Landlord’s obligation to reconcile, Tenant’s obligation to pay, and Landlord’s obligation to credit or refund shall survive the expiration or sooner termination of the Lease. Landlord’s failure to deliver the Reconciliation to Tenant as provided herein shall not constitute a default by Landlord nor waive Landlord’s right to collect all Additional Rent and other sums due hereunder.  Where only a portion of a calendar year falls within the Lease Term, Landlord shall reasonably prorate the estimated (or actual) Operating Costs and/or Tax Costs for such calendar year.

4.3Tax Costs.  “Tax Costs” shall mean the sum of the following: any and all real property taxes, assessments (including, but not limited to, general and special assessments and possessory interests), charges, surcharges, license and other fees, levies, cost of improvement bonds and any and all other taxes (other than income, franchise, inheritance and estate or gift taxes of Landlord) on or relating to all or a portion of the Project including any legal or equitable interest of Landlord therein, that may be imposed, levied, assessed or charged for any reason by any authority having the direct or indirect power to tax including, but not limited to, the United States or the state, county or city in which the Project is located, or any other local governmental authority, agency, district or political subdivision thereof, together with personal property taxes, assessments, fees and charges (other than those paid by Tenant pursuant to Article 26 below) and fees of tax consultants and attorneys retained to seek a reduction, to contest or to act in some other manner in connection with any of the foregoing Tax Costs, together with any tax, assessment or other amounts (including, without limitation, commercial rental taxes) imposed, levied or charged as a substitute for or a supplement to the foregoing.  Except as provided in Article 48.1 in the Lease Addendum, Tax Costs shall include increases caused by increases in tax rates as well as increases caused by additional or increased assessed values for any

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reason including transfers of title to the Building or the Project, to the extent not precluded elsewhere in this Lease.   See also, Paragraph 48 of the Lease Addendum.

4.4Operating Costs.

4.4.1Definition of Operating Costs.“Operating Costs” shall mean the sum of any and all costs, expenses and disbursements of any kind paid or incurred by Landlord in connection with the management, operation, security, maintenance, and repair of the Project, calculated in accordance with the audited financial statements of Landlord, including, but not be limited to, salaries, wages, benefits and related costs for employees; management fees, either as charged to Landlord by outside management companies or not exceeding the amount typically charged by outside management companies if Landlord or Landlord’s affiliate manages the Project; charges for utilities and services provided to all tenants in accordance with Article 13.1 herein, including but not limited to janitorial services, window cleaning, elevator services, HVAC services, security services (including any taxes thereon); the cost of insurance as specified in Article 12.6 herein; outside accounting fees; office supplies; building cleaning supplies and materials; garbage and waste collection; and a reasonable allowance for depreciation (or amortization) with respect to machinery and equipment and other capital expenditures and improvements; provided, however, that the only depreciation (or amortization and expenditures) includable in Operating Costs shall be a reasonable allowance for depreciation (or amortization) over the useful life of the improvements, as determined by Landlord’s accountants to conform with applicable tax laws.  See Paragraph 49 of the Lease Addendum.

4.4.2Definition of Required Alterations“Required Alterations” are any changes, alterations or improvements to the Project (excluding those attributable exclusively to Tenant’s specific use and occupancy of the Premises, which alterations shall be Tenant’s sole responsibility), including, but not limited to, the installation or modification of electrical, mechanical, water sprinkler, or other energy or life safety systems or components, required by any rule, regulation or law which became enacted and effective after the Commencement Date.  The capital costs relating to such Required Alterations, including all related financing costs, shall be amortized over the useful life of the Required Alterations, as determined by Landlord’s accountants to conform with applicable tax laws.

4.5Audit.If Tenant disputes the amount of any Additional Rent due under Article 4, Tenant shall have the right, after reasonable notice, to inspect Landlord’s accounting records at Landlord’s accounting office during its normal business hours and, if after such inspection Tenant still disputes the amount of Additional Rent owed, Tenant may retain a mutually-acceptable national or regionally-recognized independent certified public accounting firm to certify to the parties its determination of the proper amount of Operating Costs and Tax Costs payable by Tenant.  After such determination has been made, and if a dispute continues to exist between Tenant and Landlord, an independent accountant mutually-agreed upon by both Landlord and Tenant may be retained to determine the amount of any Additional Rent due or credited.  If the certification discloses that the Operating Costs and Tax Costs charged to Tenant exceed the audited operating costs by more than five percent (5%), the cost of such certification shall be borne by Landlord. Otherwise, the cost of the certification shall be borne by Tenant.

5.Security Deposit. [Intentionally Deleted]

6.Restrictions on Use; Compliance with Laws.

6.1Tenant shall use and occupy the Premises only for the specific uses, and those related thereto, specified in Article 1.1.9 above for no other uses whatsoever.  Tenant shall use and occupy the Premises in accordance with Article 36, Rules and Regulations.  In addition to the rules and regulations in Article 36, Tenant shall not: (a) do or permit anything to be done in or about the Premises which will in any way obstruct or materially interfere with the rights of other tenants or occupants of the Building or injure or annoy them; (b) use or allow the Premises to be used for any unlawful purpose; (c) cause or maintain or permit any nuisance in or about the Premises; (d) cause or permit any hazardous or toxic waste, substance or material, other than generally used office materials, to be brought to the Premises or used, handled, stored or disposed of in or about the Premises; (e) conduct business or other activity in or about the Premises that places an unreasonable or excessive burden upon the public and Common Areas or the utility systems of the Project; or (f) commit or suffer the commission of any waste in or about the Premises.

6.2Tenant shall not place a load upon any floor that exceeds 70 pounds per square foot, without Landlord’s prior written approval.  Tenant shall not install any equipment, apparatus or device in the Premises which causes vibrations or excessive noise.

6.3Tenant shall not use the Premises or permit anything to be done in or about the Premises which in any way conflicts with any law, statute, ordinance or governmental rule or regulation now in force or which may hereafter be enacted or promulgated.  With respect to the condition of the Premises, Tenant shall, at its sole cost and expense, promptly comply with all applicable laws, statutes, ordinances and governmental rules, regulations and requirements now in force or which may hereafter be in force and with the requirements of any board of fire underwriters or other similar body now or hereafter constituted relating to or affecting Tenant’s specific nature of use of the Premises and to all building codes requiring modifications to the Premises due to the improvements made by or for Tenant in the Premises.  Notwithstanding anything to the contrary in this Lease, except for grandfathered rights and variances, it shall be Landlord’s obligation, at Landlord’s cost and expense, to comply with all applicable laws relating to the Building and the Building’s systems in general, without regard to specific use, including modifications required to obtain the necessary building permits for the Work to be performed in accordance with the Construction Agreement attached hereto as Exhibit B.  Tenant shall not knowingly do or permit anything to be done in or about the Premises or bring or keep anything therein which will in any way increase the rate of any insurance upon the Building or any of its contents, or cause cancellation of said insurance or otherwise affect said insurance in any manner.  Tenant shall be responsible for any increase in cost of Landlord’s insurance caused by or resulting from Tenant’s breach of the obligations contained herein.

6.4Pursuant to Article 6.1(d) above, other than commonly used business office supplies, Tenant shall not permit nor use, generate, store, transport or dispense on the Premises any flammable, radioactive materials, hazardous wastes, chemicals, environmental poisons, pollutants, contaminants, or other substances demonstrated as hazardous or toxic pursuant to the Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended; the Hazardous Materials Transportation Act; the Resource Conservation and Recovery Act; the California Health and Safety Code, or regulations issued

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under any of said acts (collectively, “Applicable Environmental Laws”) without the prior written consent of Landlord.  Any such Landlord consent shall be conditioned upon (a) Tenant’s separate written agreement to handle, store, use and dispose of such materials in accordance with all applicable environmental laws, and (b) Tenant’s separate written agreement to indemnify and hold Landlord harmless from any and all liability including consequential damages directly or indirectly arising out of Tenant’s storage, use, or disposal of such materials, including without limitation the cost of any required or necessary repair, clean up or detoxification as a result thereof.  Tenant’s failure to provide a separate written agreement to handle, store, use and dispose and to indemnify Landlord shall not abrogate or eliminate Tenant’s obligations hereunder.

6.5As used herein, the term “Hazardous Material” means any hazardous or toxic substance, material or waste which is or becomes regulated by any local governmental authority, the state in which the Project is located or the United States government.  The term “Hazardous Material” includes, without limitation, any material or substance that is (i) defined as a “Hazardous Substance” under appropriate state law provisions, (ii) petroleum, (iii) asbestos, (iv) designated as a “Hazardous Substance” pursuant to Section 311 of the Federal Water Pollution Control Act (33 U.S.C. section 1321), (v) defined as a “Hazardous Waste” pursuant to Section 1004 of the Federal Resource Conservation and Recovery Act, 42 U.S.C. section 6901 et seq. (42 U.S.C. section 6903), (vi) defined as a “Hazardous Substance” pursuant to Section 101 of the Comprehensive Environmental Response, Compensation and Liability Act, 42 U.S.C. sections 9601 et seq. (42 U.S.C. section 9601), or (vii) defined as a “Regulated Substance” pursuant to Subchapter IX, Solid Waste Disposal Act (Regulation of Underground Storage Tanks), 42, U.S.C. sections 6991 et seq.

6.6Excluding commonly used business office supplies, as well as any preexisting asbestos and asbestos containing materials (“ACMs”) in the Building, Tenant shall, at Tenant’s sole expense and with counsel reasonably acceptable to Landlord, indemnify, defend and hold harmless Landlord and Landlord’s shareholders, directors, officers, employees, partners, affiliates, and agents (“Landlord Indemnities”) with respect to all losses arising out of or resulting from the release of any Hazardous Material in or about the Premises or the Project, by Tenant, Tenant’s Agents, contractors or invitees other than Landlord or Landlord’s Indemnitees or the violation of any Applicable Environmental Law, by Tenant or Tenant’s agents, contractors or invitees (other than Landlord and Landlord Indemnities) pursuant to Article 6.4(b) above.  This indemnification includes all losses, liabilities, obligations, penalties, fines, claims, actions (including remedial or enforcement actions of any kind and administrative or judicial proceedings, orders or judgments), damages (including consequential damages and punitive damages) and costs (including attorney, consultant and expert fees and expenses) resulting from the release of any Hazardous Substances or violation of any Applicable Environmental Law by Tenant or Tenant’s agents, contractors or invitees other than Landlord and Landlord’s Indemnitees.  This indemnification shall survive the expiration or sooner termination of the Lease. (See Lease Addendum Paragraph 50 and 51.)

7.Improvements and Alterations.

7.1Alterations, Additions or Improvements.Without the prior written consent of Landlord, and except for non-structural, cosmetic alterations costing less than Fifty Thousand Dollars ($50,000) (“Cosmetic Alterations”), Tenant shall not make nor cause alterations, additions, or improvements in, on or to any part of the Premises or the Project, except to install freestanding furniture and floor coverings, where such freestanding furniture does not place a load on the floor that exceeds 70 pounds per square foot.  Except as provided above, any alterations, additions or improvements to the Premises desired by Tenant shall be made in accordance with plans and specifications approved in advance in writing by Landlord and pursuant to any applicable governmental permits.  Landlord’s approval of Tenant’s plans and specifications shall not constitute Landlord’s representation or warranty as to the adequacy of the plans and specifications or their compliance with applicable laws.

7.2Contractors for Improvements. Except for any Cosmetic Alterations, any alterations, additions or improvements to the Premises desired by Tenant, other than any specified in the Approved Plans as defined in Exhibit B, if any, shall be made by Landlord or contractors selected by Landlord for Tenant’s account.  Landlord’s contractor shall have all major work items bid by three subcontractors or vendors.  Landlord’s contractor and Tenant shall mutually approve subcontractors for major work items (i.e., items that cost more than Thirty Thousand Dollars ($30,000).  Landlord’s contractor shall use its best efforts to hire such mutually approved qualified subcontractors with the lowest bids.

7.3Landlord’s Consent to Improvements.Landlord may impose as a condition to its consent to alterations, additions or improvements to the Premises desired by Tenant such requirements as Landlord may reasonably deem necessary including, without limitation, requirements relating to the manner in which the work is done and the times during which the work is to be accomplished so long as such requirements do not impose additional costs.  At Landlord’s request, but at Tenant’s sole cost and expense, at the expiration or sooner termination of this Lease, Tenant shall have Landlord’s contractor remove any and all improvements, additions or personal property that are not typical in comparable first class buildings in the Premises caused to be installed by Tenant other than the initial Tenant Improvements described in Article 7.5 below. At the time Landlord approves such improvements, Landlord shall specify which improvements it will require Tenant to remove at the end of the Lease Term.  Landlord’s contractor at Tenant’s sole cost and expense shall repair any damage done to the Premises in connection with such removal.

7.4Changes to Structure or Mechanical or Electrical Systems.    Notwithstanding any provision herein that permits Tenant to make its own alterations, additions or improvements to the Premises, Tenant shall not make any alterations, additions or improvements to the Premises which would negatively affect the Building’s structure or its mechanical or electrical systems, or which would materially interfere with or disrupt other tenants in the Building or any work then being carried out therein by Landlord or its contractors.

