FACTORS WHICH MAY AFFECT FUTURE OPERATING RESULTS

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-QSB/A

(Amendment No. 1)

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

for the quarterly period ended March 31, 2006

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		(I.R.S. Employer Identification No.)
incorporation or organization)

1880 Century Park East
Los Angeles, California		90067
(Address to principal executive offices)		(Zip Code)

Issuer’s telephone number, including area code: (310) 277-2265

Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the past 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. o Yes x No

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

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

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

Explanatory Note

National Mercantile Bancorp (the “Company”) is filing this amendment to Form 10-QSB for the quarter ended March 31, 2006, to amend and restate historical financial statements and other financial information filed with the Securities and Exchange Commission (“SEC”). These amendments are being filed to correct errors in the originally filed Form 10-QSB related to the Company’s derivative accounting under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”).

This amendment restates the consolidated financial statements and the other financial information as of and for the three months ended March 31, 2006. The restatement has the following impact on Net Income and Dilute Earnings Per Common Share by period:

Impact

For additional information relating to the effect of the restatement, see the following items:

Part I
	Item 1. Financial Statements
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

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

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

	March 31,			December 31,
	2006			2005
	(Dollars in thousands, restated)
ASSETS
Cash and due from banks-demand	$	15,211		$	13,507
Due from banks-interest bearing	2,000			2,000
Federal funds sold	2,790			685
Cash and cash equivalents	20,001			16,192
Securities available-for-sale, at fair value; aggregate amortized cost of $87,278 and $72,428 at March 31, 2006 and December 31, 2005, respectively	85,825			71,758
Securities held-to-maturity, at amortized cost; aggregate fair value of $2,370 and $2,572 at March 31, 2006 and December 31, 2005, respectively	2,438			2,612
Federal Reserve Bank and other stock	3,940			3,809
Loans receivable	353,500			338,558
Allowance for credit losses	(4,562		)	(4,468		)
Net loans receivable	348,938			334,090

Premises and equipment, net	5,877			5,861
Other real estate owned	—			1,056
Deferred tax asset, net	4,289			4,442
Goodwill	3,225			3,225
Intangible assets, net	1,351			1,407
Accrued interest receivable and other assets	3,448			4,008
Total assets	$	479,332		$	448,460

LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest-bearing demand	$	122,638		$	115,924
Interest-bearing demand	31,716			36,018
Money market	91,885			76,334
Savings	26,336			28,208
Time certificates of deposit:
$100,000 or more	114,296			87,468
Under $100,000	18,481			19,256
Total deposits	405,352			363,208

Securities sold under agreement to repurchase	15,000			—
Other borrowings	1,400			28,337
Junior subordinated deferrable interest debentures	15,464			15,464
Accrued interest payable and other liabilities	3,414			3,288
Total liabilities	440,630			410,297

Shareholders’ equity:
Preferred stock, no par value-authorized 1,000,000 shares:
Series B non-cumulative convertible perpetual preferred stock; authorized 1,000 shares; outstanding 1,000 shares at March 31, 2006 and December 31, 2005	1,000			1,000
Common stock, no par value-authorized 10,000,000 shares:
outstanding 5,541,280 shares and 5,503,780 shares at March 31, 2006 and December 31, 2005, respectively	45,976			45,697
Accumulated deficit	(6,324		)	(7,380		)
Accumulated other comprehensive loss	(1,950		)	(1,154		)
Total shareholders’ equity	38,702			38,163
Total liabilities and shareholders’ equity	$	479,332		$	448,460

See accompanying notes to consolidated financial statements.

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	For the Three Months Ended
	March 31,
	2006			2005
	(Dollars in thousands,
	except per share data, restated)
Interest income:
Loans, including fees	$	7,040		$	5,443
Securities	985			368
Due from banks	21			16
Federal funds sold and securities purchased under agreements to resell	5			10
Total interest income	8,051			5,837
Interest expense:
Interest-bearing demand	42			32
Money market and savings	584			220
Time certificates of deposit:
$100,000 or more	768			208
Under $100,000	176			142
Total interest expense on deposits	1,570			602
Securities sold under agreements to repurchase	145			—
Other borrowings	224			94
Junior subordinated deferrable interest debentures	396			396
Total interest expense	2,335			1,092
Net interest income before provision for credit losses	5,716			4,745
Provision for credit losses	32			89
Net interest income after provision for credit losses	5,684			4,656
Other operating income:
Trading losses on non-hedge derivatives	(448		)	(204		)
Net settlement on interest rate swap	43			116
International services	33			10
Investment division	9			15
Deposit-related and other customer services	232			297
Gain on sale of other real estate owned	48			—
Total other operating income	(83		)	234
Other operating expenses:
Salaries and related benefits	2,089			1,838
Net occupancy	261			246
Furniture and equipment	133			127
Printing and communications	166			145
Insurance and regulatory assessments	99			108
Client services	142			172
Computer data processing	217			232
Legal services	74			148
Other professional services	304			254
Amortization of core deposit intangible	56			56
Promotion and other expenses	191			160
Total other operating expenses	3,732			3,486
Income before income tax provision	1,869			1,404
Income tax provision	813			582
Net income	$	1,056		$	822
Earnings per share:
Basic	$	0.19		$	0.22
Diluted	$	0.18		$	0.14

See accompanying notes to consolidated financial statements.

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	For the Three Months Ended March 31,
	2006			2005
	(Dollars in thousands, restated)
Cash flows from operating activities:
Net income	$	1,056		$	822
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	116			103
Provision for credit losses	32			89
Trading loss on non-hedge derivatives	448			204
Gain on sale of other real estate owned	(48		)	—
Net amortization of discount on securities available-for-sale	(21		)	19
Net amortization of premium on securities held-to-maturity	5			8
Net amortization of core deposit intangible	56			56
Net amortization of premium on loans purchased	32			41
Utilization of deferred tax assets	759			—
Decrease (increase) in accrued interest receivable and other assets	(473		)	382
Increase (decrease) in accrued interest payable and other liabilities	187			(668		)
Net cash provided by operating activities	2,149			1,056
Cash flows from investing activities:
Purchase of securities available-for-sale	(24,513		)	(536		)
Proceeds from repayments and maturities of securities available-for-sale	10,114			1,336
Proceeds from repayments and maturities of securities held-to-maturity	169			215
Loan originations and principal collections, net	(14,973		)	4,219
Proceeds from sale of other real estate owned	1,104			—
Purchase of Federal Reserve stock and other stocks	(595		)	(195		)
Purchases of premises and equipment	(132		)	(140		)
Net cash provided by (used in) investing activities	(28,826		)	4,899
Cash flows from financing activities:
Net increase in demand deposits, money market and savings accounts	16,091			6,777
Net increase in time certificates of deposit	26,053			5,456
Net increase in securities sold under agreements to repurchase and federal funds purchased	15,000			—
Net decrease in other borrowings	(26,937		)	(16,000		)
Net proceeds from exercise of stock options	279			187
Net cash provided by (used in) financing activities	30,486			(3,580		)
Net increase in cash and cash equivalents	3,809			2,375
Cash and cash equivalents, January 1	16,192			16,915
Cash and cash equivalents, March 31	$	20,001		$	19,290

Supplemental disclosures of cash flow information:
Cash paid for interest	$	2,112		$	1,205
Cash paid for income taxes	325			290
Unrealized loss on securities available-for-sale, net of tax effect	353			173
Unrealized loss on cash flow hedges, net of tax effect	$	1,076		$	636

See accompanying notes to consolidated financial statements.

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

(Unaudited)

NOTE 1—RESTATEMENT

National Mercantile Bancorp has restated its consolidated financial statements as of and for the three months ended March 31, 2006 and for the years ended December 31, 2005, 2004 and 2003 as well as for each of the interim periods in 2005, 2004 and 2003. This restatement corrected errors related to the Company’s derivative accounting under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”).

