<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(MARK ONE)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from N/A to
----------- ------------
Commission File Number: 0-15982
-----------
NATIONAL MERCANTILE BANCORP
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
California 95-3819685
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1840 Century Park East, Los Angeles, California 90067
- ----------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (310) 277-2265
Not Applicable
---------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report.)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[x] Yes [ ] No
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of the registrant's Common Stock, no
par value, as of October 31, 1996 was 3,078,146.
This document contains 32 pages.
<PAGE> 2
FORM 10-Q
TABLE OF CONTENTS AND CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
Page(s) in
Form 10-Q
-----------
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . . 3-13
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS . . . . . . . . . . . . . . . . . . . . . . . . . 14-29
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Item 2. CHANGES IN SECURITIES . . . . . . . . . . . . . . . . . . . . . . . . . 31
Item 3. DEFAULTS UPON SENIOR SECURITIES . . . . . . . . . . . . . . . . . . . . 31
Item 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS . . . . . . . . . . . . . . . . . . . . . . . 31
Item 5. OTHER INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Item 6. EXHIBITS AND REPORTS ON FORM 8-K . . . . . . . . . . . . . . . . . . . . 31
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
</TABLE>
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Consolidated Balance Sheets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Consolidated Statements of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Consolidated Statement of Changes in
Shareholders' Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Consolidated Statements of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . 8
</TABLE>
3
<PAGE> 4
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
September 30, 1996 and December 31, 1995
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
(Unaudited)
------------- -----------
(dollars in thousands)
<S> <C>
ASSETS
Cash and due from banks-demand......................... $ 6,669 $ 9,272
Federal funds sold and securities purchased
under agreements to resell.......................... 13,200 21,000
------------- -------------
Cash and cash equivalents..................... 19,869 30,272
Securities available-for-sale, at fair value;
aggregate amortized cost of $15,755 at September 30,
1996 and $20,256 at December 31, 1995................ 15,558 20,102
Federal Reserve Bank stock............................. 274 315
Loans receivable....................................... 64,871 82,012
Allowance for credit losses.......................... (3,052) (3,805)
------------- -------------
Net loans receivable.......................... 61,819 78,207
Premises and equipment, net............................ 988 1,126
Other real estate owned................................ 556 581
Accrued interest receivable and other assets........... 1,237 1,389
------------- -------------
$ 100,301 $ 131,992
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing demand........................... $ 34,876 $ 44,579
Interest-bearing demand.............................. 4,595 7,737
Money market accounts................................ 17,331 18,901
Savings.............................................. 2,988 1,927
Time certificates of deposit:
$100,000 and over.................................. 5,996 8,551
Under $100,000..................................... 27,454 38,548
------------- -------------
Total deposits................................ 93,240 120,243
Securities sold under agreements to repurchase......... 434 4,497
Accrued interest payable and other liabilities......... 1,674 1,241
------------- -------------
Total liabilities............................. 95,348 125,981
Shareholders' equity:
Preferred stock, no par value; authorized 1,000,000
shares............................................. -- --
Common stock, no par value; authorized 10,000,000
shares; issued and outstanding 3,078,146 at
September 30, 1996 and December 31, 1995........... 24,614 24,614
Accumulated deficit.................................. (19,464) (18,449)
Net unrealized loss on securities available-
for-sale........................................... (197) (154)
------------- -------------
Total shareholders' equity.................... 4,953 6,011
------------- -------------
$ 100,301 $ 131,992
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
Three- and nine-month periods ended September 30, 1996 and 1995
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1996 1995 1996 1995
----------- ----------- ----------- -----------
(dollars in thousands, except per share data)
<S> <C> <C> <C> <C>
Interest income:
Loans, including fees................................ $ 1,649 $ 2,367 $ 5,179 $ 7,275
Securities available-for-sale:
Tax-exempt......................................... -- 2 -- 12
Taxable............................................ 235 325 795 1,105
Federal funds sold and securities purchased
under agreements to resell......................... 237 175 720 671
Interest-bearing deposits with other financial
institutions....................................... -- 2 -- 5
----------- ----------- ----------- -----------
Total interest income......................... 2,121 2,871 6,694 9,068
Interest expense:
Interest-bearing demand.............................. 24 33 59 111
Money market and savings............................. 147 231 476 793
Time certificates of deposit:
$100,000 and over.................................. 95 135 320 410
Under $100,000..................................... 446 426 1,513 1,630
----------- ----------- ----------- -----------
Total interest expense on deposits............ 712 825 2,368 2,944
Federal funds purchased and securities sold
under agreements to repurchase..................... 6 32 23 91
----------- ----------- ----------- -----------
Total interest expense........................ 718 857 2,391 3,035
----------- ----------- ----------- -----------
Net interest income........................... 1,403 2,014 4,303 6,033
Provision for credit losses............................ -- 1,720 -- 2,247
----------- ----------- ----------- -----------
Net interest income after provision for
credit losses............................... 1,403 294 4,303 3,786
Other operating income (loss):
(Loss) gain on sale of securities available-for-sale. -- (6) (1) (1,225)
Loss on termination of interest rate swap............ -- -- -- (1,294)
International services............................... 34 42 97 175
Investment services.................................. 13 52 68 210
Deposit-related and other customer services.......... 77 110 244 609
Other income-shareholders' insurance claims.......... -- -- -- 730
Loss on other real estate owned...................... -- -- -- (160)
----------- ----------- ----------- -----------
Total other operating income (loss)........... 124 198 408 (955)
Other operating expenses:
Salaries and related benefits........................ 749 964 1,998 2,878
Severance costs...................................... -- 88 -- 122
Net occupancy........................................ 207 432 587 1,316
Furniture and equipment.............................. 70 97 237 285
Printing and communications.......................... 40 54 151 211
Insurance and regulatory assessments................. 165 200 492 765
Customer services.................................... 144 210 446 652
Computer data processing............................. 90 114 272 324
Legal services....................................... 122 239 1,379 563
Other professional services.......................... 74 396 552 1,311
Promotion............................................ 26 34 90 106
Other real estate owned expenses..................... 6 4 26 22
Other expenses....................................... 16 181 75 250
----------- ----------- ----------- -----------
Total other operating expenses................ 1,709 3,013 6,305 8,805
----------- ----------- ----------- -----------
Loss before income taxes...................... (182) (2,521) (1,594) (5,974)
Provision for income taxes (benefit)................... -- -- (579) --
----------- ----------- ----------- -----------
Net loss...................................... $ (182) $ (2,521) $ (1,015) $ (5,974)
=========== =========== =========== ===========
Net loss per share............................ $ (0.06) $ (0.82) $ (0.33) $ (1.94)
=========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
Nine-month period ended September 30, 1996
(Unaudited)
<TABLE>
<CAPTION>
Net
Unrealized
Loss on
Common Stock Securities
Preferred ------------------------ Accumulated Available
Shares Shares Amount Deficit for Sale Total
------------- ------------ ----------- ------------- --------------- ------------
(dollars in thousands)
<S> <C> <C> <C>
Balance at January 1, 1996........ -- 3,078,146 $ 24,614 $ (18,449) $ (154) $ 6,011
Increase in net unrealized
loss on securities available
for sale...................... -- -- -- -- (43) (43)
Net loss.......................... -- -- -- (1,015) -- (1,015)
------------- ------------ ----------- ------------- --------------- ------------
