UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-QSB

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

for the quarterly period ended June 30, 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

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)

	June 30,			December 31,
	2006			2005
	(Dollars in thousands)
ASSETS
Cash and due from banks-demand	$	15,002		$	13,507
Due from banks-interest bearing	2,263			2,000
Federal funds sold	600			685
Cash and cash equivalents	17,865			16,192
Securities available-for-sale, at fair value; aggregate amortized cost of $104,577 and $72,428 at June 30, 2006 and December 31, 2005, respectively	101,701			71,758
Securities held-to-maturity, at amortized cost; aggregate fair value of $2,177 and $2,572 at June 30, 2006 and December 31, 2005, respectively	2,269			2,612
Federal Reserve Bank and other stock	3,682			3,809
Loans receivable	351,229			338,558
Allowance for credit losses	(4,648		)	(4,468		)
Net loans receivable	346,581			334,090

Premises and equipment, net	5,902			5,861
Other real estate owned	—			1,056
Deferred tax asset, net	4,198			4,442
Goodwill	3,225			3,225
Intangible assets, net	1,295			1,407
Accrued interest receivable and other assets	4,684			4,007
Total assets	$	491,402		$	448,459

LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest-bearing demand	$	115,650		$	115,924
Interest-bearing demand	30,973			36,018
Money market	97,578			76,334
Savings	24,103			28,208
Time certificates of deposit:
$100,000 or more	86,756			87,468
Under $100,000	17,516			19,256
Total deposits	372,576			363,208

Securities sold under agreement to repurchase	45,000			—
Other borrowings	12,250			28,337
Junior subordinated deferrable interest debentures	15,464			15,464
Accrued interest payable and other liabilities	7,076			3,288
Total liabilities	452,366			410,297

Shareholders’ equity:
Preferred stock, no par value-authorized 1,000,000 shares: Series B non-cumulative convertible perpetual preferred stock; authorized 1,000 shares; outstanding 1,000 shares at June 30, 2006 and December 31, 2005	1,000			1,000
Common stock, no par value-authorized 10,000,000 shares: outstanding 5,543,891 shares and 5,503,780 shares at June 30, 2006 and December 31, 2005, respectively	46,177			45,697
Accumulated deficit	(5,178		)	(7,381		)
Accumulated other comprehensive loss	(2,963		)	(1,154		)
Total shareholders’ equity	39,036			38,162
Total liabilities and shareholders’ equity	$	491,402		$	448,459

See accompanying notes to consolidated financial statements.

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

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

See accompanying notes to consolidated financial statements.

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

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

Supplemental disclosures of cash flow information:
Cash paid for interest	$	4,324		$	1,857
Cash paid for income taxes	730			800
Unrealized loss on securities available-for-sale, net of tax effect	1,290			20
Unrealized gain (loss) on cash flow hedges, net of tax effect	$	(519	)	$	44

See accompanying notes to consolidated financial statements.

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1—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 six months ended June 30, 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.

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

NOTE 2—EARNINGS PER SHARE

Basic earnings per share are 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 reflects 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:

	Earnings		Weighted
	available to		Average		Per share
	shareholders		Shares		amount
	(in thousands)

For the three months ended June 30, 2006:
Basic EPS	$	1,146	5,542,441		$	0.21

Effect of dilutive securities:
Options			250,679
Convertible preferred stock			242,406
Diluted earnings per share	$	1,146	6,035,527		$	0.19

For the three months ended June 30, 2005 (as restated):
Basic and diluted loss per share	$	1,378	3,908,376		$	0.35

Effect of dilutive securities:
Options			250,103
Convertible preferred stock			1,720,875
Diluted earnings per share	1,378		5,879,355		$	0.23

For the six months ended June 30, 2006:
Basic EPS	$	2,202	5,530,479		$	0.40

Effect of dilutive securities:
Options			259,047
Convertible preferred stock			229,535
Diluted earnings per share	$	2,202	6,019,060		$	0.37

For the six months ended June 30, 2005 (as restated):
Basic EPS	$	2,199	3,812,796		$	0.58

Effect of dilutive securities:
Options			248,186
Convertible preferred stock			1,800,579
Diluted earnings per share	$ 2,199		$	5,861,561	0.38

NOTE 3—CASH 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 4—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 second quarter 2006, the Company charged off no loans and recovered no loans previously charged off. Pursuant to management’s evaluation of the allowance for loan and lease losses at June 30, 2006, a provision for credit losses of $40,000 and $72,000 was recorded for the three months and six months ended June 30, 2006, respectively. There was no provision for credit losses during the second quarter 2005 and $89,000 for the six months ended June 30, 2005.

