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 September 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		90067
Los Angeles, California		(Zip Code)
(Address to principal executive offices)

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 November 10, 2006 was 5,564,955.

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 and its wholly-owned subsidiaries, Mercantile National Bank and South Bay Bank, N.A.

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

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

ASSETS
Cash and due from banks-demand	$	10,709		$	13,507
Due from banks-interest bearing	2,000			2,000
Federal funds sold	—			685
Cash and cash equivalents	12,709			16,192
Securities available-for-sale, at fair value; aggregate amortized cost of $103,945 and $72,428 at September 30, 2006 and December 31, 2005, respectively	103,318			71,758
Securities held-to-maturity, at amortized cost, aggregate fair value of $2,078 and $2,572 at September 30, 2006 and December 31, 2005, respectively.	2,160			2,612
FRB and other stock, at cost	3,790			3,809
Investment in Capital Trust
Loans receivable	358,220			338,558
Allowance for loan and lease losses	(4,661		)	(4,468		)
Net loans receivable	353,559			334,090

Premises and equipment, net	5,823			5,861
Other real estate owned	—			1,056
Deferred tax asset	1,864			4,442
Goodwill	3,225			3,225
Core deposit intangible, net	1,239			1,407
Accrued interest receivable and other assets	6,510			4,008
Total assets	$	494,197		$	448,460

LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest-bearing demand	$	115,740		$	115,924
Interest-bearing demand	27,768			36,018
Money market accounts	109,210			76,334
Savings	24,435			28,208
Time certificates of deposit:
$100,000 or more	84,094			87,468
Under $100,000	18,171			19,256
Total deposits	379,418			363,208

Federal funds purchased and securities sold under agreements to repurchase	45,000			—
Other borrowings	7,600			28,337
Junior subordinated deferrable interest debentures	15,464			15,464
Accrued interest payable and other liabilities	3,939			3,288
Total liabilities	451,421			410,297

Shareholders’ equity:
Preferred Stock, no par value, authorized 1,000,000 shares:
Series B non-cumulative convertible perpetual preferred stock; 1,000 shares outstanding at September 30, 2006 and December 31, 2005	1,000			1,000
Common stock, no par value; authorized 10,000,000 shares; 5,551,267 shares and 5,503,780 shares outstanding at September 30, 2006 and December 31, 2005, respectively	46,340			45,697
Accumulated deficit	(3,422		)	(7,380		)
Accumulated other comprehensive loss	(1,142		)	(1,154		)
Total shareholders’ equity	42,776			38,163
Total liabilities and shareholders’ equity	$	494,197		$	448,460

See accompanying notes to consolidated financial statements.

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2006		2005			2006			2005
	(Dollars in thousands, except per share data)
Interest income:
Loans, including fees	$	7,735	$	6,194		$	22,326		$	17,312
Securities	1,408		523			3,712			1,268
Due from banks - interest bearing	47		23			98			57
Federal funds sold	58		14			76			43
Total interest income	9,248		6,754			26,212			18,680
Interest expense:
Deposits:
Interest-bearing demand	63		46			165			113
Money market and savings	929		350			2,310			804
Time certificates of deposit:
$100,000 or more	924		323			2,683			790
Under $100,000	206		161			578			455
Total interest expense on deposits	2,122		880			5,736			2,162

Federal funds purchased and securities sold under agreements to repurchase	686		—			1,198			—
Junior subordinated deferrable interest debentures	396		396			1,189			1,189
Other borrowings	183		92			546			225
Total interest expense	3,387		1,368			8,669			3,576
Net interest income before provision (benefit) for credit losses	5,861		5,386			17,543			15,104
Provision (benefit) for credit losses	72		(213		)	144			(124		)
Net interest income after provision (benefit) for credit losses	5,789		5,599			17,399			15,228
Other operating income:
Trading gain (loss) on non-hedge derivatives	550		(493		)	(267		)	(115		)
International services	8		11			62			37
Investment services	9		15			28			44
Deposit-related and other customer services	255		252			721			818
Other noninterest income	5		70			77			286
Gain on sale of OREO/fixed assets	1		—			48			—

Total other operating income (loss)	828		(145		)	669			1,070
Other operating expenses:
Salaries and related benefits	2,131		1,998			6,413			5,684
Net occupancy	267		257			781			742
Furniture and equipment	136		127			410			378
Printing and communications	128		128			444			392
Insurance and regulatory assessments	87		105			279			318
Client services	169		152			479			471
Computer data processing	181		216			607			666
Legal services	26		133			120			589
Other professional services	225		287			879			826
Other expenses	183		327			672			749
Total other operating expenses	3,533		3,730			11,084			10,815
Net income before tax provision	3,084		1,724			6,984			5,483
Provision for income taxes	1,328		715			3,026			2,275
Net income	$	1,756	$	1,009		$	3,958		$	3,208
Earnings per share:
Basic	$	0.32	$	0.19		$	0.71		$	0.74
Diluted	$	0.29	$	0.17		$	0.66		$	0.55

See accompanying notes to consolidated financial statements.