Balance at September 30, 1995...... -- 3,078,146 $ 24,614 $ (19,464) $ (197) $ 4,953
============= ============ =========== ============= =============== ============
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE> 7
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine-month periods ended September 30, 1996 and 1995
(Unaudited)
<TABLE>
<CAPTION>
1996 1995
----------- -----------
(dollars in thousands)
<S> <C> <C>
Net cash flows from operating activities:
Net loss............................................. $ (1,015) $ (5,974)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Accretion of sublease loss......................... -- (289)
Depreciation and amortization...................... 147 277
Provision for credit losses........................ -- 2,247
Net loss on sale of securities available-for-sale.. 1 1,225
Net amortization of premiums (accretion of
discounts) on securities available-for-sale...... 50 42
Net amortization of premiums (accretion of
discounts) on loans purchased.................... 18 (177)
Loss on other real estate owned.................... -- 160
Decrease (increase) in accrued interest receivable
and other assets................................. 158 536
Increase (decrease) in accrued interest payable
and other liabilities............................ 433 (140)
----------- -----------
Net cash provided by (used in) operating
activities..................................... (208) (2,093)
Cash flows from investing activities:
Purchase of debt securities available-for-sale....... (1,000) (5,000)
Proceeds from sales of securities available-
for-sale........................................... 114 46,852
Proceeds from repayments and maturities of
securities available-for-sale...................... 5,377 1,694
Proceeds from sales of loans......................... -- 6,599
Net decrease in loans................................ 16,370 24,234
Purchase of other real estate owned.................. (43) --
Proceeds from sale of other real estate owned........ 62 --
Net purchases of premises and equipment.............. (9) --
Other, net........................................... -- (52)
----------- -----------
Net cash provided by investing activities........ 20,871 74,327
Cash flows from financing activities:
Net decrease in deposits............................. (27,003) (80,233)
Net decrease in securities sold under
agreement to repurchase............................ (4,063) (9,652)
----------- -----------
Net cash used in financing activities............ (31,066) (89,885)
----------- -----------
Net decrease in cash and cash equivalents.............. (10,403) (17,651)
Cash and cash equivalents, January 1................... 30,272 46,710
----------- -----------
Cash and cash equivalents, September 30................ $ 19,869 $ 29,059
=========== ===========
Supplemental cash flow information:
Cash paid for interest $ 2,451 $ 3,360
Increase (decrease) in unrealized loss on
securities available-for-sale $ 43 $ (2,765)
</TABLE>
See accompanying notes to consolidated financial statements.
7
<PAGE> 8
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION AND MANAGEMENT REPRESENTATIONS
The unaudited consolidated financial statements include the accounts
of National Mercantile Bancorp (the "Company") and its wholly owned subsidiary,
Mercantile National Bank (the "Bank") both sometimes referred to as "Company".
All significant intercompany transactions and balances have been eliminated.
The accounting and reporting policies of the Company conform with generally
accepted accounting principles and general practice within the banking
industry.
The unaudited consolidated financial statements have been prepared in
accordance with the instructions to Form 10-Q and, therefore, do not include
all footnotes normally required for complete financial statement disclosure.
While management believes that the disclosures presented are sufficient to make
the information not misleading, reference may be made to the consolidated
financial statements and notes thereto included at "Item 8. Financial
Statements" of the Company's Annual Report on Form 10-K for the year ended
December 31, 1995 ("1995 Form 10-K").
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
The accompanying unaudited consolidated balance sheets and statements
of operations, changes in shareholders' equity and cash flows reflect, in the
opinion of management, all material adjustments necessary for a fair
presentation of the Company's financial position as of September 30, 1996 and
results of operations for the three and nine-month periods ended September 30,
1996 and 1995 and cash flows for the nine month periods ended September 30,
1996 and 1995. The results of operations for the three and nine-month periods
ended September 30, 1996 are not necessarily indicative of the results of
operations for the full year ending December 31, 1996.
Certain items in the 1995 financial statements have been reclassified
to conform to the 1996 presentation.
8
<PAGE> 9
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2 - LOSS PER SHARE
Loss per share is computed using the weighted average number of common
shares outstanding during the period. The weighted average number of common
shares outstanding for the three and nine-month periods ended September 30,
1996 and 1995 was 3,078,146.
Loss per share computations exclude common share equivalents since the effect
would be to reduce the loss per share amount. Common share equivalents include
the number of shares issuable upon the exercise of stock options less the
number of shares that could have been purchased with the proceeds from the
exercise of the options based upon the higher of the average price of common
shares during the period or the price at the balance sheet date.
NOTE 3 - LOANS AND INTEREST INCOME
At September 30, 1996, the recorded investment in loans that are
considered to be impaired under SFAS No. 114 was $7.2 million, for which the
related allowance for loan losses was $670,000. The average recorded
investment in, and the amount of interest income recognized on those impaired
loans during the three months ended September 30, 1996 were $7.2 million and
$178,000, respectively, and $6.0 million and $571,000, respectively, for the
nine months ended September 30, 1995. Of the investment in loans that are
considered to be impaired, $4.9 million or 68% was represented by a loan which
was collateralized by residential real estate appraised at $10.0 million.
9
<PAGE> 10
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4 - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL
The Federal Reserve Board ("FRB") and the Office of the Comptroller of
the Currency (the "OCC") have issued guidelines (the "guidelines") regarding
risk-based capital requirements. The guidelines provide detailed definitions
of regulatory capital and assign different weights to various assets and credit
equivalent amounts of off-balance sheet financial instruments, depending upon
the perceived degree of credit risk to which they expose such entities. Each
banking organization is required to maintain a specified minimum ratio of
capital to the total of such risk-adjusted assets and off-balance sheet
financial instruments.
The risk-based capital ratios of the Company and the Bank are
calculated under the guidelines by dividing their respective qualifying total
capital by their respective total risk-weighted assets. The Company's
qualifying total capital and total risk-weighted assets are determined on a
fully consolidated basis. Total qualifying capital is comprised of the sum of
core capital elements ("Tier 1 capital") and supplementary capital elements
("Tier 2 capital"). At September 30, 1996 and December 31, 1995, Tier 1
capital of the Company and the Bank consisted of their respective amounts of
common shareholders' equity. Tier 1 capital excludes any net unrealized gains
or losses resulting from the implementation of SFAS No. 115. Tier 2 capital
consisted of Tier 1 capital plus the allowance for credit losses, subject to
limitations.
Under the guidelines, total risk-weighted assets of the Company and
the Bank are determined by assigning balance sheet assets and credit equivalent
amounts of off-balance sheet financial instruments to one of four broad risk
categories having risk weights ranging from 0% to 100% (see Note 2 in the Notes
to Consolidated Financial Statements in the Company's 1995 Annual Report on
Form 10-K). The aggregate dollar amount of each category is multiplied by the
risk weight associated with that category and the resulting weighted values
from each category are summed to determine total risk-weighted assets.
Each bank holding company and national bank must maintain (i) a
minimum ratio of Tier 1 capital to total risk-weighted assets of 4.0% and (ii)
a minimum ratio of total qualifying capital to total qualifying assets ("total
risk-based capital ratio") of 8.0%, with the amount of the allowance for credit
losses that may be included in Tier 2 capital limited to 1.25% of total
risk-weighted assets.
10
<PAGE> 11
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4 - SHAREHOLDERS' EQUITY AND REGULATORY CAPITAL (continued)
The capital leverage ratio standards require a minimum ratio of Tier 1
capital to adjusted total assets ("capital leverage ratio") of 4%. The
leverage ratio is only a minimum. Institutions experiencing or anticipating
significant growth or those with other than minimum risk profiles will be
expected to maintain capital well above the minimum levels.