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

	Six Months ended June 30,
	2006		2005
	(Dollars in thousands)

Balance, beginning of period	$	4,468	$	3,511
Total loans charged-off	1		6
Total recoveries of loans previously charged off	—		135
Net charge-offs	1		(129		)
Provision for credit losses	72		89
Transfer (to) from reserve for contingent losses on unfunded commitments	109		(60		)
Balance, end of period	$	4,648	$	3,669

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 5—GOODWILL AND CORE DEPOSIT INTANGIBLES

As of June 30, 2006 and December 31, 2005, the Company had goodwill of $3.2 million, and net core deposit intangibles of $1.3 million and $1.4 million, respectively, from its acquisition of South Bay Bank in December 2001. The gross carrying amount of core deposit intangibles was $2.3 million at June 30, 2006 and December 31, 2005, and accumulated amortization was $1.0 million and $900,000, 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 6—REPURCHASE AGREEMENTS

At June 30, 2006, the Company had $45.0 million of securities sold under agreement to repurchase (“Repurchase Agreements”). At December 31, 2005, there were no Repurchase Agreements. The Repurchase Agreements are adjustable, indexed to LIBOR, and contain embedded interest rate floors with various strike rates for terms ranging two to three 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 floors have not been separated from the Repurchase Agreements and accounted for as a derivative instrument because (i) the strike rate was below the LIBOR index at issuance of the Repurchase Agreements and it is clearly and closely related to the economic characteristics and risks of the Repurchase Agreements, and (ii) the Repurchase Agreements are not remeasured at fair value under otherwise applicable generally accepted accounting principles with changes in fair value reported in earnings.

NOTE 7—INCOME TAXES

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

At June 30, 2006, the Company had: (i) federal net operating loss carry forwards (“NOLS”) of approximately $402,000, which begin to expire in the year 2009; and (ii) federal alternative minimum tax (“AMT”) credits of $637,000. 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 8—SHARE-BASED PAYMENTS

At June 30, 2006, the Company had one stock incentive plan pursuant to which up to a total of 312,000 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 June 30, 2006, the only outstanding awards under this plan were stock options, and at that date 192,213 shares were available for future awards. At June 30, 2006, there were also outstanding options granted under two prior stock incentive plans. The activity of stock options for the six months ended June 30, 2006 is as shown:

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

Exercisable,June 30, 2006	396,625		$	6.51	4.3	$	2,682

The Financial Accounting Standards Board 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 and director 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 or director 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 ending on or prior to December 31, 2005.

For the three months and six months ended June 30, 2006, share-based compensation expense was $100,000 and $185,000 respectively, resulting in similar charges to net income before income tax and net income for the periods. The share-based compensation expense decreased both basic and diluted earnings per share by $0.02 for the quarter ended June 30, 2006 and $0.03 for the six months ended June 30, 2006. The income tax benefit for the six months ended June 30, 2006 was immaterial as nearly all unvested stock options were qualified incentive stock options. For the six months ended June 30, 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 three months and six months ended June 30, 2005 are presented below to reflect the impact had the Company been required to recognize compensation expense based on SFAS 123R:

	Three Months Ended June 30, 2005		Six Months Ended June 30, 2005
	(Dollars in thousands)

Reported net income	$	1,378	$	2,199
Deduct: Toal share-based compensation expense determined using fair value method, net of related tax effects	41		78
	$ 1,337		$	2,121

Basic earnings per share:
As reported	$	0.35	$	0.58
Pro forma	$	0.34	$	0.56

Diluted earnings per share:
As reported	$	0.23	$	0.38
Pro forma	$	0.23	$	0.36

The estimated per share weighted average fair value of options granted in the six months ended June 30, 2006 and 2005 was $5.99 and $9.59, respectively. The total intrinsic value of options exercised during the six months ended June 30, 2006 was $268,000. As of June 30, 2006, total unrecognized compensation cost related to stock options issued but unvested was $340,000 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 six months ended June 30, 2006, the expected volatility assumption of 32.0% 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 4.60% 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 six months ended June 30, 2006, are as follows: expected volatility 43%; expected term 10 years; risk-free interest rate 5.0%; and dividend yield 0%.