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine Months Ended September 30,
	2006			2005
	(Dollars in thousands)
Cash flows from operating activities:
Net income	$	3,958		$	3,208
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization	364			315
Provision (benefit) for credit losses	144			(124		)
Stock compensation cost	290			—
Gain on sale of other real estate owned	(48		)	—
Net amortization of premium (discount) on securities
available-for-sale	(193		)	42
Net amortization of premium on securities held-to-maturity	14			24
Net amortization of core deposit intangible	167			167
Net amortization of premium on loans purchased	80			121
Utilization of deferred tax asset	2,522			1,822
Trading loss on non-hedge derivative	267			115
Increase in accrued interest receivable and other assets	(1,484		)	(1,658		)
Increase in accrued interest payable and other liabilities	718			1,058
Net cash provided by operating activities	6,799			5,090
Cash flows from investing activities:
Purchase of securities available-for-sale	(49,682		)	(23,531		)
Proceeds from repayments and maturities of securities available-for-sale	18,408			3,746
Proceeds from repayments and maturities of securities held-to-maturity	439			688
Payment to terminate non-hedge interest rate swap	(842		)	—
Loan originations and principal collections, net	(19,765		)	(17,796		)
Recoveries of loans previously charged off	—			1,216
Proceeds from sale of other real estate owned	1,104			—
Net purchase of Federal Reserve Stock and other stocks	(444		)	(225		)
Purchases of premises and equipment	(326		)	(351		)
Net cash used in investing activities	(51,108		)	(36,253		)
Cash flows from financing activities:
Net increase in demand deposits, money market and savings accounts	20,669			10,750
Net increase (decrease) in time certificates of deposit	(4,459		)	30,264
Net increase in securities sold under agreements to repurchase	45,000			—
Net decrease in other borrowings	(20,737		)	(6,900		)
Net proceeds from exercise of stock options	354			357
Cash paid in lieu of fractional shares in 5 for 4 stock split	(1		)	—
Net cash provided by financing activities	40,826			34,471
Net increase (decrease) in cash and cash equivalents	(3,483		)	3,308
Cash and cash equivalents, January 1	16,192			16,915
Cash and cash equivalents, September 30	$	12,709		$	20,223

Supplemental disclosures of cash flow information:
Cash paid for interest	$	7,365		$	3,537
Cash paid for income taxes	1,005			960
Unrealized gain (loss) on securities available-for-sale, net of tax effect	43			(184		)
Unrealized loss on cash flow hedges, net of tax effect	$	30		$	638

See accompanying notes to consolidated financial statements.

NATIONAL MERCANTILE BANCORP AND SUBSIDIARIES

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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 three months and nine months ended September 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/A 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 nine months ended September 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. 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 dividend paid on 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:

			Weighted
			Average	Per Share
	Net Income		Shares	Amount
	(in thousands)

For the three months ended September 30, 2006:
Basic EPS	$	1,756	5,545,903	$	0.32

Effect of dilutive securities:
Options			195,599
Convertible preferred stock			244,335
Diluted earnings per share	$	1,756	5,985,837	$	0.29

For the three months ended September 30, 2005:
Basic EPS	$	1,009	5,408,969	$	0.19

Effect of dilutive securities:
Options			283,896
Convertible preferred stock			232,964
Diluted earnings per share	1,009		5,925,829	$	0.17

For the nine months ended September 30, 2006:
Basic EPS	$	3,958	5,535,676	$	0.71

Effect of dilutive securities:
Options			237,897
Convertible preferred stock			234,468
Diluted earnings per share	$	3,958	6,008,041	$	0.66

For the nine months ended September 30, 2005:
Basic EPS	$	3,208	4,350,700	$	0.74

Effect of dilutive securities:
Options			260,090
Convertible preferred stock			1,263,081
Diluted earnings per share	$	3,208	5,873,871	$	0.55

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, all with maturities of three months or less.

NOTE 4—ALLOWANCE FOR CREDIT 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 subsequent charge-offs or write-downs.

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 third quarter 2006, the Company charged off loans totaling $21,000 and recovered no loans previously charged off. Pursuant to management’s evaluation of the allowance for loan and lease losses at September 30, 2006, a provision for credit losses of $72,000 and $144,000 was recorded for the three months and nine months ended September 30, 2006, respectively. There was a $213,000 benefit for credit losses recorded during the third quarter 2005 and $124,000 benefit for the nine months ended September 30, 2005.

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

	Nine Months Ended
	September 30,
	2006		2005
	(Dollars in thousands)

Balance, beginning of period	$	4,468	$	3,511
Total loans charged-off	22		6
Total recoveries of loans previously charged off	—		1,216
Net charge-offs (recoveries)	22		(1,210		)
Provision (benefit) for credit losses	144		(124		)
Transfer (to) from reserve for contingent losses on unfunded commitments	71		(71		)
Balance, end of period	$	4,661	$	4,526

Credit quality is affected by many factors beyond the control of the Company, including local and national economies, and facts may exist which are not known to the Company that adversely affect the likelihood of repayment of various loans in the loan portfolio and realization of collateral upon a default. Accordingly, no assurance can be given that the Company will not sustain loan losses materially in excess of the allowance for credit losses. In addition, the Office of the Comptroller of the Currency (“OCC”), as an integral part of its examination process, periodically reviews the allowance for credit losses and could require additional provisions for credit losses.

NOTE 5—GOODWILL AND CORE DEPOSIT INTANGIBLES

As of September 30, 2006 and December 31, 2005 the Company had goodwill of $3.2 million, and net core deposit intangibles of $1.2 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 September 30, 2006 and December 31, 2005, and accumulated amortization was $1.1 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 for 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 September 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

Provision for income taxes of $1.3 million and $715,000 were recorded for the three months ended September 30, 2006 and 2005, respectively. Income tax provisions of $3.0 million and $2.3 were recorded for the nine months ended September 30, 2006 and 2005, respectively.

At September 30, 2006, the Company had federal alternative minimum tax “AMT” credits of $637,000 that carry forward indefinitely.

NOTE 8—SHARE-BASED PAYMENTS

At September 30, 2006, the Company had one stock incentive plan pursuant to which up to a total of 312,500 shares of common stock may be issued. Under this plan, the Company may grant to directors, officers, employees and consultants stock-based incentive compensation in a variety of forms, including without limitation nonqualified options, incentive options, sales and bonuses of common stock and stock appreciation rights, on such terms and conditions as the Board of Directors of the Company determines. The term of the stock option may not exceed 10 years. Employee stock option grants generally vest over one year or ratable over two years. Director stock options vest in one year. All stock options have vesting conditions that include only service conditions; none of the grants contains performance or market vesting conditions.