On December 14, 1995, the Bank entered into a formal agreement with
the OCC (the "Formal Agreement"), pursuant to which the Bank is required to
maintain (i) a capital leverage ratio equal to at least 6.5% and (ii) a Tier 1
risk-based capital ratio equal to at least 10.0%. As set forth below, the
Bank's capital leverage ratio at September 30, 1996 was 4.81%, and the Tier 1
risk-based capital ratio was 7.28%. As of September 30, 1996, both of these
ratios were not in compliance with the Formal Agreement. The Company entered
into a Memorandum of Understanding with the Federal Reserve Bank of San
Francisco on October 26, 1995, which includes requiring the submission of a
plan to increase the Bank's capital. The Bank's capital plan was submitted to
the OCC on February 8, 1996. The Bank may be subject to further regulatory
enforcement action by the OCC. See "Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations--Capital Resources."
11
<PAGE> 12
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 4 - Shareholders' Equity and Regulatory Capital (continued)
Information about the regulatory capital of the Company and the Bank at
September 30, 1996 and December 31, 1995 is set forth below.
<TABLE>
<CAPTION>
September 30, 1996
(Unaudited) December 31, 1995
------------------------------------- -------------------------------------
Company Bank Company Bank
----------------- ------------------ ------------------ -----------------
Amount Ratio Amount Ratio Amount Ratio Amount Ratio
--------- ------- --------- -------- --------- -------- --------- -------
(dollar amounts in thousands)
<S> <C> <C> <C> <C> <C>
Risk-based capital (1) (3):
Tier 1 capital $5,151 7.29% $5,140 7.28% $6,166 6.96% $6,157 6.95%
Tier 1 capital minimum
requirement 2,825 4.00% 7,062 10.00% 3,542 4.00% 8,856 10.00%
--------- ------- --------- -------- --------- -------- --------- -------
Excess (Deficiency) $2,326 3.29% ($1,922) ( 2.72%) $2,624 2.96% ($2,699) ( 3.05%)
========= ======= ========= ======== ========= ======== ========= =======
Total capital $6,060 8.58% $6,049 8.57% $7,306 8.25% $7,297 8.24%
Total capital minimum
requirement 5,649 8.00% 5,649 8.00% 7,085 8.00% 7,085 8.00%
--------- ------- --------- -------- --------- -------- --------- -------
Excess $411 0.58% $400 0.57% $221 0.25% $212 0.24%
========= ======= ========= ======== ========= ======== ========= =======
Total risk-weighted assets $70,617 $70,617 $88,558 $88,558
Capital Leverage Ratio (1) (2) (3):
Tier 1 capital $5,151 4.82% $5,140 4.81% $6,166 4.68% $6,157 4.67%
Tier 1 capital minimum
requirement 4,277 4.00% 6,951 6.50% 5,271 4.00% 8,565 6.50%
--------- ------- --------- -------- --------- -------- --------- -------
Excess (Deficiency) $874 0.82% ($1,811) ( 1.69%) $895 0.68% ($2,408) ( 1.83%)
========= ======= ========= ======== ========= ======== ========= =======
Average total assets, as
adjusted, during three-month
periods ended September 30,
1996 and December 31, 1995 $106,932 $106,932 $131,764 $131,764
</TABLE>
(1) The Bank's minimum Tier 1 risk-based capital and Tier 1 capital leverage
requirements are based on the provisions of the Formal Agreement, which
became effective on December 14, 1995.
(2) The regulatory capital leverage ratio represents the ratio of Tier 1
capital at September 30, 1996 and December 31, 1995 to average total assets
during the respective three-month periods then ended.
(3) Tier 1 capital excludes any net unrealized gains or losses on securities
available-for-sale recognized in the balance sheet.
12
<PAGE> 13
NATIONAL MERCANTILE BANCORP AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5 - INCOME TAXES
The Company has recognized losses for financial statement purposes
which have not yet been recognized on an income tax return. No deferred
benefit was recorded for these losses since all available income tax benefits
were recognized in prior years. In the second quarter of 1996 the Company
realized a tax benefit for a federal income tax refund received of
approximately $579,000, related to a carryback of a portion of the Company's
net operating losses, previously unrecognized. Future losses will not result
in additional tax benefits until the Company generates sufficient taxable
income to utilize the present net operating loss carryforwards.
NOTE 6 - ALLOWANCE FOR LOAN LOSSES
The Company's allowance for loan losses is maintained at a level
considered by management to be adequate to absorb estimated losses in the
existing portfolio. The allowance for loan losses is increased by the
provision for loan losses and decreased by the amount of loan charge-offs, net
of recoveries. While management believes the level of the allowance as of
September 30, 1996 is adequate to absorb losses inherent in the loan portfolio,
additional deterioration in the economy of the Bank's lending area could result
in levels of loan losses that could not be reasonably predicted at that date.
13
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
This section presents management's discussion and analysis of the
consolidated financial condition and operating results of National Mercantile
Bancorp (the "Company") and its subsidiary, Mercantile National Bank (the
"Bank"), for the three and nine month periods ended September 30, 1996 and
1995. The discussion should be read in conjunction with the Company's
unaudited consolidated financial statements and accompanying notes to the
unaudited consolidated financial statements (see "Item 1. Financial
Statements").
Except for the historical information contained herein, the matters
addressed in this Item 2 constitute "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
12E of the Securities Exchange Act of 1934, as amended. Such forward-looking
statements are subject to a variety of risks and uncertainties, including those
discussed in this Report on Form 10-Q that could cause actual results to differ
materially from those anticipated by the Company's management. The Private
Securities Litigation Reform Act of 1995 (the "Act") provides certain "safe
harbor" provisions for forward-looking statements. All forward-looking
statements made in this Quarterly Report on Form 10-Q are made pursuant to the
Act.
FINANCIAL CONDITION
The Company's consolidated assets continued to decrease during the
first nine months of 1996. At September 30, 1996, the Company's consolidated
assets decreased by $31.7 million or 24.0% to $100.3 million from $132.0
million at December 31, 1995. This decrease was due primarily to a $10.4
million decrease in cash and cash equivalents, $4.5 million decrease in
securities available for sale, and a $16.4 million decrease in net loans. The
decrease in consolidated assets from June 30, 1996 was $8.6 million, or 7.9%,
consisting mainly of a $3.4 million decrease in securities available for sale,
and a $4.4 million decrease in net loans. Customer deposits decreased by $7.3
million, or 7.2% to $93.2 million at September 30, 1996, from $100.5 million
at June 30, 1996 and $27.0 million, or 22.5%, from $120.2 million at December
31, 1995,. Securities sold under agreements to repurchase decreased by $0.7
million to $.4 million at September 30, 1996 from June 30, 1996, and $4.1
million from $4.5 million at December 31, 1995.
The decrease in the liabilities, accompanied by a decrease in assets
is consistent with the Company's planned restructuring to improve the Company's
capital ratios.
14
<PAGE> 15
OPERATING RESULTS
OVERVIEW
As set forth in the accompanying consolidated statements of
operations, the Company recorded a net loss for the three and nine month
periods ended September 30, 1996 of $182,000 or $(.06) per share, and
$1,015,000 or $(.33) per share, respectively, as compared to a net loss for the
three and nine month periods ended September 30, 1995 of $2.5 million or $(.82)
per share, and $5.9 million or $(1.94) per share, respectively.
