Peoples Financial Corp.
Annual Report 2006

Plain-text annual report

P E O P L E S F I N A N C I A L C O R P O R A T I O N A N N U A L R E P O R T 2006 RECOVERY AND RENEWAL C O N T E N T S 1 P R E S I D E N T ’ S L E T T E R 3 Y E A R I N R E V I E W 5 F I N A N C I A L S 36 C O R P O R A T E I N F O R M A T I O N O N T H E C O V E R : Cruisin’ the Coast presented by The Peoples Bank returned in 2006 after its weather-caused hiatus in 2005. The 2006 event attracted some 80% of the registered participants who attended in 2004. Each year, Cruisin’ holds its Wednesday Block Party in downtown Biloxi right in front of the Main Office. Hundreds of vintage and custom cars line Lameuse Street, showing off their best attributes for a number of awards. One of those awards is The Peoples Cup, presented every year by Chevis C. Swetman, president and CEO of Peoples Financial Corporation and the bank. Photo by Bruce W. Smith T O O U R S H A R E H O L D E R S : f 2005 is remembered as the year of destruction, then 2006 will be considered the first year of our long reconstruction and recovery process. Perhaps the most important achievement in 2006 was the recognition of the enormity of the job ahead. We took the first steps in reclaiming our Gulf Coast. I think everyone would agree that much was accom- plished in the first year after Katrina. Of course, much more work lies ahead. Your company and your bank spent 2006 repairing the immediate damage of Katrina. We were able to repair and reoccupy every permanent branch except for Pass Christian, which was completely destroyed. More importantly, we moved beyond repair and reconstruction to renewal and revival by resuming our original long-term growth plan. This is why the next few pages of this year’s annual report are titled The Year in Review & Preview. We enjoyed a good year in 2006, but we are truly excited about 2007. We have not been able to say that for a couple of years. No one can argue that the pace of our rebuilding efforts stalled in the second half of the year, primarily due to a combination of the slow- down in the flow of funds and the uncertainty caused by a crisis in the property insurance industry. Beginning in 2007, it seems we are reaching a satisfactory conclusion to the issues, and the resurgence and rebuilding of the Mississippi Gulf Coast will pick up the pace— perhaps dramatically. During 2006 our communities took the time and made the concerted effort to define what we want to be in the future. During 2007 we will take the first major steps in building the renaissance along the Gulf Coast, moving from concepts on paper to realization in bricks and mortar. Here on the Gulf Coast, we are fortunate in having the gaming indus- try, our major economic driver, move back into operation so quickly. With the help of our state legislature, casinos were allowed to operate on land. This single step facilitated the rapid reopening of several busi- nesses whose barges were washed up on shore and would have required months to replace and refurbish to get back in operation. Instead, some of our operators were able to convert their lobbies to gaming facilities and begin operations in a matter of weeks, generat- ing jobs, tax revenue and economic activity. By the end of 2006, a total of ten casinos were in operation. that will create the complete experience to bring vis- itors back to the Mississippi Gulf Coast. In that regard, it is gratifying to see many of our heritage restaurant brands reopen and the number of available rooms slowly but surely increase. One shining example of our area’s revival was the very successful renewal of Cruisin’ the Coast, presented by The Peoples Bank. After the 2005 event was lost to weather, the 2006 event drew some 80% of the record-setting number of registrants who attended in 2004. Considering the reduced number of hotel rooms and show venues available, that is a remarkable accomplishment. Once again, the Wednesday Block Party in downtown Biloxi was held to great success right in front of our Main Office, and we are proud to be the presenting sponsor of the Coast’s largest single tourism event. Despite these triumphs, the renewal effort continues to be a lot of hard work. We are faced with rebuilding our homes and our lives, as well as our economy. A good many of our great team at The Peoples Bank have yet to move back to their homes. In spite of their personal challenges, our team members have never wavered in their commitment to provide quality financial products and outstanding service to our many customers. I hope you join me in commending their efforts, without which we would simply cease to function. I also want to thank our Board of Directors for provid- ing the leadership and counsel that has taken our company and bank through the most trying, most challenging situation we are ever likely to experience in our lifetimes. The fact that The Peoples Bank is back on the road of its long-term strategic plan, building new branches, renovating existing ones and expand- ing our Main Office demonstrates the wisdom of our Board’s vision. Together, our team will continue working every day to earn your trust as we restore our community. Sincerely, Our gaming industry drives our tourism industry. Our challenge ahead is to rebuild the infrastructure of rooms, restaurants and attractions Chevis C. Swetman Chairman of the Board, President & CEO 1 N E T I N C O M E ( I N T H O U S A N D S ) E A R N I N G S P E R S H A R E N E T I N T E R E S T I N C O M E ( I N T H O U S A N D S ) $12,768 $2.30 $30,109 $24,794 $19,475 $5,794 $5,882 $1.04 $1.06 2004 2005 2006 2004 2005 2006 2004 2005 2006 M A I N O F F I C E E X P A N S I O N The Main Office extension includes 30,500 square feet of space on four floors that will match our existing historic building in finishes, color and design. The second floor of the new extension will also include meeting and training rooms to enhance employee development and continuing education programs. T H E Y E A R I N R E V I E W & P R E V I E W Financially, the Company and the bank enjoyed a very successful year with a large increase in earnings fueled by substantial gains in loan volume and net interest income. For the year, loan volume rose to $401 million, 15% higher than 2005. While that figure represents a significant increase, earlier in the year we had projected a 25% growth in loan volume. The slower pace is a result of the deceleration of money flow N E W C O N S T R U C T I O N A N D R E N O VAT I O N S B E G I N and the construction activity that the entire area experienced in the latter part of 2006. Beyond the financial results, one of our most significant achievements of 2006 was the completion of our branch repair We believe the slowdown is only temporary, the product of an atmosphere of and reconstruction efforts. By the end of the year, the bank uncertainty caused by rising construction costs, the availability and affordability had moved back into every branch except Pass Christian, of insurance, building height requirements and construction codes. Once these which was completely destroyed to the slab. underlying questions are answered, the pace of rebuilding will inevitably rebound and the recovery of our Gulf Coast will accelerate. As we move into 2007, we once again start to look forward. We have begun construction on a long-planned expansion to our Our net interest income grew 21%, faster than loan volume, benefiting from our loan Main Office that will significantly increase space for our back- portfolio’s 60/40 ratio of floating to fixed rates and from higher earnings in our office operations. investment portfolio due to our larger deposit base. S T O C K D I V I D E N D R A I S E D T W I C E The Main Office extension includes 30,500 square feet of space on four floors that will match our existing historic building in finishes, color and design. The facade of the expansion will add a complementary design to the streetscape of historic Howard Avenue in downtown Biloxi. As a result of the Company’s increased earnings and the confidence that these levels will be maintained over the next several years of reconstruction of the Coast, the The new building will connect to the present Main Office by Board of Directors increased the common stock dividend twice during 2006. means of a second-level bridge so that our existing drive-up teller lanes will not be affected. The second floor of the In June, the Board increased the semi-annual dividend to $.21 per share, followed in new extension will also include meeting and training rooms December by another increase to $.23 per share. The total 2006 dividend of $.41 per to enhance employee development and continuing share is 7.9% higher than the dividend paid in 2005. education programs. 3 P A S S C H R I S T I A N B R A N C H The new Pass Christian branch, located on the corner of Davis and Second streets, is intended to support the objectives of the post-Katrina charettes that envision a new urbanism, pedestrian-friendly design for downtown Pass Christian. The 6,000 square foot building features architectural elements that recall the Garden District of New Orleans and some of the original buildings that formerly stood in downtown Pass Christian. Existing live oaks on the property will be preserved and incorporated into the overall landscaping of the property. B R A N C H E S B U I LT A N D R E N O VAT E D L O A N V O L U M E ( I N T H O U S A N D S ) $401,194 Our branch system will also be significantly improved, with new buildings in Gautier $334,193 $349,346 and Pass Christian and a major renovation at our Orange Grove location. The new Pass Christian branch, located on the corner of Davis and Second streets, is intended to support the objectives of the post-Katrina charettes that envision a new urbanism, pedestrian-friendly design for downtown Pass Christian. The 6,000 square foot building features architectural elements that recall the Garden District of New Orleans and some of the original buildings that formerly stood in down- town Pass Christian. The design elements include a stucco finish, double-hung windows and shutters and wrought-iron porch elements, with metal roofs covering the drive- through tellers and the front entrance. Existing live oaks on the property will be preserved and incorporated into the overall landscaping of the property, which will include approximately 22 parking spaces. The new facility is expected to be completed in Fall 2007. Our Gautier branch opened in early February, 2007 to replace the branch that we estab- lished in an older building in 2002 to serve our growing customer base in Jackson County. We were able to seize the opportunity to build a new branch with a design that offers more convenience and a better banking experience for our customers in the Gautier area. The renovation of our Orange Grove branch was part of our long-term facility upgrade program that was only delayed but never abandoned in the aftermath of Hurricane Katrina. Once we completed the repairs to our Bay St. Louis branch—which itself had been renovated only months before the storm—we moved the temporary branch facil- ity to Orange Grove to begin the renovation project. We expect to move back into the renovated branch by the end of 2007. 4 2004 2005 2006 D I V I D E N D S ( P E R S H A R E ) $0.41 $0.38 $0.32 2004 2005 2006 P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S O F F I N A N C I A L C O N D I T I O N A N D R E S U L T S O F O P E R A T I O N S The following presents Management’s discussion and analysis of the consolidated financial condition and results of operations of Peoples Financial Corporation and Subsidiaries (the Company) for the years ended December 31, 2006, 2005 and 2004. These comments highlight the signifi- cant events for these years and should be considered in combination with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in this annual report. F O R W A R D - L O O K I N G I N F O R M A T I O N Congress passed the Private Securities Litigation Act of 1995 in an effort to encourage corporations to provide information about a company’s antici- pated future financial performance. This act provides a safe harbor for such disclosure which protects the companies from unwarranted litigation if actual results are different from management expectations. This report contains forward-looking statements and reflects industry conditions, company performance and financial results. These forward-looking statements are subject to a number of factors and uncertainties which could cause the Company’s actual results and experience to differ from the anticipated results and expectations expressed in such forward-looking statements. C R I T I C A L A C C O U N T I N G P O L I C I E S Certain critical accounting policies affect the more significant estimates and assumptions used in the preparation of the consolidated financial statements. The Company’s single most critical accounting policy relates to its allowance for loan losses, which reflects the estimated losses result- ing from the inability of its borrowers to make loan payments. If there was a deterioration of any of the factors considered by Management in evalu- ating the allowance for loan losses, as discussed in Note A, the estimates of loss would be updated, and additional provisions for loan losses may be required. O V E R V I E W The year 2006 proved to be another eventful year for the Company on several fronts. Net income for 2006 was $12,768,000, as compared with $5,882,000 for 2005. Earnings for 2006 included primarily income from operations, with net interest income increasing from $24,794,000 in 2005 to $30,109,000 in 2006. Total assets reached $964,023,000 at December 31, 2006, as deposits reached an all-time high of $613,170,000. 