7.5Initial Tenant Improvements.Landlord shall construct or have Landlord’s contractor construct the improvements in the Premises (the “Tenant Improvements”), if any, pursuant to Exhibit B, if any.  Tenant may install certain movable personal property (e.g., file systems, furniture) in the Premises, which Tenant shall remove upon the expiration or earlier termination of the Lease.

7.6Standard for Improvements.Any alterations, additions or improvements to the Premises shall be manufactured and installed in a good, workmanlike, diligent, prompt and expeditious manner in compliance with all Building specifications, applicable laws and Applicable Environmental Laws.

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8.Repairs and Maintenance.

8.1The Premises at Tenant’s move-in will be in good operating condition, free of debris and structurally sound in accordance with industry standards in the Project area.  By taking possession of the Premises, Tenant shall be deemed to have conclusively agreed to accept the Premises as being in good order, condition and repair, subject to “punchlist” items and latent defects and any representations or warranties that may be set forth elsewhere in this Lease.  Except as required by Article 20 below and ordinary wear and tear and subject to Article 8.2 with regard to any Building Systems in or about the Premises, Tenant shall, at all times during the Lease Term hereof and at Tenant’s sole cost and expense, keep the Premises and every part thereof in good condition, order and repair except repairs resulting from the negligence, recklessness or willful wrongful act of Landlord or Landlord’s representatives, employees or other agents (collectively, “Landlord’s Agents”).  Landlord shall have no obligation to alter, remodel, improve, repair, decorate or paint the Premises or any part thereof, or maintain any nonstandard items installed in the Premises by or at the request of Tenant, except as specified in Articles 13 and 20 below or in Exhibit B, if any.  No representations relating to the condition of the Premises, the Building or the Project have been made by Landlord or Landlord’s Agents to Tenant, except as may be specifically set forth in this Lease.

8.2Subject to the provisions of Article 8.1 above and Article 20 below, Landlord shall maintain the Common Areas, the foundation and structural portions of the Building (which shall include but not limited to floor/ceiling slabs, roof, curtain wall, exterior glass and mullions, columns, beams, shafts (including elevator shafts) parking areas, plazas, pavement and curbs (collectively, “Building Structures”), and the plumbing, heating, ventilation and air conditioning (“HVAC”), fire, life, safety, mechanical and electrical systems (collectively, “Building Systems”) providing the services and utilities to be furnished by Landlord pursuant to Article 13.1 below, in good order and condition; provided, however if any maintenance and repairs are caused by the act, neglect, fault, or omission of any duty by Tenant or Tenant’s agents, servants, employees, or invitees (collectively, “Tenant’s Agents”), Tenant shall pay to Landlord the reasonable cost of such maintenance and repairs.  Landlord shall not be liable for any failure to make any such repairs or to perform any maintenance unless such failure persists for an unreasonable time after Tenant gives written notice to Landlord of the need for such repairs or maintenance.  Notwithstanding anything in this Lease to the contrary, in the event of an interruption in essential services to the Premises (defined for these purposes as the failure to provide HVAC service, electrical service, elevator service, water or restroom facilities) or Tenant’s access to Premises is materially impaired, and such interruption or impairment continues for a period of five (5) consecutive days or twenty (20) days in any one calendar year, Tenant shall be entitled to an abatement of Rent for the period that such services are not provided where such interruption or impairment materially interferes with the normal business conduct of Tenant in the Premises.  If any such interruption occurs during a period when Tenant is not otherwise required to pay Rent, Tenant’s free rent period shall be extended for the number of days that the services were not provided.  Tenant waives the right to make repairs at Landlord’s expense under any law, statute or ordinance now or hereafter in effect.

9.Liens.Tenant shall keep the Project free from any liens arising out of any work performed, materials furnished or obligations incurred by Tenant.  If within twenty (20) days following the imposition of any lien and written notice thereof to Tenant, Tenant does not cause the lien to be released of record by payment or posting of a proper bond, Landlord shall have, in addition to all other remedies provided herein and at law or in equity, the right to cause the lien to be released by such means as it deems proper including, but not limited to, payment of the claim giving rise to such lien.  All such sums paid by Landlord and all expenses incurred in connection therewith shall be considered Additional Rent and shall be payable to Landlord by Tenant within thirty (30) days after receipt of notice from Landlord, with interest at the Interest Rate (as defined in Article 27 below).  Landlord shall have the right at all times to post and keep posted on the Premises, any notices permitted or required by law, or which Landlord shall deem proper, for the protection of Landlord, the Project and by other parties having an interest therein from mechanic’s and materialmen’s liens.  Tenant shall give Landlord at least 15 business days prior written notice of commencement of any work on the Premises.

10.Assignment and Subletting.

10.1Tenant shall not have the right to assign the Lease, or sublease all or any portion of the Premises without Landlord’s consent, which shall not be unreasonably withheld, conditioned or delayed.  If Landlord consents to an assignment or sublease, such assignment or sublease shall be subject to all the terms and conditions of the Lease, and on Landlord-approved forms.  Any assignment, sublease or other transfer without Landlord’s prior written consent shall be void.

10.2In determining whether to consent to an assignment or a sublease, Landlord may consider the nature of the proposed use and business and the financial stature of the proposed transferee.  In addition, Landlord reserves the right to condition any such consent upon its reasonable determination that the proposed assignee’s or subtenant’s use of the Premises will not adversely materially impact on the Common Areas or utility systems of the Building.

10.3Tenant shall not enter into any proposed assignment, sublease or other transfer of any interest herein or in the Premises which would (a) detract from the first-class character or image of the Building, or (b) cause a breach by Landlord of any loan obligation or agreement, any covenants, conditions, restrictions and lease obligations of record, or any insurance policy.  (Upon Tenant’s request, Landlord shall provide Tenant with a list of any existing rights in favor of any other tenant in the Building.)

10.4Tenant shall give Landlord fifteen (15) days prior written notice of its intention to assign, sublease or otherwise transfer its Lease.  Tenant shall submit the following information on Landlord-approved forms with such notice and with a written request for Landlord’s consent to any assignment, sublease or transfer: (a) all transfer and related documents, (b) financial statements or other financial information, certified by a certified public accountant or officer of the Company, sufficient to enable Landlord to make an informed judgment as to the financial capabilities of the proposed transferee, and (c) such other information, related to the proposed transfer and the parties involved therein as Landlord reasonably requests in writing.  Landlord, at its option, may void any transaction that does not comply with provisions of this Article 10.

10.5If Landlord does not consent to the proposed sublease or assignment, or other transfer, within fifteen (15) days, Tenant shall not complete such proposed assignment or sublease.  On the other hand, if Landlord consents to such proposed sublease or assignment, or other transfer, Tenant shall be required to pay Landlord’s reasonable legal and administrative fees not to exceed $1,000 for any assignment or sublease.  In addition, if Landlord consents to the proposed

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assignment or sublease: (a) any subtenant shall agree that if Landlord gives such subtenant notice that Tenant is in default under this Lease, such subtenant shall thereafter make all sublease or other payments directly to Landlord, which sublease payments will be received by Landlord without any liability to honor the sublease (except to credit such payments against sums due under the Lease) and any subtenant shall agree to attorn to Landlord or its successors and assigns should the Lease be terminated for any reason, voluntarily, or otherwise, except that in no event shall Landlord or its successors or assigns be obligated to accept such attornment and (b) Landlord may require that subtenant not then be in default hereunder in any respect.

10.6The parties acknowledge that Landlord’s economic stake in the Project is significantly greater than Tenant’s economic stake in this Lease.  Accordingly, the parties have expressly bargained for the following allocation of any “Profits” (as defined in Article 59 in the Lease Addendum) to be derived by Tenant from any assignment or subletting or other transfer of this Lease.  Except in the case of a Permitted Transferee as defined in Article 10.9 below (in which case no Transfer Premium is due), in the event Tenant assigns or subleases more than fifty percent (50%) of the Premises, Tenant shall be required to pay Landlord fifty percent (50%) of any rent, key money, transfer consideration, or other premiums of any kind or nature on the sublease, assignment or transfer in excess of the Base Rent payable by Tenant under this Lease on a per rentable square foot basis net of Tenant’s costs incurred to facilitate the transfer (the “Transfer Premium”).  Such payments shall be paid, in the same manner and at the same time as Tenant receives such Transfer Premium, whether such Transfer Premium is in the form of an increased rental, a lump sum payment or any other form of consideration.  If such sublease, assignment or transfer pertains to a portion of the Premises only, any Transfer Premium shall be computed on the assumption that Tenant’s Rent and other sums due hereunder are allocable on a pro rata per square foot basis.  [See Lease Addendum Article 52]

10.7The provisions of this Article 10 shall apply regardless of whether such assignment, sublease or other transfer is made in compliance with the provisions of this Lease.  Any payments made to Landlord pursuant to this Article 10 shall not cure any default under this Lease arising from such assignment, sublease or transfer. Tenant shall not artificially structure any sublease, assignment or other transfer or take any other steps to circumvent or to reduce the amount payable to Landlord under this Article 10.  The amount payable to Landlord under this Article 10 shall be the amount that would have been payable to Landlord had the Tenant not artificially structured the sublease, assignment or transfer or otherwise tried to circumvent this Article 10.

10.8No assignment, sublease or other transfer shall release Tenant from any of its obligations hereunder.  Landlord’s consent to any one transfer shall apply only to the specific transaction thereby authorized and such consent shall not waive the duty of Tenant or any transferee to obtain Landlord’s consent to any other or subsequent transfer, or modify or limit Landlord’s rights hereunder in any way.  Landlord’s acceptance of Rent directly from any assignee, subtenant or other transferee shall not be construed as Landlord’s consent thereto nor Landlord’s agreement to accept the attornment of any subtenant in the event of any termination of this Lease.  In no event shall Landlord’s enforcement of any provision of this Lease against transferee be deemed a waiver of Landlord’s right to enforce any Lease provision against Tenant or other person.

10.9If Tenant is a corporation, an unincorporated association or a partnership (including, without limitation, a limited liability company (“LLC”) or a limited liability partnership (“LLP”)), any cumulative transfer, assignment or hypothecation of any stock or interest in such corporation, association or partnership greater than forty-nine percent (49%) thereof, or any cumulative transfer, assignment or hypothecation (other than in the ordinary course of business) of any asset of such corporation, association, partnership, LLC or LLP greater than forty-nine percent (49%) thereof (“Change in Control”), shall be deemed an assignment within the meaning and provisions of this Article 10.  The foregoing shall not apply to corporations, where forty-nine percent (49%) or more of the stock is traded through a regional, national or over-the-counter exchange.  Provided that the transferee’s use is permitted under the Lease and provided that Tenant notifies Landlord of its intention at least thirty (30) days prior to such assignment or sublease, then notwithstanding anything in this Lease to the contrary, Tenant shall have the right, without obtaining Landlord’s consent or paying any Transfer Premium, to do the following: (a) assign this Lease or sublet all or any part of the Premises to a parent, wholly-owned subsidiary or affiliate of Tenant; (b) transfer a majority or controlling interest in the Tenant to an entity with a financial strength sufficient to meet the obligations set forth in this Lease; (c) assign this Lease or sublet all or any part of the Premises to an entity into which Tenant is merged or by which it has been acquired; (d)  assign this Lease or sublet all or any part of the Premises to an entity or entities of the Tenant created by the division of Tenant into one or more separate corporations and/or partnerships (collectively, a “Permitted Transferee”).

10.10Notwithstanding any of the foregoing provisions, covenants and conditions to the contrary, in the event that this Lease is assigned to any person or entity pursuant to the provisions of the Bankruptcy Code, 11 U.S.C. 101 et seq. (the “Bankruptcy Code”), any and all moneys or other consideration payable or otherwise to be delivered in connection with such assignment shall be paid or delivered to Landlord, shall be and remain the exclusive property of the Landlord and shall not constitute property of Tenant or of the estate of Tenant within the meaning of the Bankruptcy Code. Any and all moneys or other consideration constituting Landlord’s property under the preceding sentence not paid or delivered to Landlord shall be held in trust by the bankruptcy trustee in possession or debtor in possession for the benefit of the Landlord and shall promptly be paid to or turned over to Landlord.  If Tenant proposes to assign this Lease pursuant to the provisions of the Bankruptcy Code to any person or entity who shall have made a bona fide offer to accept an assignment of this Lease on terms acceptable to Tenant, then notice of such proposed assignment setting forth (a) the name and address of such person, (b) all of the terms and conditions of such offer, (c) the adequate assurance provided by Tenant to assure such person’s future performance under the Lease including, without limitation, the assurance referred to in Section 365 of the Bankruptcy Code, or any such successor or substitute legislation or rule thereto, shall be given to Landlord by Tenant no later than twenty (20) days after receipt of such bona fide offer by Tenant.  Tenant shall make application to a court of competent jurisdiction for authority and approval to enter into such assignment and assumption.  Landlord shall thereupon have the prior right and option, to be exercised by notice to Tenant given at any time prior to the effective date of such proposed assignment, to accept an assignment of this Lease upon the same terms and conditions and for the same consideration, if any, as the bona fide offer made by such person, less any brokerage commissions, attorneys’ fees, tenant improvement costs or other charges which may be payable out of the consideration to be paid by such person for the assignment of this Lease.  Any person or entity to which this Lease is assigned pursuant to the provisions of the Bankruptcy Code shall be deemed without further act or deed to have assumed all of the obligations arising under this Lease on and after the date of such assignment.  Any such assignee shall upon demand execute and deliver to Landlord an instrument confirming such assumption.  Subject to this Article 10 and Article 20 below, the Lease

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provisions shall be binding upon and shall inure to the benefit of the parties hereto and their respective heirs, executors, administrators, successors and assigns.