NOTE 9—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 June 30,						Six Months ended June 30,
	2006			2005			2006			2005
	(Dollars in thousands)						(Dollars in thousands)

Net income	$	1,146		$	1,378		$	2,202		$	2,199
Unrealized gain (loss) on interest rate swaps used in cash flow hedges	(317		)	712			(821		)	(370		)
Unrealized loss on interest rate floors used in cash flow hedges	(24		)	(26		)	(248		)	(26		)
Unrealized gain (loss) on securities available for sale	(1,409		)	260			(2,205		)	(34		)

Other comprehensive income (loss), before tax	(1,750		)	946			(3,274		)	(430		)
Income tax benefit (expense) related to items of other comprehensive income	705			(388		)	1,149			179
Other comprehensive income (loss)	(1,045		)	558			(2,125		)	(251		)
Total comprehensive income	$	101		$	1,936		$	77		$	1,948

NOTE 10—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. 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 derivative financial instruments and the related fair values:

	June 30, 2006					December 31, 2005
	Notional Amount		Fair Value			Notional Amount		Fair Value
	(Dollars in thousands)
Fair value hedges:
Interest rate swaps	$	50,000	$	(132	)	$	20,000	$	(23	)

Cash flow hedges:
Interest rate swaps	$	50,000	$	(1,872	)	$	50,000	$	(1,034	)
Interest rate floors	$	50,000	$	21		$	50,000	$	268

Other economic derivatives:
Interest rate floors	$	—	$	—		$	150,000	$	—
Interest rate swaps	$	15,000	$	(1,393	)	$	15,000	$	(575	)

Fair value hedges minimize the risk of changes in the fair values of assets, liabilities and certain types of firm commitments. The Company uses interest rate swaps to hedge the changes in the fair values 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 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 June 30, 2006, a loss of $1.1 million was recorded in accumulated other comprehensive income and no ineffectiveness was recorded to earnings for the six months ended June 30, 2006 related to these cash flow hedges. The premiums paid for the interest rate floors are amortized over the life of the floors.

Other economic derivatives not designated as hedges are interest rate swaps and interest rate floors that do not meet the strict criteria for hedge accounting treatment. The Company does not utilize derivatives for purely speculative purposes. The Company uses 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. The Company uses

an interest rate swap to hedge the change in fair value of its junior subordinated deferrable interest debentures, however, at June 30, 2006 and 2005 this swap was not designated as a fair value hedge. Derivatives not designated as hedges are marked-to-market through earnings as a trading gain or loss on economic derivatives. The following table reflects the effect of the trading gains and losses on economic derivatives for the periods shown:

	Three Months ended					Six Months ended
	June 30,			June 30,		June 30,			June 30,
	2006			2005		2006			2005
	(Dollars in thousands)
Trading gain (loss) on economic derivatives, gross	$	(369	)	$	582	$	(817	)	$	378
Income tax benefit (expense) related to economic derivatives	(153		)	242		(339		)	157
Trading gain (loss) on economic derivatives, net of income taxes	$	(216	)	$	340	$	(478	)	$	221

The value of the swap is largely influenced by the level of current interest rates and market participants’ expectations for the levels of future rates. Accordingly, the value of the swap, and the related trading gains or losses on economic derivatives can be expected to fluctuate from period to period, and the results in any period are not indicative of the results that can be expected in any future period.

NOTE 11—RESTATEMENT

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

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

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

	December 31, 2005
	As Originally Reported			As Restated
	(Dollars in thousands)
Deferred tax asset, net	$	4,203		$	4,442
Accrued interest receivable and other assets	4,583			4,007
Total assets	448,796			448,459

Accumulated deficit	(7,044		)	(7,381		)
Total shareholders’ equity	38,499			38,162

The following table shows the effect of the restatement for the periods shown:

	Three Months Ended					Six Months Ended
	June 30, 2005					June 30, 2005
	As Originally Reported		As Restated			As Originally Reported		As Restated
	(Dollars in thousands)
Net interest income before provision for credit losses	$	5,073	$	5,073		$	9,934	$	9,934

Net cash settlement of interest rate swap derivative	—		(100		)	—		(216		)
Total net interest income	5,073		4,973			9,934		9,718
Provision (benefit) for credit losses	—		—			89		89
Net interest income after provision for credit losses	5,073		4,973			9,845		9,629
Total other operating income	299		299			621		621
Net cash settlement of interest rate swap derivative	—		100			—		216
Change in fair value of interest rate swap derivative	—		582			—		378
Total non-interest income	299		981			621		1,215
Total other operating expenses	3,599		3,599			7,085		7,085
Income before taxes	1,773		2,355			3,381		3,759
Income tax expense	736		736			1,403		1,403
Income tax effect on restatement	—		241			—		157
Total income tax expense	736		977			1,403		1,560
Net income	$	1,037	$	1,378		$	1,978	$	2,199

Net income per share – Basic	$	0.27	$	0.35		$	0.52	$	0.58
Net income per share – Diluted	$	0.18	$	0.23		$	0.34	$	0.38

NOTE 12—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.