In 2003, the Company entered into an interest rate swap agreement in connection with the trust preferred securities related to the Company’s junior subordinated deferrable interest debentures (Trust Preferred Swap) that was accounted for as a fair value hedge under SFAS No. 133. The Company elected an abbreviated method (the “short-cut” method) of documenting the effectiveness of the swap as a hedge, which allowed the Company to assume no ineffectiveness in this transaction. As a result of later technical interpretations of SFAS 133, the Company subsequently concluded that the Trust Preferred Swap did not qualify for this method in prior periods. The presence of an interest deferral feature in the interest rate swap was determined, in retrospect, to have caused the interest rate swap to not have a fair value of zero at inception, which is required under SFAS 133 to qualify for short-cut hedge accounting treatment. Hedge accounting under SFAS No. 133 for this swap transaction is not allowed retrospectively because the hedge documentation required for the long-haul method was not in place at the inception of the hedge. Eliminating the application of fair value hedge accounting reverses the fair value adjustments that were made to the hedged item, the debt, as an adjustment to the par amount of the Trust Preferred debt. This reversal of fair value hedge accounting also results in reclassification of swap net settlements from interest expense to noninterest income as well as recording of swap mark-to-market adjustments in trading gains (losses) on economic derivatives.

The following table sets forth the effects of the adjustments to net income for the three months ended March 31, 2006. Since the Company could not apply hedge accounting for the transaction, the Trust Preferred Swap has been marked-to-market through the consolidated statement of operations with no related offset for hedge accounting.

	Three months
	ended
	March 31,
	2006
Net income as previously reported	$	1,318

Trading loss on non-hedge derivatives	(448		)
Benefit for income taxes	186
Total adjustment	(262		)

Restated net income	$	1,056
	-19.88		%

The following tables reflect the previously reported amounts and the restated results by financial statement line item for the consolidated balance sheet and statement of stockholders’ equity as of March 31, 2006 and the consolidated statements of income for the three months then ended.

	March 31,
	2006
	As Originally Reported			As Restated
	(Dollars in thousands)
Consolidated balance sheets:
Deferred tax asset, net	$	3,864		$	4,289
Accrued interest receivable and other assets	4,471			3,448
Total assets	479,930			479,332
Accumulated deficit	(5,726		)	(6,324		)
Total shareholders’ equity	39,300			38,702
Total liabilities and shareholders’ equity	479,930			479,332

	Three Months Ended
	March 31, 2006
	As Originally Reported		Restated
Consolidated Statements of Operations:
Interest expense:
Junior subordinated deferrable interest debentures	$	353	$	396
Total interest expense	2,292		2,335
Net interest income before provision for credit losses	5,759		5,716
Net interest income after provision for credit losses	5,727		5,684
Trading gains (losses) on economic derivatives	—		(448		)
Net cash settlement of interest rate swap derivative	—		43
Total other operating income	322		(83		)
Income before income tax provision	2,317		1,869
Income tax provision	999		813
Net income	1,318		1,056
Earnings per share – basic(1)	0.24		0.19
Earnings per share – diluted(1)	0.22		0.18

(1) Adjusted for the 5- for 4-stock split paid April 16, 2006

In addition, the following Notes to Consolidated Financial Statements have been restated: 2,3, 10, and 11.

NOTE 2—BASIS OF PRESENTATION AND MANAGEMENT REPRESENTATIONS

The unaudited consolidated financial statements include the accounts of National Mercantile Bancorp (“National Mercantile” on a parent-only basis, and the “Company” on a consolidated basis) and its wholly-owned subsidiaries, Mercantile National Bank and South Bay Bank, N.A., (collectively, the “Banks”). The unaudited consolidated financial statements of the Company reflect all interim adjustments, which are of a normal recurring nature and which, in management’s opinion, are necessary for the fair presentation of the Company’s consolidated financial position and results of operations and cash flows for such interim periods. The results for the three months ended March 31, 2006 are not necessarily indicative of the results expected for any subsequent period or for the full year ending December 31, 2006. The unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2005.

NOTE 3—EARNINGS PER SHARE

Basic earnings per share is computed using the weighted average number of common shares outstanding during the period. The number of shares has been adjusted for the five-for-four stock split effected in the form of a stock dividend paid April 14, 2006 and reflect the conversion of the Series A Preferred Stock in June 2005.

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

			Weighted
			Average	Per share
	Net Income		Shares	amount
	(Dollars in thousands, except per share data, restated)

For the three months ended March 31, 2006:
Basic earnings per share	$	1,056	5,518,383	$	0.19

Effect of dilutive securities:
Options			267,414
Convertible preferred stock			216,664
Diluted earnings per share	$	1,056	6,002,461	$	0.18

For the three months ended March 31, 2005:
Basic earnings per share	$	822	3,716,154	$	0.22

Effect of dilutive securities:
Options			246,269
Convertible preferred stock			1,851,363
Diluted earnings per share	822		5,813,785	$	0.14

NOTE 4—CASH AND CASH EQUIVALENTS

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

NOTE 5—ALLOWANCE FOR LOAN AND LEASE LOSSES

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

Provisions for credit losses charged (or credited) to operations reflect management’s judgment of the adequacy of the allowance for loan and lease losses and are determined through periodic analysis of the loan portfolio. This analysis includes a systematic and detailed review of the classification and categorization of problem loans; an assessment of the overall quality

and collectibility of the portfolio; and consideration of the loan loss experience, trends in problem loans, concentrations of credit risk, as well as current economic conditions (particularly Southern California). Management performs a periodic risk and credit analysis, the results of which are reported to the Board of Directors.

During the first quarter 2006, the Company charged off $1,000 and had no recoveries of loans previously charged off. Pursuant to Management’s evaluation of the allowance for loan and lease losses at March 31, 2006, a provision for credit losses of $32,000 was recorded for the first quarter 2006.

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

	Allowance for Loan and Lease Losses
	(Dollars in thousands)
For the three months ended March 31, 2006
Balance, beginning of period	$	4,468
Total loans charged-off	1
Total recoveries of loans previously charged off	—
Net charge-offs	1
Provision for credit losses	32
Transfer to (from) reserve for contingent losses on unfunded commitments	63
Balance, end of period	$	4,562

For the three months ended March 31, 2005
Balance, beginning of period	$	3,511
Total loans charged-off	6
Total recoveries of loans previously charged off	3
Net charge-offs	3
Provision for credit losses	89
Transfer to allowance for contingent losses on unfunded commitments	1
Balance, end of period	$	3,598

Credit quality is affected by many factors beyond the control of the Company, including local and national economies, and facts may exist which are not known to the Company 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 the Company will not sustain loan losses materially in excess of the allowance for credit losses. In addition, the Office of the Comptroller of the Currency (“OCC”), as an integral part of its examination process, periodically reviews the allowance for credit losses and could require additional provisions for credit losses.

NOTE 6—GOODWILL AND CORE DEPOSIT INTANGIBLES

As of March 31, 2006 and December 31, 2005, the Company had goodwill of $3.2 million, and net core deposit intangibles of $1.4 million from its acquisition of South Bay Bank in December 2001. The gross carrying amount of core deposit intangibles was $2.3 million at March 31, 2006 and December 31, 2005, and accumulated amortization was $949,000 and $893,000, respectively, at such dates. The core deposit intangibles are estimated to have a life of 10 years and 4 months. Amortization of intangibles for 2006 and each of the next four years is estimated to be $223,000 per year. In accordance with SFAS No. 142 goodwill is not amortized. The Company has no other recorded indefinite-lived intangible assets. Goodwill and other intangible assets are reviewed and assessed annually for impairment or more frequently if conditions suggest impairment may exist.