11.Waiver; Indemnity.

11.1Tenant, as a material part of the consideration to Landlord, hereby assumes all risk of damage to personal property of Tenant, or injury to persons in or about the Premises, except to the extent caused by the negligence, recklessness or willful misconduct of Landlord or Landlord’s Agents.  Notwithstanding any contrary provision herein, and except to the extent arising from the negligence, recklessness or willful misconduct of the Landlord, or Landlord’s Agents, Landlord shall not be liable and Tenant hereby waives all claims against Landlord for any injury or damage to any person or property or any other loss (including, but not limited to loss of income), which may be sustained by the person, goods, wares, merchandise or property of Tenant, or Tenant’s Agents, or any other person in or about the Premises, the Building, or the Project by or from any cause whatsoever.  Without limiting the generality of the foregoing, except to the extent caused by negligence, recklessness or willful misconduct of the Landlord or Landlord’s Agents, Landlord shall not be liable for any damage caused by or resulting from: (a) water leakage of any character from the roof, walls, windows, basement, or any other portion of the Premises or the Project; (b) fire, steam, electricity, gas or oil, or by any interruption of utilities or services, or by any tenant, occupant, or other person; or (c) any other cause whatsoever, in, on or about the Premises or the Project.  Notwithstanding any contrary provision in this Lease, Landlord shall not in any event be liable for consequential damages hereunder.

11.2Subject to Article 12.7 below, except to the extent that claims arise from the negligence, recklessness or willful misconduct of Landlord, Tenant shall indemnify and hold Landlord (as used in this Article 11.2, “Landlord” shall refer to Landlord and Landlord’s Agents) harmless from and against any and all claims, demands, losses, damages, liabilities, costs and expenses (including, but not limited to, reasonable attorney’s fees) arising from Tenant’s use or occupancy of the Premises, from the conduct of Tenant’s business, from any act or omission, work or thing done, permitted or suffered by Tenant (or any officer, employee, agent, contractor, representative, licensee, guest, invitee or visitor thereof) in or about the Project, or from any default under this Lease by Tenant. If any action or proceeding is brought against Landlord by reason of any such matter, Tenant shall, upon notice from Landlord, defend Landlord in such action or proceeding at Tenant’s expense.  The provisions of this Article 11 shall survive the expiration or termination of this Lease for a period of ninety (90) days with respect to any claims or liability arising from events occurring prior to such expiration or termination.

11.3Notwithstanding anything in this Lease to the contrary, except to the extent that claims arise from the negligence, recklessness or willful misconduct of Tenant, Tenant (as used in this Article 11.3, “Tenant” shall refer to Tenant and Tenant’s Agents) shall not be liable for and Landlord shall indemnify Tenant and hold Tenant harmless from and against all suits, actions, damages, liability and expense in connection with loss of life, bodily or personal injury or property damage arising from or out of any occurrence, in, upon, at or from the Project.

12.Insurance.

12.1Throughout the Lease Term hereof, Tenant shall carry and maintain, at its own expense, the following types, amounts and forms of insurance:

12.1.1Commercial General Liability Insurance.A policy of commercial general liability insurance with a combined single limit of One Million Dollars ($1,000,000) per occurrence with Two Million Dollars ($2,000,000) aggregate coverage, in the name of Tenant (naming, as additional insureds, Landlord, its management company Held Properties, Inc., and, if requested by Landlord, any mortgagee, trust deed holder, or secured party with an interest in this Lease).  Tenant’s liability coverage shall include, without limitation, all coverage typically provided by the Broad Form Comprehensive General Liability Endorsement, including broad form property damage, and premises-operations coverage, products-completed operations coverage, owners and contractors protective coverage, and the broadest form of contractual liability coverage, the last of which shall cover the insuring provisions of this Lease and the performance by Tenant of the indemnity agreements in Article 11 above. Such policy shall provide coverage on an occurrence basis.  The amount of such insurance required hereunder shall be subject to adjustment from time to time as reasonably requested by Landlord, but Landlord shall not raise such coverage amounts to an extent where they materially exceed that customarily carried by prudent tenants in first class office buildings in the Project area.

12.1.2Tenant’s Property Insurance.  Tenant shall procure and maintain property insurance coverage for: (a) all office furniture, trade fixtures, office equipment, merchandise and all other items of Tenant’s property in, on or about the Premises and the Project, including property installed by, for or at the expense of Tenant and (b) Tenant Improvements.  Tenant’s property insurance shall be written on the broadest available “all risk” (special causes of loss) policy form and shall include an agreed amount endorsement for no less than one hundred percent (100%) of the full replacement cost (new, without deduction for depreciation) of the covered items and property.  The property insurance coverage shall include vandalism and malicious mischief coverage, sprinkler leakage coverage and earthquake sprinkler leakage coverage.

12.2Recovery for Tenant’s Negligence.  All of the policies that Tenant is required to obtain pursuant to the provisions of Article 12.1 above shall be issued by companies legally authorized to do business in California.  Although named as an additional insured and subject to the provisions of Article 12.7 of this Lease, Landlord shall be entitled to recover under said policies for any loss occasioned to it, its servants, agents and employees, by reason of the negligence, recklessness or willful misconduct of Tenant.

12.3Delivery of Certificate, Policy and Endorsements.  Prior to Tenant’s occupancy of the Premises, Tenant shall provide Landlord with evidence of compliance with Tenant’s insurance requirements under the Lease, including the endorsements specified in Article 12.1, and, as available, certified certificates for all insurance policies regarding the Premises, executed by an authorized agent of the insurer or insurers.  Each insurance policy shall provide that it may not be modified or canceled without ten (10) days prior written notice to Landlord (by any means described in Article 27 below) and to any other additional insureds.  At least ten (10) days prior to the expiration of any of such policies, Tenant shall furnish Landlord with a renewal or binder therefor.

12.4Blanket Insurance.  Tenant may carry insurance by a combination of primary, excess and umbrella policies, provided that the policies are absolutely concurrent in all respects regarding the coverage afforded by the policies.  The

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coverage of any excess or umbrella policy must be at least as broad as the coverage of the primary policy.  All insurance policies carried by Tenant for Tenant’s Premises and personal property shall be primary and non-contributory with respect to any other insurance available to and purchased by Landlord.

12.5Tenant’s Failure to Obtain Insurance.  If Tenant fails to carry any insurance policy required hereunder or to furnish certificates pursuant hereto, Landlord may, upon no less than ten (10) business days prior written notice, and without waiving Tenant’s default, obtain such insurance.  In such case, Tenant, with the next month’s Rent due hereunder, shall reimburse Landlord for the cost thereof including interest at the Interest Rate specified in Article 27.

12.6Landlord’s Insurance.  During the Lease Term, Landlord shall procure and maintain property and liability insurance for the Project in such reasonable amounts, and with such reasonable coverage, as would be carried by a prudent owner of a similar building in the Project area, or as any lienholder may require.  Tenant acknowledges that it shall not be a named insured or an additional insured in such policies, and that it has no right to receive any proceeds from any such insurance policies carried by Landlord.  Landlord may but shall not be required to carry insurance coverage for damages caused by flood or earthquake.

12.7Waiver of Subrogation.  Landlord and Tenant hereby waive all causes of action and rights of recovery against each other, against all subtenants or assignees of Tenant and against any other person or entity holding an interest in the Project (together, the “Affected Parties”) and against the agents, officers and employees of the Affected Parties for any loss occurring to the property of the Affected Parties resulting from any of the perils insured against under any and all insurance policies (including self-insurance) in effect at the time of any such loss or which, under this Lease, were required to be insured against, regardless of cause or origin of such loss, including the negligence, recklessness or willful misconduct of the Affected Parties or the agents, officers or employees of the Affected Parties.  Landlord and Tenant shall each use commercially reasonably efforts to cause their respective insurers to issue an endorsement denying such insurer any rights of subrogation against the other party.

12.8Increases in Premiums due to Tenant’s Use or Occupancy.  If, after Landlord provides notice to Tenant that the insurance carrier is proposing increased premiums to the Project due to Tenant’s use or occupancy of the Premises, and Tenant fails to cease the offending use within ten (10) business days after receipt of such notice, Tenant shall pay said increases in insurance premiums.

13.Services and Utilities.13.1Throughout the Lease Term, Landlord shall provide the following services and utilities twenty-four (24) hours per day on every day during the Lease Term, unless otherwise stated below.

13.1.1Subject to all governmental rules, regulations and guidelines applicable thereto, Landlord shall provide heating, ventilation and air conditioning (“HVAC”) to the Premises in a manner consistent with a first class office building from Monday through Friday, from 8:00 a.m. to 6:00 p.m. and on Saturday from 9:00 a.m. to 1:00 p.m., except for the celebratory days of the following holidays: New Year’s Day, Memorial Day, Independence Day, Labor Day, Thanksgiving and Christmas (collectively “Business Hours”).   After hours HVAC is currently available to Tenant at no direct charge for the first five (5) years of the Lease Term but shall be included in Operating Costs under Article 4.  Thereafter, Landlord may charge Tenant for after-hours HVAC cost, at Landlord’s actual cost, calculated to include wear and tear and amortization of equipment and electrical.

13.1.2Landlord shall at all times provide electricity to the Premises for lighting and power of not less than three (3) watts per rentable square foot demand load on a continuous annualized basis.  Landlord shall also provide electrical lighting in all Common Areas, parking facilities or storage areas and replace building standard lamps and ballasts as required.

13.1.3Landlord shall provide hot and cold water to the Building’s rest rooms (and, as applicable, to any sink, refrigerator or dishwasher in the Premises).

13.1.4Landlord shall provide passenger elevator service at all times; provided, however, after Business Hours, Landlord may decrease the availability of passenger elevator service so long as at least one car services the floor on which the Premises are located.

13.1.5Landlord shall provide non-exclusive freight elevator service to Tenant, subject to reasonable and non-discriminatory scheduling by Landlord. After Business Hours, Tenant may be charged at a rate equal to Landlord’s cost of providing such freight elevator service.

13.1.6Landlord shall provide 24-hour security for the Project in a manner consistent with the security systems, equipment and procedures maintained in comparable first class office buildings in the Project area. In addition to Landlord’s covenant to provide 24-hour security to the Project, Tenant shall have the right to provide to the Premises its own security system.

13.1.7Landlord shall provide normal janitorial services five (5) days per week, similar to that furnished in comparable first class office buildings in the Project area and in accordance with the building standard janitorial and cleaning service specifications.

13.1.8Landlord shall provide grounds care, including the sweeping of walkways and parking areas, removal of rainwater (as may be required) and maintenance of the landscaping in an attractive manner consistent with other office buildings in the Project area.

13.1.9Landlord shall operate and maintain the Project in accordance with the standards of maintenance and operation as are customary for other comparable first class buildings in the Project area.

13.1.10Landlord shall provide controlled access to the Premises 24 hours a day, every day.

13.2Without the prior written consent of Landlord, Tenant shall not use in the Premises any apparatus, device, machine or equipment that uses excess lighting, heating, ventilation or air conditioning, electricity or water; nor shall Tenant connect any apparatus or device to sources of electrical current or water except through existing electrical outlets or water pipes in the Premises.  If Tenant requires electricity in excess of the amount provided pursuant to Article 13.1.2 herein, or any other resource in excess of that customarily supplied for use of similar premises in comparable first class buildings in the Project

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area, Tenant shall first request the consent of Landlord.  As a condition to its consent, Landlord may cause a separate metering device to be installed in the Premises, at Tenant’s cost and expense.  Tenant shall promptly pay the cost of all excess resources consumed within the Premises, together with any additional administrative expenses incurred by Landlord in connection therewith.  Any sums payable by Tenant to Landlord under this Article 13 also shall be considered Additional Rent and may be included in any installment of Rent thereafter becoming due.  Landlord shall have the same remedies for a default in payment of such sums as for a default in the payment of Rent.

13.3Except as provided otherwise in this Lease, Landlord shall not be in default or be liable for any damages directly or indirectly resulting from any interruption of utilities or services caused by: (a) the installation or repair of any equipment in connection with the furnishing of utilities or services; (b) acts of God or the elements, labor disturbances of any character, any other accidents or any other conditions beyond the reasonable control of Landlord, or due to repairs or improvements to the Premises or the Project; or (c) the limitation, curtailment, rationing or restriction imposed by any governmental agency or service or utility supplier on use of water or electricity, gas or any other form of energy or any other service or utility whatsoever serving the Premises or the Project.  .

14.Estoppel CertificateWithin twenty (20) days after any written request from Landlord, Tenant shall execute and deliver to Landlord a certificate (the “Estoppel Certificate”) provided by Landlord’s current or prospective lender or prospective purchaser stating: (a) that this Lease is then in full force and effect and has not been modified (or if modified, setting forth all modifications or attaching all amendments to the Lease), (b) the then current Base Rent and the date to which said Rent has been paid, and (c) whether or not Landlord is then under default of this Lease and if so, the nature of such default and date notice of default was given Landlord. Landlord and Tenant intend that any existing or prospective lender or any prospective purchaser or assignee of Tenant may rely on such Estoppel Certificate.  Failure of Tenant to provide, within five (5) days after notice and opportunity to cure, Landlord with a Estoppel Certificate as provided above shall be a default under the Lease.