The Company issues new shares upon the exercise of stock options. All of the share-based payment awards qualify for classification as equity. At September 30, 2006, the only outstanding awards under this plan were stock options, and at that date 195,088 shares were available for future awards. At September 30, 2006, there were also outstanding options granted under two prior stock incentive plans. The activity of stock options for the nine months ended September 30, 2006 is as shown:

	No. of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding, December 31, 2005	519,358		$	9.62	6.3	$	1,365,912
Granted	6,975		15.00			(19,185		)
Exercised	(39,815	)	7.51			188,841
Forefeited	(11,750	)	12.63			4,493
Expired	—		—			—
Five-for-four stock split	119,341		n/a			n/a
Outstanding, September 30, 2006	594,109		$	7.81	6.0	2,637,842

Exercisable, September 30, 2006	494,176		$	7.25	5.0	2,468,772

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 nine months ended September 30, 2006, share-based compensation expense was $105,000 and $290,000 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 September 30, 2006 and $0.05 for the nine months ended September 30, 2006. The income tax benefit for the nine months ended September 30, 2006 was immaterial as nearly all unvested stock options were qualified incentive stock options. For the nine months ended September 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 nine months ended September 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 September 30,		Nine Months Ended September 30,
	2005		2005
	(Dollars in thousands, except per share data)
Net income:
As reported	$	1,009	$	3,208
Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects	90		190
Pro forma	$	919	$	3,018

Income per share as reported:
Basic	$	0.19	$	0.74
Diluted	0.17		0.55
Income per share pro forma:
Basic	$	0.17	$	0.69
Diluted	0.16		0.51

The estimated per share weighted average fair value of options granted during the nine months ended September 30, 2006 was $4.77. The estimated per share weighted average fair value of options granted in the nine months ended September 30, 2005 was $5.73.

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 nine months ended September 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 5.00% 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 nine months ended September 30, 2005, are as follows: expected volatility 43%, expected term 10 years, risk-free interest rate 4.38%; and dividend yield 0%.

NOTE 9—COMPREHENSIVE INCOME

Comprehensive income 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 was as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2006			2005			2006			2005
	(Dollars in thousands)						(Dollars in thousands)
Net income	$	1,756		$	1,009		$	3,958		$	3,208
Other comprehensive income (loss) before tax, and unrealized losses on securities:
Unrealized gain (loss) on interest rate swaps used in cash flow hedges	761			(896		)	(60		)	(1,266		)
Unrealized gain (loss) on interest rate floors used in cash flow hedges	29			(151		)	(219		)	(176		)
Unrealized gain (loss) on securities available for sale	2,295			(281		)	90			(315		)
Other comprehensive income (loss), before tax	3,085			(1,328		)	(189		)	(1,757		)
Income tax benefit (expense) related to items of other comprehensive income	(1,256		)	551			(103		)	730
Other comprehensive income (loss)	1,829			(777		)	(292		)	(1,027		)
Total comprehensive income	$	3,585		$	232		$	3,666		$	2,181

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 risk management strategies and the effect of these strategies on the consolidated financial statements.

Derivative Financial Instruments
and Hedging Activities

	September 30, 2006					December 31, 2005
	Notional Amount		Fair Value			Notional Amount		Fair Value
	(Dollars in thousands)
Fair value hedges:
Interest rate swaps	$	50,000	$	(47	)	$	30,000	$	41

Cash flow hedges:
Interest rate swaps	$	50,000	$	(1,093	)	$	50,000	$	(1,034	)
Interest rate floors.	$	—	$	—		$	50,000	$	286

Non-hedge derivatives:
Interest rate floors	$	50,000	$	29		$	150,000	$	—
Interest rate swaps	—		—			$	15,000	$	(575	)

Fair value hedges are hedges that minimize the risk of changes in the fair values of assets, liabilities and certain types of firm commitments. The Company uses interest rate swaps to hedge the change in fair value of its brokered certificates of deposit. The interest rate swaps result in the Company paying or receiving the difference between the fixed and floating rates

at specified intervals calculated on the notional amounts. The differential paid or received on such interest rate swaps are recognized as an adjustment to interest expense. The net change in fair value of the derivatives and the hedged items is reported in earnings. The fair value hedges are highly effective and therefore no ineffectiveness was recognized in current earnings related to this swap.

Cash flow hedges are hedges that use simple derivatives to offset the variability of expected future cash flows. The Company’s cash flow hedges include certain interest rate swaps and interest rate floors used to manage the interest rate risk associated with its significant volume of adjustable rate loans. At September 30, 2006 a loss of $793,000 was recorded in accumulated other comprehensive loss within shareholders’ equity and no ineffectiveness was recorded to earnings for the nine months ended September 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 the circumstances in which the hedging relationship does not qualify for hedge accounting. At September 30, 2006 the Company had other interest rate floors to hedge the cash flows of its adjustable rate loans that were not designated as a hedge. Derivatives not designated as hedges are marked-to-market through earnings as a trading gain or loss on economic derivatives.