NOTE 7—REPURCHASE AGREEMENTS

At March 31, 2006, the Company had $15.0 million of securities sold under agreement to repurchase (“Repurchase Agreements”). At December 31, 2005, there were no Repurchase Agreements. The Repurchase Agreements entered into during the first quarter 2006 are adjustable, indexed to LIBOR, and contain embedded interest rate floors with a 4.0% strike rate for a term of two years and were utilized to facilitate the Company’s liquidity and interest rate risk management objectives. In the event of a sustained decline in interest rates, upon reaching the strike rate, the cost of the Repurchase Agreements will decline at double the difference between the index rate and the strike rate, but in any event, not below zero.

The embedded interest rate floor has not been separated from the Repurchase Agreement and accounted for as a derivative instrument because (i) the strike rate was below the LIBOR index at issuance of the Repurchase Agreement and it is clearly and closely related to the economic characteristics and risks of the Repurchase Agreements, and (ii) the Repurchase Agreement is not remeasured at fair value under otherwise applicable generally accepted accounting principles with changes in fair value reported in earnings.

NOTE 8—INCOME TAXES

Income tax provisions of $813,000 and $582,000 were recorded for the three months ended March 31, 2006 and 2005, respectively.

At March 31, 2006, the Company had: (i) federal net operating loss carry forwards (“NOLS”) of approximately $2.8 million, which begin to expire in the year 2009; and (ii) federal alternative minimum tax (“AMT”) credits of $819,000. The AMT credits carry forward indefinitely.

Management believes that it is more likely than not that the deferred tax asset, a portion of which is comprised of the NOLS, will be realized. Accordingly, no valuation allowance has been established against the deferred tax asset.

NOTE 9—SHARE-BASED PAYMENTS

At March 31, 2006, the Company had one stock incentive plan pursuant to which up to a total of 312,500 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 of Directors of the Company determines. The term of the stock option may not exceed 10 years. Employee stock option grants generally vest over one year or ratable over two years. Director stock options vest in one year. All stock options have vesting conditions that include only service conditions; none of the grants contains performance or market vesting conditions.

The Company issues new shares upon the exercise of stock options. All of the share-based payment awards qualify for classification as equity. At March 31, 2006, the only outstanding awards under this plan were stock options, and at that date 193,430 shares were available for future awards. At March 31, 2006, there were also outstanding options granted under two prior stock incentive plans. The activity of stock options for the three months ended March 31, 2006 is as shown:

	No. of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding, December 31, 2005	519,358		$	9.62	6.3	$	4,996,224
Granted	3,100		18.19		9.8	56,389
Exercised	(29,750	)	7.54		5.3	224,315
Forefeited	(6,750	)	12.40		9.0	83,700
Expired	—		—		—	—
Five-for-four stock split	121,490		n/a		n/a	n/a
Outstanding, March 31, 2006	607,448		$	7.81	6.0	4,744,165
Exercisable, March 31, 2006	382,659		$	5.95	4.6	2,276,821
Unvested, March 31, 2006	224,789		$	8.68	8.7	1,951,164

The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (SFAS 123R) which eliminated the ability to account for share-based compensation transactions, including grants of employee stock options, using Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), and generally requires that such transactions be accounted for using a fair value-based method with the resulting compensation cost recognized over the period that the employee is required to provide service in order to receive their compensation. The Company adopted SFAS 123R as of January 1, 2006 utilizing the modified prospective application. Under this method, the provisions of SFAS 123R are applied to new awards and to awards modified, repurchased or canceled after December 31, 2005 and to awards outstanding on December 31, 2005 for which the requisite service has not yet been rendered. Prior to December 31, 2005, the Company accounted for its stock options using the intrinsic value method, as prescribed by APB 25, and accordingly, no expense for stock options was recorded in periods prior to December 31, 2005.

In the first quarter of 2006, the adoption of SFAS 123R resulted in incremental share-based compensation expense of $85,000, net income before income tax and net income to decrease by $85,000, and basic and diluted earnings per share to decrease by $0.02 and $0.01, respectively. The income tax benefit for the three months ended March 31, 2006 was immaterial as nearly all unvested stock options were qualified incentive stock options. For the three months ended March 31, 2006, there was no impact to cash flow from financing activities as there were no tax deductions that exceeded the compensation cost for share-based payments.

The reported net income and earnings per share for the period shown are presented below to reflect the impact had the Company been required to recognize compensation expense based on SFAS 123R:

	Three Months
	Ended
	March 31,
	2005
	(Dollars in thousands)

Reported net income	$	822
Deduct: Toal share-based compensation expense determined using fair value method, net of related tax effects	(36		)
	786

Basic earnings per share:
As reported	$	0.22
Pro forma	$	0.21

Diluted earnings per share:
As reported	$	0.14
Pro forma	$	0.13

The estimated per share weighted average fair value of options granted in the three months ended March 31, 2006 and 2005 was $6.49 and $8.60, respectively. The total intrinsic value of options exercised during the three months ended March 31, 2006 was $224,000 and the total fair value of shares vested during this period was $99,000. As of March 31, 2006, total unrecognized compensation cost related to stock options issued but unvested was $420,000 that will be recognized through 2008.

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

The lattice option pricing models require certain assumptions. For the three months ended March 31, 2006, the expected volatility assumption of 32% is based upon the weekly historical volatility of the Company’s stock price for the period January 1, 2000 through December 31, 2005 using a blend of the unweighted standard deviation of closing price with a weighted mean reversion formula. The risk-free interest rate assumption ranged from 4.46% to 4.50% for the expected term of the share options and is based upon the U.S. Treasury implied forward yield curve at the time of the grant. The dividend yield assumption ranged from 0 to 2.5% during the expected term of the options and is based upon the Company’s capital planning model. The assumptions used with the Black-Sholes option pricing model, for the three months ended March 31, 2005, are as follows: expected volatility 43%; expected term 10 years; risk-free interest rate 4.50%; and dividend yield 0%.

NOTE 10—COMPREHENSIVE INCOME (LOSS)

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

	Three Months ended March 31,
	2006			2005
	(Dollars in thousands)

Net income	$	1,056		$	822

Other comprehensive income (loss) before tax, and unrealized losses on securities:
Unrealized gain (loss) on interest rate swaps used in cash flow hedges	(504		)	(1,083		)
Unrealized gain (loss) on interest rate floors used in cash flow hedges	(224		)	—
Unrealized gain (loss) on securities available for sale	(796		)	(425		)
Other comprehensive income (loss), before tax	(1,524		)	(1,508		)

Income tax benefit (expense) related to items of other comprehensive income	444			699
Other comprehensive income (loss)	(1,080		)	(809		)
Total comprehensive income	$	(24	)	$	13

NOTE 11—DERIVATIVE FINANCIAL INSTRUMENTS

The Company holds fixed rate and variable rate financial assets that are funded by fixed rate and variable rate liabilities. Consequently, they are subject to the effects of changes in interest rates. In response to this, the Company has developed an interest rate risk management policy with the objective of mitigating financial exposure to changing interest rates. These exposures are managed, in part, with the use of derivatives but only to the extent necessary to meet the overall goal of minimizing interest rate risk.

Derivatives are accounted for according to SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. This standard requires that all derivative instruments be recognized in the financial statements and measured at fair value regardless of the purpose or intent for holding them. Some derivatives have been designated fair value hedges and cash flow hedges. To qualify for hedge accounting, the details of the hedging relationship must be formally documented at inception of the arrangement, including the risk management objective, hedging strategy, hedged item, specific risks that are being hedged, the derivative instrument and how effectiveness is being assessed. The derivative must be highly effective in offsetting either changes in fair value or cash flows, as appropriate, for the risk being hedged. Effectiveness is evaluated on a retrospective and prospective basis. If a hedge relationship becomes ineffective, it no longer qualifies as a hedge. Any excess gains or losses attributable to such ineffectiveness, as well as subsequent changes in the fair value of the derivative, are recognized in earnings.