Declining loan balances and sales of securities during 1995 resulted
in decreased total interest income in 1996. Total interest income for the
three and nine month periods ended September 30, 1996 was $2.1 million and $6.7
million, respectively, compared with total interest income for the
corresponding periods of 1995 of $2.9 million and $9.1 million, respectively.
Total interest expense for the three and nine month periods ended September 30,
1996 was $718,000 and $2.4 million, respectively, compared with total interest
expense for the corresponding periods of 1995 of $857,000 and $3.0 million,
respectively. While the decrease in interest earning loans and securities
caused a $2.4 million decrease in interest income for the nine months in 1996
compared with 1995, decreases in deposits and securities sold caused a
reduction of $.6 million in interest expense. Net interest income for the
three and nine month periods ended September 30, 1996 was $1.4 million and $4.3
million, respectively, compared with net interest income for the corresponding
periods of 1995 of $2.0 million and $6.0 million, respectively.
The reduction, compared with the corresponding periods of 1995, in
loans, securities and customer deposits, which caused a decrease in net
interest income for the three and nine month periods ended September 30, 1996,
is consistent with the Company's planned restructuring and have contributed to
more positive operating results. There was no provision for loan losses
required for the nine month period in 1996, as compared with a provision of
$2.2 million for the corresponding period in 1995. The loss on sale of
securities for the nine month period in 1996 was $6,000, compared with $2.5
million during the corresponding period in 1995. Other operating income,
primarily service fees, decreased to $124,000 and $409,000 respectively, for
the three and nine-month periods ended September 30, 1996 when compared with
$204,000 and $994,000, respectively, for the corresponding periods in 1995.
Other operating expenses, excluding the $1.0 million litigation expense
discussed below, decreased to $1.7 million and $5.3 million, respectively, for
the three and nine months in 1996, when compared with $3.0 million and $8.8
million, respectively, for the corresponding periods in 1995, amounting to a
39.8% decrease in expenses for the nine month period. This $3.5 million
decrease, which excludes the litigation expense, for the nine-month period
ended September 30, 1996 was due primarily to management's efforts to
continually reduce operating expenses, most visibly in compensation expense
which decreased $880,000 or 30.6% and occupancy expense which decreased
$729,000 or 55.4% and other professional services expense which decreased
$759,000 or 57.9% during the first nine months of 1996, compared with the same
period in the prior year.
15
<PAGE> 16
Although no additional provision was made for loan losses for the nine
month period ended September 30, 1996, the Bank's allowance for loan losses as
a percentage of nonperforming loans was 51.0% at September 30, 1996, 51.3% at
June 30, 1995, and 63.8% at December 31, 1995. Included in nonperforming loans
is one loan with a balance of $4.9 million which is secured by a First Trust
Deed on a residential property with a current appraised value of $10 million.
Total assets of the Company at September 30, 1996 have continued to
decrease. As part of the Company's capital plan for the Bank and the Company's
restructuring of its organization, the Company had reduced the Bank's asset
size through sales of securities available-for-sale which were funded by high
cost deposits, reduced classified assets through the sale of loans and reduced
operating expenses through consolidating functions and reduction of personnel.
The restructuring of the Bank began during the third quarter of 1994 with an
emphasis to improve the quality of assets, minimize interest rate risk, and
reduce overhead expenses in an effort to return to profitability. The Bank has
made significant progress toward its overall restructuring goals and is working
toward a return to profitability which is now contingent upon raising
additional capital enabling necessary growth.
During the three months ended June 30, 1996, the Company recognized a
liability in connection with pending litigation, and realized a tax benefit for
federal income tax refunds received related to a previously unrecognized net
operating loss carryback. The litigation liability is a result of an agreement
in principle related to counterclaims filed against the Bank by Lloyd's
Underwriters and Company Underwriters (discussed in the 1995 Form 10-K) (See
"Legal Proceedings"). The total amount of the settlement of $1.0 million,
reflected in consolidated statements of operations, is conditional on the
recapitalization of the Bank. Since it is management's intention to raise
additional capital in response to, among other things, regulatory agreements
(See "Capital Resources"), the full amount of the agreed upon settlement was
reflected in the accompanying unaudited consolidated financial statements. The
Company and its counsel are currently negotiating formal settlement
documentation and final resolution of this litigation is dependent upon
complete execution of formal settlement documents. The federal income tax
refund of $579,000 represents the realization of previously unrecognized income
tax benefits for the carryback of net operating losses (See "Note 5 Income
Taxes" to Unaudited Consolidated Financial Statements and "Income Taxes"). The
Company incurred expenses for professional services of $145,000 directly
related to efforts to generate this tax refund.
16
<PAGE> 17
CREDIT PORTFOLIO COMPOSITION AND CREDIT RISK
EFFECTS OF THE PROLONGED ECONOMIC RECESSION AND DEPRESSED REAL ESTATE VALUES
The southern California real estate market is currently showing signs
of improving from experiencing a very serious recession since 1990. Home
sales, residential building permits, non-residential building valuations and
employment all increased during the second quarter of 1996. The drop which
home prices experienced in 1996 has been the smallest in over five years.
However, mortgage defaults and foreclosures have increased, continuing a trend
from the first quarter of 1996.
While economic conditions nationally and elsewhere in California are
improving, southern California's economy remains weak. Commercial and
residential real estate market values in southern California, while showing
some signs of improvement, continue to remain depressed, adversely impacting
the financial condition and liquidity of many of the Company's borrowers.
Nonperforming assets at September 30, 1996 totaled $6.5 million including
$556,000 of other real estate owned, compared with $6.6 million in
non-performing assets at June 30, 1996 and $6.5 million at December 31, 1995.
Other real estate owned was $581,000 at June 30, 1996 and December 31, 1995.
NONPERFORMING ASSETS
The level of nonperforming assets, as presented in Table 1, decreased
$14,000 during the third quarter 1996. The amount of nonperforming loans for
which the Company does not hold substantial collateral amounted to $414,000 at
September 30, 1996, or 6.9% of all nonperforming loans at that date, compared
to $423,000, or 7.1% at June 30, 1996.
NONACCRUAL LOANS. Nonaccrual loans increased $64,000 during the third
quarter of 1996 to $869,000 as compared to $805,000 at June 30,1996. (See "Net
Interest Income and Interest Rate Risk" for a discussion of the effects on
operating results of nonaccruing loans.)
TROUBLED DEBT RESTRUCTURINGS. Included within nonperforming loans
presented in Table 1 are troubled debt restructurings ("TDR"). TDRs represent
loans for which the Company has modified the terms of loans to borrowers by
reductions in interest rates or extensions of maturity dates at below-market
rates for loans with similar credit risk characteristics. At September 30,
1996, TDRs totaled $5.0 million compared to $5.1 million at June 30, 1996, and
$5.2 million at December 31, 1995. Included in these amounts is one loan with
a balance of $4.9 million which is secured by a First Trust Deed on property
with a current appraisal value of $10.0 million.
LOANS CONTRACTUALLY PAST DUE NINETY OR MORE DAYS. Loans contractually
past due ninety or more days and still accruing interest decreased to $78,000
at September 30, 1996 from $111,000 at June 30, 1996.
17
<PAGE> 18
LOAN DELINQUENCIES. Loan delinquencies greater than 30 days past due
increased to $1.6 million or 2.5% of loans receivable at September 30, 1996
from $1.4 million or 2.0% of loans receivable at June 30, 1996.
