SecProbe.io

CORRESP
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filename1.htm

September 23,
2005

Angela
Jackson

Senior
Accountant

Division
of Corporate Finance, Mail Stop 4561

United
States Securities and Exchange Commission

Washington,
D.C. 20549

Re:
National Mercantile Bancorp Form 10-KSB File No. 001-13015

Dear
Ms. Jackson:

This
letter is written in response to your letter dated September 22, 2005 in
which, pursuant to your review of National Mercantile Bancorp’s Form 10-KSB
filed March 31, 2005, you requested certain information regarding our
derivative instruments.

At
December 31, 2004, National Mercantile Bancorp and its consolidated
subsidiaries, Mercantile National Bank and South Bay Bank, N.A. were parties to
the following derivative instruments:

•                  In January 2003, National Mercantile
Bancorp entered into an interest rate swap agreement in which it exchanged a
fixed rate payment obligation of 10.25% on a notional principal amount of $15.0
million for a floating rate interest based on the six-month London InterBank
Offered Rate plus 458 basis points for a 29-year period ending July 25,
2031.

•                  On July 1, 2004, the Banks entered into
interest rate swaps — Mercantile National Bank $30.0 million and South Bay Bank
$20.0 million - in which they exchanged an adjustable rate interest based on
the prime rate lending index for a fixed rate payment of 6.925% on an aggregate
notional principal amount beginning at $50.0 million for a 4-year period,
declining to $30.0 million for the fifth year and $10.0 million for the sixth
year with a final maturity of June 30, 2010.

Attached
is an Accounting Designation Memo for each of our derivative instruments
prepared at the inception of the hedge relationship.  Although not enumerated to your bullet
points, the Memos are responsive to each of your requests for information.

National
Mercantile Bancorp acknowledges that (i) it is responsible for the
adequacy and accuracy of the disclosure in the filing; (ii) staff comments
or changes to disclosure in response to staff comments do not foreclose the SEC
from taking any action with respect to the filing; and (iii) the company
may not assert staff comments as a defense in any proceeding initiated by the
SEC or any person under the federal securities laws of the United States.

Please
contact me at 310-282-6703 if you have any further questions.

  Sincerely,

  David
  R. Brown

  Executive
  Vice President

  Chief
  Financial Officer

encls

2

National
Mercantile Bancorp ( the Company )

$15 Million
Interest Rate Swaption with Citigroup

SFAS 133
Accounting Designation Memo

Date of
Designation: January 6, 2003 (the trade date of the swap)

This transaction will be
subject to SFAS No. 133 (as amended), Accounting
for Derivative Instruments and Hedging Activities.  Paragraph 20 of SFAS No. 133 indicates that
the Company may designate a derivative instrument as hedging the exposure to
changes in the fair value of an asset or a liability or an identified portion
thereof.  To qualify for hedge accounting
the Company must formally document the hedging relationship and the risk
management objective and strategy for undertaking all qualifying hedges.  This documentation should include (i)
identification of the hedging instrument; (ii) the hedged item; (iii) the
nature of the risk being hedged, and (iv) how the hedging instrument’s
effectiveness in offsetting the exposure to changes in the hedged item’s fair
value attributable to the hedged risk will be assessed.

Hedging
Instrument: The
Company designates the $15 million interest rate swaption with an effective date
of January 6, 2003 and a maturity date of July 25, 2031 (the “Hedging
Instrument”) as a fair value hedge of the Hedged Item (defined below).

Hedged
Item: $15 million of
the Company’s 10.25% fixed rate junior subordinated deferrable interest
debentures due July 25, 2031 (the “Debentures” and the “Hedged Item”).

Risk
Management Objective and Nature of Risk Being Hedged: The $15 million interest rate swaption hedges
the change in fair value attributable to changes in market interest rates of
the Company’s Debentures (the “Hedged Risk”) and is consistent with the Company’s
risk management objective and strategy to reduce exposure to change in fair
value of the Debentures.  The interest
rate swaption will result in the Company’s interest rate on the Debentures
floating at the 6-month LIBOR plus 458 basis points.

Effectiveness
of the Hedging Relationship: The critical terms of the Hedging Instrument and those of the Hedged
Item are summarized below:

•                  The
notional amount of the swaption matches the principal amount corresponding to
the Hedged Item;

•                  The
fair value of the swaption at the inception of the hedging relationship is
zero;

•                  The formula for computing net settlements
under the swaption is the same for each net settlement (that is, the fixed rate
is the same throughout the term of the swaption and the variable rate equals
6-month LIBOR plus 458 basis points);

•                  All other terms of the interest rate swaption
and the Debentures are typical of those instruments;

•                  The call options in the swaption match the
Company’s call options in the Debentures – both call dates and call premiums;

•                  The expiration date of the swaption matches
the maturity date of the Debentures.