NOTE 13—RECLASSIFICATIONS

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

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’’ or “we” on a consolidated basis) is the holding company for two subsidiary banks, Mercantile National Bank (“Mercantile”) and South Bay Bank, N.A. (“South Bay”) (collectively, “the Banks”). 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.

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

RESULTS OF OPERATIONS OVERVIEW

We recorded net income of $1.1 million, or $0.21 basic earnings per share and $0.19 diluted earnings per share, for the three months ended June 30, 2006 compared to net income of $1.4 million, or $0.35 basic earnings per share and $0.23 diluted earnings per share, for the same period of 2005. The decrease in net income for the second quarter of 2006 was due to a $369,000 of trading losses on economic derivatives related to an interest rate swap not designated as a hedge as compared to a $582,000 gain for the three months ended June 30, 2005, or a change of $951,000. Net interest income before provision for credit losses increase by $993,000 primarily due to increases in the prime rate lending index, and a greater volume of interest earning assets, particularly higher-yielding loans receivable and securities available-for-sale. Noninterest expense for the second quarter of 2006 increased $220,000. 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 $100,000 to earnings for the three months ended June 30, 2006.

We recorded net income of $2.2 million for both the six month periods ended June 30, 2006 and 2005. This represented $0.40 basic earnings per share and $0.37 diluted earnings per share, for the six months ended June 30,

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

Return on average assets during the second quarter and first half of 2006 was 0.94% and 0.93%, respectively, compared to 1.44% and 1.13% during the second quarter and first half of 2005, respectively. Return on average equity during the second quarter and first half of 2006 was 11.63% and 11.17%, respectively, compared to 15.43% and 12.38% during the second quarter and first half of 2005.

NET INTEREST INCOME

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

Loan interest income increased $1.9 million due to $48.5 million greater average volume of loans receivable and a 110 basis point increase in yield, primarily due to increases in the prime rate lending index. During 2005, the Federal Reserve Bank increased interest rates 200 basis points on eight occasions and, continuing into the first half of 2006, another 100 basis points on four occasions. Approximately 80% of our $351 million loans receivable at June 30, 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 second quarter of 2006 were partially offset by the rising cost of the interest rate swaps.

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

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 averaged $104.6 million greater during the second quarter 2006 compared to 2005 while the higher interest rates and favorable change in composition to higher-yielding assets resulted in an 89 basis point increase in weighted average yield on interest-earning assets.

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

During the rising interest rate environment experienced during the past eight 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 199 basis points during the second quarter of 2006 compared to second quarter 2005. The cost of money market and savings deposits increased 159 basis points

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

The volume of other borrowings averaged $10.9 million and $5.4 million during the second 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 5.14% and 2.89% for 2006 and 2005 periods, respectively, representing an increase of 225 basis points for the second quarter of 2006.

Securities sold under agreement to repurchase (“Repurchase Agreements”) averaged $28.4 million during the second quarter of 2006 with a cost of 5.18%. The Repurchase Agreements, totaling $45 million at June 30, 2006 with adjustable interest rate based upon the 3-month LIBOR index and have embedded floors with varying strike rates ranging from 4.00% to 4.75%, 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 $115.5 million during the second quarter 2006 or $10.9 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 5.26% and 5.69% during the second quarter in 2006 and 2005, respectively, while the net interest spread was 4.25% and 4.93%, respectively. The net interest margin and net interest spread during the second quarter of 2006 have declined from recent quarters largely due to the securities leverage strategy – intermediate-term security purchases financed with adjustable wholesale funds – executed to reduce our balance sheet asset sensitivity. While the strategy protects against a possible decline in interest rates, the current margin on such leverage is relatively thin. Also, the second quarter of 2006 continued to experience a flat or inverted yield curve in which short-term rates have risen to or above the level of long-term interest rates. A preponderance of our funding sources are correlated to the short-term rates. Additionally, the net interest spread has been effected by a decline in net earning assets due to a lower proportion of noninterest-bearing deposits funding earning assets.

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

Loan interest income increased $3.5 million to $14.6 million due to $41.3 million greater average volume of loans receivable and a 114 basis point increase in yield, resulting primarily from increases in the prime rate lending index. The higher yields earned on our loans receivable during the first half of 2006 were partially offset by the rising cost of the interest rate swaps.