LOAN CHARGE-OFFS. As reflected in Table 3, the Company charged-off
loans amounted to $66,000 during the three month period ended September 30,
1996, as compared to $1.1 million during the previous quarter. In the second
quarter, the Bank charged off two non-accrual loans totaling $1.1 million.
Recoveries of loans previously charged-off totaled $54,000 for the three month
period ended September 30, 1996 as compared to $297,000 during the second
quarter of 1996.
FUTURE EFFECTS OF THE PROLONGED ECONOMIC RECESSION AND DEPRESSED REAL
ESTATE VALUES ON THE ALLOWANCE FOR CREDIT LOSSES. As indicated in Table 2, a
significant percentage of the Company's loan portfolio continues to be
unsecured or collateralized by real property. The prolonged effects of the
southern California economic recession and depressed residential and commercial
real estate values may continue to adversely impact the financial condition and
liquidity of the Company's borrowing customers. As such, the Company may
continue to experience high levels of, or further increases in, nonperforming
loans, provisions for credit losses and charge-offs of nonperforming loans.
Loan losses are fully or partially charged against the allowance when,
in management's judgment, the full collectibility of a loan's principal is in
doubt. However, there is no precise method of predicting specific losses which
ultimately may be charged against the allowance and, as such, management is
unable to reasonably estimate the amount of loans to be charged-off in future
periods.
18
<PAGE> 19
Table 1
Nonperforming Assets
<TABLE>
<CAPTION>
(dollar amounts in thousands) December 31,
Sept 30, June 30, March 31, --------------------
1996 1996 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Nonaccrual loans $ 869 $ 805 $ 1,868 $ 573 $ 3,426
Troubled debt restructurings 5,034 5,054 5,059 5,167 5,582
Loans contractually past due ninety or more days with
respect to either principal or interest and
continuing to accrue interest 78 111 23 221 1,507
-------- -------- -------- -------- --------
Nonperforming loans 5,981 5,970 6,950 5,961 10,515
Other real estate owned 556 581 581 581 1,529
-------- -------- -------- -------- --------
Total nonperforming assets $ 6,537 $ 6,551 $ 7,531 $ 6,542 $ 12,044
======== ======== ======== ======== ========
Allowance for loan losses as a percent of
nonaccrual loans 351.2% 380.6% 205.4% 664.0% 89.4%
======== ======== ======== ======== ========
Allowance for loan losses as a percent of
nonperforming loans 51.0% 51.3% 55.2% 63.8% 29.1%
======== ======== ======== ======== ========
Total nonperforming assets as a percent of
total loans outstanding 10.1% 9.5% 9.9% 8.0% 10.4%
======== ======== ======== ======== ========
Total nonperforming assets as a percent of
total shareholders' equity 132.0% 116.2% 129.7% 108.8% 116.8%
======== ======== ======== ======== ========
</TABLE>
19
<PAGE> 20
Table 2
Loan Portfolio Composition and Allocation of the
Allowance for Credit Losses
(dollar amounts in thousands)
December 31,
<TABLE>
<CAPTION>
December 31,
September 30, -------------------------------------
1996 1995 1994
---------------- ----------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Loan Portfolio Composition:
Real estate construction and land development $ 3,546 5% $ 1,093 1% $ 948 1%
Commercial loans:
Secured by one-to-four family residential properties 6,411 10% 11,012 14% 18,398 16%
Secured by multifamily residential properties 2,889 4% 2,538 3% 2,368 2%
Secured by commercial real properties 26,697 41% 33,556 41% 32,061 28%
Other - secured and unsecured 17,606 27% 23,327 28% 43,385 37%
Home equity lines of credit 973 1% 5,857 7% 2,867 1%
Consumer installment and unsecured loans to individuals 7,028 12% 4,860 6% 15,691 15%
------- -------- ------- --------- ------- --------
Gross loans outstanding $ 65,150 100% $ 82,243 100% $115,718 100%
Deferred net loan origination fees, purchased
loan discount and gains on termination of
interest rate hedging contracts (279) (231) (434)
-------- -------- --------
Loans receivable $ 64,871 $ 82,012 $115,284
======== ======== ========
Allocation of the Allowance for Loan Losses:
Real estate construction and land development $ 54 11 $ 17
Commercial loans:
Secured by one-to-four family residential properties 375 205 77
Secured by multifamily residential properties 47 25 51
Secured by commercial real properties 684 454 674
Other - secured and unsecured 1,669 2,521 1,645
Home equity lines of credit 19 64 18
Consumer installment and unsecured loans to individuals 203 523 578
-------- -------- --------
Allowance allocable to gross loans outstanding 3,051 3,803 3,060
Commitments to extend credit under standby and
commercial letters of credit 1 2 3
-------- -------- --------
Total allowance for credit losses $ 3,052 $ 3,805 $ 3,063
======== ======== ========
Allowance for loan losses allocable to gross loans
outstanding as a percent of gross loans outstanding 4.70% 4.64% 2.66%
======== ======== ========
</TABLE>
20
<PAGE> 21
Table 3
Analysis of Changes in the Allowance for Loan Losses
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Three-month periods ended
-----------------------------------------------------------------------------
September 30, June 30, March 31, December 31, September 30
1996 1996 1996 1995 1995
--------------- --------------- -------------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at beginning of period $ 3,064 $ 3,837 $ 3,805 $ 3,459 $ 3,370
Loans charged off:
Real estate construction and land development -- -- -- -- --
Commercial loans:
Secured by one-to-four family residential
properties 9 -- -- -- --
Secured by multifamily residential properties -- -- -- -- --
Secured by commercial real properties -- -- -- -- 53
Other - secured and unsecured 48 1,065 54 72 1,505
Home equity lines of credit -- -- -- -- --
Consumer installment and unsecured loans
to individuals 9 5 -- -- 84
--------------- --------------- -------------- ------------- ------------
Total loan charge-offs 66 1,070 54 72 1,642
Recoveries of loans previously charged off:
Real estate construction and land
development -- -- -- 140 --
Commercial loans:
Secured by one-to-four family residential
properties 24 1 1 10 1
Secured by multifamily residential properties -- -- -- -- --
Secured by commercial real properties -- -- -- -- --
Other - secured and unsecured 28 273 75 153 4
Home equity lines of credit -- -- -- -- --
Consumer installment and unsecured loans
to individuals 2 23 10 55 6
--------------- --------------- -------------- ------------- ------------
Total recoveries of loans previously
charged off 54 297 86 358 11
--------------- --------------- -------------- ------------- ------------
Net loan charge-offs (recoveries) 12 773 (32) (286) 1,631
Provision for loan losses -- -- -- 60 1,720
--------------- --------------- -------------- ------------- ------------
Balance at end of period $ 3,052 $ 3,064 $ 3,837 $ 3,805 $ 3,459
=============== =============== ============== ============= ============
</TABLE>
21
<PAGE> 22
NET INTEREST INCOME AND INTEREST RATE RISK
NET INTEREST INCOME
Net interest income (the amount by which interest generated from
earning assets exceeds interest expense on interest-bearing liabilities)
represents the Company's most significant source of earnings. A primary factor
affecting the level of net interest income is the Bank's net interest margin or
the yield earned on interest-earning assets and the rate paid on
interest-bearing liabilities, as well as the change in the relative amounts of
average interest-earning assets and average interest-bearing liabilities.
The Company's ability to generate profitable levels of net interest
income is largely dependent on its ability to maintain sound asset credit
quality and appropriate levels of capital and liquidity (see "Credit Portfolio
Composition and Credit Risk," "Capital Resources," and "Liquidity").