The following is a summary of our risk management strategies and the effect of these strategies on the consolidated financial statements.

	March 31, 2006					December 31, 2005
	Notional Amount		Fair Value			Notional Amount		Fair Value
	(Dollars in thousands)
Fair value hedges:
Interest rate swaps	$	60,000	$	(75	)	$	30,000	$	(41	)

Cash flow hedges:
Interest rate swaps	$	50,000	$	(1,537	)	$	50,000	$	(1,034	)
Interest rate floors	$	50,000	$	45		$	50,000	$	268

Non-hedge derivatives:
Interest rate swaps	$	15,000	$	(1,023	)	$	15,000	$	(575	)
Interest rate floors	150,000		—			150,000		—

Fair value hedges are hedges that minimize the risk of changes in the fair values of assets, liabilities and certain types of firm commitments. The Company uses interest rate swaps to hedge the change in fair value of its brokered certificates of deposit. The interest rate swaps result in the Company paying or receiving the difference between the fixed and floating rates at specified intervals calculated on the notional amounts. The differential paid or received on such interest rate swaps are recognized as an adjustment to interest expense. The net change in fair value of the derivatives and the hedged items is reported in earnings. The fair value hedges are highly effective and therefore no ineffectiveness was recognized in current earnings related to this swap.

Cash flow hedges are hedges that use simple derivatives to offset the variability of expected future cash flows. The Company’s cash flow hedges include certain interest rate swaps and interest rate floors used to manage the interest rate risk associated with its significant volume of adjustable rate loans. At March 31, 2006, a loss of $1.5 million was recorded in accumulated other comprehensive income and no ineffectiveness was recorded to earnings for the three months ended March 31, 2006 related to these interest rate swaps. At March 31, 2005, a loss of $224,000 was recorded in accumulated other comprehensive income related to the interest rate floors and no ineffectiveness was recorded to earnings for the three months ended March 31, 2005 related to these interest rate floors.

Non-hedge derivatives are interest rate floors and interest rate swaps that do not meet the strict criteria for hedge accounting treatment. We use derivatives to hedge exposures when it makes economic sense to do so, including circumstances in which the hedging relationship does not qualify for hedge accounting. Derivatives not designated as hedges are marked to

market through earnings. The Company has entered into an interest rate swap agreement to pay an adjustable rate and receive a fixed rate with terms that mirror its junior subordinated debentures. At inception of this swap, the Company designated this swap as a fair value hedge of its junior subordinated debentures and established the “short-cut” method of documenting the hedge effectiveness. As a result of subsequent technical interpretations of the “short-cut” hedge accounting rules, the Company has treated this swap as a non-hedge derivative and restated its financial statements since inception of the transaction accordingly. The effect of the non-hedge derivative treatment is to reflect the change in fair value of the swap in current income as a trading gain or loss. There was a $448,000 and $204,000 trading loss recorded for the three months ended March 31, 2006 and 2005 reflecting the change in market value of this swap. During 2005, the Company purchased a one year interest rate floor to help protect its net interest income in the event of a rapid decline in interest rates and permit it to execute other strategies to protect against declining interest rates over time. There was no charge to earnings during the first quarter 2006 as the floor has previously written down to zero.

NOTE 12—RECLASSIFICATIONS

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

NOTE 17—SUBSEQUENT EVENT

Agreement and Plan of Merger

On June 15, 2006, National Mercantile entered into an Agreement and Plan of Merger (the “Merger Agreement”) with FCB Bancorp, a California corporation (“FCB”), and First California Financial Group, Inc. (“FCFG”), a new Delaware corporation formed by National Mercantile for the purpose of the merger transactions. The Merger Agreement provides for the reincorporation merger of National Mercantile into FCFG immediately followed by the merger of FCB into FCFG (together, the “Mergers”).

Consummation of the Mergers is subject to a number of closing conditions, including approval by the shareholders of both National Mercantile and FCB and regulatory approval.

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

National Mercantile Bancorp (“National Mercantile” on a parent-only basis, and the “Company” on a consolidated basis) is the holding company for two subsidiary banks, Mercantile National Bank (“Mercantile”) and South Bay Bank, N.A. (“South Bay”) (collectively, “the Banks”). National Mercantile’s principal assets are the capital stock of Mercantile and South Bay. The per share data reflects the five-for-four stock split paid April 14, 2006 to shareholders of record March 31, 2006 as well as the conversion of the Series A Preferred stock to common stock in June 2005.

RESTATEMENT

The Company has restated its consolidated financial statements for the years ended December 31, 2003, 2004 and 2005 and as of March 31, 2006 and for the three months then ended. This restatement corrected errors related to the Company’s derivative accounting under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”).

The following table shows the statement of operations as originally reported and as restated, with the adjustments, for the three months ended March 31, 2006:

	Three Months Ended
	March 31, 2006
	As Originally Reported		Restated

Net interest income before provision for credit losses	$	5,759	$	5,759
Net cash settlement of interest rate swap derivative	—		(43		)
Total net interest income	5,759		5,716
Provision (benefit) for credit losses	32		32
Net interest income after provision for credit losses	5,727		5,684
Total other operating income	322		322
Net cash settlement of interest rate swap derivative	—		43
Change in fair value of interest rate swap derivative	—		(448		)
Total non-interest income	322		(83		)
Total other operating expenses	3,732		3,732
Income before taxes	2,317		1,869
Income tax expense	999		999
Income tax effect on restatement	—		(186		)
Total income tax expense	999		813
Net income	$	1,318	$	1,056

Net income per share – Basic	$	0.24	$	0.19
Net income per share – Diluted	$	0.22	$	0.18

RESULTS OF OPERATIONS OVERVIEW

We recorded net income of $1.1 million, or $0.19 basic earnings per share and $0.18 diluted earnings per share, for the three months ended March 31, 2006 compared to net income of $822,000, or $0.22 basic earnings per share and $0.14 diluted earnings per share, for the same period of 2005. The increase in net income for the first quarter of 2006 was primarily due to a $971,000 increase in net interest income before the provision for credit losses resulting from increases in the prime rate lending index, a greater volume of interest earning assets, particularly higher-yielding loans receivable and securities available-for-sale, and a favorable change in earning asset and funding liability composition. This increase in net interest income for the first quarter of 2005 was partially offset by a $246,000 increase in noninterest expense. The Company adopted Statement of Financial Accounting Standards No. 123R, Stock-Based Payments (SFAS 123R), January 1, 2006 resulting in the recognition of compensation expense for unvested stock options and an after-tax charge of $85,000 to earnings.

Return on average assets during the first quarter of 2006 was 0.92% compared to 0.83% during the first quarter of 2005. Return on average equity during the first quarter of 2006 was 10.68% compared to 9.31% during the first quarter of 2005.

NET INTEREST INCOME

Net interest income increased $971,000 to $5.7 million during the first quarter of 2006 compared to first quarter 2005 due to a $2.2 million increase in interest income offset by a $1.2 million increase in interest expense.