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

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

Interest expense increased $3.1 million during the first half of 2006 compared to the same period in 2005 due to a $88.1 million increase in average interest-bearing liabilities and a 142 basis point increase in the weighted average cost of interest-bearing liabilities. Interest expense on deposits increased $2.3 million due to a 147 basis point rise in weighted average cost of interest-bearing deposits in addition to $62.6 million greater average volume than 2005. Time certificates of deposit $100,000 and over averaged $46.6 million greater during the 2006 period than 2005 due to an increased volume of Brokered CDs. The average volume of money market and savings deposits increased $17.9 million during the first half of 2006 compared to first half of 2005.

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

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

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

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

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

The following table presents the components of net interest income for the three months ended June 30, 2006 and 2005.

	Three Months ended
	June 30, 2006							June 30, 2005
						Weighted							Weighted
				Interest		Average					Interest		Average
	Average			Income/		Yield/		Average			Income/		Yield/
	Amount			Expense		Rate		Amount			Expense		Rate
	(Dollars in thousands)
Assets:
Federal funds sold and securities purchased under agreements to resell	$	1,211		$	13	4.31	%	$	2,526		$	19	3.02	%
Due from banks-interest-bearing	2,500			30		4.81	%	2,032			18		3.55	%
Securities available-for-sale	98,047			1,295		5.30	%	40,235			346		3.44	%
Securities held-to-maturity	2,372			24		4.06	%	3,194			31		3.88	%
Loans receivable (1) (2)	350,878			7,551		8.63	%	302,382			5,675		7.53	%
Total interest earning assets	455,008			8,913		7.86	%	350,369			6,089		6.97	%

Noninterest earning assets:
Cash and due from banks - demand	16,636							16,352
Other assets	22,370							20,881
Allowance for credit losses and net unrealized gain on sales of securities available-for-sale	(6,642		)					(4,358		)
Total assets	$	487,372						$	383,244

Liabilities and shareholders’ equity:
Interest-bearing deposits:
Demand	$	32,056		60		0.75	%	$	30,865		35		0.45	%
Money market and savings	125,394			797		2.55	%	97,512			234		0.96	%
Time certificates of deposit:
$100,000 or more	91,657			991		4.34	%	44,198			259		2.35	%
Under $100,000	24,032			196		3.27	%	26,175			152		2.33	%
Total time certificates of deposit	115,689			1,187		4.12	%	70,373			411		2.34	%
Total interest-bearing deposits	273,139			2,044		3.00	%	198,750			680		1.37	%
Other borrowings	10,853			139		5.14	%	5,404			39		2.89	%
Junior subordinated debentures	15,464			397		10.30	%	15,464			397		10.30	%
Federal funds purchased and securities sold under agreements to repurchase	28,406			367		5.18	%	—			—		—
Total interest-bearing liabilities	327,862			2,947		3.61	%	219,618			1,116		2.04	%

Noninterest-bearing liabilities:
Noninterest-bearing demand deposits	115,474							126,399
Other liabilities	4,628							1,497
Shareholders’ equity	39,408							35,730
Total liabilities and shareholders’ equity	$	487,372						$	383,244

Net interest income (spread)				$	5,966	4.25	%				$	4,973	4.93	%

Net yield on earning assets (2)						5.26	%						5.69	%

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

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

The following table presents the components of net interest income for the six months ended June 30, 2006 and 2005.

	Six Months ended
	June 30, 2006							June 30, 2005
						Weighted							Weighted
				Interest		Average					Interest		Average
	Average			Income/		Yield/		Average			Income/		Yield/
	Amount			Expense		Rate		Amount			Expense		Rate
	(Dollars in thousands)
Assets:
Federal funds sold and securities purchased under agreements to resell	$	829		$	18	4.38	%	$	2,098		$	29	2.79	%
Due from banks-interest-bearing	2,103			51		4.89	%	2,378			34		2.88	%
Securities available-for-sale	87,950			2,254		5.17	%	40,073			680		3.42	%
Securities held-to-maturity	2,459			50		4.10	%	3,304			65		3.97	%
Loans receivable (1) (2)	346,831			14,591		8.48	%	305,556			11,118		7.34	%
Total interest earning assets	440,172			16,964		7.77	%	353,409			11,926		6.81	%

Noninterest earning assets:
Cash and due from banks - demand	15,814							17,736
Other assets	23,008							20,726
Allowance for credit losses and net unrealized gain on sales of securities available-for-sale	(5,940		)					(4,213		)
Total assets	$	473,054						$	387,658