Additionally, during the third quarter 2006 the Company terminated its position in a $15.0 million interest rate swap that was used to hedge the fair value of its junior subordinated deferrable interest debentures. The swap was not designated as a hedge. A trading gain on non-hedge derivatives of $550,000 was recorded for the third quarter and a trading loss of $267,000 was recorded for the nine months ended September 30, 2006. The following table reflects the effect of the trading gains and losses on economic derivatives for the periods shown:

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2006		2005			2006			2005
	(Dollars in thousands)
Trading gain (loss) on non-hedge derivatives, gross	$	550	$	(493	)	$	(267	)	$	(115	)
Income tax expense (benefit) related to non-hedge derivatives.	228		(205		)	(111		)	(48		)
Trading gain (loss) on non-hedge derivatives, net of income taxes	$	322	$	(288	)	$	(156	)	$	(67	)

NOTE 11 — RESTATEMENT

The financial statements as of December 31, 2005 and September 30, 2005, and for the nine 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			4,008
Total assets	448,796			448,460
Accumulated deficit	(7,044		)	(7,380		)
Total shareholders’ equity.	38,499			38,163

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

	Three Months Ended						Nine Months Ended
	September 30, 2005						September 30, 2005
	As Originally Reported			As Restated			As Originally Reported			As Restated

Net interest income before provision for credit losses	$	5,456		$	5,456		$	15,390		$	15,390
Net cash settlement of interest rate swap derivative	—			(70		)	—			(286		)
Total net interest income	5,456			5,386			15,390			15,104
Provision (benefit) for credit losses	(213		)	(213		)	(124		)	(124		)
Net interest income after provision for credit losses	5,669			5,599			15,514			15,228
Total other operating income	278			278			899			899
Net cash settlement of interest rate swap derivative	—			70			—			286
Change in fair value of interest rate swap derivative	—			(493		)	—			(115		)
Total non-interest income	278			(145		)	899			1,070
Total other operating expenses	3,730			3,730			10,815			10,815
Income before taxes	2,217			1,724			5,598			5,483
Income tax expense	920			920			2,323			2,323
Income tax effect on restatement	—			(205		)	—			(47		)
Total income tax expense	920			715			2,323			2,275
Net income	$	1,297		$	1,009		$	3,275		$	3,208

Net income per share — Basic	$	0.24		$	0.19		$	0.75		$	0.74
Net income per share — Diluted	$	0.22		$	0.17		$	0.56		$	0.55

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.

RESULTS OF OPERATIONS OVERVIEW

The Company recorded net income of $1.8 million, or $0.32 basic earnings per share and $0.29 diluted earnings per share, for the three months ended September 30, 2006 compared to net income of $1.0 million, or $0.19 basic earnings per share and $0.17 diluted earnings per share, for the same period of 2005. The increase in net income for the third quarter of 2006 was attributable to (i) a $475,000 increase in net interest income before the provision for credit losses resulting from increases in the prime rate lending index, a greater volume of interest earning assets, particularly higher-yielding loans receivable and securities available-for-sale, (ii) a $973,000 increase in other operating income as a result of a $550,000 trading gain on non-hedge derivatives compared to a $493,000 charge for the 2005 period, and (iii) a $197,000 decrease in other operating expenses. These favorable changes were partially offset by a $613,000 increase in provision for income taxes and a $285,000 increase in provision for loan losses resulting from a $72,000 charge in the 2006 quarter compared to a $213,000 benefit for credit losses in the third quarter 2005 resulting from the recovery of loans previously charged off. Additionally, 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 $105,000 for the three months ended September 30, 2006. There was no SFAS 123R charge for the 2005 quarter.

The Company recorded net income of $4.0 million, or $0.71 basic earnings per share and $0.66 diluted earnings per share, for the nine months ended September 30, 2006 compared to net income of $3.2 million, or $0.74 basic earnings per share and $0.55 diluted earnings per share, for the same period of 2005. The increase in net income for the 2006 period was primarily due to a $2.4 million increase in net interest income before provision for credit losses resulting from increases in the prime rate lending index, interest rate swaps, a greater volume of interest earning assets, particularly higher-yielding loans receivable and securities available-for-sale. This positive change was partially offset by (i) a $751,000 increase in provision for income taxes, (ii) a $401,000 decrease in other operating income, (iii) a $269,000 increase in other operating expenses, and (iv) a $268,000

increase in provision for loan losses. The SFAS 123R after-tax charge for stock options for the nine months ended September 30, 2006 was $290,000. There was no such charge for the 2005 period.

Return on average assets during the third quarter and first nine months of 2006 was 1.43% and 1.10%, respectively, compared to 0.99% and 1.09% during the third quarter and first nine months of 2005, respectively. Return on average equity during the third quarter and first nine months of 2006 was 17.05% and 13.27%, respectively, compared to 10.72% and 11.83% during the third quarter and first nine months of 2005, respectively.

NET INTEREST INCOME

Third Quarter

Net interest income before the provision for credit losses increased $475,000 to $5.9 million for the three months ended September 30, 2006 compared to the same quarter of 2005 due to a $2.5 million increase in total interest income partially offset by a $2.0 million increase in interest expense. Loan interest income increased $1.5 million due to a $33.0 million greater average volume of loans receivable and a 102 basis point increase in yield, resulting primarily from increases in the prime rate lending index. The greater loan volume was primarily due to the more rapid funding of construction loans originated in earlier periods and fewer payoffs of commercial real estate loans. During 2005, the Federal Reserve Bank increased the target federal funds rate 200 basis points on eight occasions and, continuing into the first half of 2006, another 100 basis points on four occasions. Approximately 70% of our $358.2 million loans receivable have adjustable interest rates; consequently, rising interest rates positively affect interest income for these earning assets. 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, among other techniques, we have entered into interest rate swaps in which we exchanged an adjustable rate interest payment based on the prime rate for a fixed payment on an aggregate notional amount of $50.0 million. The higher yields earned on our loans receivable during the third quarter of 2006 were partially offset by the rising cost of the interest rate swaps.

Interest income from securities available-for-sale increased $890,000 during the third quarter 2006 compared to the third quarter 2005 due to a $44.9 million increase in average volume and a 188 basis point increase in yield. At September 30, 2006 securities available-for-sale were $103.3 million, an increase of $31.6 million from December 31, 2005. During the third and fourth quarters 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, during the period of higher interest rates, and the maturity of lower yielding securities in the portfolio, resulted in an increase in the securities portfolio yield.