Loan interest income increased $1.6 million due to $34.0 million greater average volume of loans receivable and a 118 basis point increase in yield, resulting primarily from increases in the prime rate lending index. During the second half of 2004, the Federal Reserve Bank increased interest rates 125 basis points on five occasions after a prolonged period of accommodative monetary policy in response to signs of stronger economic activity and perceived higher inflation risk. During 2005, the Federal Reserve Bank increased interest rates 200 basis points on eight occasions and, continuing into the first quarter of 2006, another 50 basis points on two occasions. Approximately 75% of our $353.5 million loans receivable at March 31, 2006, have adjustable interest rates; consequently, rising interest rates positively affect interest income. Conversely, declining interest rate environments have the potential to negatively impact our net interest income. In order to reduce the negative impact in the event of a decline in the prime rate lending index, we have entered into interest rate swaps, in which we exchanged an adjustable rate interest payment based on the prime rate lending index for a fixed rate payment on an aggregate notional amount of $50.0 million. The higher yields earned on our loans receivable during the first quarter of 2006 were partially offset by the rising cost of the interest rate swaps.

Interest income from securities available-for-sale increased $625,000 during the first quarter of 2006 compared to the same period of 2005 due to $37.8 million greater average volume and a 159 basis point increase in yield. During the third and fourth quarter of 2005 and continuing into 2006, we have steadily added newly purchased securities to our investment portfolio as part of a strategy to further reduce the exposure of net interest income to a declining interest rate environment. The additions to securities have been instruments that we expect to have limited prepayment of principal in the event of declining interest rates (and muted term extension in rising interest rates). These investments, as well as loans receivable, have been largely financed with adjustable rate wholesale funds that will decline in cost in a falling interest rate environment. The more recently purchased securities, in a period of higher interest rates, and the maturity of lower yielding securities in the portfolio, resulted in an increase in the portfolio yield.

Overall, interest-earning assets were $64.0 million greater during 2006 period than 2005 while the higher interest rates and favorable change in composition to higher-yielding assets resulted in a 112 basis point increase in weighted average yield on interest-earning assets.

Interest expense increased $1.2 million during the first quarter of 2006 compared to the same period in 2005 due to a $63.5 million increase in average interest-bearing liabilities and a 128 basis point increase in the weighted average cost of interest-bearing liabilities. Interest expense on deposits increased $1.0 million due to a 133 basis point rise in weighted average cost of interest-bearing deposits in addition to $46.0 million greater average volume than 2004. Time certificates of deposit $100,000 and over averaged $41.0 million greater during the 2006 period than 2005 due to an increased volume of brokered certificates of deposit (“Brokered CDs”). The volume of money market and savings deposits increased $7.8 million during the first quarter of 2006 compared to first quarter of 2005 while time certificates of deposit under $100,000 declined $3.6 million.

During the rising interest rate environment experienced during the past six quarters, we strategically elected to only moderately increase transaction deposit rates and to fund asset growth, and runoff of these deposits, with Brokered CDs. Although this type of funding is typically higher costing and exhibits higher interest rate sensitivity, the Brokered CDs facilitate our liquidity and interest rate risk management that we utilize to reduce our net interest income exposure to possible declining interest rates. The greater interest expense on the incremental Brokered CDs needed to fund asset growth is less than the impact of increasing rates on the significantly greater volume of transaction accounts. As market interest rates continue to rise, the cost of our deposits has been increasing more rapidly due to more frequent exceptions to our posted interest rates granted to depositors in order to prevent deposit withdrawals.

The cost of time certificates of deposit $100,000 and over increased 175 basis points during the first quarter of 2006 compared to first quarter 2005. The cost of money market and savings deposits increased 127 basis points while the cost of interest-bearing demand deposits and time certificates of deposit under $100,000 increased 11 basis points and 88 basis points, respectively.

The volume of other borrowings averaged $20.3 million and $15.1 million during the first quarter of 2006 and 2005, respectively. We continue to employ a liquidity strategy of maintaining relatively low levels of short-term assets and utilizing Federal Home Loan Bank overnight advances, against pledged loans and securities, to fund asset and deposit fluctuations. Minimizing short-term assets and increasing short-term liabilities furthers the interest rate risk management of our asset sensitive balance sheet. The cost of other borrowings was 4.48% and 2.52% for 2005 and 2004 periods, respectively, representing an increase of 196 basis points for the first quarter of 2006.

The restatement eliminating hedge accounting treatment for the interest rate swap on our junior subordinated debentures resulted in a reclassification of the interest rate swap net settlement payment from interest expense to other operating income increasing interest expense $43,000 and $116,000 for the three months ended March 31, 2006 and 2005.

Securities sold under agreement to repurchase (“Repurchase Agreements”) averaged $12.3 million during the first quarter of 2006 with a cost of 4.77%. The Repurchase Agreements, total $15.0 million with an adjustable interest rate based upon the LIBOR index and have an embedded floor with a strike rate of 4.0% maturing in January 2008, further our interest rate risk management objectives. In the event that the LIBOR index declines below the strike rate, the cost of the Repurchase Agreements will decline at double the difference between the LIBOR index and the strike rate. We had no Repurchase Agreements during 2005.

Noninterest-bearing demand deposits averaged $113.4 million during the first quarter 2006 or $8.0 million less than during the same quarter in 2005. Rising interest rates increase depositors’ opportunity cost of noninterest-bearing deposits and their sensitivity to maintaining such balances, resulting in the redeployment of their funds into higher yielding deposits and alternative investments outside the Banks.

The net yield on interest earning assets (net interest margin) was 5.45% during the first quarter in 2006 compared to 5.32% during the first quarter in 2005, while the net interest spread was 4.54% and 4.70%, respectively. The net interest margin and net interest spread during the first quarter of 2006 have declined from recent quarters largely due to the securities leverage strategy – intermediate-term security purchases financed with short-term wholesale funds – executed to reduce our balance sheet asset sensitivity. Also, the first quarter of 2006 experienced a “flat yield curve” in which short-term rates have risen to the level of long-term interest rates. A preponderance of our funding sources are correlated to the short-term rates.

The following table presents the components of net interest income for the three months ended March 31, 2006 and 2005.

Average Balance Sheet and

Analysis of Net Interest Income

	Three Months ended
	March 31, 2006							March 31, 2005
						Weighted							Weighted
				Interest		Average					Interest		Average
	Average			Income/		Yield/		Average			Income/		Yield/
	Amount			Expense		Rate		Amount			Expense		Rate
	(Dollars in thousands)
Assets:
Federal funds sold and securities
Federal funds sold	$	443		5		4.58	%	$	1,667		10		2.43	%
Due from banks-interest bearing	2,000			21		4.26	%	7,660			16		0.85	%
Securities available-for-sale	77,729			959		4.94	%	39,909			334		3.35	%
Securities held-to-maturity	2,546			26		4.08	%	3,415			34		3.98	%
Loans receivable (1) (2)	342,737			7,040		8.33	%	308,766			5,443		7.15	%
Total interest earning assets	425,455			8,051		7.67	%	361,417			5,837		6.55	%

Noninterest earning assets:
Cash and due from banks - demand	15,020							19,135
Other assets	23,635							20,569
Allowance for credit losses and net unrealized gain on sales of securities available-for-sale	(5,229		)					(4,066		)
Total assets	$	458,881						$	397,055

Liabilities and shareholders’ equity:
Interest-bearing deposits:
Demand	$	32,909		42		0.52	%	$	32,036		32		0.41	%
Money market and savings	110,886			584		2.14	%	103,132			220		0.87	%
Time certificates of deposit:
$100,000 or more	86,395			768		3.61	%	45,433			208		1.86	%
Under $100,000	24,217			176		2.95	%	27,767			142		2.07	%
Total time certificates of deposit	110,612			944		3.46	%	73,200			350		1.94	%
Total interest-bearing deposits	254,407			1,570		2.50	%	208,368			602		1.17	%
Other borrowings	20,283			224		4.48	%	15,139			94		2.52	%
Junior subordinated debentures	15,464			396		10.39	%	15,464			396		10.39	%
Federal funds purchased and securities sold under agreements to repurchase	12,333			145		4.77	%	—			—		—
Total interest-bearing liabilities	302,487			2,335		3.13	%	238,971			1,092		1.85	%

Noninterest-bearing liabilities:
Noninterest-bearing demand deposits	113,413							121,408
Other liabilities	3,417							1,349
Shareholders’ equity	39,564							35,327
Total liabilities and shareholders’ equity	$	458,881						$	397,055

Net interest income (spread)				$	5,716	4.54	%				$	4,745	4.70	%

Net yield on earning assets (2)						5.45	%						5.32	%

(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 $341,000 and $423,000 for the three months ended March 31, 2006 and 2005, respectively.