Liabilities and shareholders’ equity:
Interest-bearing deposits:
Demand	$	32,478		102		0.63	%	$	31,448		67		0.43	%
Money market and savings	118,180			1,381		2.36	%	100,307			454		0.91	%
Time certificates of deposit:
$100,000 or more	88,917			1,759		3.99	%	42,352			467		2.22	%
Under $100,000	24,096			372		3.11	%	26,973			294		2.20	%
Total time certificates of deposit	113,013			2,131		3.80	%	69,325			761		2.21	%
Total interest-bearing deposits	263,671			3,614		2.76	%	201,080			1,282		1.29	%
Other borrowings	15,326			363		4.78	%	10,244			133		2.62	%
Junior subordinated debentures	15,464			793		10.34	%	15,464			793		10.34	%
Federal funds purchased and securities sold under agreements to repurchase	20,415			512		5.06	%	—			—		0.00	%
Total interest-bearing liabilities	314,876			5,282		3.38	%	226,788			2,208		1.96	%

Noninterest-bearing liabilities			:
Noninterest-bearing demand deposits	114,428							123,917
Other liabilities	4,329							1,423
Shareholders’ equity	39,421							35,530
Total liabilities and shareholders’ equity	$	473,054						$	387,658

Net interest income (spread)				$	11,682	4.39	%				$	9,718	4.85	%

Net yield on earning assets (2)						5.35	%						5.55	%

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

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

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

Average Volume and Average Rate (1)

	Three Months ended June 30,
	2006 vs 2005
						Net
	Increase (decrease) due to:					Increase
	Volume			Rate		(Decrease)
	(Dollars in thousands)
Interest Income:
Federal funds sold and securities purchased
Federal funds sold	$	(10	)	$	4	$	(6	)
Interest-bearing deposits with other financial institutions	4			8		12
Securities available-for-sale	496			453		949
Securities held-to-maturity	(8		)	1		(7		)
Loans receivable (2)	910			966		1,876
Total interest-earning assets	1,392			1,432		2,824

Interest Expense:
Interest-bearing deposits:
Demand	$	1		$	24	$	25
Money market and savings	67			496		563
Savings
Time certificates of deposit:
$100,000 or more	278			454		732
Under $100,000	(12		)	56		44
Total time certificates of deposit	266			510		776
Total interest-bearing deposits	334			1,030		1,364
Other borrowings	39			61		(100		)
Junior subordinated debentures	—			—		—
Federal funds purchased and securities sold under agreements to repurchase	367			—		367
Total interest-bearing liabilities	740			1,091		1,831

Net interest income	$	652		$	341	$	993

(1) The change in interest income or 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.

	Six Months ended June 30,
	2006 vs 2005
						Net
	Increase (decrease) due to:					Increase
	Volume			Rate		(Decrease)
	(Dollars in thousands)

Interest Income:
Federal funds sold	$	(18	)	$	7	$	(11	)
Interest-bearing deposits with other financial institutions	(4		)	21		17
Securities available-for-sale	812			762		1,574
Securities held-to-maturity	(17		)	2		(15		)
Loans receivable (2)	1,502			1,971		3,473
Total interest-earning assets	2,275			2,763		5,038

Interest Expense:
Interest-bearing deposits:
Demand	$	2		$	33	$	35
Money market and savings	81			846		927
Time certificates of deposit:
$100,000 or more	513			779		1,292
Under $100,000	(31		)	109		78
Total time certificates of deposit	482			888		1,370
Total interest-bearing deposits	565			1,767		2,332
Other borrowings	66			164		230
Junior subordinated debentures	—			—		—
Federal funds purchased and securities sold under agreements to repurchase	512			—		512
Total interest-bearing liabilities	1,143			1,931		3,074

Net interest income	$	1,132		$	832	$	1,964

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

PROVISION FOR CREDIT LOSSES

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

OTHER OPERATING INCOME (LOSS)

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

Deposit-related fees decreased in 2006 compared to 2005 due to higher compensating balance rates and changes in fee structure. Other operating income includes the net settlement payments on the interest rate swap not designated as a hedge. The 2006 periods reflect a decline in net settlement payments under this swap due to rising interest rates.

Other operating income for the first half of 2006 included a $47,000 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 were $3.8 million for the three months ended June 30, 2006 compared to $3.6 million for the same period of 2005. Significant variances within operating expenses were: (i) salaries and related benefits expense increased $345,000 or 18.7% 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 $288,000 or 93.5% primarily due to fewer problem assets and the decline in related legal activity; and (iii) other professional services expense increased $65,000 or 22.8% due to increased costs for audit services, recruiting fees and directors’ fees.