2005 earnings included a loss of $281,000, net of taxes, on the sale of available for sale securities and a gain of $538,000, net of taxes, from the Pulse EFT Association Exchange. During 2006, the Company settled all of its outstanding claims relating to damaged branch facilities, lost earnings and extra expenses resulting from Hurricane Katrina. As a result, the Company realized a gain of $2,674,000, net of taxes. During 2006, considerable resources were dedicated to the restoration of our branch facilities. The Company completed the renovation of our branch loca- tions in Waveland, Bay St. Louis, D’Iberville and Downtown Gulfport. Construction is well underway for a new Money Center building in downtown Biloxi with an expected completion date in the third quarter of 2007. On February 15, 2007, the groundbreaking for the construction of a new Pass Christian branch facility in the city’s downtown business district took place. Long-awaited renovations to our thriving Orange Grove branch have begun. Management has continued its efforts in evaluating its loan portfolio, especially with respect to potential losses on loans as a result of Hurricane Katrina. Earnings for 2005 were impacted by the net provision of $3,614,000, or $2,385,000, net of taxes. This net provision included a negative provision for the first six months of $999,000,net of tax, and a provision of $3,368,000, net of tax in the third quarter of that year. In 2006, a provision for losses of only $93,000, net of taxes, was recorded for potential losses on overdraft accounts. The initial effort to evaluate losses after the hurricane has proven to be accurate, with no additional losses having been identified since September 2005. The Company continues to evaluate the area’s recovery and rebuilding efforts. While much has been accomplished in the last eighteen months, the vast scale of these efforts is sobering. The pace of the recovery is being impacted by the availability and affordability of insurance, housing for residents and construction workers, availability of workforce and the increasing cost of materials. F I N A N C I A L C O N D I T I O N Available for Sale Securities Available for sale securities increased $218,814,000 at December 31, 2006 as compared with December 31, 2005. The increase in these securities is the result of the management of the liquidity position of the bank subsidiary. The growth in funds from deposits and non-deposit products has significantly outpaced the growth in loans during the last eighteen months. These excess funds have been invested in U.S. Treasury and U.S. Government securities. Proceeds from maturities of these investments are funding the purchase of U.S. Agency securities with longer maturities and which are being classified as available for sale. The Company continues to monitor its investment in bonds issued by local municipalities which have been affected by Hurricane Katrina. At December 31, 2006, Management has determined that no provi- sion for loss for these investments is required. Gross unrealized gains were $694,000, $132,000 and $347,000 and gross unre- alized losses were $3,109,000, $4,328,000 and $1,754,000 for available for sale securities at December 31, 2006, 2005 and 2004, respectively. Losses of $426,000 and $237,000 were realized on the liquidation or sale of available for sale securities in 2005 and 2004, respectively. Held to Maturity Securities Held to maturity securities decreased $48,473,000 at December 31, 2006, compared with December 31, 2005. As discussed above, the Company invests primarily in U.S. Treasury and U.S. Government Agency securities. During 2005, purchases were primarily classified as Held to Maturity and in 2006 purchases were primarily classified as Available for Sale. The Company continues to monitor its investment in bonds issued by local municipalities which have been affected by Hurricane Katrina. At December 31, 2006, Management has determined that no provision for loss for these investments is required. Gross unrealized gains were $62,000, $93,000 and $113,000, at December 31, 2006, 2005 and 2004 respectively, while gross unrealized losses were $117,000, $132,000 and $2,000 at December 31, 2006, 2005 and 2004, respectively. There were no significant realized gains or losses from calls of these investments for the years ended December 31, 2006, 2005 and 2004. Loans The Company’s loan portfolio increased $51,848,000 at December 31, 2006, as compared with December 31, 2005. The initial phase of rebuilding after Hurricane Katrina is well underway, yet Management believes that more than a decade will be needed to complete the recovery of the Mississippi Gulf Coast. As the pace of funds available to businesses and individuals from insurance, grants, and other sources has slowed, rebuilding has been negatively impacted. The anticipated loan growth of 25% for 2006 stalled 5 at 15% due to the uncertainty that exists in the market place. Resources available to fund development, rising construction costs and the avail- ability and affordability of insurance are among the concerns creating this uncertainty. These factors, and others, are impacting rebuilding efforts, and will directly impact loan demand and growth during the coming years. See Provision for Loan Losses for further discussion of these and other issues relating to the evaluation of the quality of the loan portfolio and the allowance for loan losses. Fluctuations in the various categories of loans and information relating to concentrations are presented in Note C. Bank Premises and Equipment, net: Bank premises and equipment increased $1,771,000 at December 31, 2006 as compared with December 31, 2005. During 2006, the Company settled its outstanding claims relating to damage to bank premises and equip- ment as a result of Hurricane Katrina. A gain of $3,793,000 was realized from this settlement and bank premises and equipment with a book value of $1,290,000 were retired. The Company will utilize its insurance proceeds to fund the renovation and construction of new facilities. Accrued Interest Receivable Accrued interest receivable increased $3,827,000 at December 31, 2006 as compared with December 31, 2005 due to an increase in interest earning assets and the rate earned on these assets. Other Assets Other assets decreased $779,000 at December 31, 2006, as compared with December 31, 2005, due to deferred taxes on deferred gains on the sale and retirement of bank premises. Deposits Total deposits increased $20,952,000 at December 31, 2006, as compared with December 31, 2005. Typically, significant increases or decreases in total deposits and/or significant fluctuations among the different types of deposits are anticipated by Management as customers in the casino industry and county and municipal areas reallocate their resources peri- odically. Since Hurricane Katrina, the Company has realized a significant increase in demand and savings deposits and jumbo certificates of deposit as municipal customers receive federal and state funding and commercial and personal customers receive insurance proceeds, SBA loans, block grants and other forms of assistance. Based on previous post-hurricane experience and expectations with respect to the time frame for reconstruction, the Company anticipates that deposits will continue at or near their present level, and may even increase, during 2007. The Company has managed its funds including planning the timing of investment maturities and the classification of investments and using other funding sources and their maturity to manage the potential volatility of its deposits. Federal Funds Purchased and Securities Sold Under Agreements to Repurchase Federal funds purchased and securities sold under agreements to repurchase increased $76,765,000 at December 31, 2006, as compared with December 31, 2005. This fluctuation is directly related to customers’ periodic reallocation of their funds between deposit and non-deposit products. Other Liabilities Other liabilities increased $10,336,000 at December 31, 2006, as compared with December 31, 2005, primarily due to the increase in the liability for the Company’s retiree health plan of $1,158,000 due to the adoption of SFAS 158 during 2006 and the liability for investments not yet settled. Shareholders' Equity During 2006, 2005 and 2004, there were significant events that impacted the components of shareholders’ equity. These events are detailed in Note J to the Consolidated Financial Statements included in this report. Strength, security and stability have been the hallmark of the Company since its founding in 1985 and of its bank subsidiary since its founding in 1896. A strong capital foundation is fundamental to the continuing pros- perity of the Company and the security of its customers and shareholders. There are numerous indicators of capital adequacy including primary capital ratios and risk-based capital ratios. The Five-Year Comparative Summary of Selected Financial Information on page 33 presents these ratios for those periods. One measure of capital adequacy is the primary capital ratio. As presented in the Five-Year Summary, the Company’s ratios are well above the regu- latory minimum of 6.00%, but have declined in 2006 and 2005. This decrease has been the result of the significant increase in assets since September 30, 2005, rather than an indication of a weakening of the Company’s capital position. Management continues to emphasize the importance of maintaining the appropriate capital levels of the Company and has established a goal of maintaining its primary capital ratio at 8.00%, which is the minimum requirement for classification as being “well capitalized” by the banking regulatory authorities. Bank regulations limit the amount of dividends that may be paid by the bank subsidiary without prior approval of the Commissioner of Banking and Consumer Finance of the State of Mississippi. At December 31, 2006, approximately $25,021,000 of undistributed earnings of the bank sub- sidiary included in consolidated surplus and retained earnings was avail- able for future distribution to the Company as dividends, subject to approval by the Board of Directors. The Company cannot predict what div- idends, if any, will be paid in the future, however the Board of Directors has established a goal of achieving a 35% dividend payout ratio. R E S U L T S O F O P E R A T I O N S Net Interest Income Net interest income, the amount by which interest income on loans, invest- ments and other interest earning assets exceeds interest expense on deposits and other borrowed funds, is the single largest component of the Company’s income. Management’s objective is to provide the largest possible amount of income while balancing interest rate, credit, liquidity and capital risk. The following schedule summarizes net interest earnings and net yield on inter- est earning assets (in thousands): For the years ended December 31, Total interest income (1) Total interest expense Net interest earnings Net yield on interest earning assets (2) 2006 $ 49,335 18,785 $ 30,550 3.73% 2005 $32,759 7,550 $25,209 4.15% 2004 $24,841 5,091 $19,750 3.70% (1) All interest earned is reported on a taxable equivalent basis using a tax rate of 34% in 2006, 2005 and 2004. (2) Interest income in 2005 included $900,000 received in nonaccrual loan income from prior years not previously recognized. Net yield would have been 4.00% without this interest. Total interest income increased $16,551,000 for the year ended December 31, 2006, as compared with the year ended December 31, 2005, and had increased $7,777,000 for the year ended December 31, 2005, as compared with the year ended December 31, 2004. Coinciding with the Federal Reserve’s increases in the discount rates during this time frame, the Company’s yield on loans has improved, given that the loan portfolio includes a 40%/60% mix of fixed/floating rate term. Interest income has also increased significantly as a result of the increase in volume of the investment portfolio. 6 Total interest expense increased $11,235,000 for the year ended December 31, 2006, as compared with the year ended December 31, 2005, and increased $2,459,000 for the year ended December 31, 2005, as compared with the year ended December 31, 2004. During the last five months of 2005, the Company’s deposit and non-deposit funds increased significantly, as discussed previ- ously. During 2005, the increase in interest expense was primarily due to the increase in volume of these funds after Hurricane Katrina. Although deposits continued to increase during 2006, the increase in interest expense is largely attributable to the increase in rates paid on these funds as competition to maintain funds in the Company’s trade area became more robust during the year. Provision for Loan Losses Management continuously monitors the Company’s relationships with its loan customers, especially those in concentrated industries such as gam- ing and hotel/motel, as well as the exposure for out of area loans, and their direct and indirect impact on its operations. A thorough analysis of current economic conditions and the quality of the loan portfolio is con- ducted on a quarterly basis. Management utilized these analyses, with special emphasis on the impact of Hurricane Katrina on the loan portfolio and underlying collateral, in determining the adequacy of its allowance for loan losses at December 31, 2006. During the first six months of 2005, the Company recorded a negative provision of $1,513,000 as a result of positive events relating to the quality of the loan portfolio. As a result of Hurricane Katrina, however, Management recorded a provision for loan losses of $5,055,000 during the third quarter of 2005. This provision was determined based on established Company methodology in compliance with generally accepted account- ing principles. In determining potential loan losses as a result of Hurricane Katrina in August 2005, the Company evaluated its commercial and residen- tial loan portfolios separately. For commercial loans, Management evaluated potential losses for individual credits based on criteria including post- Katrina value of the collateral, existence and adequacy of insurance and available sources of repayment. Based on this evaluation, a provision for loan losses on commercial loans of $3,455,000 was recorded. The Company eval- uated the residential portfolio as a pool of loans. This portfolio was analyzed based on the census tract in which the collateral is located. Assumptions based on this information as well as the post-Katrina value of collateral and existence and adequacy of insurance for the loans within each census tract were developed. Based on this evaluation, a provision of loan losses on residential loans of $1,600,000 for the residential portfolio was recorded. This on-going analysis has been enhanced by the completion of the evaluation of the impact of Katrina on every credit in the residential loan portfolio during the second quarter of 2006. Management continues its evaluation in recognition of the extraordinary impact of Katrina on its entire trade area, attempting to quantify poten- tial losses in accordance with the Company’s established methodology. Loan delinquencies and deposit overdrafts are closely monitored in order to identify developing problems as early as possible. Additionally, Management has considered the historical data available from the impact of other natural disasters on the Mississippi Gulf Coast and other coastal communities, including the length of time between the storm’s landfall and identification of all losses. Past bank experience with hurricanes and FDIC research have shown that the actual loss position may not be known until 24 months after the event. Although more than one year has passed, much uncertainty remains regarding the impact of federal and state assistance, settlement of insur- ance claims, the availability and affordability of windstorm insurance and the rate and pace of recovery in the Company’s trade area. Commercial and personal customers are still assessing their resources and making decisions about their future plans. Meanwhile, construction costs continue to escalate, further impacting recovery efforts. The ability of customers to service their debt must be carefully considered. The slow release of Community Development Block Grants (CDBG), which should have started in July 2006, has added to our uncertainty. We are just starting to realize the full impact of Hurricane Katrina on insur- ance coverage going forward. Several carriers have announced their inten- tion to restrict coverage in our trade area. For those carriers continuing to write policies on the Gulf Coast, premiums are increasing significantly. Commercial development has already been negatively impacted by the abil- ity to obtain insurance coverage. Ultimately, the effect of the insurance ques- tion may pose a potential risk to a large portion of our loan portfolio. The Company has identified no additional significant potential losses as a result of Hurricane Katrina since its initial evaluation in September 2005. In fact, some