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

	Three Months ended March 31,
	2006 vs 2005
						Net
	Increase (decrease) due to:					Increase
	Volume			Rate		(Decrease)
	(Dollars in thousands)
Interest Income:
Federal funds sold	$	(7	)	$	2	$	(5	)
Interest-bearing deposits with other financial institutions	(12		)	17		5
Securities available-for-sale	317			308		625
Securities held-to-maturity	(9		)	1		(8		)
Loans receivable (2)	599			998		1,597
Total interest-earning assets	888			1,326		2,214

Interest Expense:
Interest-bearing deposits:
Demand	$	1		$	9	$	10
Money market and savings	17			347		364
Time certificates of deposit:
$100,000 or more	188			372		560
Under $100,000	(18		)	52		34
Total time certificates of deposit	170			424		594
Total interest-bearing deposits	188			780		968
Other borrowings	32			98		130
Junior subordinated debentures	—			—		0
Federal funds purchased and securities sold under agreements to repurchase	145			—		145
Total interest-bearing liabilities	365			878		1,243

Net interest income	$	523		$	448	$	971

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

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

PROVISION FOR CREDIT LOSSES

We recorded a provision for credit losses of $32,000 for the first quarter 2006, reflecting the growth in loans receivable partially offset by a decrease in unfunded loan commitments, compared to $89,000 for the first quarter 2005. During the first quarter 2006, we charged off loans receivable of $1,000.

OTHER OPERATING INCOME

Other operating income was an $83,000 loss for the first quarter of 2006 compared to $234,000 for the same period in 2005. The 2006 period included a $448,000 trading loss on non-hedge derivatives compared to a $204,000 trading loss for the first quarter 2005. The trading losses reflect the restatement in which hedge accounting treatment is not applied to an interest rate swap, but rather its change in fair value is recognized in current income. Deposit-related fees decreased in the 2006 period due to higher compensating balance rates and changes in fee structure. This decline was offset by a $48,000 gain on the sale of other real estate owned acquired through foreclosure and an increase in international services fees.

OTHER OPERATING EXPENSES

Other operating expenses increased to $3.7 million for the three months ended March 31, 2006 compared to $3.5 million for the same period of 2005. Significant variances within operating expenses were: (i) salaries and related benefits expense increased $251,000 or 13.7% due to the adoption of SFAS 123R requiring stock options to be expensed, the addition of business development staff and increased incentive expense; (ii) legal services expense decreased $74,000 or 50.0% primarily due to fewer problem assets and the decline in related legal activity; and (iii) other professional services expense increased $50,000 or 19.7% due to increased costs for audit services, recruiting fees and directors’ fees.

BALANCE SHEET ANALYSIS

INVESTMENT SECURITIES

The following comparative period-end table sets forth certain information concerning the estimated fair values and unrealized gains and losses of securities available-for-sale and securities held-to-maturity.

Estimated Fair Values of and Unrealized

Gains and Losses on Securities

	March 31, 2006
	Total		Gross		Gross		Estimated
	amortized		unrealized		unrealized		fair
	cost		gains		loss		value
	(Dollars in thousands)
Available-for-Sale:
U.S. Treasury securities	$	599	$	—	$	3	$	596
GNMA-issued/guaranteed mortgage pass through certificates	89		1		—		90
Other U.S. Government and federal agency securities	9,036		—		109		8,927
FHLMC/FNMA-issued mortgage pass through certificates	49,793		38		934		48,897
CMO’s and REMIC’s issued by U.S. government-sponsored agencies	2,526		—		1		2,525
Privately issued corporate bonds, CMO and REMIC securities	25,235		—		445		24,790
	$	87,278	$	39	$	1,492	$	85,825

FRB and other equity stocks	$	3,940	—		—		$	3,940

	March 31, 2006
	Total		Gross		Gross		Estimated
	amortized		unrealized		unrealized		fair
	cost		gains		loss		value
	(Dollars in thousands)
Held-to-Maturity:
FHLMC/FNMA-issued mortgage pass through certificates	$	2,438	$	—	$	68	$	2,370
	$	2,438	$	—	$	68	$	2,370

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

FRB and other equity stocks	$	3,809	—		—		$	3,809

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

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

LOAN PORTFOLIO

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

Loan Portfolio Composition

	March 31,					December 31,
	2006					2005
	Amount			Percent		Amount			Percent
	(Dollars in thousands)
Commercial loans - secured and unsecured	$	91,928		26	%	$	89,474		26	%
Real estate loans:
Secured by commercial real properties	132,542			37	%	121,641			36	%
Secured by one to four family residential properties	9,279			3	%	10,498			3	%
Secured by multifamily residential properties	18,828			5	%	18,663			6	%
Total real estate loans	160,649			45	%	150,802			45	%
Construction and land development	94,629			27	%	92,077			27	%
Consumer installment, home equity and unsecured loans to individuals	7,289			2	%	7,239			2	%
Total loans outstanding	354,495			100	%	339,592			100	%

Deferred net loan origination fees	(995		)			(1,034		)
Loans receivable, net	$	353,500				$	338,558

Loans receivable increased $14.9 million to $353.5 million at March 31, 2006 compared to $338.6 million at December 31, 2005 primarily due to increased funding of commercial real estate loans, secured and unsecured commercial loans and construction loans. We have increased funding of intermediate-term fixed rate commercial real estate loans as part of our interest rate risk management strategy.

NONPERFORMING ASSETS

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

Nonperforming Assets

	March 31,			December 31,
	2006			2005
	(Dollars in thousands)

Nonaccrual loans	$	300		$	319
Troubled debt restructurings	—			—
Loans contractually past due ninety or more days with respect to either principal or interest and still accruing interest	—
Nonperforming loans	300			319
Other real estate owned	—			1,056
Other nonperforming assets	—			—
Total nonperforming assets	$	300		$	1,375

Allowance for credit losses as a percent of nonaccrual loans	1520.7		%	1400.6		%
Allowance for credit losses as a percent of nonperforming loans	1520.7		%	1400.6		%
Total nonperforming assets as a percent of loans receivable	0.1		%	0.4		%
Total nonperforming assets as a percent of total shareholders’ equity	0.8		%	3.6		%

During the first quarter of 2006, we sold other real estate owned recording a $48,000 gain on sale. A single secured commercial loan was on nonaccrual status due to borrower financial weakness and uncertainty surrounding collateral value. The loan was originated as part of a settlement of a legal dispute and is current by way of advances from an interest reserve, typical for this type of financing. The borrower’s ability to repay our loan is highly dependent upon its success in marketing certain distribution rights.

ALLOWANCE FOR CREDIT LOSSES

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

We charged off $1,000 of loans during the first quarter of 2006, compared to $6,000 of loans charged off during the first quarter of 2005. There were no recoveries of loans previously charged off during the first quarter of 2006, respectively, compared to $3,000 during the first quarter of 2005. Pursuant to our evaluation of the allowance for credit losses at March 31, 2006, we recorded a provision for credit losses of $32,000 for the first quarter 2006.

the loan portfolio and realization of collateral upon a default. Accordingly, no assurance can be given that the Company 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 the allowance for credit losses and could require additional provisions for credit losses.