15.Subordination; Requirements of Lenders.

15.1This Lease shall be subject and subordinate at all times to (a) all ground leases or underlying leases which may now exist affecting all or any portion of the Project, and (b) the lien of any mortgage or deed of trust which may now exist affecting all or any portion of the Project.

15.2If any ground lease or underlying lease terminates for any reason or any mortgage or deed of trust is foreclosed or a deed in lieu of foreclosure is made for any reason, then Tenant shall, notwithstanding any subordination, attorn to and become the tenant of the successor-in-interest.   It shall be a condition to any future subordination of this Lease that the ground lessor, air space lessor, or mortgagee or beneficiary requesting such subordination shall agree that so long as Tenant is not in default under this Lease as defined Article 17, Tenant’s possession of the Premises shall not be disturbed as a result of such termination, foreclosure or deed in lieu of foreclosure. Tenant shall execute and deliver, within thirty (30) days of demand by Landlord, any additional, commercially reasonable documents evidencing the priority or subordination of this Lease and the attornment of Tenant with respect to any such ground leases or underlying leases or the lien of any such mortgage or deed of trust. [See Article 44 of the Lease Addendum.]

16.Access by Landlord.

16.1Landlord (and its agents, contractors and employees) reserves the right, without abatement of Rent, to enter the Premises at reasonable times and after reasonable advance notice (except in cases of emergency) to inspect it, to supply janitorial services and any other service to be provided by Landlord to Tenant hereunder, to show the Premises to any prospective purchaser, beneficiary, mortgagee, to post notices of non-responsibility, to make any alteration, improvement or repair to the Premises required by law or consented to by Tenant, or, during the last six (6) months of the Lease Term, to show it to prospective tenants.  For the purpose of making any alterations, improvement or repair to the Premises or any portion of the Project, Landlord may erect, use and maintain scaffolding, pipes, conduits and other necessary structures in and through the Project and the Premises where reasonably required by the character of the work to be performed and in conformance with good construction practices, provided that entrance to the Premises shall not be blocked thereby, and provided further that Landlord works expeditiously and uses its best efforts to minimize any interference with Tenant’s use of and access to the Premises.  At Tenant’s election, Tenant may accompany Landlord and all persons entering under the authority or right of Landlord, during any such entry.  Tenant hereby waives any claim for damages or abatement of Rent for any injury or inconvenience to or interference with Tenant’s business, any loss of occupancy or quiet enjoyment of the Premises, and any other loss occasioned thereby, except as otherwise set forth in the Lease or to the extent arising from the negligence, recklessness or willful misconduct of Landlord or Landlord’s employees, agents, representatives, contractors, or invitees.

16.2For each of the aforesaid purposes, Landlord shall at all times have and retain a key to all of the doors in, upon and about the Premises, excluding Tenant’s vaults and safes, and Landlord shall have the right to use any and all means which Landlord may deem reasonably necessary or proper to open said doors in any emergency, and any such entry to the Premises or portions thereof by Landlord shall not under any circumstances be construed or deemed to be a forcible or unlawful entry into, or a detainer of, the Premises, or an eviction, actual or constructive, of Tenant from the Premises or any portion thereof. If at any time during the Lease Term Tenant wishes to re-key its Premises, all such re-keying shall be done by Landlord with locks and hardware supplied by Landlord all at Tenant’s sole cost and expense.

17.Default by Tenant.

17.1The occurrence of any of the following shall constitute a breach of the Lease, and a default if not cured by Tenant after notice and a reasonable opportunity to cure such breach:

17.1.1Failure by Tenant to pay Rent or any amount due hereunder when such amount becomes payable in accordance with this Lease, or to duly, promptly and completely perform any obligation of Tenant under Articles 14 or 15 above, and continuation of such failure for a period of three (3) business days after receipt of the written statutory notice from Landlord to Tenant specifying the nature of such failure.

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17.1.2Failure by Tenant in the due, prompt and complete performance or observance of any other express or implied covenant, agreement or obligation of Tenant contained in this Lease, and the continuation of such failure for a period of thirty (30) days after written notice from Landlord to Tenant specifying the nature of such failure; provided, however, that if any such failure cannot reasonably be cured within such period, Tenant shall not be deemed to be in default hereunder if Tenant promptly commences such cure within such period and thereafter diligently pursues such cure to completion.

17.1.3Tenant’s abandoning the Premises, which shall mean for these purposes, Tenant’s absence for a period of more than two (2) weeks from the Premises while otherwise in default of this Lease as described in this Article 17.

17.1.4Tenant, its assignee, sublessee, other transferee, successor or any guarantor of this Lease gives to Landlord any financial statement or representation which proves to be materially false or materially misleading.

17.1.5The insolvency of Tenant; the making by Tenant of any assignment for the benefit of creditors; the filing by or against Tenant of a petition to have Tenant adjudged bankrupt or of a petition for reorganization or arrangement under any law relating to bankruptcy, insolvency or creditors’ rights in general (unless in the case of a petition filed against Tenant, the same is dismissed within sixty (60) days); the appointment of a trustee or receiver to take possession of all or a substantial part of Tenant’s assets or of Tenant’s interest under this Lease, where such seizure is not discharged within sixty (60) days.  The occurrence of any of the acts or events referred to in this Article with respect to any Guarantor of this Lease shall also constitute a default hereunder.

17.1.6The attachment, execution or other judicial seizure of a substantial portion of Tenant’s assets or of Tenant’s interest in this Lease, where such seizure is not discharged within sixty (60) days.

17.2The notices referred to in Article 17.1.1 and 17.1.2 above shall be in lieu of, and not in addition to, any notice required under Section 1161 et seq. of the California Code of Civil Procedure.

18.Remedies of Landlord.

18.1In the event of Tenant’s default under this Lease as provided in Article 17 above, Landlord, at Landlord’s option, and without limiting Landlord in the exercise of any other right or remedy Landlord may have on account of such default, and without any further demand or notice, may terminate this Lease, recover possession of the Premises and/or, to the extent permitted by California Civil Code Section 1951.3 or any other law, remove all persons and property from the Premises, which property shall be stored by Landlord at a warehouse or elsewhere at the risk, expense and for the account of Tenant.

18.2On termination of this Lease as provided in Article 18.1 above, Landlord shall be entitled to recover from Tenant the aggregate of:

18.2.1The worth at the time of the award of the unpaid Rent, as defined in Article 3.2, late charges and interest earned as of the date of the termination hereof;

18.2.2The worth at the time of the award of the amount by which the unpaid Rent, late charges, interest and other amounts due hereunder, which would have been earned after the date of termination hereof until the time of the award, exceeds the amount of such unpaid Rent, late charges and interest that Tenant proves could have been reasonably avoided by Landlord mitigating its damages;

18.2.3The worth at the time of the award of the amount by which the unpaid Rent for the balance of the term hereof after the time of the award exceeds the amount of such unpaid Rent, interest and late charges that Tenant proves could have been reasonably avoided by Landlord mitigating its damages; and

18.2.4Any other amount necessary to compensate Landlord for the detriment proximately caused by Tenant’s uncured default under this Lease, including but not limited to brokerage commissions and advertising expenses, expenses incurred for removing and storing any of Tenant’s property remaining on the Premises, expenses of remodeling the Premises for a new tenant and any special concessions made to obtain a new tenant.

18.3For the purposes of this Article 18, the “time of the award” shall mean the date upon which the judgment in any action brought by Landlord against Tenant by reason of such default is entered or such earlier date as the court may determine; the “worth at the time of award” (referred to in Articles 18.2.1 and 18.2.2) shall be computed by including interest at the Interest Rate and late charges set forth in Article 27 below; and the “worth at the time of award” (referred to in Article 18.2.3) shall be computed by applying the discount rate of the Federal Reserve Bank of San Francisco at the time of the award plus one percent (1%) per annum.

18.4Nothing in this Article 18 shall be deemed to alter Landlord’s right to indemnification under the indemnification clause or clauses contained in this Lease for claims or liabilities arising from events occurring prior to the termination of this Lease.

18.5Notwithstanding anything to the contrary set forth herein, Landlord’s reentry into the Premises to perform acts of maintenance or preservation of, or in connection with efforts to relet the Premises, or any portion thereof, or the appointment of a receiver upon Landlord’s initiative to protect Landlord’s interest under this Lease shall not terminate Tenant’s right to possession of the Premises or any portion thereof and, until Landlord does elect to terminate this Lease, this Lease shall continue in full force and Landlord may pursue all its remedies hereunder including, without limitation, the right to recover from Tenant as they become due hereunder all Rent and other charges required to be paid by Tenant under the terms of this Lease.

18.6If Tenant abandons the Premises, or if Landlord elects to reenter or take possession of the Premises pursuant to any legal proceeding or pursuant to any notice provided by law, and until Landlord elects to terminate this Lease, Landlord may, from time to time, without terminating this Lease, recover all Rent as it becomes due under Article 18.5 above, subject to interest and late charges as set forth in Article 27, and/or relet the Premises or any part thereof for the account of and on behalf of Tenant, on any terms, for any term (whether or not longer than the Lease Term) and at any rental rate as Landlord in its reasonable discretion may deem advisable, and Landlord may make any alterations and repairs to the Premises in connection therewith.  In the event that Landlord shall elect to so relet the Premises on behalf of Tenant, then base rent and additional rent received by Landlord from such reletting shall be applied:

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18.6.1First, to reimburse Landlord for the reasonable costs and expenses of such reletting (including, without limitation, legal and other costs and expenses of repossessing the Premises, removing persons and property therefrom, obtaining new tenants, brokerage fees, costs of preparing the Premises for occupancy by such new tenants, and, if Landlord maintains and operates the Premises, the costs thereof).

18.6.2Second, to the payment of any indebtedness of Tenant to Landlord other than Base Rent, adjustments to Base Rent, Additional Rent and other sums due and unpaid hereunder.

18.6.3Third, to the payment of Rent and other sums due and unpaid hereunder; the residue, if any, shall be held by Landlord and applied in payment of other or future obligations of Tenant to Landlord as they may become due and payable.

18.7Should the rent received from such reletting, when applied in the manner and order indicated above, be less than the total amount owing from Tenant pursuant to this Lease, then Tenant shall pay such deficiency to Landlord, and if Tenant does not pay such deficiency within five (5) days of its receipt of written notice, Landlord may bring an action against Tenant for recovery of such deficiency or pursue its other remedies hereunder or under California Civil Code Section 1951.8, California Code of Civil Procedure Section 1161 et seq., or any similar, successor or related provision of law.

18.8All rights, powers and remedies of Landlord under the Lease and any other agreement between Landlord and Tenant shall be cumulative and not alternative and shall be in addition to all rights, powers and remedies given to Landlord at law or in equity.  The exercise of any one or more of such rights or remedies shall not impair Landlord’s right to exercise any other right or remedy, including, without limitation, any and all rights and remedies of Landlord under California Civil Code Section 1951.8, California Code of Civil Procedure Section 1161 et seq., or any similar, successor or related provision of law.

18.9[Intentionally Deleted]

18.10If Tenant abandons the Premises and leaves behind any items of personal property, then Landlord shall store such property at Tenant’s cost and expense at a warehouse or any other location at the risk of Tenant, and Tenant’s property shall be released only upon Tenant’s payment of any and all moving and storage charges, as well as any expense or damages incurred as a result of the removal, moving and storage of such property, together with all sums due and owing under this Lease. If Tenant does not reclaim such property within the period permitted by law, Landlord may sell such property in accordance with law and apply the proceeds of such sale to any sums due and owing hereunder, or retain said property, granting Tenant credit against sums due and owing hereunder for the reasonable value of such property.

18.11To the extent permitted by law, Tenant and Landlord each hereby waive all provisions of, and protection under, any decisions, statutes, rules, regulations and other laws of the State of California to the extent same are inconsistent and in conflict with specific terms and provisions of this Article 18.

19.Default by Landlord; Limitation of Liability.

19.1Landlord shall not be deemed to be in default hereunder unless Landlord does not perform its material obligations under the Lease after written notice of Landlord’s breach by Tenant to Landlord and to such other parties whose names and addresses are furnished to Tenant.  The notice shall specify that Landlord has failed to perform such obligations; provided, however, that if the nature of such obligations is such that more than thirty (30) days are reasonably required for their cure, Landlord shall not be deemed to be in default hereunder if Landlord or any such other party(ies) commences such cure within such thirty (30) day period and thereafter diligently pursues such cure to completion.

19.2If Landlord is in default hereunder and, as a consequence thereof, Tenant recovers a judgment against Landlord, such judgment may be satisfied only out of the right, title and interest of Landlord in the Project and out of the rent or other revenue receivable by Landlord from the Project, or out of the proceeds receivable by Landlord from the sale or other disposition of all or any portion of Landlord’s right, title and interest in the Project. Neither Landlord nor any of the partners of Landlord shall be personally liable for any deficiency or otherwise.