loans which were thought to pose a potential loss during the initial evaluation have shown positive developments. It is also very possi- ble that potential losses, despite the best efforts of the Company, have not yet been identified. Management believes that it is reasonably possible that the actual amount of potential losses as a result of Hurricane Katrina may be less than what was estimated in September 2005, but as a result of the factors discussed above, this amount cannot be reasonably estimated at this time and no provision or negative provision for losses on loans was recorded for the year ended December 31, 2006. The Company recorded a provision of $141,000 during 2006 relating to potential losses on overdrawn deposit accounts. The allowance for loan losses is an estimate, and as such, events may occur in the future which affect its accuracy. The Company anticipates that it is probable that additional information will be gathered in the coming quarters which may require an adjustment to the allowance for loan losses. Management will continue to closely monitor its portfolio, work with individual customers and take such action as it deems appropriate to accurately report its financial condition and results of operations. Trust Income and Fees Trust income and fees increased $193,000 for the year ended December 31, 2006 as compared with the year ended December 31, 2005, as a result of an increase in cash management accounts funded with insurance and other proceeds. Service Charges on Deposit Accounts Service charges on deposit accounts increased $901,000 for the year ended December 31, 2006 as compared with the year ended December 31, 2005. In 2005, ATM and NSF fees decreased $660,000 as a result of Hurricane Katrina in August of that year. Loss on Liquidation, Sale and Calls of Securities The Company realized a loss of $426,000 and $237,000 for the years ended December 31, 2005 and 2004, respectively as a direct result of the sale of investment securities. The sales were executed in order to provide funding for increased loan demand. There were no sales of securities in 2006. Gain from Settlement of Insurance Proceeds The Company realized gains in 2006 and 2005 of $3,793,000 and $449,000, respectively, from the settlement of its insurance claims arising from the significant damage to six of the bank subsidiary’s sixteen branch loca- tions and the impact on the operations of the bank subsidiary. Proceeds from insurance settlement will be used to fund the construction and ren- ovation of bank premises during 2007. 7 Other Income Other income increased $148,000 for the year ended December 31, 2006, as compared with the year ended December 31, 2005, primarily due to a gain of $250,000 from the sale of “The Mint” trademark in 2006. See Note K for further information. Salaries and Employee Benefits Salaries and employee benefits increased $1,635,000 for the year ended December 31, 2006 as compared with the year ended December 31, 2005. The Company increased salaries and incentives to its employees in order to reward performance and retain personnel within the local, post-Katrina competitive employment conditions. Net Occupancy Net occupancy increased $351,000 for the year ended December 31, 2006 as compared with the year ended December 31, 2005 as a result of the increase in costs associated with insurance coverage. Equipment Rentals, Depreciation and Maintenance Equipment rentals, depreciation and maintenance increased $316,000 for the year ended December 31, 2006 as compared with the year ended December 31, 2005. This increase is attributable to an increase in repairs expenditures in 2006 as any post-Katrina repairs in 2005 were covered under insurance. Other Expense Other expense increased $279,000 for the year ended December 31, 2006, as compared with the year ended December 31, 2005, primarily as a result of consulting fees of $350,000 associated with the settlement of the Company’s insurance claims. See Note K for further information. R E L A T E D P A R T I E S The Company extends loans to certain officers and directors and their personal business interests, at terms and rates comparable to other loans of similar credit risks. Further disclosure of these transactions is presented in Note C. The Company may also hold deposits for these related parties and/or provide other banking services in the ordinary course of business. Further disclosure of these deposits is presented in Note E. The Company has not currently engaged, nor does it have any plans to engage, in any transactions outside of the ordinary course of banking business with any related persons or entities. L I Q U I D I T Y Liquidity represents the Company’s ability to adequately provide funds to satisfy demands from depositors, borrowers and other commitments by either converting assets to cash or accessing new or existing sources of funds. Note M discloses information relating to financial instruments with off-balance-sheet risk, including letters of credit and outstanding unused loan commitments. The Company closely monitors the potential effects of funding these commitments on its liquidity position. Management monitors these funds requirements in such a manner as to satisfy these demands and provide the maximum earnings on its earning assets. The Company monitors its liquidity position closely through a number of methods, including the computation of liquidity and dependency ratios on a monthly basis. The formula for these ratios are those used for the Uniform Bank Performance Report, such that the Company may monitor and evaluate its own risk, but also compare itself to its peers. Management carefully mon- itors its liquidity needs, particularly relating to potentially volatile deposits. It has continued to implement these procedures since Hurricane Katrina, and the Company has encountered no problems with meeting its liquidity needs. Deposits, payments of principal and interest on loans, proceeds from maturities of investment securities and earnings on investment securities are the principal sources of funds for the Company. The Company also uses other, non-traditional sources of funds, including borrowings from the Federal Home Loan Bank. The Company generally anticipates relying on traditional sources of funds, especially deposits and purchases of federal funds, for its liquidity needs in 2007. Since Hurricane Katrina, the Company’s deposits and non-deposit accounts have increased significantly. Management carefully monitors its liquidity needs, particularly relating to these potentially volatile funds, which are currently invested in U.S. Treasury and U.S. Agency securities. It is anticipated that expanding loan demand in future quarters will be funded from the maturity of these investments. Federal funds sold and federal funds purchased are utilized by the Company to manage its daily liquidity position. At December 31, 2006, the Company was able to purchase federal funds up to $88,000,000. T H E S A R B A N E S - O X L E Y A C T O F 2 0 0 2 The Sarbanes-Oxley Act of 2002 provides for, among other things, the accel- eration of filing deadlines for quarterly and annual reports for companies that meet certain criteria. The Company became an accelerated filer at December 31, 2005. As a result of the impact of Hurricane Katrina, the Company was not able to be compliant with the reporting requirements relating to internal controls over financial reporting in a timely manner. The Company requested relief relating to this reporting from the Securities and Exchange Commission. On March 31, 2006, the Securities and Exchange Commission issued an order providing that the Company will first comply with the disclosure specified in paragraphs (a) and (b) of Item 308 of Regulation S-K and Exchange Act Rule 13a-15(c) for the fiscal year ended December 31, 2006. O F F - B A L A N C E S H E E T A R R A N G E M E N T S The Company is a party to off-balance-sheet arrangements in the normal course of business to meet the financing needs of its customers. These arrangements include unused commitments to extend credit, which amounted to $149,457,000 at December 31, 2006, and irrevocable letters of credit, which amounted to $3,038,096 at December 31, 2006. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet arrangements. Since some of the commitments and irrevocable letters of credit may expire without being drawn upon, the total amount does not necessarily represent future cash requirements. As discussed previously, the Company carefully mon- itors its liquidity needs and considers the cash requirements, especially for loan commitments, in making decisions on investments and obtaining funds from its other sources. Further information relating to off-balance- sheet instruments can be found in Note L. Q U A N T I T A T I V E A N D Q U A L I T A T I V E D I S C L O S U R E S A B O U T M A R K E T R I S K Market risk is the risk of loss arising from adverse changes in market prices and rates. Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities. Also, the Company does not currently, and has no plans to, engage in trading activities or use derivative or off-bal- ance sheet instruments to manage interest rate risk. 8 The Company has risk management policies in place to monitor and limit exposure to market risk. The Asset/Liability Committee (ALCO), whose members include the chief executive officer and senior and middle man- agement from the financial, lending, investing, and deposit areas, is responsible for the day-to-day operating guidelines, approval of strate- gies affecting net interest income and coordination of activities within policy limits established by the Board of Directors based on the Company’s tolerance for risk. Specifically, the key objectives of the Company’s asset/liability management program are to manage the exposure of planned net interest margins to unexpected changes due to interest rate fluctuations. These efforts will also affect loan pricing policies, deposit interest rate policies, asset mix and volume guidelines and liquidity. The ALCO Committee utilizes a number of tools in its activities, including software to assist with interest rate risk management and balance sheet management. The ALCO committee reports to the Board of Directors on a quarterly basis. The Company has implemented a conservative approach to its asset/liabil- ity management. The net interest margin is managed on a daily basis largely as a result of the management of the liquidity needs of the bank subsidiary. The Company generally follows a policy of investing in short term U.S. Treasury Bills and U.S. Agency securities with maturities of two years or less. Due to the low interest rate environment, the duration of investments has been extended up to seven years with call provisions. The loan portfolio consists of a 40%/60% blend of fixed/floating rate loans. It is the general loan policy to offer fixed rate loans with maturities of five years or less. The market is now dictating floating rate loans with maturities up to fifteen years. On the liability side, more than 68% of the deposits are demand and savings transaction accounts. Additionally, more than 75% of the certificates of deposit mature within eighteen months. Since the Company’s deposits are generally not rate-sensitive, they are considered to be core deposits. The short term nature of the financial assets and liabilities allows the Company to meet the dual requirements of liquidity and interest rate risk management. The interest rate sensitivity tables below provide additional information about the Company’s financial instruments that are sensitive to changes in interest rates. The negative gap in 2007 is mitigated by the nature of the Company’s deposits, whose characteristics have been previously described. The tabular disclosure reflects contractual interest rate repric- ing dates and contractual maturity dates. Loan maturities have been adjusted for the reserve for loan losses. There have been no adjustments for such factors as prepayment risk, early calls of investments, the effect of the maturity of balloon notes or the early withdrawal of deposits. The Company does not believe that the aforementioned factors have a significant impact on expected maturity. Interest rate sensitivity at December 31, 2006 was as follows (in thousands): Loans, net Average rate Securities Average rate Total Financial Assets Average rate Interest Bearing Deposits Average rate Funds Management Average rate Long-term funds Average rate Total Financial Liabilities Average Rate $ 2 0 0 7 245,810 8.40% 165,435 4.80% 411,245 7.42% 430,645 3.40% 226,032 3.87% 196 6.09% 656,873 3.58% $ 2 0 0 8 22,747 6.36% 105,856 4.40% 128,603 4.87% 18,536 4.46% $ $ 2 0 0 9 61,099 6.34% 37,625 4.64% 98,724 5.82% 10,375 3.91% $ 2 0 1 0 24,129 6.79% 60,596 5.11% 84,725 5.70% 3,094 4.05% 184 6.09% 18,720 4.48% 178 6.09% 10,553 3.96% 5,177 6.09% 8,271 4.21% 2 0 1 1 31,524 7.45% 44,184 5.42% 75,708 6.44% 2,064 4.05% 177 6.09% 2,241 4.28% Interest rate sensitivity at December 31, 2005 was as follows (in thousands): Loans, net Average rate Securities Average rate Total Financial Assets Average rate Interest Bearing Deposits Average rate Funds Management Average rate Long-term funds Average rate Total Financial Liabilities Average Rate $ 2 0 0 6 221,074 7.57% 151,017 3.97% 372,091 6.64% 387,861 1.91% 149,268 1.48% 298 5.68% 537,427 1.81% 2 0 0 7 5,168 $ 6.75% 51,532 3.93% 56,700 4.36% 8,745 2.98% 211 5.68% 8,956 3.09% $ 2 0 0 8 28,746 6.26% 46,743 3.71% 75,489 5.03% 2,562 3.24% $ 2 0 0 9 54,525 $ 6.91% 14,883 3.88% 69,408 5.61% 9,853 3.79% 2 0 1 0 23,438 6.29% 20,104 4.20% 43,542 5.54% 6,569 3.79% 198 5.68% 2,760 3.53% 198 5.68% 10,051 3.84% 198 5.68% 6,767 3.87% $ $ $ B E Y O N D 5,044 6.97% 70,214 5.48% 75,258 5.61% 1,355 6.42% 1,355 6.42% $ B E Y O N D 5,429 6.62% 29,238 4.53% 34,667 4.99% \ 6,249 6.24% 6,249 6.24% T O T A L 390,353 7.86% 483,910 4.93% 874,263 6.60% 464,714 3.48% 226,032 3.87% 7,267 6.38% 698,013 3.67% T O T A L 338,380 7.14% 313,517 4.01% 651,897 6.10% 415,590 2.10% 149,268 1.48% 7,352 6.16% 572,210 2.04% 1 2 / 3 1 / 0 6 F A I R V A L U E 389,072 $ 483,855 483,855 464,873 226,032 8,002 698,907 1 2 / 3 1 / 0 5 F A I R V A L U E 341,016 $ 313,478 654,494 415,582 149,268 7,728 572,578 9 P E O P L E S F I N A N C I A L C O R P O R AT I O N A N D S U B S I D I A R I E S C O N S O L I D A T E D S T A T E M E N T S O F C O N D I T I O N D E C E M B E R 3 1 , Assets Cash and due from banks Federal funds sold Available for sale securities Held to maturity securities, fair value of $85,519,000 - 2006; $134,008,000 - 2005; $6,698,000 - 2004 Federal Home Loan Bank Stock, at cost Loans Less: Allowance for loan losses Loans, net Bank premises and equipment, net Other real estate Accrued interest receivable Other assets Total assets Liabilities & Shareholders' Equity Liabilities: Deposits: Demand, non-interest bearing Savings and demand, interest bearing Time, $100,000 or more Other time deposits Total deposits Federal funds purchased and securities sold under agreements to repurchase Borrowings from Federal Home Loan Bank Notes payable Other liabilities Total liabilities Shareholders' Equity: Common Stock, $1 par value, 15,000,000 shares authorized, 5,548,199, 5,549,128 and 5,555,419 shares issued and outstanding at December 31, 2006, 2005 and 2004, respectively Surplus Undivided profits Accumulated other comprehensive income, net of tax Total shareholders' equity 2 0 0 6 2 0 0 5 2 0 0 4 $ 37,793,493 $ 52,277,524 $ 32,573,125 6,400,000 397,207,489 100,340,000 178,393,652 151,500 173,030,808 85,574,260 1,128,500 401,194,010 10,841,367 390,352,643 19,658,585 44,538 8,142,230 17,721,330 134,046,959 1,076,600 349,346,340 10,966,022 338,380,318 17,887,907 106,046 4,315,358 18,500,668 6,587,375 1,401,900 334,193,124 6,569,614 327,623,510 18,018,504 168,091 2,745,235 15,141,101 $ 964,023,068 $ 845,325,032 $ 577,441,149 $ 148,455,754 $ 176,627,048 $ 89,529,270 271,331,272 132,846,509 60,536,259 613,169,794 226,032,370 7,267,349 19,320,860 865,790,373 5,548,199 65,780,254 29,253,825 (2,349,583) 98,232,695 301,052,887 51,292,708 63,244,699 592,217,342 149,267,750 7,352,005 8,984,804 757,821,901 5,549,128 65,780,254 18,942,855 (2,769,106) 87,503,131 180,464,256 51,948,077 67,249,927 389,191,530 87,277,125 7,202,970 1,239 7,966,852 491,639,716 5,555,419 65,780,254 15,391,524 (925,764) 85,801,433 Total liabilities and shareholders' equity $ 964,023,068 $ 845,325,032 $ 577,441,149 See Notes to Consolidated Financial Statements. 