DEPOSITS

Total deposits were $405.4 million and $363.2 million at March 31, 2006 and December 31, 2005, respectively. Noninterest-bearing demand deposits increased to $122.6 million at March 31, 2006 compared to $115.9 million at December 31, 2005. Our noninterest-bearing demand deposits experience significant variability and seasonality due to the nature of our depositors’ businesses and the cash needs of our business customers for quarterly tax payments and owner distributions. Noninterest-bearing demand deposits declined significantly at December 31, 2005 from the fourth quarter average of $122.8 million; thus the increase at March 31, 2006 reflected a normalization following this year-end variability. Money market deposits and savings deposits were $91.9 million and $26.3 million, respectively, at March 31, 2006 compared to $76.3 million and $28.2 million, respectively, at December 31, 2005. Interest-bearing demand deposits, which for the most part are limited to individuals, decreased to $31.7 million at March 31, 2006 from $36.0 million at December 31, 2005. Interest-bearing demand deposits increased significantly at December 31, 2005 from the fourth quarter average of $32.6 million, thus the decline at March 31, 2006 reflected a normalization following the year-end variability. Time certificates of deposit increased to $132.8 million at March 31, 2006 from $106.7 million at December 31, 2005 due to an increase in brokered deposits. We had $60 million in brokered time certificates of deposit at March 31, 2006 compared to $37.5 million at December 31, 2005.

Additionally, although we have priced our retail certificates of deposit to encourage runoff during the past several years, in the rising rate environment experienced during the past 7 quarters, we have elected to only moderately increase rates on its immediately repriceable base of deposits – interest-bearing demand deposits, and savings and money market deposits – and price new time certificates of deposit to generate growth.

In a sustained rising interest rate environment, increases in deposit interest rates will be required to prevent net deposit withdrawals. Additionally, in order to generate new deposit growth, we have paid significantly higher rates than that paid on existing deposits.

SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

Securities sold under agreements to repurchased (“Repurchase Agreements”) totaled $15.0 million at March 31, 2006. We entered into the Repurchase Agreements to further our liquidity and interest rate sensitivity objectives. The Repurchase Agreements are adjustable rate and contain embedded interest rate floors that will result in an exponential decline in cost in the event of a sustained decline in interest rates. The embedded interest rate floors are clearly and closely related to the economic characteristics and risks of the underlying Repurchase Agreements and accordingly are not separated and accounted for as derivative instruments. We had no repurchase agreements at December 31, 2005.

OTHER BORROWINGS

There were $1.4 million of other borrowings, consisting of advances from the Federal Home Loan Bank, at March 31, 2006 compared to $28.3 million at December 31, 2005. The decline in other borrowings reflected repayment with alternative wholesale funding sources, including brokered time certificates of deposit and Repurchase Agreements.

SHAREHOLDERS’ EQUITY

Shareholders’ equity increased from $38.2 million at December 31, 2005 to $38.7 million at March 31, 2006 due to the retained earnings for the three months ended March 31, 2006 partially offset by a decrease in market value of interest rate swaps and securities available-for-sale.

CAPITAL ADEQUACY REQUIREMENTS

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

Regulatory Capital Information

of the National Mercantile Bancorp and Banks

	Minimum
	For Capital		Well
	Adequacy		Capitalized		March 31,		December 31,
	Purposes		Standards		2006		2005
National Mercantile Bancorp:
Tier 1 leverage	4.00	%	N/A		10.92	%	10.74	%
Tier 1 risk-based capital	4.00	%	N/A		12.13	%	11.98	%
Total risk-based capital	8.00	%	N/A		13.89	%	13.72	%

Mercantile National Bank:
Tier 1 leverage	4.00	%	5.00	%	10.47	%	10.49	%
Tier 1 risk-based capital	4.00	%	6.00	%	12.88	%	13.59	%
Total risk-based capital	8.00	%	10.00	%	14.13	%	14.84	%

South Bay Bank, NA:
Tier 1 leverage	4.00	%	5.00	%	8.98	%	9.04	%
Tier 1 risk-based capital	4.00	%	6.00	%	9.32	%	9.00	%
Total risk-based capital	8.00	%	10.00	%	10.54	%	10.22	%

LIQUIDITY

We manage our liquidity through a combination of core deposits, federal funds purchased, repurchase agreements, collateralized borrowing lines, and a portfolio of securities available for sale. Liquidity is also provided by maturing investment securities and loans.

Our cash and due from banks - demand was $15.2 million on March 31, 2006 compared to $13.5 million on December 31, 2005. Due from banks-interest-bearing was $2.0 million at March 31, 2006 and December 31, 2005. There was $2.8 million in Federal funds sold at March 31, 2006 compared to $685,000 at December 31, 2005. Mercantile had $12.5 million and South Bay had $10.0 million in Federal funds borrowing lines with correspondent banks as of March 31, 2006. Additionally, at March 31, 2006 we had $73.4 million remaining borrowing capacity at the FHLB against pledged loans and securities.

National Mercantile is a legal entity separate and distinct from the Banks and, therefore, it must provide for its own liquidity. National Mercantile’s principal sources of funds are proceeds from the sales of securities and dividends or capital distributions from the Banks. In addition to funding its own operating expenses, National Mercantile is responsible for the payment of the interest on the outstanding Junior Subordinated Debentures. The semiannual interest payments on the Junior Subordinated Debentures are deferrable at National Mercantile’s option, for a period up to ten consecutive semiannual payments, but in any event not beyond June 25, 2031. National Mercantile has not deferred any interest payments.

National Mercantile’s cash and due from banks, including interest-bearing, was $628,000 on March 31, 2006.

Dividends and capital distributions from the Banks constitute the principal ongoing source of cash to National Mercantile. 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. A bank’s ability to pay dividends in the future is, and could be, further influenced by regulatory policies or agreements and by capital guidelines.

Mercantile has an accumulated deficit and does not anticipate having positive cumulative retained earnings until 2008 at the current rate of earnings. South Bay had cumulative retained earnings of $3.8 million as of March 31, 2006. 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 likely that such consent could not be obtained unless the distributing bank remained “well capitalized” following such distribution.

ASSET LIABILITY MANAGEMENT

We manage interest rate sensitivity by matching the repricing opportunities on our earning assets to those on our funding liabilities. Various strategies are used to manage the repricing characteristics of 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, the use of derivative financial instruments (see Note 10 of the Notes to the Consolidated Financial Statements) and managing the deployment of 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.

The Company’s interest rate sensitivity position during a period of moderate rising interest rates is expected to have a positive impact on net interest income due to the Company’s large base of noninterest-bearing deposits as well as interest rates paid on funding liabilities typically change in smaller magnitude compared to changes in the yield of its substantial adjustable earning assets. Since interest rates began increasing in June 2004, the Company’s net interest income has in fact significantly increased with funding costs lagging the increase in earning asset yields. This lag in funding costs could narrow future net interest margins in the event that rates paid on deposits begin rising more rapidly due to increased funding needs or competitive pressures.

In a period of declining rates, such as the environment that was experienced during 2001 and 2002, the decline is expected to have a negative effect on the Company’s net interest income as changes in the rates of interest-bearing deposits historically have not changed in similar magnitude to changes in market interest rates. Additionally, in relatively low and declining interest rate environments, 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. To partially mitigate the negative effects of declining interest rates on its net interest margin, during the third quarter 2005 the Company accelerated its purchases of intermediate term investment securities which were partly funded by short-term liabilities. Additionally, the Company has entered into interest rate swap agreements and has purchased interest rate floors at various strike prices and terms that have the effect of further reducing its exposure to declining interest rates.