Overall, interest-earning assets averaged $81.3 million greater during the third quarter 2006 than third quarter 2005 and the higher yields and favorable change in composition to higher-yielding assets resulted in a 89 basis point increase in weighted average yield on interest-earning assets.

Interest expense increased $2.0 million for the three months ended September 30, 2006 compared to the same period in 2005, due to a $91.0 million increase in interest-bearing liabilities and a 180 basis point increase in cost of funds. Interest expense on deposits increased $1.2 million due to a 162 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 $34.3 million greater during the third 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 $16.0 million during the third quarter of 2006 compared to 2005 period while time certificates of deposit under $100,000 declined $1.2 million.

During the rising interest rate environment experienced during the past nine quarters, we strategically elected to only moderately increase transaction deposit rates and to fund runoff of these deposits, as well as asset growth, 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 and to generate new deposits.

The cost of time certificates of deposit $100,000 and over increased 179 basis points during the third quarter of 2006 compared to the same quarter 2005. The cost of money market and savings deposits increased 177 basis points while the cost of interest-bearing demand deposits and time certificates of deposit under $100,000 increased 28 basis points and 88 basis points, respectively.

The volume of other borrowings averaged $12.3 million and $9.9 million during the third 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 adjust our funding of asset and deposit volume changes. 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 5.92% and 3.68% for the 2006 and 2005 periods, respectively, representing an increase of 224 basis points for the third quarter of 2006.

Securities sold under agreement to repurchase (“Repurchase Agreements”) averaged $43.3 million during the third quarter of 2006 with a cost of 6.29%. The Repurchase Agreements, totaling $45 million at September 30, 2006 with adjustable interest rate based upon the 3-month LIBOR index, have embedded floors with varying strike rates ranging from 4.00% to 4.75%, advancing 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 $114.8 million during the third quarter 2006 or $13.7 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 5.09% and 5.69% during the third quarter in 2006 and 2005, respectively, while the net interest spread was 3.95% and 4.86%, respectively. The net interest margin and net interest spread during the third 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 third 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 is correlated to the short-term rates. Additionally, the net interest spread has been affected by a decline in net earning assets due to a lower proportion of noninterest-bearing deposits funding earning assets.

Nine-Months

Net interest income increased $2.4 million to $17.5 million for the nine months ended September 30, 2006 compared to the same period of 2005 due to a $7.5 million increase in interest income offset by a $5.1 million increase in interest expense.

Loan interest income increased $5.0 million to $22.3 million due to $40.1 million greater average volume of loans receivable and a 106 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 three quarters 2006 were partially offset by the rising cost of the interest rate swaps.

Interest income from securities available-for-sale increased $2.5 million to $3.6 million during the first three quarters of 2006 compared to the same period of 2005 due to $48.9 million greater average volume and a 169 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 $88.7 million greater during the 2006 period than 2005 while the higher interest rates and favorable change in composition to higher-yielding assets resulted in a 88 basis point increase in weighted average yield on interest-earning assets.

Interest expense increased $5.1 million during the first three quarters of 2006 compared to the same period in 2005 due to a $91.2 million increase in average interest-bearing liabilities and a 153 basis point increase in the weighted average cost of interest-bearing liabilities. Interest expense on deposits increased $3.6 million due to a 152 basis point rise in weighted average cost of interest-bearing deposits in addition to $56.6 million greater average volume than 2005. Time certificates of deposit $100,000 and over averaged $40.3 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 $19.0 million during the first three quarters 2006 compared to same period in 2005.

The cost of time certificates of deposit $100,000 and over increased 186 basis points during the first three quarters 2006 compared to the 2005 period. The cost of money market and savings deposits increased 151 basis points while the cost of certificates of deposit under $100,000 increased 91 basis points.

The volume of other borrowings averaged $14.9 million and $10.1 million during the first three quarters 2006 and 2005, respectively. The cost of other borrowings was 4.89% and 2.97% for the 2006 and 2005 periods, respectively, representing an increase of 192 basis points for the first three quarters 2006.

Repurchase Agreements averaged $29.8 million during the first three quarters 2006 with a cost of 5.37%. We had no Repurchase Agreements during 2005.

Noninterest-bearing demand deposits averaged $114.2 million during the first three quarters 2006 or $11.3 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 5.22% and 5.60% during the first three quarters in 2006 and 2005, respectively, while the net interest spread was 4.20% and 4.85%, respectively. Similar to the quarterly results, the net interest margin and net interest spread during the first three quarters 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 September 30, 2006 and 2005.

Average Balance Sheet and
Analysis of Net Interest Income

	Three Months ended
	September 30, 2006							September 30, 2005
	Average Amount			Interest Income/ Expense		Weighted Average Yield/ Rate		Average Amount			Interest Income/ Expense		Weighted Average Yield/ Rate
	(Dollars in thousands)
Assets:
Federal funds sold and securities purchased under agreements to resell	$	4,396		$	58	5.23	%	$	1,604		$	14	3.46	%
Due from banks-interest-bearing	3,216			47		5.80	%	2,000			23		4.56	%
Securities available-for-sale	97,991			1,384		5.60	%	53,050			494		3.72	%
Securities held-to-maturity	2,319			24		4.11	%	2,954			29		3.93	%
Loans receivable (1) (2)	348,738			7,735		8.80	%	315,735			6,194		7.78	%
Total interest earning assets	456,660			9,248		8.03	%	375,343			6,754		7.14	%

Noninterest earning assets:
Cash and due from banks - demand	13,300							15,196
Other assets	22,679							20,428
Allowance for credit losses and net unrealized gain on sales of securities available-for-sale	(6,303		)					(5,395		)
Total assets	$	486,336						$	405,572