•                  There is no floor or ceiling on the variable
interest rate of the swaption;

•                  The repricing dates of the swaption match
those of the Debentures;

•                  The net settlement payments on the swaption
are deferrable at the Company’s option on identical terms as the deferral
option under the Debentures;

•                  Based on the Company’s current assessment,
the likelihood of the swaption counterparty (Citigroup), not defaulting is
probable.

Effectiveness
Assessments and Measurement of Ineffectiveness:
The critical
terms of the swaption and the Debenture match at inception resulting in the
fair value hedge being fully effective throughout the term and there will be no
ineffectiveness to recognize in earnings during the term of the hedge.  That is, the entire gain or loss on the
Hedging Instrument exactly offsets the loss or gain on the Hedged Item
attributable to the Hedged Risk.
Additionally, it is probable that the swap counterparty will not default
on the swaption, therefore, the Company concludes that the hedging relationship
is highly effective at achieving offsetting changes in fair value attributable
to changes in market interest rates at inception and on an ongoing basis.

The Company will assess the
risk of counterparty default whenever financial statements are reported and at
least quarterly.

Impact on
Financial Statements:

When financial statements are
prepared, an adjustment will be made to record the swaption at fair value on
the balance sheet.  Since no hedge
ineffectiveness occurs, an offsetting adjustment will be made to the
Debentures.  Net interest accruals from
the swap will flow through earnings as adjustments to interest expense on the
Debentures.

Mercantile National Bank (“the
Company”)

$30 Million Amortizing Interest
Rate Swap with Bear Stearns Bank PLC

FAS 133 Accounting Designation
Memo

Date of Designation: July 1, 2004
(the trade date of the swap)

CFNATLMERC2004070101

This transaction will be
subject to SFAS No. 133 (as amended), Accounting for Derivative Instruments
and Hedging Activities. Paragraph 28 of SFAS No. 133 indicates that
the Company must formally document the hedging relationship and the risk
management objective and strategy for undertaking all qualifying hedges. This
documentation should include identification of the hedging instrument, the
hedged transaction, the nature of the risk being hedged, and how the hedging instrument’s
effectiveness in hedging the exposure to the hedged transaction’s variability
in cash flows attributable to the hedged risk will be assessed.

Risk Management Objective and
Nature of Risk Being Hedged: The $30 million amortizing interest rate swap hedges the overall
changes in cash flows (the hedged risk) on the Company’s designated Prime-based
interest receipts (see “hedged transactions” below) and is consistent with the
Company’s risk management objective and strategy to reduce exposure to variability
in cash flows relating to interest receipts on its variable-rate assets. (The
interest rate swap will effectively fix the Company’s interest rate on $30
million [amortizing] of loan assets at 6.925% plus the credit spread over
Prime, if any.)

Hedging Instrument: The Company designates the $30 million
amortizing interest rate swap with an effective date of July 1, 2004 and a
maturity date of July 1, 2010 (the hedging instrument) as a cash flow hedge of
the hedged transactions (defined below).

Hedged Transactions: The first Prime-based payments received by
the Company each calendar month (beginning with payments received on loans with
spreads over Prime as designated below*) during the term of the hedging
instrument that, in the aggregate for each period, are interest payments on
principal equal to 102% of the hedging instrument’s notional amount on the Company’s
then existing Prime-based loans (the hedged transactions).

* The $30 million amortizing
interest rate swap is designated as follows:

•                  $5 million to loans with 0.75% spread over
Prime;

•                  $10 million to loans with 1.00% spread over
Prime;

•                  $5 million to loans with 1.25% spread over
Prime; and

•                  $10 million to loans with 1.50% spread over
Prime.

Only in the event that there
becomes insufficient interest payments on the Prime-based loans as designated
above, then the Company further designates as the hedged transactions the first
payments received on otherwise unhedged Prime-based loans with the next closest
spreads to Prime.