Other operating expenses were $7.5 million for the six months ended June 30, 2006 compared to $7.1 million for the same period of 2005. Significant variances within operating expenses were, similar to the quarterly results, (i) salaries and related benefits expense increased $596,000 or 16.2% due to the adoption of SFAS 123R, which accounted for $185,000 of this increase, and the addition of business development staff and increased incentive expense; (ii) legal services expense decreased $362,000 or 79.4% primarily due to fewer problem assets and the decline in related legal activity; and (iii) other professional services expense increased $115,000 or 21.3% 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

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

FRB and other equity stocks	$	3,682	—		—		$	3,682

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

	$	2,269	$	—	$	92	$	2,177

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

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

	December 31, 2005
	Total		Gross		Gross		Estimated
	amortized		unrealized		unrealized		fair
	cost		gains		loss		value
	(Dollars in thousands)

Held-to-Maturity:
FHLMC/FNMA-issued mortgage pass through certificates	$	2,612	$	—	$	40	$	2,572

	$	2,612	$	—	$	40	$	2,572

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

LOAN PORTFOLIO

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

	June 30,					December 31,
	2006					2005
	Amount			Percent		Amount			Percent
	(Dollars in thousands)
Commercial loans - secured and unsecured	$	91,485		26	%	$	89,474		26	%
Real estate loans:
Secured by commercial real properties.	137,177			39	%	121,641			36	%
Secured by one to four family residential properties	8,431			2	%	10,498			3	%
Secured by multifamily residential properties	18,786			5	%	18,663			6	%
Total real estate loans	164,394			47	%	150,802			45	%
Construction and land development	88,717			25	%	92,077			27	%
Consumer installment, home equity and unsecured loans to individuals	7,686			2	%	7,239			2	%
Total loans outstanding	352,282			100	%	339,592			100	%

Deferred net loan origination fees	(1,053		)			(1,034		)
Loans receivable, net	$	351,229				$	338,558

Loans receivable increased $12.7 million to $351.2 million at June 30, 2006 compared to $338.6 million at December 31, 2005 primarily due to increased funding of commercial real estate loans and to a lesser extent, secured and unsecured commercial loans. We have increased funding of intermediate-term fixed rate commercial real estate loans as part of our interest rate risk management strategy. The balance of construction loans declined at June 30, 2006 from year end 2005 due to a greater volume of payoffs of outstanding loans than additional funding of loan commitments and newly generated loans. Commitments to fund loans at June 30, 2006 totaled $95.0 million compared to $116.7 million at December 31, 2005.

NONPERFORMING ASSETS

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

	June 30,			December 31,
	2006			2005
	(Dollars in thousands)

Nonaccrual loans	$	343		$	319
Troubled debt restructurings	—			—
Loans contractually past due ninety or more days with respect to either principal or interest and still accruing interest	—			—
Nonperforming loans	343			319
Other real estate owned	—			1,056
Other nonperforming assets	—			—
Total nonperforming assets	$	343		$	1,375

Allowance for credit losses as a percent of nonaccrual loans	1355.1		%	-1400.6		%
Allowance for credit losses as a percent of nonperforming loans	1355.1		%	1400.6		%
Total nonperforming assets as a percent of loans receivable	0.1		%	0.4		%
Total nonperforming assets as a percent of total shareholders’ equity	0.9		%	3.6		%

During the six months ended June 30, 2006, we sold other real estate owned recording a $47,000 gain on sale during the first quarter of 2006. A single secured commercial loan was 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.

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

We charged off $1,000 of loans during the six months ended June 30, 2006 compared to $6,000 of loans charged off during the same period of 2005. There were no recoveries of loans previously charged off during the six months

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

The following table reflects the balances and activity in the allowance for loan losses for the dates shown:

	Six Months ended June 30,
	2006		2005
	(Dollars in thousands)

Balance, beginning of period	$	4,468	$	3,511
Total loans charged-off	1		6
Total recoveries of loans previously charged off	—		135
Net charge-offs	1		(129		)
Provision for credit losses	72		89
Transfer (to) from reserve for contingent losses on unfunded commitments	109		(60		)
Balance, end of period	$	4,648	$	3,669

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, 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 $372.6 million and $363.2 million at June 30, 2006 and December 31, 2005, respectively. Noninterest-bearing demand deposits were nearly flat at $115.7 million at June 30, 2006 compared to $115.9 million at December 31, 2005. Money market deposits and savings deposits were $97.6 million and $24.1 million, respectively, at June 30, 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 $30.9 million at June 30, 2006 from $36.0 million at December 31, 2005. Time certificates of deposit decreased to $104.3 million at June 30, 2006 from $106.7 million at December 31, 2005. Our Brokered CDs increased to $50.0 million at June 30, 2006 compared to $37.5 million at December 31, 2005. The Brokered CDs are typically 1-year terms and have been swapped to adjustable rate. We utilize the brokered CDs as part of our interest rate risk management and liquidity management strategies.