Net Income
Adjustment

Diluted
EPS
Adjustment

(Dollars in
thousands)

The Company’s results of operations and financial condition are affected by many factors, including the following:

Risk from changes in interest rates.

The success of the Company’s business depends, to a large extent, on its net interest income. Changes in market interest rates can affect net interest income by affecting the spread between interest-earning assets and interest-bearing liabilities. This may be due to the different maturities of 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:

· The Company’s ability to originate loans;

· The ability of borrowers to make payments on their loans;

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

· The average life of interest-earning assets;

· The ability to generate deposits instead of other available funding alternatives;

· The ability to access the wholesale funding market; and

· The value of our derivative financial instruments.

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

Risk from possible declines in the quality of the Company’s assets.

The Company’s financial condition depends significantly on the quality of its assets. While its has developed and implemented underwriting policies and procedures to guide management 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 non-performing assets rises, the 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.

Allowances for credit losses may be inadequate.

Allowances for credit losses are established against each segment of the loan portfolio. At March 31, 2006, the allowance for credit losses equaled 1.29% of loans receivable and 1520% of nonperforming loans. Although management believes that it has established adequate allowances for credit losses as of March 31, 2006, the credit quality of the Company’s assets is affected by many factors beyond its control, including local and national economic conditions, and the possible existence of facts which are not currently known which adversely affect the likelihood of repayment of various loans in the loan portfolio and realization of the collateral upon a default. Accordingly, there is no assurance that the Company 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 the 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 the loan portfolio. Increases in the provisions for credit losses would adversely affect the Company’s results of operations.

Economic conditions may worsen.

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

Because a significant amount of the loans are made to borrowers in Southern California, the Company’s operations could suffer as a result of local recession or natural disasters in California.

At March 31, 2006, a large majority of the loans outstanding were collateralized by real properties located in California. Because of this concentration in Southern California, the Company’s financial position and results of operations have been and 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 the loans, together with any primary financing on the mortgaged properties, equal or exceed the value of the mortgaged properties, the Company 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 the ability to recover losses on properties affected by such disasters and adversely impact the Company’s results of operations.

The Company’s business is very competitive.

There is intense competition in Southern California and elsewhere in the United States for banking customers. The Company experiences 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. The Company competes for loans and deposits primarily with other commercial banks, 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 the competitors have greater financial strength, marketing capability and name recognition, 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 small business customers. Such advantages may give the competitors opportunities to realize greater efficiencies and economies of scale than the Company can. There is no assurance that the Company will be able to compete effectively against its competition.

The Company’s business is heavily regulated.

Both National Mercantile as a bank holding company, and Mercantile and South Bay, as national banks, are subject to significant governmental supervision and regulation, which is intended primarily for the protection of depositors. Statutes and regulations affecting the Company may be changed at any time, and the interpretation of these statutes and regulations by examining authorities also may change. There is no assurance that future changes in applicable statutes and regulations or in their interpretation will not adversely affect the Company’s business.

Goodwill is evaluated annually and any impairment must be recorded as a charge to earnings.

Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” (“SFAS No. 142”), among other provisions, prescribes that goodwill and intangible assets that have indefinite useful lives will not be amortized but rather tested annually, or more frequently upon the occurrence of certain events, for impairment. SFAS No. 142 provides specific guidance for the testing of goodwill for impairment, which may require re-measurement of the fair value of the reporting unit. Impairment losses are to be reported as a charge to current period earnings.

The Company has goodwill of $3.2 million in connection with the South Bay acquisition in December 2001. During the fourth quarter of 2005, the required impairment tests of goodwill were completed. The tests determined that goodwill was not considered impaired. No assurance can be given that goodwill will not become impaired in the future.

The Company annually evaluates whether the deferred tax asset will be realized and must establish a valuation allowance if necessary to reduce it to its realizable value.

On a periodic basis, at least annually, an analysis is performed to determine if it is more likely than not that some or all of the gross deferred tax asset will not be realized. Factors used in the analysis that are reflective of the future realization of a deferred tax asset are:

· Future earnings are likely;

· Expected future taxable income arising from the reversal of temporary differences adequate to realize the tax asset

A valuation allowance may be established to reduce the deferred tax asset to its realizable value. The determination of whether a valuation allowance is necessary involves considering the positive and negative factors related to whether the deferred tax asset is more likely than not to be realized. 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 a valuation allowance to the deferred tax asset is necessary. No such valuation allowance existed at March 31, 2006.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements about the Company. Forward-looking statements consist of description of plans or objectives for future operations, products or services, forecasts of revenues, earnings or other measures of economic performance and assumptions underlying or relating to any of the foregoing. Because forward-looking statements discuss future events or conditions and not historical facts, they often include words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should” or similar expressions. Do not rely unduly on forward-looking statements. They give the Company’s expectations about the future and are not guarantees or predictions of futures events, conditions or results. Forward-looking statements speak only as of the date they are made, and the Company does not undertake to update them to reflect changes that occur after that date.

Many factors, most beyond the Company’s control, could cause actual results to differ significantly from the Company’s expectations. These include, among other things, changes in interest rates which reduce interest margins, impact funding sources or diminish loan demand; increased competitive pressures; adverse changes in national and local economic conditions, and in real estate markets in California; changes in fiscal policy, monetary policy; legislative or regulatory environments, requirements or changes which adversely affect the Company; and declines in the credit quality of the Company’s loan portfolio. See “Factors Which May Affect Future Operating Results.”

ITEM 3. CONTROLS AND PROCEDURES

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

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

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

As a result of a recent interpretation on the “short cut” method of accounting for derivatives as hedges under of SFAS 133, the Company undertook additional review and testing of its internal controls. After initial discussions with its auditors, the Audit Committee held a meeting on August 8, 2006 to review with management the potential impact of these matters. After completing further analysis, management recommended to the Audit Committee, at a follow-up meeting held on August 14, 2006, that previously reported financial results be restated to eliminate hedge accounting for the derivative. The Audit Committee agreed with management’s recommendation.

In connection with this amended Form 10-QSB, under the direction of our Chief Executive Officer and Chief Financial Officer, we reevaluated our disclosure controls and procedures. We considered the reasons why the restatement was necessary and whether the restatement resulted from a material weakness in our disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer determined that the restatement does not affect their conclusion that our disclosure controls and procedures were effective as of March 31, 2006. Factors that led to this determination included: (i) we had retained and received advice from professional experts in the accounting for derivatives as hedges transactions at the time of the transaction and in connection with subsequent financial reporting, including our Form 10-QSB for the quarter ended March 31, 2006; (ii) the accounting treatment previously used by us was consistent with industry practice; (iii) our interpretation of the accounting rules under SFAS No. 133 was reasonable; and (iv) management, and our Audit Committee, identified the recent interpretation on the “short cut” method of accounting for derivatives as hedges that resulted in the restatement of our financial statements.

There was no change in the Company's internal control over financial reporting during the Company’s most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

None.

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

None.

Item 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

None.

Item 5. OTHER INFORMATION

None.

Item 6. EXHIBITS

31.1 Certification of Scott A. Montgomery on disclosure controls

31.2 Certification of David R. Brown on disclosure controls

32.1 Certification of Scott A. Montgomery pursuant to section 906 of the Sarbanes-Oxley Act of 2002

32.2 Certification of David R. Brown pursuant to section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

Pursuant to the requirements 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)

DATE:	October 2, 2006	/s/ SCOTT A. MONTGOMERY
		Scott A. Montgomery
		Chief Executive Officer

DATE:	October 2, 2006	/s/ DAVID R. BROWN
		David R. Brown
		Principal Financial and Principal Accounting Officer