20.Damage and Destruction.

20.1If the Project (whether or not including the Premises) is damaged by an insured casualty (or a casualty for which Landlord is required to insure under the terms of this Lease) occurring more than six (6) months prior to the expiration of this Lease and any extensions thereof, Landlord shall forthwith repair same, or cause same to be repaired, to the extent that insurance proceeds are made available to Landlord therefor and provided that such repairs can, in Landlord’s reasonable opinion, be made within one hundred eighty (180) days from the date of such damage  under the laws and regulations of the federal, state and local governmental authorities having jurisdiction thereof.  Landlord agrees to repair any casualty damage as long as the uninsured portion of such casualty damage does not exceed $15.00 per rentable square foot.

20.2If (a) the Premises or the Project is damaged by an uninsured casualty which costs more than $15.00 per rentable square foot to repair, (b) the casualty repair requires more than one hundred eighty (180) days to complete without payment of overtime or other premium or (c) if the Premises, or the Project is damaged by a casualty as described in Article 20.1 above within the last six (6) months of this Lease and any extensions thereof, then Landlord shall have the option within thirty (30) days from the date of such damage either to (1) notify the Tenant of its election to continue the Lease, in which event Landlord shall thereafter repair such damage; or (2) notify the Tenant of its election to immediately terminate this Lease, in which event this Lease shall be so terminated.  Landlord shall refund to Tenant any Rent previously paid for any period of time subsequent to the earlier of such termination or untenantability of the Premises.  Notwithstanding any contrary provision herein, Landlord shall not be required to repair any casualty damage to the property of Tenant or to repair or replace any paneling, decorations, railings, floor coverings, alterations, additions, fixtures or improvements installed on the Premises by or at the expense of Tenant.  To the extent permitted by law, Tenant hereby waives the provisions of Section 1932, subdivision 2, and Section 1933, subdivision 4, of the Civil Code of California, and any similar law, statute or ordinance now or hereafter in effect.

20.3Until the Premises are restored, Rent shall be abated in the proportion that the area of the Premises rendered unusable by Tenant bears to the total area of the Premises.  Except for abatement of Rent, Tenant shall have no claim against the Landlord for any damage suffered by reason of (a) any damage to the Premises, (b) such repairs, or (c) any inconvenience,

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interruption, annoyance, loss of business, or continued expense of operation caused by such damage or repair, except to the extent resulting from the negligence, recklessness or willful misconduct of Landlord, its employees agents, representatives, contractors or invitees.

20.4Should the Premises be damaged or destroyed by fire or other casualty insured under a standard fire and casualty insurance policy (or which could be insured under a standard fire and casualty insurance policy), Landlord shall within forty-five (45) days of the date of the casualty, notify Tenant in writing of Landlord’s good faith estimate of the time necessary to repair and rebuild the Premises.  If such estimate sets forth a period of one hundred eighty (180) days or less, Landlord shall, except as otherwise provided herein this Article, repair and/or rebuild the same with reasonable diligence.  Landlord’s obligation hereunder shall be limited to the Building and Tenant Improvements originally provided by Landlord at the Commencement Date, and any alterations provided by Landlord that Landlord has not requested Tenant to remove upon expiration of the Lease Term.

21.Eminent Domain.

21.1If the entire Premises, or enough thereof so as to render the balance thereof not reasonably usable for the conduct of Tenant’s business, is taken or appropriated by a governmental agency under the power of eminent domain or conveyed in lieu thereof, either party hereto may terminate this Lease by serving written notice upon the other party hereto within thirty (30) days thereafter.  If any substantial part of the Project excluding the Premises is taken or appropriated by a governmental agency under the power of eminent domain or conveyed in lieu thereof, Landlord may so terminate this Lease.  In either event, Landlord shall receive (and Tenant shall assign to Landlord upon demand by Landlord) any income, Rent, award or any interest therein which may be paid in connection therewith, and Tenant shall have no claim for any part of any sum so paid, whether or not attributable to the value of the unexpired Lease Term; provided, however, that nothing herein shall prevent Tenant from pursuing a separate award in connection with the taking of Tenant’s removable tangible personal property placed in the Premises solely at Tenant’s expense, for Tenant’s relocation costs and for loss of goodwill.

21.2If a part of the Premises is so taken, appropriated or conveyed by a governmental agency, and neither party hereto elects to terminate this Lease, then Base Rent and Additional Rent payable hereunder shall be abated in the proportion that the portion of the Premises so taken, appropriated or conveyed bears to the area of the entire Premises.

21.3Notwithstanding anything to the contrary contained in this Article 21, if the temporary use or occupancy of any part of the Premises (for a period not to exceed 60 days) is taken or appropriated by a governmental agency under the power of eminent domain or conveyed in lieu thereof during the Lease Term, this Lease shall be and remain unaffected by such taking, appropriation or conveyance and Tenant shall continue to pay in full all Rent payable by Tenant.  In the event of any such temporary taking, appropriation or conveyance, Tenant shall be entitled to receive that portion of any award that represents compensation for loss of this use or occupancy of the Premises during the Lease Term, and Landlord shall be entitled to receive the balance of such award.  To the extent that it is inconsistent with the above, each party hereto hereby waives the provisions of Section 1265.130 of the California Code of Civil Procedure allowing either party to petition a court to terminate this Lease in the event of a partial taking of the Premises.

22.Sale by Landlord.If Landlord sells or transfers all or any portion of the Project including the Premises, Landlord shall, upon consummation of the sale or transfer, be released from any liability relating to its obligations or covenants thereafter to be performed or observed under this Lease, and Tenant agrees to look solely to Landlord’s successor-in-interest with respect to such liability.  If Landlord transfers or credits any security deposit or prepaid Rent to Landlord’s successor-in-interest, then upon such transfer Landlord shall be discharged from any further liability therefor.

23.Surrender of Premises.Upon the expiration or sooner termination of the Lease, Tenant shall surrender to Landlord the Premises broom clean and free of debris, with all repairs, changes, alterations, additions and improvements thereto, in good order, condition and repair, ordinary wear and tear and damage from insured casualty excepted.  At Tenant’s sole cost and expense, Tenant shall upon expiration or sooner termination of the Lease: (a) remove its personal property from the Premises; (b) remove any improvements to the Premises caused to be installed by Tenant that Landlord may require Tenant to remove pursuant to Article 7.3; and (c) repair any damage caused by the removal of any such property or improvements.  If Tenant leaves any personal property at the Premises, Landlord may remove such personal property and dispose of it, at Tenant’s expense.

24.Quiet Enjoyment.So long as Tenant is not in default hereunder, Tenant shall have the right to the quiet peaceful enjoyment and possession of the Premises and the use of the Common Areas during the Lease Term, subject to the terms and conditions of this Lease.

25.Notices.Any notice, demand or other communication to be given under the provisions of this Lease shall be in writing to the appropriate address set forth in Article 1.1.10 (or such address furnished by either party hereto to the other party hereto in writing) and shall be (a) personally served, (b) mailed by United States registered or certified mail, return receipt requested, postage prepaid, (c) sent by a nationally recognized courier service (e.g. Federal Express) for next day delivery, to be confirmed in writing by such courier or (d) sent by electronic facsimile with appropriate provisions for confirmation of receipt.  Service by mail shall be deemed complete on the day of actual delivery as shown by the addressee’s registered or certified mail receipt or at the expiration of the third business day after the date of mailing, whichever first occurs.  Service by personal service or courier shall be deemed complete on receipt.  Service by electronic facsimile shall be deemed complete on confirmation of receipt if received prior to the close of business, and on the next business day if received after the close of business.

26.Personal Property Taxes.Tenant shall pay before delinquency all taxes, assessments, license fees and other charges (collectively, “Tenant’s Taxes”) that are levied and assessed against Tenant’s trade fixtures and other personal property installed or located in or on the Premises that become payable during the Lease Term.  On demand by Landlord, Tenant shall furnish Landlord with satisfactory evidence of such payments.  If any taxes on Tenant’s personal property are levied against Landlord or Landlord’s property, or if the assessed value of the Building is increased by the inclusion of a value placed on Tenant’s personal property or above-standard leasehold improvements, Tenant, on demand, shall immediately reimburse Landlord for any such taxes.  Landlord shall have the right to pay these taxes regardless of the validity of the levy.

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Notwithstanding the foregoing, Landlord agrees to: (a) notify Tenant in writing prior to paying any taxes under this Article 26 on Tenant’s behalf (“Landlord’s Tax Notice”), and (b) not pay any such taxes on Tenant’s behalf if Tenant notifies Landlord in writing within five (5) business days after it receives Landlord’s Tax Notice that Tenant, in good faith, disputes that the assessed taxes are properly due and owing by Tenant, provided that Tenant diligently pursues such dispute with the appropriate taxing authority in good faith within thirty (30) days from notice.

27.Interest and Late Charges.Any Rent, Additional Rent or other amount not paid by Tenant to Landlord when due hereunder shall bear interest from the due date until paid, unless otherwise specifically provided herein, at a rate (the “Interest Rate”) equal to the lesser of (a) the rate per annum announced from time to time by Bank of America, N.A. as its prime rate (or, if such bank fails to announce such rate, then the prime rate announced by the Chase Manhattan Bank, USA, N.A.) plus two (2) percentage points, or (b) the maximum rate permitted by law.  The payment of such interest shall not excuse or cure any such default by Tenant under this Lease.  In addition to such interest, if any Rent, Additional Rent or other amount is not paid within ten (10) days of when due, a late charge equal to five percent (5%) of such amount shall be assessed against Tenant, which late charge Tenant hereby agrees is a reasonable estimate of the damages Landlord would suffer as a result of Tenant’s late payment.  The parties agree that it would be impracticable and extremely difficult to fix Landlord’s actual damages in such event.  Such interest and late charges are separate and cumulative and are in addition to and shall not diminish or substitute for any or all of Landlord’s rights or remedies under any other provision of this Lease.

28.Collection Agency and Attorneys’ Fees.Tenant shall pay the costs incurred by Landlord if Landlord uses a collection agency or attorneys to collect any moneys unpaid by Tenant or to enforce the terms of this Lease. In any action to enforce or interpret this Lease, including any suit by Landlord for the recovery of Rent or possession of the Premises, the non-prevailing party shall pay to the prevailing party its actual attorneys’ fees.  The prevailing party will be determined by the court, arbitrator or arbitration panel before whom the action was brought based upon an assessment of which party’s major arguments or positions could fairly be said to have prevailed. Any attorneys’ fees and other costs and expenses incurred by the prevailing party in enforcing a judgment under this Lease shall be recoverable separately from and in addition to any other amount included in such judgment in favor or the prevailing party.

29.Light and Air.Tenant covenants and agrees that no diminution of light, air or view by any structure that may hereafter be erected shall entitle Tenant to any reduction of Rent under this Lease, result in any liability of Landlord to Tenant, or in any other way affect this Lease or Tenant’s obligations hereunder.

30.Signs and Directory.

30.1Without the prior written consent of Landlord, Tenant shall not place, construct or maintain any sign, advertisement, awning, banner or other decoration on or visible from, or otherwise use, the exterior of the Premises or any other portion of the Project.  All door signs on the exterior of the Premises must be installed by Landlord, at Tenant’s sole cost and expense or as part of any tenant improvement allowance, that the Landlord provides for installation of improvements to the Premises, and must conform to standards of the Project as to size, style, placement, color and number of the names, and other matters as reasonably determined by Landlord.  In the event that Tenant violates the foregoing, Landlord may remove the sign without any liability, and may charge Tenant the expense incurred, including but not limited to the cost incurred for the repair of the wall, door surface or other area on which the sign was mounted.

30.2Landlord shall place, construct and maintain a directory in the Building lobby and in such other locations, if any, as Landlord, in its sole discretion, may determine, which directory(ies) shall be for the display of the business names of Building tenants and their respective suite numbers.  Landlord shall have the sole right to determine and change from time to time the type of such directory(ies) and all common Project signage, including, but not limited to, size of letters, style, color content and placement.  Tenant shall have the right at Landlord’s cost to three (3) lines per directory per 1,000 rentable square feet of the Premises, but listings on such directory(ies) shall be limited to professional personnel of Tenant located principally at the Premises.  Tenant shall notify Landlord in writing of the business names that it desires to include on any such directory and shall, upon demand by Landlord, pay the cost associated with any subsequent changes to such names on the directory.

31.Parking.Subject to applicable rules and regulations any other charges, fees and taxes to be collected by Landlord, or other parking operator, Tenant shall have the right, but not the obligation, throughout the Lease Term to lease the number of parking spaces in the parking facility that serves the Building at such parking rate(s) and upon such other terms as may be specified in Article 1.1.11.  Notwithstanding anything to the contrary contained herein, Tenant shall be obligated to lease at least fifty percent (50%) of the parking spaces designated in Article 1.1.11 for the entire Lease Term.    Tenant may lease additional parking spaces on an “as available” monthly basis.  If Tenant desires to relinquish any of the spaces that Tenant is leasing, Tenant shall give not less than thirty (30) days notice thereof to Landlord.  Tenant may not sell, assign or transfer its parking rights hereunder, except pursuant to a permitted sublease or assignment of this Lease.  Except as may otherwise be specifically provided elsewhere in this Lease, Tenant shall not be entitled to any designated, reserved, assigned or valet parking. Landlord reserves the right to establish and alter, from time to time, on a non-discriminatory basis, all parking rates, rules and regulations, provided said rates shall be comparable to rates charged by other similar buildings in the Project area.  Tenant may purchase validation stickers at the prevailing rate then charged by the Project. See also Article 46 of the Lease Addendum.