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 8 quarters, we have elected to only moderately

increase rates on our 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. Also, we have been making more frequent exceptions to our posted rates in order to generate and retain deposits.

SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

Repurchase Agreements totaled $45.0 million at June 30, 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.

JUNIOR SUBORDINATED DEBENTURES

The recorded balance of Junior Subordinated Debentures was $15.5 million at June 30, 2006 and December 31, 2005. The Junior Subordinated Debentures have a 10.25% fixed rate and are due July 25, 2031. 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.

OTHER BORROWINGS

There were $12.3 million of other borrowings, consisting of overnight advances from the Federal Home Loan Bank, at June 30, 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 $39.0 million at June 30, 2006 due to the retained earnings for the six months ended June 30, 2006 partially offset by a decrease in market value of cash flow hedge derivatives and securities available-for-sale.

CAPITAL ADEQUACY REQUIREMENTS

At June 30, 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 June 30, 2006 and December 31, 2005.

Regulatory Capital Information
of the National Mercantile Bancorp and Banks

	Minimum
	For Capital		Well
	Adequacy		Capitalized		June 30,		December 31,
	Purposes		Standards		2006		2005
National Mercantile Bancorp:
Tier 1 leverage	4.00	%	N/A		11.72	%	10.84	%
Tier 1 risk-based capital	4.00	%	N/A		12.68	%	12.10	%
Total risk-based capital	8.00	%	N/A		14.05	%	13.81	%

Mercantile National Bank:
Tier 1 leverage	4.00	%	5.00	%	9.11	%	10.49	%
Tier 1 risk-based capital	4.00	%	6.00	%	11.95	%	13.59	%
Total risk-based capital	8.00	%	10.00	%	13.20	%	14.84	%

South Bay Bank, NA:
Tier 1 leverage	4.00	%	5.00	%	10.06	%	9.04	%
Tier 1 risk-based capital	4.00	%	6.00	%	10.29	%	9.00	%
Total risk-based capital	8.00	%	10.00	%	11.46	%	10.22	%

LIQUIDITY

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 interest and principal payments on securities and loans.

Our cash and due from banks - demand was $15.0 million on June 30, 2006 compared to $13.5 million on December 31, 2005. Due from banks-interest-bearing was $2.3 million at June 30, 2006 and $2.0 million at December 31, 2005. There was $600,000 in Federal funds sold at June 30, 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 June 30, 2006. Additionally, at June 30, 2006 we had $42.1 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, including interest-bearing deposits, was $1.1 million on June 30, 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 $4.7 million as of June 30, 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.

Through various interest rate risk management strategies, we believe that our balance sheet is nearly neutral and that changes in interest rates will have a limited impact upon our net interest income. These strategies have included securities leverage in which purchases of intermediate term investment securities which were funded by short-term or adjustable wholesale liabilities. Some of the wholesale liabilities are adjustable Repurchase Agreements with embedded floors that, in a declining interest rate environment, will decline at an exponential rate to the decline in the underlying index. 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.

Since interest rates began increasing in June 2004, the Company’s deposit funding costs have lagged 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

FACTORS WHICH MAY AFFECT FUTURE OPERATING RESULTS

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; and

· The 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 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 June 30, 2006, the allowance for credit losses equaled 1.32% of loans receivable and 1355.1% of nonperforming loans. Although management believes that it has established adequate allowances for credit losses as of June 30, 2006, the credit quality of the Company’s assets is affected by many factors beyond 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 June 30, 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.

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.

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

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

		Votes
Name	Votes For	Withheld

Donald E. Benson	4,127,357	96,515

Joseph N. Cohen	2,514,198	176,577

Robert E. Gipson	2,553,394	111,844

W. Douglas Hile	4,127,857	96,015

Antoinette Hubenette, M.D.	4,127,957	96,015

Scott A. Montgomery	4,127,357	95,915

Dion G. Morrow	4,127,357	96,515

Carl R. Terzian	4,127,857	97,015

Robert E. Thomson	4,126,776	97,106

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

Proposal to approve an amendment to Article XIII of the Company’s Amended and Restate Articles of Incorporation to extend the termination date of that Article from July 2, 1006 to July 1, 2009.

For	Against	Abstain	Broker Non-Vote

3,630,778	146,147	16,090	430,857

Item 5. OTHER INFORMATION

None.

Item 6. EXHIBITS

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

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

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

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 4, 2006	/s/ Scott A. Montgomery
		Scott A. Montgomery
		Chief Executive Officer

DATE:	October 4, 2006	/s/ David R. Brown
		David R. Brown
		Principal Financial and Principal Accounting Officer