Effectiveness of the Hedging
Relationship: The
critical terms of the interest rate swap and those of the hedged transactions
are summarized below:

•                  The
principal amount corresponding to the hedged transactions is equal to 102% of
the notional amount of the swap;

•                  The fair value of the swap at the inception
of the hedging relationship is zero;

•                  The
formula for computing net settlements under the swap is the same for each net settlement
(that is, the fixed rate is the same throughout the term of the swap and the variable
rate equals Prime);

•                  All
other terms of the interest rate swap and the variable-rate loan assets on
which the hedged transactions are based are typical of those instruments;

•                  All
interest receipts on the hedged transactions during the term of the swap are designated
as hedged, and no interest receipts beyond the term of the swap are designated
as hedged;

•                  There
is no floor or cap on the variable interest rate of the swap, and any floors or
caps on the variable-rate assets, if present, are significantly
out-of-the-money;

•                  The
repricing dates of the swap match those of the variable-rate assets on which
the hedged transactions are based;

•                  Based
on the Company’s current assessment, the likelihood of the swap counterparty (Bear
Stearns Bank PLC), not defaulting is probable; and

•                  Based
on the Company’s current assessment, it is probable that there will be
sufficient Prime-based interest receipts through the maturity date of the
hedging instrument (that is, the hedged forecasted transactions are probable of
occurring).

Effectiveness Assessments and
Measurement of Ineffectiveness: Since the critical terms of the swap and hedged transactions match
(or almost match) at inception and it is probable that the swap counterparty
will not default on the swap, the Company concludes at inception that the
hedging relationship is expected to be highly effective at achieving offsetting
changes in cash flows. However, the Company may not assume no ineffectiveness
in this hedging relationship because Prime is not considered a benchmark
interest rate, the critical terms do not exactly match, and the hedging
relationship does not involve hedging the cash inflows related to the same
recognized loan throughout the life of the hedging relationship. Consequently,
the Company will consider the amount and timing of the hedged transactions’
cash flows vis-à-vis the swap’s cash flows when assessing effectiveness and
calculating ineffectiveness. Each period (at least quarterly), the Company will
assess the risk of counterparty default, whether it is probable that the
Company will continue to receive interest payments on principal equal to at
least 102% of the swap’s notional on its then existing Prime-based loans (as
described above), and whether exact offset has occurred by comparing the
variable cash flows on the swap that occurred cumulatively from inception of
the hedge with the variable cash flows on the hedged transactions.

In addition to the
notional/principal mismatch noted above, a source of potential ineffectiveness may
result from loans that prepay (or mature or are sold) and that are replaced
with loans that have different credit spreads to Prime. The change in cash
flows on the hedged transactions due to changes in the credit spreads could
result in ineffectiveness that may affect reported earnings. However, the hedge
would likely continue to be considered “highly effective” and continue to qualify
for hedge accounting. In addition, the effect of any caps/floors (if present)
in the variablerate assets (to determine whether the caps/floors may affect the
expected future cash flows on the hedged forecasted transactions) and any
potential differences in reset dates will be considered in assessing
effectiveness and measuring ineffectiveness.

Because of potential ineffectiveness,
prospective and retrospective evaluations of hedge effectiveness will be based
on the results of the “Change in Variable Cash Flows Method” described in DIG
Issue G7 (Method 1). This methodology will also be used to measure hedge
ineffectiveness each quarter. This calculation involves a comparison of the
present value of the cumulative change in the expected future cash flows on the
variable leg of the swap and the present value of the cumulative change in the
expected future interest cash flows on the hedged transactions. As long as the
ratio calculated by this method falls between .8 and 1.25, and it remains
probable that the swap counterparty will not default, hedge accounting will be
applied for the period and the hedge will be expected to be highly effective in
the future.

Impact on Financial Statements: When financial statements are prepared, an
adjustment will be made to record the swap at fair value on the balance sheet.
If no hedge ineffectiveness occurs, an offsetting adjustment will be made to
other comprehensive income (OCI). If hedge ineffectiveness exists, accumulated
OCI will be adjusted to a balance that reflects the difference between the overall
change in the fair value of the swap since the inception of the hedging
relationship and the amount of ineffectiveness that must be recorded in
earnings (as calculated per the “Change in Variable Cash Flows” method
discussed above). Net interest accruals from the swap will flow through
earnings as adjustments to interest income on the loan assets. The fair value
of the swap and the amount recorded in OCI will be zero at the expiration date
of the swap.

South Bay Bank, N.A. (“the
Company”)

$20 Million Amortizing Interest
Rate Swap with Citigroup Financial Products, Inc.

FAS 133 Accounting Designation
Memo

Date of Designation: July 1, 2004
(the trade date of the swap)

CFNATLMERC2004070102

This transaction will be
subject to SFAS No. 133 (as amended), Accounting for Derivative Instruments
and Hedging Activities. Par