December 5, 2005
Angela Connell
Senior Accountant
United States Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Dear Ms. Connell:
This letter is written in response to your letter dated November 17, 2005 in which you requested information regarding National Mercantile Bancorp’s accounting for derivative instruments and hedging activities, specifically, the $15 million interest rate swaption (the “Swaption”) designated as a fair value hedge of $15 million of our junior subordinated deferrable interest debentures (the “Debentures”).
The detailed terms of the Debentures and Swaption follows:
|
| Debentures |
| Swaption |
|
Maturity/expiration |
| July 25, 2031 |
| July 25, 2031 |
|
Interest rate |
| 10.25% fixed |
|
|
|
Fixed rate payor |
|
|
| Salomon Smith Barney |
|
Fixed rate |
|
|
| 10.25% |
|
Floating rate payor |
|
|
| National Mercantile Bancorp |
|
Floating rate |
|
|
| 6-month LIBOR + 458 bp |
|
Payment dates |
| Each January 25 and July 25 |
| Each January 25 and July 25 |
|
Floating rate reset date |
|
|
| Each January 25 and July 25 |
|
Interest rate caps/floors |
| None |
| None |
|
Optional early termination |
| Redemption Price*: |
| Optional Early Termination |
| ||||
|
| July 25, 2006 |
| 107.6875 | % | July 25, 2006 |
| 7.6875 | % |
|
| July 25, 2007 |
| 106.1500 | % | July 25, 2007 |
| 6.1500 | % |
|
| July 25, 2008 |
| 104.6125 | % | July 25, 2008 |
| 4.6125 | % |
|
| July 25, 2009 |
| 103.0750 | % | July 25, 2009 |
| 3.0750 | % |
|
| July 25, 2010 |
| 101.5375 | % | July 25, 2010 |
| 1.5375 | % |
|
| July 25, 2011 and after |
| 100 | % | July 25, 2011 and after |
| 0 | % |
|
| *Redemption Price is the price set forth for any redemption that occurs within the 12-month period beginning in the date shown, expressed as a percentage of principal. | |||||||
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|
|
|
|
|
|
|
|
|
|
| **Salomon holds an option of early termination with payment of the product of (i) Swap notional amount and (ii) Optional Early Termination Fee. |
We structured the derivative (an interest rate swap with an early termination option) so that the terms of the Swaption would mirror the terms of the Debentures, including the early
termination option at matching option premiums, in order to increase hedge effectiveness. We want to clarify that the Swaption is an interest rate swap with an option for early termination by the counterparty on terms that mirror our early redemption option on our Debentures rather than an agreement that provides us an option to enter into an interest rate swap.
Regarding the assessment of hedge effectiveness, the prepayment option in the Debentures results in not all of the conditions required under paragraph 68 of SFAS 133 being present for the assumption of no ineffectiveness. Accordingly, we determine the fair value of the Debentures and the Swaption. There is no observable market for our Debentures; accordingly, the pricing model utilized for the Swaption is used to determine the fair value of our Debentures. The terms of the Swaption, including the early termination option, exactly match without exception the terms of the Debentures, consequently, we are not making an assumption of no ineffectiveness but rather the Swap has de facto no hedge ineffectiveness.
Please contact me at 310-282-6703 if you require any additional information.
Sincerely,
David R. Brown
Executive Vice President
Chief Financial Officer