32.Brokerage Fees.Landlord shall have no obligation to pay commissions or fees to any real estate broker, finder or intermediary other than Tenant’s Broker, if any, listed in Article 1.1.13 and Held Properties, Inc., who represents Landlord.  Landlord and Tenant each warrant that with respect to this Lease neither has dealt with any other real estate broker, finder or intermediary.  To the extent that Tenant breaches the foregoing, any commissions or fees payable with respect to this Lease shall be paid exclusively by Tenant, and Landlord shall have no obligation of any kind with respect to such commissions or fees.  Landlord agrees to pay a commission to Tenant’s Broker pursuant to a separate agreement.

33.Relocation Right.[Intentionally Deleted]

34.Authority.If Tenant is a corporation, trust or partnership, each individual executing this Lease on behalf of Tenant represents and warrants that he or she is duly authorized to so execute and deliver this Lease, and within ten (10) days

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after its execution shall deliver to Landlord satisfactory evidence of such authority.  If Tenant or Guarantor is a corporation, it shall, upon demand, also deliver satisfactory evidence of (a) good standing in California, and in Tenant’s or Guarantor’s state of incorporation, (b) qualification to do business in California, and (c) a corporate resolution duly certified by the secretary of Tenant or Guarantor authorizing execution and delivery of this Lease or Guarantee, as the case may be, by the parties who have signed it on behalf of Tenant or Guarantor.

35.Miscellaneous.

35.1If either Landlord or Tenant waives the performance of any term, covenant or condition contained in this Lease, such waiver shall not be deemed to waive any other breach of the same or of any other term, covenant or condition contained herein.  Furthermore, the acceptance of Rent by Landlord shall not constitute a waiver of any preceding breach by Tenant of any term, covenant or condition of this Lease, other than the failure of Tenant to pay the particular Rent so accepted, regardless of Landlord’s knowledge of such breach at the time of Landlord’s acceptance of such Rent.  Failure by Landlord to enforce any of the terms, covenants or conditions of this Lease for any length of time shall not be deemed to waive or to affect the right of Landlord to insist thereafter upon strict performance by Tenant.  Landlord’s or Tenant’s waiver of any term, covenant or condition of this Lease may only be made by a written document signed by the waiving party.

35.2Any voluntary or other early surrender of this Lease by Tenant, mutual termination hereof or prior termination hereof by Landlord shall not work a merger, and shall, at the option of Landlord, terminate all or any existing subleases or sub-tenancies.  If Landlord elects to assume any sublease or enter into a lease with any subtenant, such assumption shall not relieve Tenant of any remaining liability under this Lease.

35.3This Lease shall not be recorded; and no memorandum of lease shall be recorded without Landlord’s prior written consent.

35.4Rent, Additional Rent and all other sums payable under this Lease must be paid in lawful money of the United States of America.

35.5This Lease may be executed in counterparts with the same effect as if both parties hereto had executed the same document.  Both counterparts shall be construed together and shall constitute a single lease.

35.6Nothing contained in this Lease shall be construed to create the relationship of principal and agent, partnership, joint venture or any other relationship between the parties hereto, other than the relationship of Landlord and Tenant.

35.7Any provision of this Lease that proves to be invalid, void or illegal shall in no way affect, impair or invalidate any other provision hereof, and such other provisions shall remain in full force and effect.

35.8The term “Premises” shall be deemed to include (unless, based on the context, such meaning would clearly be unintended) the space hereby demised and all improvements on or at any time hereafter constructed or built in such space.

35.9The term “Tenant” or any pronoun used in place thereof shall indicate and include the masculine or feminine, the singular or plural number, individual, firms or corporations, and any Tenant’s successor in interest.

35.10The section headings herein are for convenience of reference only and shall in no way define, increase, limit or describe the scope or intent of any provision of this Lease.

35.11If this Lease is entered into by co-tenants, the obligations of such co-tenants hereunder shall be joint and several.

35.12Time is of the essence of this Lease and all of its provisions.

35.13The laws of California shall in all respects govern this Lease.  The parties acknowledge that the laws of California may change by virtue of legislative enactment or judicial decision.  The parties further acknowledge that they have entered into this Lease based on the laws of California at the time of the execution of this Lease, and each hereby expressly waives any future rights, benefits, or advantages derived from or as a result of any future changes in the law of California to the extent not inconsistent with the terms of the Lease.  In any action or proceeding arising therefrom, Tenant hereby consents to (a) the jurisdiction of any competent court within the state of California, (b) service of process by any means authorized by the laws of the state of California, and (c) trial without a jury except for actions primarily based upon personal injury.

35.14This Lease contains the entire agreement of the parties hereto with respect to the subject matter hereof and supersedes any previous negotiations, and may not be modified, except by a written document executed by the parties hereto.  There have been no representations or understandings made between the parties other than those set forth in this Lease.  Without limiting the generality of the foregoing, Tenant specifically acknowledges and agrees that neither Landlord nor any broker, agent or representative thereof has made any warranty or representation with respect to the tenant mix of the Building, the identity of prospective tenants or other tenants of the Building, profitability or suitability of the Premises for Tenant’s use, the state of repair of the Project and the Premises, or the amount and extent of provided services, except as otherwise specifically set forth herein.

35.15If any guarantee of this Lease is required by Landlord, such guarantee shall be in the form and content attached hereto or, if none, as supplied and/or approved by Landlord.

35.16The words “person” and “persons” as used herein shall include individuals, firms, partnerships, associations and corporations.

35.17The language in all parts of this Lease shall be construed simply according to its fair meaning, and not strictly for or against Landlord or Tenant.  Any reference to any Article herein shall be deemed to include all subsections thereof unless otherwise specified or reasonably required from the context.  Any reference to “days” or “months” herein shall refer to calendar days or months, respectively, unless specifically provided to the contrary.  Unless clearly inconsistent with the context, any reference herein to the “term hereof” or “the Lease Term” shall refer to the term of this Lease as the same may be extended pursuant to any extension option(s) contained herein.  The terms “herein”, “hereunder” and “hereof” as used in this Lease shall

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mean “in this Lease” and “under this Lease” or “of this Lease” respectively, except as otherwise specifically set forth in this Lease.

35.18All exhibits and the addendum referred to in this Lease are incorporated herein as a part hereof.

35.19Tenant hereby acknowledges and agrees that the exterior walls of the Building and the area between the demising walls of premises and the finished ceilings and floors of the Premises and the slab of the floor above or below have not been demised hereby and that the use thereof, together with the right to install, maintain, use, repair and replace pipes, ducts, conduits and wires leading through, under, above or alongside the Premises, is hereby reserved unto Landlord.

35.20The submittal of this Lease by Landlord or its agent or representative for examination or execution by Tenant does not constitute an option or offer to lease the Premises upon the terms and conditions contained herein or a reservation of the Premises in favor of Tenant.  This Lease shall become effective only upon the execution hereof by Landlord and Tenant and delivery of a fully executed counterpart hereof to Tenant.

35.21Tenant warrants and represents that neither its execution of this Lease nor its performance hereunder will violate any agreement, instrument, contract, law, rule or regulation by which Tenant is bound.  Tenant shall indemnify Landlord against any loss, cost, damage or liability including, without limitation, reasonable attorneys’ fees and related costs arising out of Tenant’s breach of this warranty and representation.

36.Rules and Regulations.  Tenant shall observe and comply with the rules and regulations set forth in this Article 36 and any and all reasonable modifications thereof and additions thereto established in writing by Landlord written notice of which has been given to Tenant.  Landlord shall not be responsible for the non-observance of, or noncompliance with, any of said rules and regulations by any other tenant or occupant of the Building, but Landlord shall use its reasonable efforts to enforce the rules and regulations in a non-discriminatory and consistent manner.  In the event of any conflict between said rules and regulations and other provisions hereof, the latter shall control.

36.1Tenant shall not obstruct, encumber or use any sidewalks, entrance, passages, courts, elevators, vestibules, stairways, corridors or halls or Common Area for any purpose other than ingress and egress to and from the Premises or the Building.

36.2Tenant shall neither attach any awning or other projection to the outside walls or windows of the Building, nor attach or hang any curtains, blinds, shades, drapes or screen to, in or on any window or door of the Premises without the prior written consent of Landlord.  Such awnings, projections, curtains, blinds, shades, drapes, screens and other fixtures must be of a quality, type, design, color, material, installation and general appearance approved by Landlord.  All electrical fixtures hung in offices or spaces along the window perimeter of the Premises must be of a quality, type, design, bulb color, size and general appearance approved by Landlord and must be installed by Landlord at Tenant’s cost.

36.3Tenant shall not cover or obstruct the sashes, sash doors, skylights, windows, and doors that admit light or air into the interior Common Areas, nor shall any articles be placed on the windowsills of the Project.

36.4No articles or signs shall be placed in front of or affixed to any part of the exterior of the Building, nor placed in public portions thereof without the prior written consent of Landlord.

36.5The water and janitorial closets and other plumbing fixtures shall not be used for any purposes other than those for which they were constructed, and no sweepings, rubbish, rags or other substances shall be thrown or stored therein.  All damages resulting from any misuse of the fixtures shall be borne by Tenant to the extent caused by Tenant or Tenant’s agents, servants, employees, contractors, visitors or licensees.

36.6Except for Cosmetic Alterations, Tenant shall not mark, paint, drill into or in any way deface any part of the Premises or the Project, or string any wires except with the prior written consent of Landlord and as Landlord may direct. Notwithstanding the foregoing, Landlord hereby consents to the hanging of normal office decorations.

3.67No animal (except for seeing-eye dogs or other ADA-approved animals), bird of any kind, or bicycles shall be brought into or kept in or about the Premises or the Building.

36.8Prior to leaving the Premises for the day, Tenant shall use its best efforts to conserve energy and electricity, including but not limited to drawing or lowering window coverings and extinguishing all lights.

36.9Tenant shall not make, or permit to be made, any unseemly or disturbing noises or smells, or disturb or interfere with occupants of or visitors to the Building or neighboring buildings.  Tenant shall not throw anything out of the doors, windows or skylights or down the passageways.  Tenant shall at all times keep the doors closed from Tenant’s suite into the Common Areas of the Project except upon prior written approval of Landlord.

36.10Tenant shall not permit any principal, agent, servant, employee, contractor, visitor or licensee to smoke any tobacco products or any non-tobacco products.  No smoking of any substance will be allowed in the Building at any time.  Landlord reserves the right to exclude or expel from the Building any person who, in Landlord’s judgment, is smoking any tobacco or non-tobacco products.  If, in Landlord’s judgment, Tenant, or Tenant’s principals, agents, servants, employees, contractors, visitors or licensee continue to smoke after adequate warning continues to smoke any tobacco or non-tobacco product, then Landlord may provide Tenant with a notice of default and give Tenant 30 days to cure or quit the premises.

36.11Neither Tenant nor any of Tenant’s agents, servants, employees, contractors, visitors or licensees shall at any time bring or keep upon the Premises any inflammable, combustible or explosive fluid, chemical or substance except in such small quantities and in original manufacturer’s containers as may reasonably be required for the proper operation and maintenance of Tenant’s office equipment.  All quantities of the inflammable, combustible or explosive fluids, chemicals or substances shall be stored as per guidelines set forth on their containers in a safe manner. After use, any hazardous wastes shall be disposed of by certified hazardous waste methods in accordance with the manufacturers’ instructions.

36.12Landlord shall deliver keys to Tenant upon Tenant’s occupancy.  Tenant shall not place any additional locks, bolts or mail slots of any kind upon any of the doors or windows, nor shall Tenant change any existing locks or the mechanism thereof without Landlord’s prior written consent.  Upon the termination of the tenancy, Tenant must turn over to Landlord all

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keys for the Premises or the Project and, in the event of the loss of any keys so furnished, Tenant shall pay to Landlord the cost thereof.

36.13Delivery or removal of any safes, freight, furniture, fixtures, bulky matter or heavy equipment of any description must take place during the hours which Landlord or its agent may reasonably determine from time to time, upon previous notice to the Landlord and in a manner and at times reasonably prescribed by Landlord, and the persons employed by Tenant for such work are subject to Landlord’s reasonable prior approval.  Landlord reserves the right to prescribe the weight and position of all safes, or other extra heavy equipment or furniture or improvements so as to distribute the weight or to require reinforcing at the cost of Tenant.  Landlord reserves the right to inspect all safes, freight or other bulky articles to be brought into the Building and to exclude from the Building all safes, freight or other bulky articles which violate any of these Rules and Regulations of this Lease, normal office equipment excluded.

36.14Tenant shall not occupy or permit any portion of the Premises to be occupied in a way that is not otherwise permitted by and consistent with Article 1.1.9, or is not generally consistent with the character and nature of all other tenancies in the Building.