Liabilities and shareholders’ equity:
Interest-bearing deposits:
Demand	$	30,827		$	63	0.81	%	$	34,483		$	46	0.53	%
Money market and savings	117,774			929		3.13	%	101,809			350		1.36	%
Time certificates of deposit:
$100,000 or more	86,044			924		4.26	%	51,794			323		2.47	%
Under $100,000	23,665			206		3.45	%	24,873			161		2.57	%
Total time certificates of deposit	109,709			1,130		4.09	%	76,667			484		2.50	%
Total interest-bearing deposits	258,310			2,122		3.26	%	212,959			880		1.64	%
Other borrowings	12,267			183		5.92	%	9,912			92		3.68	%
Junior subordinated debentures	15,464			396		10.24	%	15,464			396		10.24	%
Federal funds purchased and securities sold under agreements to repurchase	43,250			686		6.29	%	—			—		—
Total interest-bearing liabilities	329,291			3,387		4.08	%	238,335			1,368		2.28	%

Noninterest-bearing liabilities:
Noninterest-bearing demand deposits	114,790							128,523
Other liabilities	1,399							1,363
Shareholders’ equity	40,856							37,351
Total liabilities and shareholders’ equity	$	486,336						$	405,572

Net interest income (spread)				$	5,861	3.95	%				$	5,386	4.86	%

Net yield on earning assets (2)						5.09	%						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 $440,000 and $421,000 for the three months ended September 30, 2006 and 2005, respectively.

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

Average Balance Sheet and
Analysis of Net Interest Income

	Nine Months ended
	September 30, 2006							September 30, 2005
	Average Amount			Interest Income/ Expense		Weighted Average Yield/ Rate		Average Amount			Interest Income/ Expense		Weighted Average Yield/ Rate
	(Dollars in thousands)
Assets:
Federal funds sold and securities purchased under agreements to resell	$	1,933		$	76	5.26	%	$	1,932		$	43	2.98	%
Due from banks-interest-bearing	2,776			98		4.72	%	2,250			57		3.39	%
Securities available-for-sale	93,348			3,638		5.21	%	44,446			1,174		3.52	%
Securities held-to-maturity	2,382			74		4.16	%	3,186			94		3.93	%
Loans receivable (1) (2)	349,061			22,326		8.55	%	308,986			17,312		7.49	%
Total interest earning assets	449,500			26,212		7.80	%	360,800			18,680		6.92	%

Noninterest earning assets:
Cash and due from banks - demand	14,164							16,880
Other assets	22,927							20,628
Allowance for credit losses and net unrealized gain on sales of securities available-for-sale	(6,180		)					(4,611		)
Total assets	$	480,411						$	393,697

Liabilities and shareholders’ equity:
Interest-bearing deposits:
Demand	$	31,964		$	165	0.69	%	$	32,471		$	113	0.47	%
Money market and savings	119,802			2,310		2.58	%	100,814			804		1.07	%
Time certificates of deposit:
$100,000 or more	86,159			2,683		4.16	%	45,885			790		2.30	%
Under $100,000	23,741			578		3.26	%	25,914			455		2.35	%
Total time certificates of deposit	109,900			3,261		3.97	%	71,799			1,245		2.32	%
Total interest-bearing deposits	261,666			5,736		2.93	%	205,084			2,162		1.41	%
Other borrowings	14,918			546		4.89	%	10,132			225		2.97	%
Junior subordinated debentures	15,464			1,189		10.25	%	15,464			1,189		10.25	%
Federal funds purchased and securities sold under agreements to repurchase	29,826			1,198		5.37	%	—			—		—
Total interest-bearing liabilities	321,874			8,669		3.60	%	230,680			3,576		2.07	%

Noninterest-bearing liabilities:
Noninterest-bearing demand deposits	114,183							125,469
Other liabilities	4,594							1,404
Shareholders’ equity	39,760							36,144
Total liabilities and shareholders’ equity	$	480,411						$	393,697

Net interest income (spread)				$	17,543	4.20	%				$	15,104	4.85	%

Net yield on earning assets (2)						5.22	%						5.60	%

(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 $1.4 million and $1.3 million for the nine months ended September 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 September 30, 2006 vs 2005
	Incease (decrease) due to:						Net Increase
	Volume			Rate			(Decrease)
	(Dollars in thousands)
Interest Income:
Federal funds sold and securities purchased under agreement to resell	$	24		$	20		$	44
Interest-bearing deposits with other financial institutions	14			10			24
Securities available-for-sale	422			468			890
Securities held-to-maturity	(6		)	1			(5		)
Loans receivable (2)	647			894			1,541
Total interest-earning assets	$	1,101		$	1,393		$	2,494

Interest Expense:
Interest-bearing deposits:
Demand	$	(5	)	$	22		$	17
Money market and savings	55			524			579
Time certificates of deposit:
$100,000 or more	214			387			601
Under $100,000	(8		)	53			45
Total time certificates of deposit	206			440			646
Total interest-bearing deposits	256			986			1,242
Other borrowings	22			69			91
Junior subordinated debentures	—			—			—
Federal funds purchased and securities sold under agreements to repurchase	—			686			686
Total interest-bearing liabilities	278			1,741			2,019

Net interest income	$	823		$	(348	)	$	475

(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 relationship of the absolute amounts of changes in each.