The Company analyzes its earnings performance using, among other
measures, the interest rate spread and net yield on earning assets. During the
three months ended September 30, 1996 the Company's asset base continued to
decrease, and as a result, average interest-earning assets and average
interest-bearing liabilities continued to decrease. Average interest-earning
assets for the three months ended September 30, 1996 decreased to $101.8
million, compared with $108.9 million for the three months ended June 30, 1996,
and $130.2 million for the three months ended September 30, 1995. Average
interest-earning assets as a percentage of total average for the three months
ended September 30, 1996 was 95.3%, compared with 95.5% for the three months
ended June 30, 1996, and 92.7% for the three months ended September 30, 1995.
Average interest-bearing liabilities for the three months ended September 30,
1996 decreased to $65.9 million, compared with $69.4 million for the three
months ended June 30, 1996, and $75.3 million for the three months ended
September 30, 1995. Average interest-bearing liabilities as a percentage of
total average assets for the three months ended September 30, 1996 increased to
61.8%, compared with 60.9% for the three months ended June 30, 1996, and 53.5%
for the three months ended September 30, 1995.
Noninterest-bearing deposits decreased to $34.9 million at September 30, 1996
from $36.6 million and $44.6 million at June 30, 1996 and December 31, 1995,
respectively. Noninterest-bearing deposits as a percentage of total deposits
increased to 37.4% at September 30, 1996, as compared to 36.4% and 37.1% at
June 30, 1996 and December 31, 1995, respectively.
EFFECTS OF NONPERFORMING LOANS ON NET INTEREST INCOME. Foregone
interest income attributable to nonperforming loans amounted to $44,000 for the
three month period ended September 30, 1996, compared with $33,000 for the
corresponding period in 1995. (See "Credit Portfolio Composition and Credit
Risk" for a discussion of the Company's asset credit quality
22
<PAGE> 23
experience and the effects of nonperforming loans on the provision and
allowance for credit losses.)
COMPARISON OF NET YIELD AND INTEREST RATE SPREAD. The Company's net
yield on interest-earning assets remains high in comparison with the interest
rate spread due to the continued significance of noninterest-bearing demand
deposits relative to total funding sources. While these deposits are
noninterest-bearing, they are not cost-free funds, as the Company incurs
substantial other operating expense to provide accounting, data processing and
other banking-related services to these customers to the extent that certain
average noninterest-bearing deposits are maintained by such depositors, and
such deposit relationships are deemed to be profitable.
Customer service expense related to these deposits is classified as
noninterest expense. If customer service expenses related to real estate title
and escrow customers were classified as interest expense, the Company's
reported net interest income and noninterest expense would be reduced
correspondingly, by $64,000 and $257,000 for the three and nine month periods
ended September 30, 1996, and by $131,000 and $364,000 for corresponding
periods in 1995.
INTEREST RATE RISK MANAGEMENT
Interest rate risk management focuses on controlling changes in net
interest income that result from fluctuating market interest rates as they
impact the rates earned and paid on interest-earning assets and
interest-bearing liabilities whose interest rates are subject to change prior
to their maturity. Net interest income can be vulnerable to fluctuations
arising from changes in market interest rates to the extent that the yields on
various categories of earning assets respond differently to such changes from
the costs of interest rate-sensitive funding sources.
INTEREST RATE MATURITIES OF ASSETS AND FUNDING SOURCES. Management
also monitors the sensitivity of net interest income to potential interest rate
changes by distributing the interest rate maturities of assets and supporting
funding liabilities into interest rate-sensitivity periods, summarizing
interest rate risk in terms of the resulting interest rate-sensitivity "gaps".
The gap position is but one of several variables that affect net interest
income. The gap measure is a static indicator and, as such, is not an
appropriate means for forecasting changes in net interest income in a dynamic
business and economic environment. Consequently, these measures are not used
in isolation by management in forecasting short-term changes in net interest
income.
The weighted average yield on loans receivable was 9.81% and 9.58% for
the three and nine month periods ended September 30, 1996, compared with 9.86%
and 9.78% for the corresponding periods in 1995. Weighted average yield on
total earning assets was 8.30% and 8.17% for the three and nine month periods
ended September 30, 1996, compared with 8.75% and 8.37% for the corresponding
periods in 1995. Weighted average rate on interest bearing deposits was 4.39%
and 4.54% for the three and nine month periods ended September 30, 1996,
compared with 4.65% and 4.70% for the corresponding periods in 1995.
23
<PAGE> 24
INVESTMENT SECURITIES
Investment securities decreased to $15.6 million at September 30,
1996, from $18.9 million at June 30, 1996, and $20.1 million at December 31,
1995. The decrease from June 30, 1996 and December 31, 1995 was primarily due
to the maturity of $3 million of agency notes, principal payments received and
to a lesser extent the sale of a security valued at $114,000 generating a loss
of $1,000. Investment securities sold in 1995 valued at $43.0 million resulted
in realized losses through September 30, 1995 of $1.2 million. Net unrealized
losses on securities available for sale at September 30, 1996 was $197,000,
compared to $262,000 at June 30, 1996 and $154,000 at December 31, 1995.
Management believes that the unrealized loss is temporary in nature.
OTHER OPERATING INCOME
As set forth in the accompanying unaudited consolidated statements of
operations and discussed in the 1995 Form 10-K, the Company's principal sources
of recurring other operating income continue to be letters of credit, foreign
exchange services, investment services, and deposit-related and other customer
services. Fee income decreased to $124,000 and $409,000 for the three and nine
month periods ended September 30, 1996, as compared to $204,000 and $994,000
for the corresponding periods in 1995. These decreases resulted primarily from
reductions in investment, deposit and other related customer services. The
international services department was closed in December, 1995, while retaining
the letter of credit and foreign exchange functions. The Bank seeks to provide
a wide range of financial services to a limited number of niche markets,
primarily with concerns related to the entertainment, technology and escrow
industries, along with business and private banking and Small Business
Administration (SBA) lending. Management anticipates that fee income from
services to these niche markets and the origination and sale of SBA loans will
continue to represent important sources of other operating income.
OTHER OPERATING EXPENSES
As indicated in the accompanying unaudited consolidated statements of
operations, the Company reduced total operating expenses by $1.3 million, or
43%, during the third quarter of 1996 from the third quarter of 1995 and by
$2.5 million or 28% for the nine months ended September 30, 1996 from the
corresponding period in 1995. However, included as part of total other
operating expense in 1996 is a litigation settlement of $1.0 million resulting
from an agreement in principle related to counterclaims filed by Lloyd's
Underwriters and Company Underwriters (See "Legal Proceedings"). Other
operating expenses, excluding the $1.0 million legal settlement, decreased to
$1.7 million and $5.3 million, respectively, for the three and nine months in
1996, representing a 32% and 40% decrease respectively when compared to the
same period in 1995. Management's continued efforts to focus on reducing
operating expenses has, in part, created the decreases in 1996. The reduction
for the three and nine month periods, is mainly attributable to the reduction
in salaries and related expenses of $215,000 and $880,000, respectively, the
reduction in occupancy expenses of $225,000 and $729,000, respectively, and
24
<PAGE> 25
the reduction in other professional services of $322,000 and $759,000,
respectively. Included as part of the expense for other professional services
is $145,000 for consulting services directly related to efforts associated with
the federal income tax refund. (See "Note 5 Income Taxes" to unaudited
consolidated financial statements and "Income Taxes").