36.15Tenant shall not purchase janitorial or maintenance or other like service from any company or persons not approved by Landlord, except that Landlord’s approval shall not be required in connection with any maintenance or other like service that does not affect the structure or other major systems of the Building.  Landlord shall approve a sufficient number of sources of such services to provide Tenant with a reasonable selection, but only in such instances and to such extent, as Landlord in its judgment considers consistent with security and proper operation of the Building.

36.16Landlord shall have the right to prohibit any advertising or business conducted by Tenant referring to the Building which, in Landlord’s opinion, tends to impair the reputation of the Building or its desirability as a first class office building, and upon notice from Landlord, Tenant shall refrain from or cease such advertising.

36.17Outside of Business Hours, Landlord reserves the right to exclude from the Building all persons who are not otherwise authorized by Tenant to enter the Premises.

36.18Tenant’s interior designers and installers of Tenant’s decoration, furniture, carpentry, wall coverings, and window coverings, shall, while in the Building or elsewhere in the Project, be subject to and under the control and direction of the Building manager (but not as agent or servant of said manager or of Landlord).

36.19If the Premises is or becomes infested with vermin as a result of the use or any misuse or neglect by Tenant, its agents, servants, employees, contractors, visitors or licensees, then Landlord shall forthwith at Tenant’s expense cause the same to be exterminated by licensed exterminators to the satisfaction of Landlord and, as necessary, from time to time thereafter.

36.20Tenant shall make requests for services at and as instructed by the office of the Building.

36.21Canvassing, soliciting and peddling in the Building are prohibited and Tenant shall cooperate to prevent the same.

36.22No air conditioning unit(s) shall be installed or used by Tenant without Landlord’s written consent.

36.23No hand trucks or dollies, except those equipped with rubber tires and side guards, may be used in any space in the Project, either by Tenant or by jobbers or others. Tenant shall not permit its customers, clients or invitees to wait in the public corridors of the Building.  Tenant shall not permit its employees to loiter or smoke in the interior Common Areas.

36.24Tenant, Tenant’s agents, servants, employees, contractors, licensees or visitors shall not park or stop any vehicles in any driveways, service entrances, or areas posted as “No Parking” or “No Stopping.”

36.25Landlord shall install and maintain for the Premises, at Landlord’s sole cost and expense, such safety equipment as may be mandated by applicable governmental authority.

36.26Tenant shall not use the name of the Building for any purpose other than as the address of the Tenant’s business in the Premises, nor shall Tenant use any picture of the Building in its advertising, stationery or in any other manner without the prior written permission of Landlord.  Landlord expressly reserves the right at any time to change name of the Building or Project without in any manner being liable to Tenant therefor.

37.Compliance with Laws.Landlord shall pay the cost of any repairs, capital additions, replacements or take any other actions necessary to cause the Building to comply with governmental laws, statutes or regulations that are in effect, applicable to and enforced with respect to the Building and/or the Premises as of the Commencement Date, including but not limited to American with Disabilities Act (“ADA”).

38.Good Faith.Without regard to any references to the terms “sole” or “absolute”, except for matters which could adversely affect the Building’s plumbing, HVAC or electrical systems, or its exterior appearance (in which case Landlord shall have the right to act in its sole and absolute discretion, exercised in good faith), any time the consent of Landlord or Tenant is required, such consent shall not be unreasonably withheld or delayed.  Whenever the Lease grants Landlord or Tenant the right to take action, exercise discretion, establish rules and regulations or make allocations or other determinations, Landlord and Tenant shall act reasonably and in good faith and take no action which might result in the frustration of the reasonable expectations of a sophisticated tenant or landlord concerning the Lease.

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IN WITNESS WHEREOF, the parties hereto have executed this Lease as of                                          , 2003.

LANDLORD		TENANT
Century Park,		Mercantile National Bank, N.A., a National Bank
a California limited partnership
By:	Held Properties, Inc.
Its:	Management Company
By:		By:
	Joel R. Delman		Scott A. Montgomery
Its:	Director of Leasing	Its:	President and Chief Executive Officer

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LEASE ADDENDUM

This Addendum is attached to and made a part of that certain office lease (this “Lease”) dated November 12, 2003 between Century Park, a California limited partnership, as Landlord (“Landlord”) and Mercantile National Bank, N.A., a National Bank, as Tenant (“Tenant”) relating to the premises (“Premises”) known as Suite 800 consisting of approximately 13,880 rentable square feet on the 8th floor of the Building located at 1880 Century Park East, Los Angeles, California.  The provisions set forth below shall supersede any inconsistent provisions set forth in the Lease.  Except as otherwise provided below, capitalized items used below shall have their respective meaning set forth in the Lease.

39.Option to Renew.Provided that Tenant is not in default under this Lease and provided that the Lease has not been terminated as a result of Tenant’s default or other acts or failures to act by Tenant, Tenant shall have an option to renew the Lease for two additional five (5) year terms (each an “Extended Term”).  Tenant shall provide Landlord with at least six (6) months but not more than twelve (12) months prior written notice indicating its intention to exercise such option to renew.  The rights contained in this Article 39 shall be personal to the originally named Tenant and may not be assigned nor transferred except with Landlord’s written consent.

39.1The monthly base rent during the Extended Term shall be an amount equal to the Prevailing Rate (as hereinafter defined) at the time of the commencement of the Extended Term for space leased within the previous six months that are Comparable Transactions, as defined below.  The term “Prevailing Rate” shall mean the monthly rent per rentable square foot that Landlord has accepted in contemporaneous transactions between nonaffiliated parties for non-expansion, renewal and non-equity tenants of comparable creditworthiness, for comparable space, comparable use and comparable lease terms (collectively, “Comparable Transactions”) in the Building.  If there are no Comparable Transactions in the Building, then the Prevailing Rate shall be prevailing fair market rental value for Comparable Transactions in the Project area.  In any determination of Comparable Transactions, appropriate consideration shall be given to the rental rates, abatement provisions or other concessions, brokerage commissions, if any, that actually have been paid by Landlord (or other landlords) in similar transactions, length of the lease term, size and location of the premises being leased, building standard tenant improvement allowances, if any, and other generally applicable conditions of tenancy.  The intent is that Tenant will obtain the same rent and other economic benefits that Landlord would otherwise give in Comparable Transactions and that Landlord will make and receive the same economic payments and concessions that Landlord would otherwise make and receive in Comparable Transactions.

39.2If Landlord and Tenant are unable to agree on the Prevailing Rate, then Landlord and Tenant shall agree upon, and jointly appoint, one arbitrator who shall be an active real estate broker in the Project area over the most recent 5-year period.  If the Landlord and Tenant fail to agree upon and appoint an arbitrator, then the appointment of the arbitrator shall be made by the Presiding Judge of the Superior Court, or if he or she refuses to act, by any judge having jurisdiction over the parties.  Within five (5) business days after said appointment, Landlord and Tenant may submit to the arbitrator (with a copy to the other party) any market data and additional information that such party deems relevant to the determination of the Prevailing Rate and the other party may submit a reply in writing within five (5) business days thereafter.  The determination of the arbitrator shall be limited solely to the issue of whether Landlord’s or Tenant’s submitted Prevailing Rate is the closest to the actual fair market rent for the Premises, taking into account the criteria of Comparable Transactions.  Neither Landlord nor Tenant may consult with such arbitrator as to his or her opinion of the fair market rent prior to the appointment or resolution of the issue regarding Prevailing Rate for the Premises.

39.3Within fifteen (15) days of being appointed, the arbitrator shall decide whether the parties shall use Landlord’s or Tenant’s submitted Prevailing Rate, and shall so notify Landlord and Tenant.  The decision of the arbitrator shall be binding upon the Landlord and Tenant.  The cost of the arbitration shall be paid by the Landlord and Tenant equally.

39.4Rent during the Extended Term shall continue to be subject to adjustment based upon Tenant’s pro-rata share of increases in Recurring Operating Costs except that the new base year shall be the calendar year in which the Extended Term commences.

39.5If Tenant fails to exercise in a timely manner the option to renew herein provided, said option to renew shall expire and have no further force and effect.  Tenant’s exercise of said option to renew shall not operate to cure any uncured default by Tenant under this Lease, nor to extinguish or impair any rights or remedies of Landlord arising by virtue of such default.  If the Lease or Tenant’s right to possession of the Premises terminates in any manner whatsoever before Tenant exercises the option to renew herein provided, such option to renew shall terminate; or if Tenant has assigned the Premises to an unaffiliated, independent third party, then immediately upon such assignment, the transferability of the option to renew shall be reasonably approved by Landlord, provided Tenant notifies Landlord in writing at the time of such assignment of its desire to transfer the option provided hereunder.

40.Tenant Improvements.In the event Tenant does not use the entire allowance, Tenant shall have the right to use up to $15.00 per usable square foot as a rent credit amortized over the first sixty (60) months of the Lease Term.

41.Temporary Space.     As of January 1, 2004, Landlord will provide Tenant with temporary space on the entire twelfth (12th) floor of the Building (the “Temporary Space”) under the terms and conditions of this Lease except that rent shall be paid as follows: Rent for the Temporary Space occupied by Tenant will be abated for the first sixty (60) days following Tenant’s occupancy in the Temporary Space.  If, after two months, Tenant continues to occupy the Temporary Space and until such time as the Tenant Improvements in the Premises are Substantially Complete and Tenant has vacated the Temporary Space, Tenant shall pay rent (“Temporary Space Rent”) in the amount of $15,268.00 per month for each month (or on a per diem basis for any partial month) after the end of the second month of occupancy that Tenant continues to occupy the Temporary Space.  Landlord shall provide the Temporary Space free of debris and broom clean with all Building Systems fully operative.

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42.Option to Terminate.

42.1Option to Terminate (Ground Floor).Landlord will use its best efforts to reach and execute, by April 1, 2004, an agreement with Krueger International (the “Ground Floor Tenant”) an agreement to amend the Ground Floor Tenant’s lease to reduce its space, which reduced space will become the subject of a lease (the “Ground Floor Lease”) between Tenant and Landlord.  If Landlord and Ground Floor Tenant fail to execute such amendment of the Ground Floor Tenant’s Lease by April 1, 2004, or if Landlord fails to deliver the Ground Floor Premises by October 1, 2004, Tenant shall have an option to terminate this Lease; this Lease shall become a month-to-month lease, which Tenant may terminate upon thirty (30) days prior written notice. 

42.2Option to Terminate (Premises).If Landlord or Landlord’s contractor is unable to deliver Premises with all Tenant Improvements installed, except for punchlist items and decorative and design issues, by August 31, 2004, Tenant shall have an option to terminate the Lease.  In such case, Tenant shall have thirty (30) days to deliver to Landlord a notice of termination of the Lease.  If Tenant elects to terminate the Lease, Tenant shall have until February 28, 2005 to vacate the Temporary Space.  (See also, Paragraph III.J of the Construction Agreement)

42.3Option to Terminate (Fifth Year Anniversary).At any time prior to the date nine months prior to the fifth (5th) anniversary date of the Commencement Date, Tenant shall have the option, with written notice to Landlord, to terminate the Lease.  The Premises subject to the termination notice shall be referred to as the “Canceled Premises.”  The termination shall be effective as of the day before the fifth (5^th) anniversary date of the Commencement Date.  Tenant’s delivery of the Termination Notice to Landlord shall be accompanied by an amount equal to the Lease Termination Fee, which will be equal to the unamortized Tenant Improvement Allowance and leasing commissions plus three (3) months Base Rent, which amount shall be Three Hundred Sixty-Two Thousand One Hundred Sixty-Two Dollars ($362,162.00)

43.Signage.

43.1Tenant’s Monument Sign.Tenant shall have the non-exclusive right to have its name (including its logo) displayed, at Landlord’s sole cost and expense, on a monument sign located in the front of the Building (the “Monument Sign”).   Such signage shall be no smaller than any other tenant’s sign.  Until the Monument Sign has been installed, Tenant shall have the right at Tenant’s cost and expense to have a temporary sign to be installed at a mutually agreed location that is visible by a passing vehicle from Century Park East.

43.2Requirements.  Tenant’s right to maintain its name on the Monument Sign shall be subject to the following requirements:

a.All expenses in connection with the construction, installation and maintenance of Tenant’s sign shall be paid by Landlord.

b.The design, size, location, materials, colors and lighting of the Monument Sign shall be determined by Tenant and Landlord.

c.Landlord shall have the right to relocate, redesign or reconstruct the Monument Sign from time to time so long as the Monument Sign is visible by a passing vehicle, as described in sub-section (e).

d.The cost of graphics related to Tenant’s portion of sign will be part of the Tenant Improvement Allowance.

e.The Monument Sign shall be visible by a passing vehicle on Century Park East.

44.Non-Disturbance.Landlord shall use its best efforts to secure as soon as commercially possible a commercially reasonable Non-Disturbance Agreement from the Lender, the form of which shall be provided to Tenant prior to lease execution.

45.Proposition 13.[See Article 48.1]

46.Parking.Tenant shall have the right, during the Lease Term or any extension thereof, to lease two and one-half (2.5) parking spaces per every 1,000 rentable square foot leased, at the then current prevailing rates.  However, the parking rates shall not be increased during the first twelve (12) months of the Lease Term.  Tenant shall be entitled to lease twenty-five percent (25%) of such parking spaces as “VIP Call-Down” spaces.  Tenant shall receive a twenty percent (20%) discount on parking validation sticker books purchased in quantities of Five Thousand Dollars ($5,000.00) or more.