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

Increase (Decrease) in Interest Income/Expense Due to Change in
Average Volume and Average Rate (1)

	Nine Months ended September 30, 2006 vs 2005
	Increase (decrease) due to:						Net Increase
	Volume			Rate			(Decrease)

Interest Income:
Federal funds sold and securities purchased under agreement to resell	$	—		$	33		$	33
Interest-bearing deposits with other financial institutions	13			28			41
Securities available-for-sale	1,288			1,176			2,464
Securities held-to-maturity	(24		)	4			(20		)
Loans receivable (2)	2,245			2,769			5,014
Total interest-earning assets	3,522			4,010			7,532

Interest Expense:
Interest-bearing deposits:
Demand	$	(1	)	$	54		$	52
Money market and savings	151			1,355			1,506
Time certificates of deposit:
$100,000 or more	693			1,200			1,893
Under $100,000	(38		)	161			123
Total time certificates of deposit	655			1,361			2,016
Total interest-bearing deposits	805			2,769			3,574
Other borrowings	106			215			321
Junior subordinated debentures	—			—			—
Federal funds purchased and securities sold under agreements to repurchase	—			1,198			1,198
Total interest-bearing liabilities	911			4,182			5,093

Net interest income	$	2,613		$	(172	)	$	2,439

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

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

PROVISION FOR CREDIT LOSSES

We recorded provisions for credit losses of $72,000 for the third quarter 2006 and $144,000 for the nine months ended September 30, 2006, reflecting (i) the growth in loans receivable, (ii) an increase in unfunded loan commitments, and (iii) a change in portfolio credit migration, compared to a benefit for loan losses of $213,000 for the third quarter 2005 and $124,000 for the nine months ended September 30, 2005. During the first three quarters of 2006, we charged off loans receivable of $22,000 and had no recoveries of loans previously charged off. During the third quarter 2005, the Company recovered $1.2 million of loans charged off in a previous period.

OTHER OPERATING INCOME

Other operating income increased to $828,000 during the third quarter of 2006 compared to a loss of $145,000 during the third quarter of 2005. The 2006 period included a trading gain on non-hedge derivatives of $550,000 compared to a $493,000 trading loss on non-hedge derivates during the third quarter 2005. As a result of recent technical accounting interpretations, we restated our financial statements for the incorrect accounting treatment related to an interest rate swap that was designated as a fair value hedge against our junior subordinated debentures. The restatement resulted in the changes in fair value of the swap being recorded in current income. Due to the undesired volatility created by this treatment, we terminated our position in the swap during the third quarter 2006 resulting in the trading gain.

Other operating income decreased to $669,000 during the nine months ended September 30, 2006 from $1.1 million during the nine months ended September 30, 2005 due to a $209,000 decrease in other noninterest income and a $152,000 greater trading loss on non-hedge derivatives. While the change in fair value for the swap discussed above resulted in a gain during the third quarter, overall it resulted in a $267,000 loss for the nine months ended September 30, 2006.

OTHER OPERATING EXPENSES

Other operating expenses decreased $197,000 for the three months ended September 30, 2006 to $3.5 million. Significant variances within operating expenses were: (i) salaries and related benefits expense increased $133,000 or 6.7% due to the adoption of SFAS 133R requiring stock options to be expensed, the addition of business development staff and increased commission expense, (ii) legal services expense decreased $107,000 or 80.5% primarily due to fewer problem assets and the decline in related legal activity; and (iii) other noninterest expenses declined $144,000 due to the reversal of a loss contingency in the 2006 quarter recorded in the 2005 quarter related to a potential operating loss.

Other operating expenses increased to $11.1 million for the nine months ended September 30, 2006 compared to $10.8 million for the same period of 2005. Significant variances within operating expenses were: (i) salaries and related benefits expense increased $729,000 or 12.8% due to the adoption of SFAS 133R requiring stock options to be expensed, the addition of business development staff and increased commission; and (ii) legal services expense decreased $469,000 or 79.6% primarily due to activity on the settlement of a dispute over collateral securing a loan and fewer problem assets.

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

	September 30, 2006
	Total		Gross		Gross		Estimated
	amortized		unrealized		unrealized		fair
	cost		gains		loss		value
	(Dollars in thousands)
Available-for-Sale:
U.S. Treasury securities	$	2,561	$	—	$	26	$	2,527
GNMA-issued/guaranteed mortgage pass through certificates	78		—		—		78
Other U.S. Government and federal agency securities	9,018		2		53		8,966
FHLMC/FNMA-issued mortgage pass through certificates	55,838		139		600		55,377
CMO’s and REMIC’s issued by U.S. government-sponsored agencies	6,460		25		32		6,453
Privately issued corporate bonds, CMO and REMIC securities	29,990		185		258		29,917
	$	103,945	$	351	$	969	$	103,318

FRB and other equity stocks	$	3,790	$	—	$	—	$	3,790

	September 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	$	2,160	$	—	$	82	$	2,078
	$	2,160	$	—	$	82	$	2,078

	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 September 30, 2006, the Company did not hold securities of any issuer, other than U.S. government-chartered agencies, the aggregate book value of which exceeded 10% of the Company’s shareholders’ equity. At September 30, 2006 and December 31, 2005 there were no securities deemed by management to be other-than-temporarily impaired.

LOAN PORTFOLIO

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

Loan Portfolio Composition

	September 30,					December 31,
	2006					2005
	Amount			Percent		Amount			Percent
	(Dollars in thousands)
Commercial loans - secured and unsecured	$	100,757		28	%	$	89,474		26	%
Real estate loans:
Secured by commercial real properties	135,577			38	%	121,641			36	%
Secured by one to four family residential properties	10,170			2	%	10,498			3	%
Secured by multifamily residential properties	16,490			5	%	18,663			6	%
Total real estate loans	162,237			45	%	150,802			45	%
Construction and land development	88,407			25	%	92,077			27	%
Consumer installment, home equity and unsecured loans to individuals	7,434			2	%	7,239			2	%
Total loans outstanding	358,835			100	%	339,592			100	%

Deferred net loan origination fees	(615		)			(1,034		)
Loans receivable, net	$	358,220				$	338,558

Total loans outstanding increased by $19.7 million to $358.2 million at September 30, 2006 compared to $338.6 million at December 31, 2005 due primarily to increased funding of commercial real estate loans and 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 September 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 September 30, 2006 totaled $55.0 million compared to $120.8 million at December 31, 2005.