10 P E O P L E S F I N A N C I A L C O R P O R AT I O N A N D S U B S I D I A R I E S C O N S O L I D A T E D S T A T E M E N T S O F I N C O M E Y E A R S E N D E D D E C E M B E R 3 1 , 2 0 0 6 2 0 0 5 2 0 0 4 Interest income: Interest and fees on loans Interest and dividends on securities: U.S. Treasury U.S. Government agencies and corporations States and political subdivisions Other investments Interest on federal funds sold Total interest income Interest expense: Deposits Long-term borrowings Federal funds purchased and securities sold under agreements to repurchase Total interest expense Net interest income Provision for allowance for losses on loans Net interest income after provision for allowance for losses on loans Other operating income: Trust department income and fees Service charges on deposit accounts Loss on liquidation, sale and calls of securities Gain from sale of bank premises Gain from settlement of insurance proceeds Other income Total other operating income Other operating expense: Salaries and employee benefits Net occupancy Equipment rentals, depreciation and maintenance Other expense Total other operating expense Income before income taxes and extraordinary gain Income taxes Income before extraordinary gain Extraordinary gain, net of taxes Net income Basic and diluted earnings per share Basic and diluted earnings per share before extraordinary gain See Notes to Consolidated Financial Statements. $ 28,735,424 $ 22,690,169 $ 17,526,210 5,725,317 12,610,083 856,450 188,965 777,742 48,893,981 11,384,540 484,398 6,915,690 18,784,628 30,109,353 141,000 29,968,353 1,670,063 5,407,901 159,669 3,792,942 1,278,124 12,308,699 13,033,108 1,870,011 2,836,392 5,310,641 23,050,152 19,226,900 6,459,000 12,767,900 $ $ $ 12,767,900 2.30 2.30 $ $ $ 2,675,827 4,568,700 804,664 193,709 1,410,226 32,343,295 5,296,667 437,712 1,815,131 7,549,510 24,793,785 3,614,000 21,179,785 1,477,401 4,506,634 (426,094) 100,449 448,963 1,130,023 7,237,376 11,398,469 1,518,620 2,520,339 5,031,513 20,468,941 7,948,220 2,604,000 5,344,220 538,000 5,882,220 1.06 .96 1,366,831 4,833,893 532,688 229,550 76,780 24,565,952 3,600,386 447,401 1,043,112 5,090,899 19,475,053 448,000 19,027,053 1,391,314 5,758,727 (236,618) 1,270,698 1,378,736 9,562,857 11,334,384 1,461,492 2,416,749 5,551,947 20,764,572 7,825,338 2,031,300 5,794,038 $ $ $ 5,794,038 1.04 1.04 11 P E O P L E S F I N A N C I A L C O R P O R AT I O N A N D S U B S I D I A R I E S C O N S O L I D A T E D S T A T E M E N T S O F S H A R E H O L D E R S ’ E Q U I T Y N u m b e r o f C o m m o n S h a r e s 5,557,379 C o m m o n S t o c k $ 5,557,379 S u r p l u s $ 65,780,254 Balance, January 1, 2004 Comprehensive Income: Net income Net unrealized loss on available for sale securities, net of tax Reclassification adjustment for available for sale securities called or sold in current year, net of tax Total comprehensive income Cash dividends ($ .17 per share) Dividend declared ($ .18 per share) Allocation of ESOP shares Retirement of stock Balance, December 31, 2004 Comprehensive Income: Net income Net unrealized loss on available for sale securities, net of tax Reclassification adjustment for available for sale securities called or sold in current year, net of tax Total comprehensive income Cash dividends ($ .20 per share) Dividend declared ($ .20 per share) Effect of retirement of stock on accrued dividends Retirement of stock Balance, December 31, 2005 Comprehensive Income: Net income Net unrealized gain on available for sale securities, net of tax Reclassification adjustment for available for sale securities called or sold in current year, net of tax Loss from unfunded post-retirement benefit obligation, net of tax Total comprehensive income Cash dividends ($ .21 per share) Dividend declared ($ .23 per share) Retirement of stock Balance, December 31, 2006 See Notes to Consolidated Financial Statements. (1,960) 5,555,419 (1,960) 5,555,419 65,780,254 (6,291) 5,549,128 (6,291) 5,549,128 65,780,254 (929) 5,548,199 (929) $ 5,548,199 $ 65,780,254 12 U n d i v i d e d P r o f i t s $ 11,574,074 5,794,038 (944,591) (999,975) (32,022) 15,391,524 5,882,220 (1,109,826) (1,109,826) 399 (111,636) 18,942,855 12,767,900 (1,165,122) (1,276,086) (15,722) U n e a r n e d C o m p e n s a t i o n A c c u m u l a t e d O t h e r C o m p r e h e n s i v e I n c o m e $ (94,899) $ 687,141 C o m p r e h e n s i v e I n c o m e T o t a l $ 83,503,949 94,899 (1,720,706) 107,801 (925,764) (2,077,657) 234,315 (2,769,106) 1,158,333 12,017 (750,827) $ 5,794,038 (1,720,706) 107,801 $ 4,181,133 $ 5,882,220 (2,077,657) 234,315 $ 4,038,878 $ 12,767,900 1,158,333 12,017 (750,827) $ 13,187,423 5,794,038 (1,720,706) 107,801 (944,591) (999,975) 94,899 (33,982) 85,801,433 5,882,220 (2,077,657) 234,315 (1,109,826) (1,109,826) 399 (117,927) 87,503,131 12,767,900 1,158,333 12,017 (750,827) (1,165,122) (1,276,086) (16,651) $ 29,253,825 $ $ (2,349,583) $ 98,232,695 13 P E O P L E S F I N A N C I A L C O R P O R AT I O N A N D S U B S I D I A R I E S C O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W S Y E A R S E N D E D D E C E M B E R 3 1 , Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation Provision for allowance for loan losses Provision for losses on other real estate Gain on sales of other real estate Loss on sales, calls and liquidation of securities Gain on sale of bank premises Gain on settlement of insurance Changes in assets and liabilities: Accrued interest receivable Other assets Other liabilities Net cash provided by operating activities Cash flows from investing activities: Proceeds from maturities, sales and calls of available for sale securities Investment in available for sale securities Proceeds from maturities and calls of held to maturity securities Investment in held to maturity securities Investment in Federal Home Loan Bank stock Redemption of Federal Home Loan Bank stock Proceeds from sales of other real estate Loans, net increase Proceeds from sale and retirement of bank premises Acquisition of premises and equipment Other assets Net cash used in investing activities Cash flows from financing activities: Demand and savings deposits, net increase (decrease) Time deposits made, net increase (decrease) Principal payments on notes Cash dividends Retirement of common stock Borrowings from Federal Home Loan Bank Repayments to Federal Home Loan Bank Federal funds purchased and securities sold under agreements to repurchase, net increase (decrease) Net cash provided by (used in) financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year See Notes to Consolidated Financial Statements. 2 0 0 6 2 0 0 5 2 0 0 4 $ 12,767,900 $ 5,882,220 $ 5,794,038 1,606,000 141,000 14,908 (153,400) (159,669) (3,792,942) (3,826,872) 330,657 9,750,102 16,677,684 55,190,291 (272,222,910) 265,074,303 (216,601,604) (51,900) 344,000 (52,257,325) 5,400,045 (4,824,112) (493,320) 1,473,539 3,614,000 21,910 (366,865) 426,094 (100,449) (448,963) (1,570,123) (93,683) (933,187) 7,904,493 144,782,701 (153,360,763) 23,435,000 (150,894,584) 325,300 495,000 (14,458,808) 769,807 (1,563,337) (478,814) (220,442,532) (150,948,498) (57,892,909) 78,845,361 (2,274,948) (16,651) 20,940,973 (21,025,629) 76,764,620 95,340,817 (108,424,031) 152,617,524 207,686,409 (4,660,597) (1,239) (2,109,402) (117,927) 402,819 (253,784) 61,990,625 262,936,904 119,892,899 32,724,625 1,447,000 448,000 354,360 (100,750) 258,888 (1,270,698) 350,767 (238,021) 778,940 7,822,524 174,457,599 (142,688,628) 1,405,000 (3,639,521) (28,700) 601,000 1,074,000 (32,427,179) 2,837,500 (3,079,803) (417,441) (1,906,173) 15,424,238 (3,021,702) (14,097) (1,778,198) (33,982) 30,292,102 (40,158,980) (7,762,136) (7,052,755) (1,136,404) 33,861,029 $ 44,193,493 $ 152,617,524 $ 32,724,625 14 N O T E S T O C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S N O T E A - B U S I N E S S A N D S U M M A R Y O F S I G N I F I C A N T A C C O U N T I N G P O L I C I E S : after December 31, 2007. The Company does not expect the issue will have a material impact on its results from operations or financial position. Business of The Company Peoples Financial Corporation is a one-bank holding company headquar- tered in Biloxi, Mississippi. Its two operating subsidiaries are The Peoples Bank, Biloxi, Mississippi, and PFC Service Corp. Its principal subsidiary is The Peoples Bank, Biloxi, Mississippi, which provides a full range of bank- ing, financial and trust services to individuals and small and commercial businesses operating in Harrison, Hancock, Stone and Jackson counties. Principles of Consolidation The consolidated financial statements include the accounts of Peoples Financial Corporation and its wholly-owned subsidiaries, The Peoples Bank, Biloxi, Mississippi, and PFC Service Corp. All significant intercompany transactions and balances have been eliminated in consolidation. Basis of Accounting Peoples Financial Corporation and Subsidiaries recognize assets and liabilities, and income and expense, on the accrual basis of accounting. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure 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 these estimates. New Accounting Pronouncements In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting and disclosure for uncertainty in tax positions, as defined. FIN 48 seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement related to accounting for income taxes. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company does not expect the interpretation will have a material impact on its results from operations or financial position. In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements”, (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with accounting prin- ciples generally accepted in the United States, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years begin- ning after November 15, 2007, with earlier application encouraged. Any amounts recognized upon adoption as a cumulative effect adjustment will be recorded to the opening balance of retained earnings in the year of adoption. The Company has not yet determined the impact of this Statement on its financial position or results from operations. In September 2006, the Emerging Issues Task Force (EITF) issued EITF Issue No. 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements,” (EITF 06-4). EITF 06-4 requires the accrual of the post-retirement benefit over the service period. EITF 06-4 is effective for fiscal years beginning Cash and Due from Banks The Company is required to maintain average reserve balances in its vault or on deposit with the Federal Reserve Bank. The average amount of these reserve requirements was approximately $24,539,000, $15,133,000 and $11,623,000 for the years ending December 31, 2006, 2005 and 2004, respectively. The Company’s bank subsidiary maintained account balances in excess of amounts insured by the Federal Deposit Insurance Corporation. At December 31, 2006, the bank subsidiary had excess deposits of $8,781,000. Securities The classification of securities is determined by Management at the time of purchase. Securities are classified as held to maturity when the Company has the positive intent and ability to hold the security until maturity. Securities held to maturity are stated at amortized cost. Securities not classified as held to maturity are classified as available for sale and are stated at fair value. Unrealized gains and losses, net of tax, on these securities are recorded in shareholders’ equity as accumulated other comprehensive income. The amortized cost of available for sale securities and held to maturity securities is adjusted for amortization of premiums and accretion of dis- counts to maturity, determined using the interest method. Such amortiza- tion and accretion is included in interest income on securities. Declines in the fair value of securities below their cost that are deemed to be other than temporary would be reflected in earnings as realized losses. In esti- mating other-than-temporary losses, management considers the length of time and the extent to which the fair value has been less than cost, the financial condition and nature of the issuer, the cause of the decline, espe- cially if related to a change in interest rates, and the intent and ability of the Company to retain the investment in the issuer for a period of time suf- ficient to allow for any anticipated recovery in fair value. The specific identification method is used to determine realized gains and losses on sales of securities, which are reported as gain or loss on sale and calls of securities in other operating income. Loans The loan portfolio consists of commercial and industrial and real estate loans within the Company’s trade area in South Mississippi. The loan policy establishes guidelines relating to pricing, repayment terms, collateral standards including loan to value limits, appraisal and environmental standards, lending authority, lending limits and documentation requirements. Loans are stated at the amount of unpaid principal, reduced by unearned income and the allowance for loan losses. Interest on loans is recognized over the terms of each loan based on the unpaid principal balance. Loan origination fees are recognized as income when received. Revenue from these fees is not material to the financial statements. The Company places loans on a nonaccrual status when, in the opinion of Management, they possess sufficient uncertainty as to timely collection 15 of interest or principal so as to preclude the recognition in reported earnings of some or all of the contractual interest. Accrued interest on loans classified as nonaccrual is reversed at the time the loans are placed on nonaccrual. Interest received on nonaccrual loans is applied against principal. Loans are restored to accrual status when the obligation is brought current or has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. The Company considers a loan to be impaired when, based upon current information and events, it believes it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Company’s impaired loans include performing and non-performing major loans for which full payment of principal or interest is not expected. The Company calculates an allowance required for impaired loans based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of its collateral. If the recorded investment in the impaired loan exceeds the measure of fair value, a valuation allowance is required as a component of the allowance for loan losses. Changes to the valuation allowance are recorded as a component of the provision for loan losses. Generally, loans which become 90 days delinquent are reviewed relative to collectibility. Unless such loans are in the process of terms revision to bring to a current status or foreclosure or in the process of collection, those loans deemed uncollectible are charged off against the allowance account. Allowance for Loan Losses The allowance for loan losses is established through provisions for loan losses charged against earnings. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is based on Management's evaluation of the loan portfolio under current economic conditions and is an amount that Management believes will be adequate to absorb probable losses on loans existing at the reporting date. The evaluation includes Management’s assessment of several factors: review and evaluations of specific loans, changes in the nature and volume of the loan portfolio, current and antic- ipated economic conditions and the related impact on specific borrowers and industry groups, a study of loss experience, a review of classified, nonperforming and delinquent loans, the estimated value of any under- lying collateral, an estimate of the possibility of loss based on the risk characteristics of the portfolio, adverse situations that may affect the bor- rower’s ability to repay and the results of regulatory examinations. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. The allowance consists of specific and general components. The specific component relates to loans that are classified as either doubtful or substandard. For such loans, a specific allowance is established when the collateral value is lower than the carrying value of the loan. The gen- eral component of the allowance relates to loans that are not classified and is based on historical loss experience. Bank Premises and Equipment Bank premises and equipment are stated at cost, less accumulated depre- ciation. Depreciation is computed by the straight-line method based on the estimated useful lives of the related assets. Other Real Estate Other real estate acquired through foreclosure is carried at the lower of cost (primarily outstanding loan balance) or estimated market value, less estimated costs to sell. If, at foreclosure, the carrying value of the loan is greater than the estimated market value of the property acquired, the excess is charged against the allowance for loan losses and any subse- quent adjustments are charged to expense. Costs of operating and main- taining the properties, net of related income and gains (losses) on their disposition, are charged to expense as incurred. Trust Department Income and Fees Corporate trust fees are accounted for on an accrual basis and personal trust fees are recorded when received. Income Taxes The Company files a consolidated tax return with its wholly-owned sub- sidiaries. The tax liability of each entity is allocated based on the entity’s contribution to consolidated taxable income. The provision for applicable income taxes is based upon reported income and expenses as adjusted for differences between reported income and taxable income. The primary differences are exempt income on state, county and municipal securities; differences in provisions for losses on loans as compared to the amount allowable for income tax purposes; directors' and officers' insurance; depreciation for income tax purposes over (under) that reported for financial statements; gains reported under the installment sales method for tax purposes and gains on the sale of bank premises which were struc- tured under the provisions of Section 1031 of the Internal Revenue Code. Leases All leases are accounted for as operating leases in accordance with the terms of the leases. Earnings Per Share Basic and diluted earnings per share are computed on the basis of the weighted average number of common shares outstanding, 5,548,300, 5,550,477 and 5,556,251 in 2006, 2005 and 2004, respectively. Statements of Cash Flows The Company has defined cash and cash equivalents to include cash and due from banks and federal funds sold. The Company paid $18,444,672 $7,389,847 and $5,044,207 in 2006, 2005 and 2004, respectively, for inter- est on deposits and borrowings. Income tax payments totaled $5,310,000, $4,856,000 and $2,062,000 in 2006, 2005 and 2004, respectively. Loans transferred to other real estate amounted to $144,000, $88,000 and $112,250 in 2006, 2005 and 2004, respectively. The income tax effect from the unrealized gain (loss) on available for sale securities on accumulated other comprehensive income was $602,907, $(949,600) and $(830,890), at December 31, 2006, 2005 and 2004, respectively. The income tax effect from the loss from unfunded post-retirement benefit obligation on accu- mulated other comprehensive income was $407,201 at December 31, 2006. Reclassifications Certain reclassifications have been made to the prior year statements to conform to current year presentation. The reclassifications had no effect on prior year net income. 16 N O T E B - S E C U R I T I E S : The amortized cost and estimated fair value of securities at December 31, 2006, 2005 and 2004, respectively, are as follows (in thousands): December 31, 2006 Amortized cost Gross unrealized gains Gross unrealized losses Estimated fair value Available for sale securities: Debt securities: U.S. Treasury U.S. Government agencies and corp. States and political subdivisions Total debt securities Equity securities $ 73,937 304,156 17,001 395,094 4,528 Total available for sale securities $ 399,622 Held to maturity securities: U.S. Treasury U.S. Government agencies and corp. States and political subdivisions $ 53,517 26,970 5,087 Total held to maturity securities $ 85,574 $ $ $ $ 81 304 247 632 62 694 62 62 $ (364) $ 73,654 (1,950) (163) (2,477) (632) 302,510 17,085 393,249 3,958 $ (3,109) $ 397,207 $ $ (70) (29) (18) (117) $ 53,447 26,941 5,131 $ 85,519 December 31, 2005 Amortized cost Gross unrealized gains Gross unrealized losses Estimated fair value Available for sale securities: Debt securities: U.S. Treasury $ 37,953 $ U.S. Government agencies and corp. States and political subdivisions Total debt securities Equity securities 126,444 14,364 178,761 3,829 Total available for sale securities $ 182,590 Held to maturity securities: U.S. Treasury U.S. Government agencies and corp. States and political subdivisions $ 106,897 21,000 6,150 Total held to maturity securities $ 134,047 $ $ $ 2 68 70 62 132 93 93 93 $ (525) $ 37,430 (2,573) (282) (3,380) (948) $ (4,328) $ $ (66) (19) (47) (132) 123,871 14,150 175,451 2,943 178,394 106,831 20,981 6,196 $ $ $ 134,008 17 December 31, 2004 Available for sale securities: Debt securities: U.S. Treasury U.S. Government agencies and corp. States and political subdivisions Total debt securities Equity securities Total available for sale securities Held to maturity securities: States and political subdivisions Total held to maturity securities Amortized cost Gross unrealized gains Gross unrealized losses Estimated fair value $ $ $ $ 64,817 92,538 13,254 170,609 3,829 174,438 6,587 6,587 $ $ $ $ 347 41 244 285 62 347 113 113 $ $ $ $ (165) (766) (115) (1,046) (708) (1,754) (2) (2) $ $ $ $ 64,652 91,813 13,383 169,848 3,183 173,031 6,698 6,698 The amortized cost and estimated fair value of debt securities at December 31, 2006, (in thousands) by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Amortized cost Estimated fair value Available for sale securities: Due in one year or less Due after one year through five years Due after five years through ten years Due after ten years Totals Held to maturity securities: Due in one year or less Due after one year through five years Due after five years through ten years Due after ten years Totals $ $ $ $ 84,823 247,640 56,409 6,222 395,094 80,948 2,032 2,364 230 85,574 $ $ $ $ 84,487 246,229 56,253 6,280 393,249 80,849 2,048 2,388 234 85,519 Information pertaining to securities with gross unrealized losses at December 31, 2006, aggregated by investment category and length of time that individual securities have been in a continuous loss position is as follows (in thousands): Less than twelve months Over twelve months Total U.S. Treasury U.S. Government Agencies States and political subdivisions FHLMC preferred stock Total Fair Value $ 65,458 100,883 2,970 $ 169,311 Gross Unrealized Loss 102 200 15 $ $ 317 Fair Value $ 29,647 105,697 7,016 2,443 $ 144,803 $ Gross Unrealized Loss 331 1,779 167 632 2,909 $ $ Fair Value Gross Unrealized Loss 433 $ 1,979 182 632 3,226 95,105 206,580 9,986 2,443 $ 314,114 $ Information pertaining to securities with gross unrealized losses at December 31, 2005, aggregated by investment category and length of time that indi- vidual securities have been in a continuous loss position is as follows (in thousands): Less than twelve months Over twelve months Total $ Gross Unrealized Loss 332 1,538 179 948 2,997 $ U.S. Treasury U.S. Government Agencies States and political subdivisions FHLMC preferred stock Total Fair Value $ 100,001 81,411 9,106 Gross Unrealized Loss 259 1,054 150 $ $ 190,518 $ 1,463 Fair Value 17,656 $ 50,441 3,485 2,127 $ 73,709 18 $ Fair Value Gross Unrealized Loss 591 $ 117,657 2,592 131,852 329 12,591 948 2,127 4,460 $ 264,227 $ Management evaluates securities for other-than-temporary impairment on a monthly basis. Consideration is given to the length of time and the extent to which the fair value has been less than cost. The Company has also considered that securities are primarily issued by U.S. Treasury and U.S. Government Agencies, the cause of the decline in value, the intent and ability of the Company to hold these securities until maturity and that the Company has traditionally held virtually all of its securities, including those classified as available for sale, until maturity. Any sales of available for sale securities, which have been infrequent and immaterial, have been for liquidity purposes. The Company has also carefully considered the specific issues related to the valuation of the FHLMC preferred stock. As a result of the evaluation of the impairment of these securities, the Company has determined that the declines summarized in the table above are not deemed to be other-than-temporary. Proceeds from maturities and calls of held to maturity debt securities dur- ing 2006, 2005 and 2004 were $265,074,303, $23,435,000 and $1,405,000, respectively. There were no sales of held to maturity debt securities dur- ing 2006, 2005 and 2004. Proceeds from maturities, sales and calls of N O T E C - L O A N S : The composition of the loan portfolio was as follows (in thousands): December 31, Real estate, construction Real estate, mortgage Loans to finance agricultural production and other loans to farmers Commercial and industrial loans Loans to individuals for household, family and other consumer expenditures Obligations of states and political subdivisions (primarily industrial revenue bonds and local government tax anticipation notes) All other loans Totals Transactions in the allowance for loan losses are as follows (in thousands): Balance, January 1 Recoveries Loans charged off Provision for allowance for loan losses Balance, December 31 available for sale debt securities were $55,190,291, $144,782,701 and $174,457,599 during 2006, 2005 and 2004, respectively. Available for sale debt securities were sold in 2005 and 2004 for a realized loss of $443,000 and $259,000. There were no sales of available for sale debt securities during 2006. The Company realized gains of $16,441 and $22,270 from the liquidation of equity securities in 2005 and 2004, respectively. Securities with an amortized cost of approximately $269,628,000, $217,009,000 and $166,311,000 at December 31, 2006, 2005 and 2004, respectively, were pledged to secure public deposits, federal funds purchased and other balances required by law. Federal Home Loan Bank (FHLB) common stock was purchased during 1999 in order for the Company to participate in certain FHLB programs. The amount to be invested in FHLB stock was calculated according to FHLB guidelines as a percentage of certain mortgage loans. Based on this calculation, the FHLB may periodically automatically redeem its common stock. The investment is carried at cost. Dividends received are reinvested in FHLB stock. $ 2006 24,317 300,807 2,502 57,796 13,415 2,094 263 2005 2004 $ 20,663 $ 20,926 258,573 2,795 53,473 11,812 1,423 607 250,676 4,251 44,983 11,387 1,654 316 $ 401,194 $ 349,346 $ 334,193 2006 10,966 463 (729) 141 $ 2005 6,570 1,344 (562) 3,614 10,841 $ 10,966 $ $ 2004 6,399 494 (771) 448 6,570 $ $ As a part of its evaluation of the quality of the loan portfolio, Management continuously monitors the Company’s credit concentrations on a monthly basis. Total outstanding concentrations were as follows (in thousands): December 31, Gaming Hotel/motel Out of area Total 2006 60,105 24,907 19,357 104,369 $ $ 2005 42,855 21,532 17,600 81,987 $ $ 2004 26,600 24,602 14,062 65,264 $ $ In the ordinary course of business, the Company extends loans to certain officers and directors and their personal business interests at, in the opinion of Management, terms and rates comparable to other loans of similar credit risks. These loans do not involve more than normal risk of collectibility and do not include other unfavorable features. An analysis of the activity with respect to such loans to related parties is as follows (in thousands): Balance, January 1 New loans and advances Repayments Balance, December 31 2006 8,670 10,248 (10,364) 8,554 $ $ 2005 8,836 20,300 (20,466) 8,670 $ $ 2004 7,637 14,381 (13,182) 8,836 $ $ 19 Loans past due ninety days or more and still accruing were $3,295,000, $762,000 and $1,190,000 at December 31, 2006, 2005 and 2004, respectively. Nonaccrual loans amounted to approximately $349,000, $267,000 and $6,164,000 at December 31, 2006, 2005 and 2004, respectively. The Company's other individually evaluated impaired loans include per- forming loans and totaled $12,350,000, $17,162,000 and $10,957,000 at December 31, 2006, 2005 and 2004, respectively. At December 31, 2006, 2005 and 2004, the average recorded investment in impaired loans was $15,877,000, $17,827,000 and $14,962,000, respectively. The Company had $4,389,000, $6,176,000 and $3,673,000 of specific allowance related to impaired loans at December 31, 2006, 2005 and 2004, respectively. Interest income recognized on impaired loans was $990,000, $1,132,000 and $678,000 in 2006, 2005 and 2004, respectively. Interest income recognized on impaired loans if the Company had used the cash-basis method of accounting would have approximated $900,000, $1,056,000 and $680,000 in 2006, 2005 and 2004, respectively. N O T E D - B A N K P R E M I S E S A N D E Q U I P M E N T : Bank premises and equipment are shown as follows (in thousands): Years Ended December 31, Estimated useful lives Land Buildings Furniture, fixtures and equipment Totals, at cost Less: Accumulated depreciation Totals 5-40 years 3-10 years N O T E E - D E P O S I T S At December 31, 2006, the scheduled maturities of time deposits (in thousands) are as follows: $ 2006 5,720 14,731 13,806 34,257 14,598 $ 2005 4,926 17,476 13,511 35,913 18,025 $ 19,659 $ 17,888 2004 5,033 17,463 12,697 35,193 17,174 18,019 $ $ 2007 2008 2009 2010 2011 Total $ 159,315 18,536 10,375 3,094 2,063 $ 193,383 Deposits held for related parties amounted to $15,399,924, $12,130,015 and $15,011,100 at December 31, 2006, 2005 and 2004, respectively. N O T E F - F E D E R A L F U N D S P U R C H A S E D A N D S E C U R I T I E S S O L D U N D E R A G R E E M E N T S T O R E P U R C H A S E N O T E G - B O R R O W I N G S F R O M F E D E R A L H O M E L O A N B A N K : At December 31, 2006, the Company had $7,267,349 outstanding in At December 31, 2006, 2005 and 2004, federal funds purchased and advances under a $96,259,000 line of credit with the Federal Home Loan securities sold under agreements to repurchase consist only of funds Bank of Dallas (“FHLB”). One advance in the amount of $5,000,000 bears invested by customers in a non-deposit product of the bank subsidiary. interest at 6.50% and matures in 2010. The remaining balance consists These accounts are non-insured, non-deposit accounts which allow cus- of a number of smaller advances at a fixed rate of interest from 2.24% tomers to earn interest on their account with no restrictions as to the to 7.00% with maturity dates from 2007 – 2030. The advances are collat- number of transactions. They are set up as sweep accounts with no eralized by a blanket floating lien on the Company’s residential first check-writing capabilities, and require the customer to have at least one mortgage loans. operating deposit account. At December 31, 2006, the Company had facilities in place to purchase federal funds up to $88,000,000 under established credit arrangements. N O T E H - N O T E S P A Y A B L E : At December 31, 2004, the Company had a note payable on auto- mobiles of $1,239 that was non-interest-bearing and which matured In January 2005. 