In 1995, the Company negotiated with its landlord a restructuring of
its lease for the Bank's premises. The restructuring of the Bank's leases
represents an annual savings of $852,000 over the next five years.
Operations for the remainder of 1996 and beyond will benefit from the
substantial reductions in operating costs achieved so far. The decrease in
rent expense as a result of the restructuring of the leases, the decrease in
compensation expense as a result of the reduction in staff, and the decrease in
other non-interest expense such as other professional services will contribute
directly to the improved performance in future years.
Management continues to explore measures to further reduce the level
of other operating costs.
INCOME TAXES
The Company has recognized losses for financial statement purposes
which have not yet been recognized on an income tax return. As a result of
existing net operating loss carryforwards for financial statement purposes
(discussed in the 1995 Form 10-K), the Company's 1996 net losses did not give
rise to additional income tax benefits. During the second quarter the Company
realized a tax benefit for a federal income tax refund received of
approximately $579,000, related to a carryback of a portion of the Company's
net operating losses previously unrecognized.
25
<PAGE> 26
CAPITAL RESOURCES
REGULATORY CAPITAL REQUIREMENTS AND REGULATORY AGREEMENTS
CAPITAL GUIDELINES
See Note 4 of the accompanying notes to unaudited consolidated
financial statements for a discussion of the capital requirements applicable to
the Company and the Bank.
FORMAL AGREEMENT
The Bank entered into a formal agreement with the OCC on December 14,
1995 (the "Formal Agreement"), pursuant to which the Bank is required to
maintain (i) Tier 1 capital equal to at least 6.5 percent of the Bank's
adjusted total assets ("capital leverage ratio") and (ii) Tier 1 qualifying
capital equal to at least 10.0 percent of the Bank's total risk-weighted assets
("Tier 1 risk-based capital ratio"). As set forth in Note 4, the Bank's
capital leverage ratio and Tier 1 risk-based capital ratio at September 30,
1996 were 4.81% and 7.28%, respectively. At September 30, 1996, the Bank was
not in compliance with the capital requirements required by the Formal
Agreement. The Formal Agreement also requires the Bank to appoint a new chief
financial officer (which the Bank had complied with in August, 1996), to make
certain determinations as to the reasonableness of any salary, consulting fee,
expense reimbursement or other type of compensation, to review the need for,
and the reasonableness of, all existing consulting, employment and severance
contracts, to prepare a written analysis of any new products or services, to
maintain the Bank's liquidity at a level sufficient to sustain current and
anticipated operations, to develop a three year capital plan and strategic
plan, and to improve the Bank's loan administration. The Company submitted a
capital plan for the Bank on February 8, 1996 to the OCC and a copy to the FRB.
The Company updated its strategic plan, which was filed with the "OCC" in March
1996. As a result of the Bank's failure to comply with all of the requirements
of the Formal Agreement, the Bank may be subject to further regulatory
enforcement action by the OCC.
The Company entered into a Memorandum of Understanding ("MOU") on
October 26, 1995 with the Federal Reserve Bank of San Francisco ("FRBSF"). The
MOU prohibits the Company from paying dividends without prior approval of the
FRB, requires the submission of a plan to increase the Bank's capital ratios,
requires the Company to conduct a review of the senior and executive management
of the Company and the Bank, prohibits the incurrence or renewal of debt
without the FRB's approval, restricts cash expenditures in excess of $10,000 in
any month and prohibits the Company from making acquisitions or divestitures or
engaging in new lines of business without the FRB's approval. The Company may
be subject to further regulatory enforcement action by the FRB.
26
<PAGE> 27
FUTURE EFFECTS OF AGREEMENT ON DIVIDENDS. There are statutory and
regulatory limitations on the amount of cash dividends which may be distributed
by a national bank. As a result of those limitations and reported net losses
in 1990, 1991, 1992, 1994, 1995 and the first nine months of 1996, the Bank
could not have declared dividends to the Company at September 30, 1996 without
the prior approval of the OCC. In addition, management expects the Formal
Agreement will substantially impair the ability of the Bank to declare and pay
dividends to the Company during the foreseeable future, since the Bank
currently intends to retain any earnings in order to augment its regulatory
capital. As dividends from the Bank are the principal source of income to the
Company, it is unlikely that the Company will declare and pay dividends in the
foreseeable future. Moreover, the MOU prohibits the Company from paying
dividends to its shareholders without the prior written approval of the FRB.
FUTURE EFFECTS OF NONPERFORMING LOANS AND CREDIT LOSSES ON CAPITAL RESOURCES
The ability of the Company and the Bank to maintain appropriate levels
of capital resources is ultimately dependent on their ability to support
earning asset growth with continued earnings. The Company experienced net
losses in 1990, 1991, 1992, 1994 , 1995 and the first nine months of 1996,
primarily as a result of increased provisions for credit losses, losses on the
sale of investment securities, losses on OREO and other assets, and reductions
in interest earning assets without a corresponding reduction in operating
expenses. The Company experienced decreases in the level of nonperforming
assets since December 31, 1993 (see "Credit Portfolio Composition and Credit
Risk") with the September 30, 1996 level at $6.5 million and $6.6 million at
June 30, 1996. Increases in nonperforming assets may negatively affect the
Company's ability to generate adequate earnings to the extent that such
nonperforming assets result in increased provisions for credit losses and
charge- offs or adversely affect the level of income from loans in those future
periods (see "Net Interest Income and Interest Rate Risk"). For the immediate
future, the Company and the Bank intend to maintain their capital leverage
ratio and its Tier 1 risk-based capital ratio primarily through the declining
loan balances and earning asset levels. At the same time, the Company is
committed to pursuing all options regarding the future of the Bank, including
working with investment banking advisors on efforts to raise additional capital
to ensure the Bank's growth and prosperity.
27
<PAGE> 28
LIQUIDITY
LIQUIDITY MANAGEMENT
The accompanying consolidated statements of cash flows present certain
information about cash flows from operating, investing and financing
activities. The Bank's principal cash flows relate to investing and financing
activities, rather than operating activities. While the statements present the
periods' net cash flows from lending and deposit activities, they do not
reflect certain important aspects of the Bank's liquidity, including (i)
anticipated liquidity requirements under outstanding credit commitments to
customers (ii) intraperiod volatility of deposits, particularly fluctuations in
the volume of commercial customers' noninterest-bearing demand deposits, and
(iii) unused borrowings available under federal funds lines, repurchase
agreements and other arrangements. Management believes that the liquidity
guidelines are generally more indicative of the Bank's overall liquidity
position. A source of operating cash flows is net interest income. See "Net
Interest Income and Interest Rate Risk" for a discussion of the impact of
recent trends and events on this source of operating cash flows. While the
Bank no longer has a credit accommodation facility at a correspondent bank, an
accommodation has been put in place at the Federal Reserve Bank. Management
monitors the Bank's assets and liabilities on a daily basis to ensure that
funding sources remain adequate to meet anticipated demand. While management
believes the Bank's funding sources are adequate to meet anticipated demand, no
assurance can be made that demand on the Bank's resources will not exceed the
Bank's funding sources.
The Company has only limited expenses at the present time and has no
ability to fund the Bank's cash needs. In order to meet the Bank's cash needs
the Bank must demonstrate the ability to produce a consistent level of adequate
earnings. The Bank's ability to establish adequate earnings is dependent
primarily on augmenting capital sufficient to support growth of its asset base.
The Company is evaluating available methods to raise additional capital.