NONPERFORMING ASSETS

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

Nonperforming Assets

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

Nonaccrual loans	$	338		$	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	338			319
Other real estate owned	—			1,056
Other nonperforming assets	—			—
Total nonperforming assets	$	338		$	1,375

Allowance for credit losses as a percent of nonaccrual loans	1379.0		%	1400.6		%
Allowance for credit losses as a percent of nonperforming loans	1379.0		%	1400.6		%
Total nonperforming assets as a percent of loans receivable	0.1		%	0.4		%
Total nonperforming assets as a percent of total shareholders’ equity	0.8		%	3.6		%

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 third quarter of 2006 compared to $1.2 million during the third quarter of 2005. Pursuant to our evaluation of the allowance for credit losses at September 30, 2006, we recorded a provision for credit losses of $72,000 for the third quarter 2006 compared to a benefit for loan losses of $213,000 in the 2005 quarter.

We charged off $22,000 of loans during the nine months ended September 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 nine months ended

September 30, 2006 compared to $1.2 million during the same period of 2005. We recorded a provision for credit losses of $144,000 for the nine months September 30, 2006 compared to a benefit for loans losses of $124,000 in the 2005 period.

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

Analysis of Changes in Allowance for Credit Losses

	Nine Months ended September 30,
	2006		2005
	(Dollars in thousands)

Balance, beginning of period	$	4,468	$	3,511
Total loans charged-off	22		6
Total recoveries of loans previously charged off	—		1,216
Net charge-offs	22		(1,210		)
Provision (benefit) for credit losses	144		(124		)
Transfer (to) from reserve for contingent losses on unfunded commitments	71		(71		)
Balance, end of period	$	4,661	$	4,526

DEPOSITS

Total deposits were $379.4 million and $363.2 million at September 30, 2006 and December 31, 2005, respectively. Noninterest-bearing demand deposits were nearly flat at $115.7 million at September 30, 2006 compared to $115.9 million at December 31, 2005. Money market deposits and savings deposits were $109.2 million and $24.4 million, respectively, at September 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 $27.7 million at September 30, 2006 from $36.0 million at December 31, 2005. Time certificates of deposit (“TCDs”) decreased to $102.2 million at September 30, 2006 from $106.7 million at December 31, 2005. There were $50.0 million in brokered TCDs at September 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 nine 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, the Company has 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 September 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 $7.6 million of other borrowings, consisting of overnight advances from the Federal Home Loan Bank, at September 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 $42.8 million at September 30, 2006 due to the retained earnings for the nine months ended September 30, 2006 in addition to an increase in market value of derivative financial instruments designated as cash flow hedges and securities available-for-sale.

CAPITAL ADEQUACY REQUIREMENTS

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

Regulatory Capital Information
of the National Mercantile Bancorp and Banks

	Minimum
	For Capital		Well
	Adequacy		Capitalized		September 30,		December 31,
	Purposes		Standards		2006		2005

National Mercantile Bancorp:
Tier 1 leverage	4.00	%	N/A		11.15	%	10.74	%
Tier 1 risk-based capital	4.00	%	N/A		12.56	%	11.98	%
Total risk-based capital	8.00	%	N/A		13.94	%	13.72	%

Mercantile National Bank:
Tier 1 leverage	4.00	%	5.00	%	9.37	%	10.49	%
Tier 1 risk-based capital	4.00	%	6.00	%	11.83	%	13.59	%
Total risk-based capital	8.00	%	10.00	%	13.07	%	14.84	%

South Bay Bank, NA:
Tier 1 leverage	4.00	%	5.00	%	10.39	%	9.04	%
Tier 1 risk-based capital	4.00	%	6.00	%	11.20	%	9.00	%
Total risk-based capital	8.00	%	10.00	%	12.44	%	10.22	%

LIQUIDITY

The Company manages its liquidity through a combination of core deposits, federal funds purchased, repurchase agreements, collateralized borrowing lines, and a portfolio of securities available for sale. Liquidity is also provided by maturing investment securities and loans. The Consolidated Statement of Cash Flows reflects the Company’s sources and uses of cash flows from operating, investing and financing activities.

The Company’s cash and due from banks - demand was $10.7 million on September 30, 2006 compared to $13.5 million on December 31, 2005. Due from banks-interest-bearing was $2.0 million at September 30, 2006 and December 31, 2005.

There were no Federal funds sold at September 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 lines with correspondent banks as of September 30, 2006.

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

National Mercantile’s cash and due from banks was $237,000 on September 30, 2006 compared to $137,000 at December 31, 2005. Due from banks-interest bearing was $1.0 million at December 31, 2005 and none at September 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 a substantial accumulated deficit and does not anticipate having positive cumulative retained earnings for the foreseeable future. South Bay had cumulative retained earnings of $5.6 million as of September 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.

INTEREST RATE RISK 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 September 30, 2006, the allowance for credit losses equaled 1.30% of loans receivable and 1379.0% of nonperforming loans. Although management believes that it has established adequate allowances for credit losses as of September 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 California, the Company’s operations could suffer as a result of local recession or natural disasters in California.

At September 30, 2006, a large majority of the loans outstanding were collateralized by real properties located in California. Because of this concentration in 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

None.

Item 5. OTHER INFORMATION

None.

Item 6. EXHIBITS

31.1 Certification of Scott A. Montgomery on disclosure controls

31.2 Certification of David R. Brown on disclosure controls

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

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

SIGNATURES

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

		NATIONAL MERCANTILE BANCORP
		(Registrant)

DATE:	November 14, 2006	/s/	SCOTT A. MONTGOMERY
		Scott A. Montgomery
		Chief Executive Officer

DATE:	November 14, 2006	/s/	DAVID R. BROWN
		David R. Brown
		Principal Financial and Principal Accounting Officer