20 N O T E I - I N C O M E T A X E S : Deferred taxes (or deferred charges) as of December 31, 2006, 2005 and 2004, included in other assets or other liabilities, were as follows (in thousands): December 31, Deferred tax assets: Allowance for loan losses Employee benefit plans' liabilities Unrealized loss on available for sale securities, charged from equity Earned retiree health benefits plan liability Unearned retiree health benefits plan liability Other Deferred tax assets Deferred tax liabilities: Bank premises and equipment Other Deferred tax liabilities Net deferred taxes Income taxes consist of the following components (in thousands): Years Ended December 31, Current Deferred Totals 2006 2005 2 0 0 4 $ 4,089 $ 3,503 $ 2,030 911 798 435 356 8,619 3,989 39 4,028 1,638 1,427 525 7,093 2,239 2,239 $ 4,591 $ 4,854 $ 2006 6,511 (52) $ 6,459 2005 3,653 (1,049) 2,604 $ $ $ $ $ 2,282 1,489 479 915 5,165 2,308 2,308 2,857 2004 2,660 (629) 2,031 21 Income taxes amounted to less than the amounts computed by applying the U.S. Federal income tax rate of 35.0% for 2006 and 34% for 2005 and 2004, to earnings before income taxes. The reason for these differences is shown below (in thousands): Years Ended December 31, Taxes computed at statutory rate Increase (decrease) resulting from: Tax-exempt interest income Other, net Total income taxes 2006 Amount $ 6,729 (292) 22 $ 6,459 % 35.0 (1.5) 0.1 33.6 2005 Amount % 2004 Amount $ 2,702 34.0 $ 2,660 (272) 174 $ 2,604 (3.4) 2.2 32.8 (230) (399) $ 2,031 % 34.0 (2.9) (5.2) 25.9 N O T E J - S H A R E H O L D E R S ' E Q U I T Y : capital requirements can initiate certain mandatory, and possibly addi- Banking regulations limit the amount of dividends that may be paid by tional discretionary, actions by the regulators that, if undertaken, could the bank subsidiary without prior approval of the Commissioner of have a direct material effect on the bank subsidiary’s financial statements. Banking and Consumer Finance of the State of Mississippi. At December 31, Under capital adequacy guidelines and the regulatory framework for 2006, approximately $25,021,000 of undistributed earnings of the bank prompt corrective action, the bank subsidiary must meet specific capital subsidiary included in consolidated surplus and retained earnings was guidelines that involve quantitative measures of the bank subsidiary’s available for future distribution to the Company as dividends, subject to assets, liabilities and certain off-balance sheet items as calculated under the approval by the Board of Directors. regulatory accounting practices. The bank subsidiary’s capital amounts and classification are also subject to qualitative judgments by the regula- On November 26, 2002, the Company’s Board of Directors approved the tors about components, risk weightings and other factors. repurchase of up to 2.50% of the outstanding shares of the Company’s common stock. At November 26, 2005, the date this repurchase was set to Quantitative measures established by regulation to ensure capital ade- expire, the Company had the authorization to repurchase and retire quacy require the bank subsidiary to maintain minimum amounts and another 109,610 shares. On November 22, 2005, the Board of Directors ratios of Total and Tier 1 capital to risk-weighted assets, and Tier 1 capital approved a three year extension of the repurchase plan originally to average assets. approved on November 26, 2002. As of December 31, 2006, 30,793 shares had been repurchased and retired under the plan approved November 26, As of December 31, 2006, the most recent notification from the Federal 2002 and extended on November 22, 2005. Deposit Insurance Corporation categorized the bank subsidiary as well capitalized under the regulatory framework for prompt corrective action. On December 8, 2006, the Company’s Board of Directors approved a semi- To be categorized as well capitalized, the bank subsidiary must have a annual dividend of $.23 per share. This dividend has a record date of Total risk-based capital ratio of 10.00% or greater, a Tier 1 risk-based cap- January 8, 2007 and a distribution date of January 16, 2007. ital ratio of 6.00% or greater and a Leverage capital ratio of 5.00% or greater. There are no conditions or events since that notification that The bank subsidiary is subject to various regulatory capital requirements Management believes have changed the bank subsidiary’s category. administered by the federal banking agencies. Failure to meet minimum 22 The Company’s actual capital amounts and ratios and required minimum capital amounts and ratios for 2006, 2005 and 2004, are as follows (in thousands): December 31, 2006: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) December 31, 2005: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) December 31, 2004: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) Actual For Capital Adequacy Purposes Amount Ratio Amount $ 102,480 96,415 96,415 $ 90,418 85,163 85,163 $ 88,983 84,405 84,405 21.12% 19.87% 10.60% 21.51% 20.26% 12.57% 24.29% 23.04% 14.66% $38,818 19,409 36,374 $33,630 16,815 27,104 $29,302 14,651 23,028 Ratio 8.00% 4.00% 4.00% 8.00% 4.00% 4.00% 8.00% 4.00% 4.00% The bank subsidiary’s actual capital amounts and ratios and required minimum capital amounts and ratios for 2006, 2005 and 2004, are as follows (in thousands): December 31, 2006: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) December 31, 2005: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) December 31, 2004: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) N O T E K - O T H E R I N C O M E A N D E X P E N S E S : Other income consisted of the following: Years Ended December 31, Other service charges, commissions and fees Rentals Other Totals Other expenses consisted of the following: Years Ended December 31, Advertising Data processing Legal and accounting ATM expense Consulting fees Trust expense Other Totals Actual For Capital Adequacy Purposes Amount Ratio Amount $ 102,111 95,991 95,991 $ 94,922 89,376 89,376 $ 90,616 85,998 85,998 21.06% 19.80% 9.98% 21.66% 20.39% 11.59% 24.66% 23.40% 14.31% $38,791 19,396 38,482 $35,061 17,531 30,843 $29,397 14,698 24,040 2006 222,681 257,091 798,352 1,278,124 2006 586,646 314,570 492,296 1,066,411 429,336 426,156 1,995,226 5,310,641 $ $ $ $ 2005 207,809 376,176 546,038 1,130,023 2005 534,509 281,263 485,805 954,168 242,110 387,351 2,146,307 5,031,513 $ $ $ $ $ $ $ $ Ratio 8.00% 4.00% 4.00% 8.00% 4.00% 4.00% 8.00% 4.00% 4.00% 2004 220,443 480,267 678,026 1,378,736 2004 553,104 232,473 443,152 1,256,013 119,182 397,610 2,550,413 5,551,947 23 N O T E L - F I N A N C I A L I N S T R U M E N T S W I T H O F F - B A L A N C E - S H E E T R I S K : The Bank had made a routine loan to the Judge in November 1998, which was guaranteed by the Attorney. The loan was repaid in February 2000 by The Company is a party to financial instruments with off-balance-sheet someone other than the Judge, apparently at the request of the Attorney. risk in the normal course of business to meet the financing needs of its Neither the Attorney nor the Judge disclosed the loan or the repayment to customers. These financial instruments include commitments to extend USF&G or its counsel. credit and irrevocable letters of credit. These instruments involve, to vary- ing degrees, elements of credit and interest rate risk in excess of the During the course of the case, the Bank and USF&G filed competing motions amount recognized in the balance sheet. The contract amounts of those for summary judgment. The Judge granted summary judgment in the Bank’s instruments reflect the extent of involvement the bank subsidiary has in favor on the issue of liability and subsequently presided over a settlement particular classes of financial instruments. The Company's exposure to conference in which he expressed his opinion about the value of the case in credit loss in the event of nonperformance by the other party to the finan- monetary terms. The case was settled on December 24, 2001, for $1.5 million. cial instrument for commitments to extend credit and irrevocable letters of credit is represented by the contractual amount of those instruments. In 2003, the Attorney, the Judge and other parties were indicted for alleged The Company uses the same credit policies in making commitments and fraud, bribery, etc. involving various events, including allegations concerning conditional obligations as it does for on-balance-sheet instruments. the Bank v. USF&G lawsuit. Neither the Bank nor any Bank employee was indict- ed. Following the indictments, USF&G filed a civil action against the Attorney, Commitments to extend credit are agreements to lend to a customer as the Judge and the Bank alleging fraud in connection with the outcome of the long as there is no violation of any conditions established in the agree- Bank v. USF&G lawsuit. The complaint demands $2.5 million in compensatory ment. Irrevocable letters of credit written are conditional commitments damages and $10 million in punitive damages, prejudgment interest and attor- issued by the Company to guarantee the performance of a customer to a neys’ fees, etc. The USF&G v. Bank suit was stayed until 30 days following the third party. Commitments and irrevocable letters of credit generally have completion of the criminal case. There has been no discovery. fixed expiration dates or other termination clauses and may require pay- ment of a fee. Since some of the commitments and irrevocable letters of The criminal case against the Attorney, the Judge and other parties con- credit may expire without being drawn upon, the total amounts do not cluded on August 12, 2005. No guilty verdicts were returned. The defen- necessarily represent future cash requirements. The Company evaluated dants received not guilty verdicts on several counts and there was no ver- each customer's creditworthiness on a case-by-case basis. The amount of dict (mistrial) on a number of other counts, including the Bank v. USF&G collateral obtained upon extension of credit is based on Management's matter. On September 16, 2005, the U.S. Attorney’s office announced that credit evaluation of the customer. Collateral obtained varies but may it will retry the Attorney, the Judge and other parties on fraud and include equipment, real property and inventory. bribery charges related to the Bank v. USF&G matter. The new trial began on February 7, 2007. The USF&G v. Bank suit will remain subject to the stay The Company generally grants loans to customers in its primary trade area order until the criminal matters are concluded. of Harrison, Hancock, Jackson and Stone counties. The Company understands that this litigation, as with any litigation, is At December 31, 2006, 2005 and 2004, the Company had outstanding inherently uncertain and it is reasonably possible that the Company may irrevocable letters of credit aggregating $3,038,096, $4,491,773 and incur a loss in this matter. The Company has no reason to conclude, how- $3,113,033, respectively. At December 31, 2006, 2005 and 2004, the ever, that the loss is probable and cannot reasonably estimate the amount Company had outstanding unused loan commitments aggregating of any possible loss. No liability for the USF&G lawsuit has been accrued. $149,457,000, $121,369,000 and $113,500,000, respectively. Approximately This conclusion is based on relevant legal advice, the fact that this lawsuit $67,621,000, $65,721,000 and $24,637,000 of outstanding commitments is in its very earliest stages with no discovery having been undertaken and were at fixed rates and the remainder were at variable rates at December the Company’s resolve to vigorously contest the case. 31, 2006, 2005 and 2004, respectively. (cid:2) N O T E M - C O M M I T M E N T S A N D C O N T I N G E N C I E S : The Company’s bank subsidiary (the “Bank”) filed suit against USF&G in 1998 to recover damages for USF&G’s bad faith failure to defend and indemnify the Bank in connection with a lawsuit filed against the Bank in 1996. The Bank obtained legal representation from a local plaintiff’s attor- ney and customer (“Attorney”) on a contingent basis. In December 2000, the case was transferred from the judge to whom it was originally assigned to a second judge (the “Judge”). The Judge had The bank is involved in various other legal matters and claims which are being defended and handled in the ordinary course of business. None of these mat- ters is expected, in the opinion of Management, to have a material adverse effect upon the financial position or results of operations of the Company. The Company has made commitments relating to the construction and renovation of its bank premises. At December 31, 2006, such commitments totaled $10,340,000, of which $614,000 was included in Bank Premises and Equipment as construction in process. These expenditures are being fund- ed through the proceeds of the settlement of insurance claims and current previously handled some discovery matters in the case. operating capital. 