47.Option to Negotiate for Additional Space.Subject to the rights of existing tenants that have been granted as of the date hereof, Tenant shall have an option during the Lease Term to negotiate for additional space (“ONAS”) on the eighth (8^th) floor (“ONAS Space”) by giving Landlord written notice of Tenant’s desire for additional space.  Provided that Tenant is not in default under the Lease, and subject to availability of eighth (8th) floor, Landlord shall offer ONAS Space to Tenant (subject to Tenant’s right of renewal set forth in this Lease) at a prevailing rent and base year determined in the same manner as during the Extended Term as set forth in Article 39; provided, however, that if Tenant exercises its option in the first year of the Lease Term, the terms and conditions for the ONAS Space shall be the same as those contained in this Lease.  Tenant shall have a period of ten (10) business days in which to either accept or reject Landlord’s offer.  If Tenant does not timely accept the ONAS Space specified in Landlord’s notice, Landlord may lease the ONAS Space to any third party.  If Tenant exercises the ONAS, Landlord and Tenant promptly shall execute and deliver an amendment to this Lease reflecting the

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terms of the ONAS Space. This ONAS shall be personal to Tenant or any entity described in Article 10 and may not be assigned nor otherwise transferred to any assignee or sub-tenant without Landlord’s consent.

48.Exclusions from Tax Costs.Notwithstanding anything in this Lease to the contrary, the following items shall be excluded from the definition of Tax Costs.

48.1Any increases in Tax Costs resulting from a reassessment due to a sale or change of ownership in the Project occurring during the Initial Lease Term, except for change in ownership resulting from a non-voluntary foreclosure sale, deed in lieu of foreclosure or similar transfer of interest.

48.2Tax Costs for the Base Year and any subsequent year shall be calculated without taking into account any decreases in real estate taxes that may be obtained in connection with Revenue and Taxation Code Section 51 (“Proposition 8”).

48.3Any excess profits taxes, franchise taxes, gift taxes, capital stock taxes, inheritance and succession taxes, estate taxes, federal and state income taxes and other taxes to the extent applicable to Landlord’s general or net income (as opposed to rents or receipts);

48.4Any Tax Costs based on taxes on tenant improvements in any space in the Building based upon an assessed level in excess of Building standard improvements, to the extent that the related taxes are separately designated on the tax bill;

48.5Any Tax Costs based on penalties incurred as a result of Landlord’s negligence, inability or unwillingness to pay, and/or to file any tax or informational returns with respect to, any real property taxes when due, and any additional costs arising as a result of Landlord’s failure to pay taxes in the maximum number of installments;

48.6Any Tax Costs based on increase of, or reassessment in, real property taxes and assessments resulting from major alterations, improvements, modifications or renovations to the Project, to the extent that the related taxes are separately designated on the tax bill;

48.7Any costs or expenses incurred by Landlord for personal property taxes, leasehold taxes in lieu thereof, or taxes or assessments levied in lieu thereof, or in addition thereto;

48.8Any other taxes or assessments charged or levied against Landlord that are not directly incurred as a result of the operation of the Building.

49.Exclusions from Operating Costs.Notwithstanding anything in this Lease to the contrary, the following items shall be excluded from the definition of Operating Costs:

49.1.Costs incurred for repairs or other work to the Project occasioned by fire, windstorm or other insurable casualty or by the exercise of eminent domain or any expenditures for which Landlord is reimbursed.

49.2Marketing costs, advertising costs, promotional expenses, leasing commissions, attorneys’ fees, space planning costs, and other costs and expenses incurred in connection with any lease, sublease and/or assignment negotiations and transactions with current or prospective tenants or other occupants of the Building.

49.3Costs incurred for renovating or otherwise improving or decorating, painting or redecorating space for other tenants or occupants of the Building.

49.4The cost incurred for special services or utilities separately chargeable to other tenants.

49.5Depreciation and amortization except as provided above.

49.6Expenses incurred for services or other benefits that are not offered to Tenant but which are provided to another tenant or occupant of the Building.

49.7Legal fees and related costs, together with any damages awarded by a court of law or arbitration panel to Tenant or any other tenants, or any repair and maintenance costs incurred by Landlord due to the violation by Landlord or any tenant of the terms and conditions of any lease in the Building.

49.8Overhead and profit increment paid to subsidiaries or affiliates of Landlord for services on or to the Project, to the extent that the costs of such services exceed competitive costs of such services for similar buildings in the Project area.

49.9Interest on debt or amortization payments on any mortgage or mortgages, and rental under any ground or underlying lease or leases, or other financing costs, including points, commitment fees, or legal costs related thereto.

49.10Landlord’s in-house accounting or legal costs, general overhead and executive salaries, except for salaries of project manager, project engineer or other employees to the extent directly related to the operation and management of the Project.

49.11Any compensation paid to clerks, attendants or other persons in commercial concessions operated by Landlord.

49.12All items and services for which Tenant reimburses Landlord or pays directly to third parties.

49.13Any costs, fines or penalties incurred due to violations by Landlord of any governmental rule or authority, or due to Landlord’s negligence, recklessness or willful misconduct.

49.14Costs incurred for sculpture, paintings or other objects of art.

49.15Rentals and other related expenses incurred in leasing air-conditioning systems, elevators or other equipment ordinarily considered of a capital nature, except equipment which is used in providing janitorial services and which is not affixed to the Building.

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49.16Costs incurred in the testing, encapsulation or other treatment or removal of asbestos, Hazardous Materials as defined herein, or other substances considered detrimental to the health or the environment of occupants of the Building including, without limitation, the cost and expense incurred by or on behalf of Landlord in removing and disposing any cooling or chilling system and the chemicals used in the HVAC system from either (1) the Building or (2) another tenant’s premises within the Building or (3)_Tenant’s Premises.

49.17The value of any lost income to Landlord of any office space in the Project that is utilized for the management of the Building.

49.18Costs incurred by Landlord to remedy any defects in the design, installation, construction, or materials used in any part of the Project.

49.19Costs incurred by Landlord in compliance with the Americans with Disabilities Act (the “ADA”) or statutes, laws regulations or other legislation of similar import.

49.20Costs of Landlord’s charitable or political contributions.

49.21Insurance premiums to the extent any tenant causes Landlord’s existing insurance premiums to increase or requires Landlord to purchase additional insurance, to the extent that any related premiums are separately designated on the insurance bill.

49.22Increases in reserves not presently being maintained for future expenses.

49.23Costs associated with the ownership of the Project or Landlord or Landlord’s property manager, as distinguished from the cost of Building operations, including the costs of partnership or corporate accounting (other than partnership tax preparation) and legal matters, selling or syndicating any of Landlord’s interest in the Project; and disputes between Landlord and Landlord’s property manager.

49.24Maintenance to or replacement of any utility, mechanical or other system solely dedicated to the single use of any other tenant.

49.25Costs relating to any areas leased on a triple net basis.

49.26Premiums for earthquake or flood insurance, unless included in recalculating the Operating Costs for the Base Year, or other costs relating to expansion in scope of services or addition of new services not included in the Base Year.

49.27Costs of items considered capital repairs, replacements, improvements and equipment under generally accepted accounting principles consistently applied or otherwise (“Capital Items”) except for (i) the annual amortization (amortized as provided in Article 4.4) of costs, including financing costs, if any, incurred by Landlord after the Commencement Date for any capital improvements installed or paid for by Landlord and required by any new (or change in) laws, rules or regulations of any governmental or quasi-governmental authority which are enacted after the Commencement Date; (ii)  the annual amortization (amortized as provided in Article 4.4) of costs, including financing costs, if any, of any equipment, device or capital improvement purchased or incurred as a labor-saving measure or to affect other economics in the operation or maintenance of the Building (provided the annual amortized costs does not exceed the actual cost savings realized and such savings do not redound primarily to the benefit of any particular tenant.

50.Tenant acknowledges that Landlord has advised Tenant that the Building contains or, because of its age, is likely to contain asbestos-containing materials (“ACMs”).  If Tenant undertakes any alterations, additions, or improvements to the Premises, as permitted by Article 7, Tenant shall, in addition to complying with the requirements of Article 7, undertake the alterations, additions, or improvements in a manner that avoids disturbing ACMs in the Building.  If ACMs are likely to be disturbed in the course of such work, Tenant shall notify Landlord, and Landlord shall, at its sole cost, encapsulate or remove the ACMs in accordance with an approved asbestos-removal plan and otherwise in accordance with all applicable Environmental Laws, including giving all notices required by Health and Safety Code sections 2591-25919.7.

51.Landlord has removed or has caused to be removed all accessible, friable ACMs in the Premises.  Landlord shall use its best efforts to comply with all Applicable Environmental Laws in the Premises, and throughout the Project during the Lease Term. Landlord shall, at Landlord’s sole expense and with counsel reasonably acceptable to Tenant, indemnify, defend and hold harmless Tenant and Tenant’s shareholders, directors, officers, employees, partners, affiliates and agents (“Tenant Indemnitees”) with respect to all losses arising out of or resulting from the release of any Hazardous Material in or about the Premises or the Project, or the violation of any Applicable Environmental Laws, existing prior to the Commencement Date or brought onto the Premises or Project by Landlord, or Landlord’s agents, employees, contractors or invitees (other than Tenant and Tenant Indemnitees).  This indemnification includes all losses, liabilities, obligations, penalties, fines, claims, actions (including remedial or enforcement actions of any kind and administrative or judicial proceedings, orders or judgments), damages (including consequential damages and punitive damages), and costs (including attorneys, consultants or experts fees and expenses) resulting from the release or violation. This indemnification shall survive the expiration or sooner termination of the Lease.

52.Profits (Article 10.6).For the purposes of Article 10.6, “Profits” shall mean the gross revenue received from the assignee or sublessee during the assignment or the sublease term with respect to the space covered by the assignment or sublease (“Transferred Space”) less: (i) the gross revenue paid to Landlord by Tenant during the period of the assignment or sublease term with respect to the Transferred Space; (b) any improvement allowance or other economic concession (planning allowance, moving expenses, etc.) paid by Tenant to sublessee or assignee; (c) brokers’ commissions; (d) attorneys’ fees; (e) costs of advertising the space for sublease or assignment; (f) unamortized cost of initial and subsequent improvements to the Premises by Tenant; and (g) any other costs actually paid in assigning or subletting the Transferred Space or in negotiating or effectuating the assignment or sublease.

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IN WITNESS WHEREOF, the parties hereto have executed this Lease as of November 19, 2003.

LANDLORD		TENANT
Century Park,		Mercantile National Bank, N.A., a National Bank
a California limited partnership
By:Held Properties, Inc.
Its:Management Company
By:	/s/ JOEL R. DELMAN	By:	/s/ SCOTT A. MONTGOMERY
	Joel R. Delman		Scott A. Montgomery
Its:	Director of Leasing	Its:	President and Chief Executive Officer

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EX-21

Exhibit 21

Subsidiaries

Mercantile National Bank

South Bay Bank, National Association

EX-23

Exhibit 23

Consent of Independent Auditors

We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 333-64316, 333-83723, 333-59667 and 333-33095) of our report dated February 13, 2004, with respect to the consolidated financial statements of National Mercantile Bancorp and Subsidiaries included in this Annual Report (Form 10-KSB) for the year ended December 31, 2003.

	ERNST & YOUNG LLP
Los Angeles, California
March 30, 2004

EX-31.1

Exhibit 31.1

I, Scott A. Montgomery, certify that:

1. I have reviewed this annual report on Form 10-KSB of National Mercantile Bancorp;

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

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report;

4. The small business issuer’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 (b) Evaluated the effectiveness of the small business issuer’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the small business issuer’s internal control over financial reporting that occurred during the small business issuer’s most recent fiscal quarter (the small business issuer’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the small business issuer’s internal control over financial reporting; and

5.  The small business issuer’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer’s auditors and the audit committee of the small business issuer’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer’s internal control over financial reporting.

Date:	March 29,  2004	/s/  SCOTT A. MONTGOMERY
		Scott A. Montgomery
		Chief Executive Officer

EX-31.2

Exhibit 31.2

I, David R. Brown, certify that:

1. I have reviewed this annual report on Form 10-KSB of National Mercantile Bancorp;

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

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report;

4. The small business issuer’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Evaluated the effectiveness of the small business issuer’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the small business issuer’s internal control over financial reporting that occurred during the small business issuer’s most recent fiscal quarter (the small business issuer’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the small business issuer’s internal control over financial reporting; and

5.  The small business issuer’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer’s auditors and the audit committee of the small business issuer’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer’s internal control over financial reporting.

Date:	March 29,  2004	/s/  DAVID R. BROWN
		David R. Brown
		Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of National Mercantile Bancorp (the “Company”) on Form 10-KSB for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Scott A. Montgomery, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

(1)  The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)  The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

	/s/  SCOTT A. MONTGOMERY
	Scott A. Montgomery
	Chief Executive Officer
Date:  March 29, 2004

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EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of National Mercantile Bancorp (the “Company”) on Form 10-KSB for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, David R. Brown, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

(1)  The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)  The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

	/s/  DAVID R. BROWN
	David R. Brown
	Chief Financial Officer
Date:  March 29, 2004

1