LIQUIDITY TRENDS
During 1995, the Bank experienced a decline, continuing through the
first nine months of 1996, in total deposits. During the nine months ended
September 30, 1996, total deposits decreased with reductions in virtually all
deposit categories except savings deposits which increased.
Time certificates of deposit of $100,000 or more were $6.0 million at
September 30, 1996 compared with $7.5 million at June 30, 1996 and $8.6 million
at December 31, 1995. Time certificates of deposit of $100,000 or more
continued to play a less significant role as a source of funding, representing
the continuation of a trend which began in 1991. In general, deposits of more
than $100,000 are considered to be more volatile than fully-insured deposits in
denominations of less than $100,000.
28
<PAGE> 29
The Bank maintains a wholesale institutional funds acquisition
operation ("money desk"). This operation provided 25% of the Bank's average
total funding sources during the third quarter of 1996, as compared to 18%
during the third quarter of 1995, while noninterest-bearing demand deposits
provided 34% of average total funding sources during the third quarter of 1996,
compared to 42% during the comparable 1995 period. The Bank will enhance its
efforts to obtain direct, non-brokered funds through its own marketing programs
within its own market area, through direct solicitation, as well as by
attracting traditional local market area deposits. However, the Bank's policy
is to activate the money desk operation, as necessary, if the Bank's liquidity
falls below specified levels. Brokered deposits will not be solicited through
Money Desk activities.
29
<PAGE> 30
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In February 1995, counterclaims were filed against the Bank in an
action commenced by British & Commonwealth Merchant Bank ("BCMB"), as
agent for itself and the Bank, in England against Lloyd's Underwriters
and Company Underwriters (collectively, "Lloyds"). The Bank and BCMB
claim that Lloyd's owes them a further $120,659 of insurance proceeds
relating to a claim filed by BCMB (for itself and the Bank) for
approximately $7.8 million under policies insuring repayment of a loan
from the Bank and BCMB to Performance Guarantees, Inc. for production
of a film entitled "Barr Sinister". In or about November 1991,
Lloyd's paid approximately $7.8 million in insurance proceeds, which
Lloyd's now seeks to recover a half each from the Bank and BCMB. In
its counterclaim, Lloyd's contends that the Leading Underwriter lacked
authority to issue the insurance policies and endorsements on behalf
of all of the insurers under which payment was made and secondly, that
material misrepresentations were made to the Leading Underwriter as to
the likely budget for the film and that if the leading Underwriter had
known the true position, the the film would not have accepted under
the relevant policies. Lloyd's position, therefore, is that such
payment should be returned to Lloyd's.
An agreement in principle was reached on June 7, 1996 with Lloyds for
the settlement of the Bank's claim against Lloyds and Lloyds'
counterclaims against the Bank. The parties and their counsel are
negotiating formal settlement documentation and final resolution of
this litigation is dependent upon complete execution of formal
settlement documents. The Bank has determined to enter into the
contemplated settlement not as a result of the Bank's conclusions as
to the merits of Lloyds' counterclaims against the Bank, but solely as
a matter of resolving those counterclaims in connection with the
Bank's effort to recapitalize.
The settlement is conditional on the recapitalization of the Bank and,
in light of that condition, "tolling" agreements have been entered
into with various third parties to preserve the Bank's ability to
institute, if necessary, further proceedings against those third
parties for potential losses that may arise from the continuation of
the Lloyds' counterclaims, should the settlement not be concluded.
The settlement contemplates that the Bank will pay $500,000 to Lloyds
upon completion of the Bank's recapitalization and a further $500,000
on the second anniversary of that payment. Settlement negotiations
also contemplate that BCMB will release the Bank from any claim that
BCMB might have against the Bank should BCMB suffer loss in connection
with Lloyds' counterclaims against BCMB in the continuing litigation.
Discussions with BCMB in this regard have not yet been concluded. No
assurances can be made that BCMB will agree to such release or in fact
that the overall settlement will be effectuated.
30
<PAGE> 31
ITEM 2. CHANGES IN SECURITIES
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 AND REPORTS ON FORM 8-K
Exhibits required by Item 601 of Regulation S-K.
10.1 Employment Agreement and Addendum dated July 17, 1996 between
Mercantile National Bank and Joseph W. Kiley III.
(b) Reports on Form 8-K.
None.
31
<PAGE> 32
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)
November 14, 1996 /s/ Howard P. Ladd
--------------------------------
Howard P. Ladd
Chief Executive Officer
November 14, 1996 /s/ Joseph W. Kiley III
--------------------------------
Joseph W. Kiley III
Chief Financial Officer
Chief Financial Officer
32
<PAGE> 1
EXHIBIT 10.1
[MERCANTILE NATIONAL BANK LOGO]
Joseph W. Kiley, III
Title: Executive Vice President and Chief Financial Officer
of Mercantile National Bank and National Mercantile
Bancorp.
Job Responsibilities: As outlined on the Initial Expectations Sheet dated
5/15/96. A normal job description is attached. Your
employment is "at will."
Base Compensation: Until recapitalization has been completed $10,000.00 per
month ($120,000 annually). After recapitalization
$10,416.66 per month ($125,000 annually).
Incentive Compensation: Annually agreed upon goals and objectives based on the
annual budget and performance of the Company. Incentive
could be earned up to 60% of base salary.
Option Stock: Initial stock option grant of 20,000 shares plus 10,000
additional shares at the time of recapitalization based
on the existing National Mercantile Bancorp stock option
program. Vesting for all shares would be in accordance
with the National Mercantile Bancorp's employee stock
option plan.
Automobile: A car allowance of $550.00 per month will be paid.
Telephone: $50.00 per month.
Club Memberships: Los Angeles Country Club - $400.00 per month
Jonathan Club - $250.00 per month.
Professional & Will be reimbursed by the Bank.
Educational Dues:
As an employee of Mercantile National Bank all normal and regular
benefits are available. Vacation would be 20 days per year or four weeks.
/s/ JOSEPH W. KILEY, III /s/ SCOTT A. MONTGOMERY
- ------------------------------ --------------------------------
Joseph W. Kiley, III Scott A. Montgomery
Dated: July 17, 1996 Dated: 7/17/96
----------------------- --------------------------
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 6,669
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 13,200
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 15,832
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 64,871
<ALLOWANCE> 3,052
<TOTAL-ASSETS> 100,301
<DEPOSITS> 93,240
<SHORT-TERM> 434
<LIABILITIES-OTHER> 1,674
<LONG-TERM> 0
0
0
<COMMON> 24,614
<OTHER-SE> (19,661)
<TOTAL-LIABILITIES-AND-EQUITY> 100,301
<INTEREST-LOAN> 5,179
<INTEREST-INVEST> 795
<INTEREST-OTHER> 720
<INTEREST-TOTAL> 6,694
<INTEREST-DEPOSIT> 2,368
<INTEREST-EXPENSE> 23
<INTEREST-INCOME-NET> 4,303
<LOAN-LOSSES> 0
<SECURITIES-GAINS> (1)
<EXPENSE-OTHER> 6,305
<INCOME-PRETAX> (1,594)
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,015)
<EPS-PRIMARY> (0.33)
<EPS-DILUTED> (0.33)
<YIELD-ACTUAL> 0
<LOANS-NON> 869
<LOANS-PAST> 78
<LOANS-TROUBLED> 5,034
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 3,805
<CHARGE-OFFS> 1,190
<RECOVERIES> 437
<ALLOWANCE-CLOSE> 3,052
<ALLOWANCE-DOMESTIC> 2,063
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 989
</TABLE>