24 N O T E N - C O N D E N S E D P A R E N T C O M P A N Y O N L Y F I N A N C I A L I N F O R M A T I O N : Peoples Financial Corporation began its operations September 30, 1985, when it acquired all the outstanding stock of The Peoples Bank, Biloxi, Mississippi. A condensed summary of its financial information is shown below. C O N D E N S E D B A L A N C E S H E E T S ( I N T H O U S A N D S ) 2006 2005 2004 $ 98,147 $ 87,740 $ 85,991 December 31, Assets Investments in subsidiaries, at underlying equity: Bank subsidiary Nonbank subsidiary Cash in bank subsidiary Other assets Total assets Liabilities and Shareholders' Equity Other liabilities Total liabilities Shareholders' equity Total liabilities and shareholders' equity 1 55 1,535 99,738 1,505 1,505 98,233 99,738 $ $ $ C O N D E N S E D S T A T E M E N T S O F I N C O M E ( I N T H O U S A N D S ) Years Ended December 31, Income Earnings of unconsolidated bank subsidiary: Distributed earnings Undistributed earnings Interest income Other income Total income Expenses Other expense Total expenses Income before income taxes Income tax (benefit) Net income 2006 2,800 10,014 5 25 12,844 93 93 12,751 (17) 12,768 $ $ 1 285 842 88,868 1,365 1,365 87,503 88,868 2005 2,300 3,618 4 37 5,959 96 96 5,863 (19) 5,882 $ $ $ $ $ 1 268 823 87,083 1,282 1,282 85,801 87,083 2004 1,575 4,246 3 43 5,867 87 87 5,780 (14) 5,794 $ $ $ $ $ 25 C O N D E N S E D S T A T E M E N T S O F C A S H F L O W S ( I N T H O U S A N D S ) Years Ended December 31, Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Gain on liquidation of investment Net income of unconsolidated subsidiaries Changes in assets and liabilities: Other assets Net cash used in operating activities Cash flows from investing activities: Investment in equity securities Proceeds from liquidation of investment Dividends from unconsolidated subsidiary Net cash provided by investing activities Cash flows from financing activities: Retirement of stock Dividends paid Net cash used in financing activities Net increase (decrease) in cash Cash, beginning of year Cash, end of year 2006 2005 2004 $ 12,768 $ 5,882 $ 5,794 (12,814) 8 (38) (700) 2,800 2,100 (17) (2,275) (2,292) (230) 285 55 $ (16) (5,918) (20) (72) 16 2,300 2,316 (118) (2,109) (2,227) 17 268 285 $ (22) (5,821) (14) (63) 22 1,575 1,597 (34) (1,778) (1,812) (278) 546 268 $ Peoples Financial Corporation paid income taxes of $5,310,000, $ 4,856,000 and $2,042,000 in 2006, 2005 and 2004, respectively. No interest was paid during the three years ended December 31, 2006. N O T E O - E X T R A O R D I N A R Y G A I N : by the employee (up to 6% of compensation). Contributions are deter- An extraordinary gain of $538,000, net of taxes, was recorded in 2005 as a result of the Pulse EFT Association Exchange. N O T E P - E M P L O Y E E B E N E F I T P L A N S : The Company sponsors the Peoples Financial Corporation Employee Stock Ownership Plan (ESOP). Employees who are in a position requiring at least 1,000 hours of service during a plan year and who are 21 years of age are eligible to participate in the ESOP. The Plan included 401(k) provisions and the former Gulf National Bank Profit Sharing Plan. Effective January 1, 2001, the ESOP was amended to separate the 401(k) funds into the Peoples Financial Corporation 401(k) Plan. The separation had no impact on the eligibility or benefits provided to participants of either plan. The 401(k) provides for a matching contribution of 75% of the amounts contributed mined by the Board of Directors and may be paid either in cash or Peoples Financial Corporation capital stock. Total contributions to the plan charged to operating expense were $460,000, $300,000 and $459,000 in 2006, 2005 and 2004, respectively. Compensation expense of $8,245,151, $7,277,442 and $7,323,267, was the basis for determining the ESOP contribution allocation to participants for 2006, 2005 and 2004, respectively. The ESOP held 457,691, 468,084 and 472,744, allocated shares at December 31, 2006, 2005 and 2004, respectively. 26 The Company established an Executive Supplemental Income Plan and a acquired insurance policies, with the bank subsidiary as owner and ben- Directors' Deferred Income Plan, which provide for pre-retirement and eficiary, that it may use as a source to pay potential benefits to the plan post-retirement benefits to certain key executives and directors. Benefits participants. Additionally, there are two endorsement split dollar policies, under the Executive Supplemental Income Plan are based upon the posi- with the bank subsidiary as owner and beneficiary, which provide a tion and salary of the officer at retirement or death. Normal retirement guaranteed death benefit to the participants’ beneficiaries. These con- benefits under the plan are equal to 67% of salary for the president and tracts are carried at their cash surrender value, which amounted to chief executive officer, 58% of salary for the executive vice president and $826,680, $816,025 and $780,898 at December 31, 2006, 2005 and 2004, 50% of salary for all other executive officers and are payable monthly over respectively and are included in Other Assets. The present value of accu- a period of fifteen (15) years. Under the Directors’ Deferred Income Plan, mulated benefits under these plans using an interest rate of 7.50% in 2006, the directors are given an opportunity to defer receipt of their annual 2005 and 2004 and the projected unit cost method has been accrued. The directors’ fees until age sixty-five. For those who choose to participate, accrual amounted to $613,510, $628,515 and $597,096 at December 31, 2006, benefits are payable monthly for ten (10) years beginning the month after 2005 and 2004, respectively and is included in Other Liabilities. the director attains age sixty-five. Interest on deferred fees accrues at an annual rate of ten percent, compounded annually. The Company has The Company provides post-retirement health insurance to certain of its acquired insurance policies, with the bank subsidiary as owner and ben- retired employees. Employees are eligible to participate in the retiree health eficiary, that it may use as a source to pay potential benefits to the plan plan if they retire from active service no earlier than age 65. In addition, the participants. These contracts are carried at their cash surrender value, employee must have at least 25 continuous years of service with the which amounted to $12,157,922, $11,672,568 and $11,221,549 at December 31, Company immediately preceding retirement. However, any active employ- 2006, 2005 and 2004, respectively, and are included in Other Assets. The ee who was at least age 65 as of January 1, 1995, does not have to meet the present value of accumulated benefits under these plans, using an inter- 25 years of service requirement. The accumulated post-retirement benefit est rate of 7.00% in 2006 and 7.50% for 2005 and 2004 and the interest obligation at January 1, 1995, was $517,599, which the Company elected to ramp-up method for 2006, 2005 and 2004, has been accrued. The accrual amortize over 20 years. The Company reserves the right to amounted to $4,769,461, $4,189,779 and $3,783,850 at December 31, 2006, modify, reduce or eliminate these health benefits. The Company has chosen 2005 and 2004, respectively, and is included in Other Liabilities. to not offer this post-retirement benefit to individuals entering the employ of the Company after December 31, 2006. The Company also has additional plans for non-vested post-retirement benefits for certain key executives and directors. The Company has The following is a summary of the components of the net periodic post-retirement benefit cost: Years Ended December 31, Service cost, including amortization of loss Interest cost Amortization of net transition obligation Net periodic post-retirement benefit cost 2006 315,561 175,982 20,600 512,143 $ $ 2005 $ 237,731 139,449 20,600 2004 $ 212,933 133,262 20,600 $ 397,780 $ 366,795 The discount rate used in determining the accumulated post-retirement Medicare Part D. The Act became effective in 2006. The Company believes benefit obligation was 6.00% in 2006, 5.500% in 2005, and 5.75% in 2004. that the coverage it provides under its plan is actuarially equivalent to The assumed health care cost trend rate used in measuring the accumulated Medicare Part D and that it will be entitled to the subsidy. The Company post-retirement benefit obligation was 10.00% in 2003. The rate was elected to recognize the effect of this subsidy as of December 31, 2004. The assumed to decrease gradually to 5.00% for 2013 and remain at that level recognition of this subsidy had no effect on the 2004 net periodic post- thereafter. If the health care cost trend rate assumptions were increased retirement benefit cost but did reduce the accumulated benefit obligation 1.00%, the accumulated post-retirement benefit obligation as of December as of December 31, 2004 by $650,109. 31, 2006, would be increased by 24.07%, and the aggregate of the service and interest cost components of the net periodic post-retirement benefit The following table presents the estimated benefit payments and effect of cost for the year then ended would have increased by 29.49%. If the health the Medicare Part D subsidy for each of the next five years and in the care cost trend rate assumptions were decreased 1.00%, the accumulated aggregate for the next five years: post-retirement benefit obligation as of December 31, 2006, would be decreased by 18.46%, and the aggregate of the service and interest cost components of the net periodic post-retirement benefit cost for the year then ended would have decreased by 21.89%. The Medicare Prescription Drug, Improvement and Modernization Act of Year 2007 2008 2009 2010 2011 2003, (the “Act”) provided a prescription drug benefit under Medicare 2012-2016 Part D as well as a federal subsidy to sponsors of retiree health care bene- fit plans that provide a benefit that is at least actuarially equivalent to With Subsidy Without Subsidy $ 58,000 64,000 70,000 76,000 86,000 744,000 $ 8,000 9,000 10,000 10,000 11,000 119,000 Subsidy $ 50,000 55,000 60,000 66,000 75,000 625,000 27 The following is a reconciliation of the accumulated post-retirement benefit obligation: Accumulated post-retirement benefit obligation as of December 31, 2005 Service cost Interest cost Actuarial loss Benefits paid Accumulated post-retirement benefit obligation as of December 31, 2006 3,222,003 250,923 175,982 (305,654) (73,202) 3,270,052 $ $ The following is a summary of the change in plan assets: Fair Value of Plan Assets at Beginning of Year Actual Return of Assets Employer Contribution Benefits Paid (net) Fair Value of Plan Assets at End of Year The following is a summary of the accrued post-retirement benefit cost at December 31, 2005 and 2004: December 31, Accumulated post-retirement benefit obligation: Retirees Not eligible to retire Total Plan assets at fair value Accumulated post-retirement benefit obligation in excess of plan assets Unrecognized transition obligation Unrecognized cumulative net gain from past experience different from that assumed and from changes in assumptions Accrued post-retirement benefit cost $ $ $ 2006 2005 2004 73,202 (73,202) $ $ 68,860 (68,860) $ $ 61,070 (61,070) 2005 830,354 2,391,649 3,222,003 3,222,003 (185,397) 2004 $ 717,323 1,517,246 2,234,569 2,234,569 (205,997) (1,363,523) 1,673,083 $ (684,409) 1,344,163 $ The Company adopted FASB Statement No. 158, “Employers Accounting for Defined Benefit Pensions and Other Postretirement Plans (an amendment of FASB Statements No. 87, 88, 106 and 132R (SFAS 158). SFAS 158 requires the recognition of the funded status of the Company’s postretirement benefit plan and to provide additional disclosure. As a result of the adop- tion of SFAS 158, accrued postretirement benefit cost of $3,270,052 is included in Other Liabilities and the loss from unfunded post-retirement benefit obligation of $750,827, net of taxes, is included in accumulated other comprehensive income in 2006. Other changes in plan assets and accumulated post-retirement benefit obligation recognized in accumulated other comprehensive income includes the following, net of tax, at December 31, 2006. Unrecognized Actuarial Loss Unrecognized Transition Obligation Unrecognized Prior Service Cost Total recognized in other comprehensive income Amortization of net loss Amortization of prior service cost Total recognized in net periodic benefit cost and other comprehensive income The estimated net loss and prior transition obligation for the other postretirement plan that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year is $41,355 and $20,600, respectively. 750,827 42,015 13,390 55,405 645,600 105,227 $ $ $ $ N O T E Q - F A I R V A L U E O F F I N A N C I A L I N S T R U M E N T S : All entities are required to disclose the fair value of financial instruments, both assets and liabilities, recognized and not recognized in the statement of condition, for which it is practical to estimate its fair value. SFAS 107 excluded certain financial instruments and all nonfinancial instruments from its disclosure requirements. Significant assets and liabilities that are not considered financial instruments include deferred income taxes and bank premises and equipment. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. In preparing these disclosures, Management made highly subjective estimates and assumptions in devel- oping the methodology to be utilized in the computation of fair value. These estimates and assumptions were formulated based on judgments regarding economic conditions and risk characteristics of the financial instruments that were present at the time the computations were made. Events may occur that alter these conditions and thus perhaps change the assumptions as well. A change in the assumptions might affect the fair value of the financial instruments disclosed in this footnote. These esti- 28 mates do not reflect any premium or discount that could result from offer- ing for sale at one time the Company's entire holdings of a particular financial instrument. Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and lia- bilities that are not considered financial instruments. In addition, the tax consequences related to the realization of the unrealized gains and losses have not been computed or disclosed herein. These fair value estimates, methods and assumptions are set forth below. Cash and Due from Banks The carrying amount shown as cash and due from banks approximates fair value. Federal Funds Sold The carrying amount shown as federal funds sold approximates fair value. Available for Sale Securities The fair value of available for sale securities is based on quoted market prices. Held to Maturity Securities The fair value of held to maturity securities is based on quoted market prices. Federal Home Loan Bank Stock The carrying amount shown as Federal Home Loan Bank Stock approximates fair value. Loans The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings for the remaining maturities. The cash flows considered in computing the fair value of such loans are segmented into categories relating to the nature of the contract and collateral based on contractual principal maturities. Appropriate adjustments are made to reflect probable credit losses. Cash flows have not been adjusted for such fac- tors as prepayment risk or the effect of the maturity of balloon notes. The fair value of floating rate loans is estimated to be its carrying value. Cash Surrender Value The carrying amount of cash surrender value of bank-owned life insurance, which is included in Other Assets, approximates fair value. Deposits The fair value of non-interest bearing demand and interest bearing savings and demand deposits is the amount reported in the financial statements. The fair value of time deposits is estimated by discounting the cash flows using current rates of time deposits with similar remaining maturities. The cash flows considered in computing the fair value of such deposits are based on contractual maturities, since approximately 98% of time deposits provide for automatic renewal at current interest rates. Federal Funds Purchased and Securities Sold under Agreements to Repurchase The carrying amount shown as federal funds purchased and securities sold under agreements to repurchase approximates fair value. Borrowings from FHLB The fair value of FHLB fixed rate borrowings is estimated using discounted cash flows based on current incremental borrowing rates for similar types of borrowing arrangements. The Company has no FHLB variable rate borrowings. Commitments To Extend Credit and Standby Letters of Credit Because commitments to extend credit and standby letters of credit are generally short-term and at variable rates, the contract value and estimated fair value associated with these instruments are immaterial. The following table presents carrying amounts and estimated fair values for financial assets and financial liabilities at December 31, 2006, 2005 and 2004 (in thousands): 2006 2005 2004 Financial Assets: Cash and due from banks Federal funds sold Available for sale securities Held to maturity securities Federal Home Loan Bank Stock Loans, net Cash surrender value Financial Liabilities: Deposits: Non-interest bearing Interest bearing Total deposits Federal funds purchased and securities sold under agreements to repurchase Borrowings from FHLB Notes payable Carrying Amount $ 37,793 6,400 397,207 85,574 1,129 390,353 12,985 148,456 464,714 613,170 226,032 7,267 Fair Value $ 37,793 6,400 397,207 85,519 1,129 389,072 12,985 148,456 464,873 613,329 226,032 8,002 Carrying Amount $ 52,278 100,340 178,394 134,047 1,077 338,380 12,489 176,627 415,590 592,217 149,268 7,352 Fair Value $ 52,278 100,340 178,394 134,008 1,077 341,016 12,489 176,627 415,582 592,209 149,268 7,728 Carrying Amount $ 32,573 152 173,031 6,587 1,402 327,624 12,003 89,529 299,662 389,191 87,277 7,203 1 Fair Value $ 32,573 152 173,031 6,698 1,402 331,044 12,003 89,529 300,188 389,717 87,277 7,906 1 29 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S To the Board of Directors Peoples Financial Corporation Biloxi, Mississippi We have audited management's assessment, included in the accompany- ing Management's Report on Internal Controls over Financial Reporting, that Peoples Financial Corporation maintained effective internal control over financial reporting as of December 31, 2006, based on criteria estab- lished in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Peoples Financial Corporation’s management is responsible for maintaining effec- tive internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibil- ity is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and oper- ating effectiveness of internal control, and performing such other proce- dures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for exter- nal purposes in accordance with accounting principles generally accept- ed in the United States of America. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are record- ed as necessary to permit preparation of financial statements in accor- dance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and direc- tors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or dispo- sition of the Company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial report- ing may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteri- orate. In our opinion, management's assessment that Peoples Financial Corporation maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by COSO. Also in our opinion, Peoples Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control- Integrated Framework issued by COSO. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of condition of Peoples Financial Corporation and subsidiaries as of December 31, 2006, and the related statements of income, sharehold- ers’ equity and cash flows for the year then ended, and our report dated February 14, 2007, expressed an unqualified opinion on those consolidat- ed financial statements. Atlanta, Georgia February 14, 2007 30 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Peoples Financial Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 14, 2007, expressed an unqualified opinion on manage- ment’s assessment of the effectiveness of Peoples Financial Corporation’s internal control over financial reporting and an unqualified opinion on the effectiveness of Peoples Financial Corporation’s internal control over financial reporting. Atlanta, Georgia February 14, 2007 To the Board of Directors Peoples Financial Corporation Biloxi, Mississippi We have audited the accompanying consolidated statements of condi- tion of Peoples Financial Corporation and subsidiaries as of December 31, 2006, and the related statements of income, shareholders’ equity and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. The consolidated financial statements of Peoples Financial Corporation and subsidiaries as of December 31, 2005 and 2004 were audited by other auditors whose report dated January 25, 2006, expressed an unqualified opinion on those statements. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assur- ance about whether the financial statements are free of material mis- statement. An audit includes examining, on a test basis, evidence sup- porting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and signifi- cant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the 2006 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Peoples Financial Corporation and subsidiaries as of December 31, 2006, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. 31 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S Board of Directors Peoples Financial Corporation and Subsidiaries Biloxi, Mississippi We have audited the accompanying consolidated statements of condition of Peoples Financial Corporation and Subsidiaries as of December 31, 2005 In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Peoples Financial Corporation and Subsidiaries at December 31, 2005 and 2004, and the results of its operations and its cash flows for the years then ended, in conformity with U. S. generally accepted accounting principles. and 2004, and the related consolidated statements of income, sharehold- Certified Public Accountants ers’ equity and cash flows for the years then ended. These financial state- ments are the responsibility of the Company’s Management. Our respon- sibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant esti- mates made by Management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. PILTZ, WILLIAMS, LAROSA & CO. Biloxi, Mississippi January 25, 2006 32 F I V E - Y E A R C O M P A R A T I V E S U M M A R Y O F S E L E C T E D F I N A N C I A L I N F O R M A T I O N ( I N T H O U S A N D S E X C E P T P E R S H A R E D A T A ) Peoples Financial Corporation and Subsidiaries Balance Sheet Summary Total assets Available for sale securities Held to maturity securities Loans, net of unearned discount Deposits Borrowings from FHLB Long term notes payable Shareholders' equity Summary of Operations Interest income Interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Non-interest income Non-interest expense Income before taxes and extraordinary gain Applicable income taxes Extraordinary gain Net income Per Share Data Basic and diluted earnings per share Basic and diluted earnings per share before extraordinary gain Dividends per share Book value 2006 2005 2004 2003 2002 $ 964,023 $ 845,325 $ 577,441 $ 579,669 $ 553,671 397,207 85,574 401,194 613,170 7,267 178,394 134,047 349,346 592,217 7,352 173,030 6,588 334,193 389,192 7,203 98,233 87,503 85,801 207,486 4,353 302,155 376,789 17,070 110 83,504 151,484 17,588 315,827 391,705 6,313 334 81,732 $ 48,894 $ 32,343 $ 24,566 $ 25,065 $ 27,424 18,785 30,109 141 29,968 12,309 (23,050) 19,227 6,459 12,768 2.30 2.30 .44 17.71 $ $ 7,550 24,793 3,614 21,179 7,237 5,091 19,475 448 19,027 9,563 (20,468) (20,765) 7,825 2,031 $ $ 7,948 2,604 538 5,882 1.06 .96 .38 15.77 $ $ 5,838 19,227 447 18,780 9,737 (21,464) 7,053 2,035 9,616 17,808 2,428 15,380 10,372 (21,874) 3,878 687 5,794 $ 5,018 $ 3,191 1.04 $ .90 $ .57 1.04 .32 15.44 .90 .29 15.03 .57 .24 14.64 Weighted average number of shares 5,548,300 5,550,477 5,556,251 5,563,015 5,603,834 Selected Ratios Return on average assets Return on average equity Primary capital to average assets Risk-based capital ratios: Tier 1 Total 1.41% 13.75% 11.91% 19.87% 21.12% .82% 6.79% 13.67% 20.26% 21.51% 1.00% 6.84% 15.87% 23.04% 24.29% .88% 6.07% 15.79% 23.56% 24.81% .56% 3.94% 15.39% 22.91% 24.16% 33 S U M M A R Y O F Q U A R T E R L Y R E S U L T S O F O P E R A T I O N S ( I N T H O U S A N D S E X C E P T P E R S H A R E D A T A ) Peoples Financial Corporation and Subsidiaries Quarter Ended, 2006 Interest income Net interest income Provision for loan losses Income before income taxes Net income Basic and diluted earnings per share Quarter Ended, 2005 Interest income Net interest income Provision for loan losses Income before income taxes Net income Basic and diluted earnings per share Market Information March 31 $ 10,505 June 30 September 30 December 31 $ 11,489 $ 13,151 $ 13,749 7,507 35 3,823 2,533 .46 7,505 42 3,976 2,556 .46 7,607 48 4,115 2,685 .48 7,490 16 7,313 4,994 .90 March 31 $ 6,728 June 30 September 30 December 31 $ 8,220 $ 7,985 $ 9,410 5,252 (679) 2,705 2,392 .43 6,468 (834) 3,964 2,727 .49 5,902 5,103 (2,675) (1,767) (.32) 7,171 24 3,954 2,530 .46 The Company's stock is traded under the symbol PFBX and is quoted in publications under "PplFnMS". The following table sets forth the high and low sale prices of the Company's common stock as reported on the NASDAQ Capital Market Exchange: Year 2006 2005 Quarter High Low Dividend per share 1st 2nd 3rd 4th 1st 2nd 3rd 4th $ 19.19 $ 16.85 $ .20 22.27 26.35 27.94 $ 19.49 $ 19.00 19.00 18.50 18.75 23.00 25.50 17.50 17.30 17.39 16.51 .21 $ .18 .20 There were 593 holders of record of common stock of the Company at paid to the Company by its bank subsidiary. Although Management January 31, 2007, and 5,548,199 shares issued and outstanding. The cannot predict what dividends, if any, will be paid in the future, principal source of funds to the Company for payment of dividends is the the Company has paid regular semiannual cash dividends since its earnings of the bank subsidiary. The Commissioner of Banking and founding in 1985. Consumer Finance of the State of Mississippi must approve all dividends 34 B R A N C H L O C A T I O N S The Peoples Bank, Biloxi, Mississippi Handsboro 412 E. Pass Road, Gulfport, Mississippi 39507 Main Office 152 Lameuse Street, Biloxi, Mississippi 39530 (228) 897-8717 Long Beach (228) 435-5511 Asset Management & Trust Services 758 Vieux Marché, Biloxi, MS 39530 (228) 435-8208 Bay St. Louis 298 Jeff Davis Avenue, Long Beach, Mississippi 39560 (228) 897-8712 Ocean Springs 2015 Bienville Boulevard, Ocean Springs, Mississippi 39564 (228) 435-8204 408 Highway 90 East, Bay St. Louis, Mississippi 39520 Orange Grove (228) 897-8710 Cedar Lake 1740 Popps Ferry Road, Biloxi, Mississippi 39532 (228) 435-8688 Diamondhead 12020 Highway 49 North, Gulfport, Mississippi 39503 (228) 897-8718 Pass Christian 129 Fleitas Avenue, Pass Christian, Mississippi 39571 (228) 897-8719 4408 West Aloha Drive, Diamondhead, Mississippi 39525 Saucier (228) 897-8714 D’Iberville-St. Martin 17689 Second Street, Saucier, Mississippi 39574 (228) 897-8716 10491 Lemoyne Boulevard, D’Iberville, Mississippi 39540 Waveland (228) 435-8202 Downtown Gulfport 1105 30th Avenue, Gulfport, Mississippi 39501 (228) 897-8715 Gautier 470 Highway 90, Waveland, Mississippi 39576 (228) 467-7257 West Biloxi 2560 Pass Road, Biloxi, Mississippi 39531 (228) 435-8203 2609 Highway 90, Gautier, Mississippi 39553 Wiggins (228) 435-8694 1312 S. Magnolia Drive, Wiggins, Mississippi 39577 (601) 928-1761 or (228) 897-8722 35 37 C O R P O R A T E I N F O R M A T I O N Peoples Financial Corporation and Subsidiaries Shareholder Information Corporate Office Mailing Address P. O. Box 529 Biloxi, MS 39533-0529 Physical Address 152 Lameuse Street Biloxi, MS 39530 (228) 435-8205 Website www.thepeoples.com For complete information concerning the common stock of Peoples Financial Corporation, including dividend reinvestment, or general information about the Company, direct inquiries to transfer agent/investor relations: Asset Management & Trust Services Department The Peoples Bank, Biloxi, Mississippi P. O. Box 1416, Biloxi, Mississippi 39533-1416 (228) 435-8208, e-mail: investorrelations@thepeoples.com Independent Auditors Porter Keadle Moore, LLP Atlanta, Georgia Corporate Stock S.E.C. Form 10-K Requests The common stock of Peoples Financial Corporation is traded A copy of the Annual Report on Form 10-K, as filed with the on the NASDAQ Capital Market under the symbol: PFBX. Securities and Exchange Commission, may be obtained without The current market makers are: charge by directing a written request to: FIG Partners FTN Midwest Research Secs. Knight Equity Markets, L.P. Morgan Keegan & Company, Inc. Sterne, Agee & Leach, Inc. Stifel Nicolaus & Co. Lauri A. Wood, Chief Financial Officer and Controller Peoples Financial Corporation P. O. Drawer 529, Biloxi, Mississippi 39533-0529 (228) 435-8412, e-mail: lwood@thepeoples.com 36 B O A R D O F D I R E C T O R S B O A R D O F D I R E C T O R S Peoples Financial Corporation B O A R D O F D I R E C T O R S The Peoples Bank, Biloxi, Mississippi Chevis C. Swetman, Chairman of the Board Chevis C. Swetman, Chairman of the Board Dan Magruder, Vice-Chairman; President, Rex Distributing Co., Inc. Tyrone J. Gollott, Vice-Chairman; President, G & W Enterprises, Inc. Drew Allen, President, Allen Beverages, Inc. Drew Allen, President, Allen Beverages, Inc. Rex E. Kelly, Business Executive (retired) Liz Corso Joachim, President, Frank P. Corso, Inc. Lyle M. Page, Partner, Page, Mannino, Peresich & McDermott, PLLC Rex E. Kelly, Business Executive (Retired) O F F I C E R S Peoples Financial Corporation Chevis C. Swetman, President and CEO A. Wes Fulmer, Executive Vice-President Thomas J. Sliman, First Vice-President Dan Magruder, President, Rex Distributing Co., Inc. Jeffrey H. O’Keefe, President, Bradford-O’Keefe Funeral Homes, Inc. Lyle M. Page, Partner, Page, Mannino, Peresich & McDermott, PLLC S E N I O R M A N A G E M E N T The Peoples Bank, Biloxi, Mississippi Jeannette E. Romero, Second Vice-President Chevis C. Swetman, President and CEO Robert M. Tucei, Vice-President A. Wes Fulmer, Executive Vice-President Lauri A. Wood, Chief Financial Officer and Controller Thomas J. Sliman, Senior Vice-President Ann F. Guice, Vice-President and Secretary Jeannette E. Romero, Senior Vice-President Robert M. Tucei, Senior Vice-President Lauri A. Wood, Senior Vice-President and Cashier Ann F. Guice, Senior Vice-President PEOPLES FINANCIAL CORPORATION THE PEOPLES BANK, BILOXI, MISSISSIPPI BACK ROW FROM LEFT: Jeffrey H. O’Keefe, President, Bradford-O’Keefe Funeral Homes, Inc.; Tyrone J. Gollott, Vice-Chairman; President, G & W Enterprises, Inc.; Lyle M. Page*, Partner, Page, Mannino, Peresich & McDermott, PLLC. FRONT ROW FROM LEFT: Rex E. Kelly*, Business Executive (retired); Drew Allen*, President, Allen Beverages, Inc.; Chevis C. Swetman*, Chairman of the Board; Dan Magruder*, Vice-Chairman of Peoples Financial Corporation; President, Rex Distributing Co., Inc.; Liz Corso Joachim, President, Frank P. Corso, Inc. *Member of both boards 37 P E O P L E S F I N A N C I A L C O R P O R A T I O N 

Continue reading text version or see original annual report in PDF format above