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 2 0 0 8 A N N U A L R E P O R T T H I S P A G E L E F T B L A N K I N T E N T I O N A L L Y MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Peoples Financial Corporation (the “Company”) is a one-bank holding company headquartered in Biloxi, MS. The following presents Management’s discussion and analysis of the consolidated financial condition and results of operations of the Company and its consolidated subsidiaries for the years ended December 31, 2008, 2007 and 2006. These comments highlight the significant 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. FF OO RR WW AA RR DD -- LL OO OO KK II NN GG II NN FF OO RR MM AA TT II OO NN Congress passed the Private Securities Litigation Act of 1995 in an effort to encourage corporations to provide information about a company’s anticipated 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. Such factors and uncertainties include, but are not limited to: changes in interest rates and market prices, changes in local economic and business conditions, increased competition for deposits and loans, a deviation in actual experience from the underlying assumptions used to determine and establish the allowance for loan losses, changes in the availability of funds resulting from reduced liquidity, changes in government regulations and acts of terrorism, weather or other events beyond the Company’s control. CC RR II TT II CC AA LL AA CC CC OO UU NN TT II NN GG PP OO LL II CC II EE SS 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 resulting from the inability of its borrowers to make loan payments. If there was a deterioration of any of the factors considered by Management in evaluating the allowance for loan losses, the estimate of loss would be updated, and additional provisions for loan losses may be required. OO VV EE RR VV II EE WW The Company is a community bank serving the financial and trust needs of its customers in Harrison, Hancock, Jackson and Stone Counties in Mississippi. Maintaining a strong core deposit base and commercial and real estate lending in that trade area are the traditional focus of the Company. Growth has largely been achieved through de novo activity, and it is expected that these principles will continue to be emphasized. With the focus of our core business being on the Mississippi Gulf Coast, the local economy impacts the Company’s business. Additionally, the Company is impacted by national economic trends, as the actions taken by the Federal Reserve touch all financial institutions. The interest rate reductions, decline in value of real estate and general economic downturn have affected the Company’s results in 2008. Managing the net interest margin in the Company’s highly competitive market and in context of the larger national economic conditions has been very challenging and will continue to be so for the foreseeable future. Total assets decreased to $896,407,501 at December 31, 2008 from $927,356,573 at December 31, 2007. This decrease was primarily attributable to the net decrease in available for sale securities of $45,566,853 during 2008. Investment securities with a par value of more than $184,000,000 were called during the year, with proceeds from these calls funding loan demand and liquidity needs. Any excess funds were primarily reinvested in U.S. Agency securities. During 2008, non-performing loans, particularly non-accrual loans, increased significantly. This increase was primarily the result of the deterioration in the performance of a small number of residential development loans. A provision for loans losses of $1,549,000, net of taxes, was recorded in 2008, largely as a result of these loans. During 2007, the Company recorded a negative provision of $679,000, net of taxes, as it effectively reversed a portion of the reserve established after Hurricane Katrina. Net income for 2008 was $5,033,690 as compared with $11,026,129 for 2007. In addition to the impact of the provision for loan losses during 2008, the Company realized a loss of $1,956,000, net of taxes, from the other-than-temporary impairment of the Company’s investment in Federal Home Loan Mortgage Corporation (“FHLMC”) preferred stock. Earnings for 2007 were impacted by the negative provision for loan losses. 1 RR EE SS UU LL TT SS OO FF OO PP EE RR AA TT II OO NN SS NNeett IInntteerreesstt IInnccoommee Net interest income, the amount by which interest income on loans, investments 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. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities combined with changes in market rates of interest directly affect net interest income. The Federal Open Market Committee (the “Committee”), a component of the Federal Reserve System, is charged under United States law with overseeing the nation’s open market operations by making key decisions about interest rates and the growth of the United States money supply. In managing the current conditions in 2006, the Committee increased the discount rate by a total of 100 basis points by June 30 of that year and did not adjust rates again until September of 2007, when the decision was made to begin decreasing interest rates. During 2008, the Committee dropped the discount rate by a total of 400 basis points. The Committee’s actions were a part of the U.S. Government’s larger plan to stabilize the financial markets and stimulate the national economy and flow of capital. The impact of these rate fluctuations was significant to the Company’s financial condition and results of operations as changes in the discount rate typically result in corresponding changes in the prime rate. 2008 as compared with 2007 The Company’s average interest-earning assets decreased approximately $68,296,000, or 8%, from approximately $873,138,000 for 2007 to approximately $804,842,000 for 2008. As a direct result of the Committee’s rate reductions, available for sale securities with a par value of $184,000,000 were called during 2008. Also as a result of the Committee’s actions, the average yield on earning assets decreased 98 basis points, from 6.46% for 2007 to 5.48% for 2008. The Company’s loan portfolio generally has a 40%/60% blend of fixed/floating rate term. This results in the Company being more asset sensitive to market interest rates and generally is the cause of the decrease in interest income. In addition, the proceeds from the called securities that were reinvested in similar securities were at lower interest rates. Average interest-bearing liabilities decreased approximately $51,179,000, or 7%, from approximately $715,917,000 for 2007 to approximately $664,738,000 for 2008. The average rate paid on interest-bearing liabilities decreased 131 basis points, from 3.56% for 2007 to 2.25% for 2008. The Company’s trade area generally experiences a very competitive interest rate environment for deposits. During the last two quarters of 2007 and continuing into 2008, this competition ramped up significantly. In some cases, the Company chose to not match higher rates offered to our customers by competitors. This strategy has resulted in a favorable improvement in the yield on interest-bearing liabilities as well as an overall reduction in total deposits. The Company’s net interest margin on a tax-equivalent basis, which is net interest income as a percentage of average earning assets, was 3.62% at December 31, 2008, up 7 basis points from 3.55% at December 31, 2007. 2007 as compared with 2006 The Company’s average interest-earning assets increased approximately $53,935,000, or 7%, from approximately $819,203,000 for 2006 to approximately $873,138,000 for 2007. The large increase in funds from deposit and funds management account growth during 2005 and 2006 funded the overall increase in total assets. More specifically, these funds were invested in loans and U.S. Agency securities. The average yield on earning assets increased 44 basis points, from 6.02% for 2006 to 6.46% for 2007. The Company’s sensitivity to market interest rates caused the increase in interest income. Average interest-bearing liabilities increased approximately $70,846,000, or 11%, from approximately $645,071,000 for 2006 to approximately $715,917,000 for 2007. The average rate paid on interest-bearing liabilities increased 65 basis points, from 2.91% for 2006 to 3.56% for 2007. The Company’s net interest margin on a tax-equivalent basis, which is net interest income as a percentage of average earning assets, was 3.55% at December 31, 2007, down 18 basis points from 3.73% at December 31, 2006. The tables on the following pages analyze the changes in tax-equivalent net interest income for the years ended December 31, 2008 and 2007 and the years ended December 31, 2007 and 2006. 2 A N A L Y S I S O F A V E R A G E B A L A N C E S , I N T E R E S T E A R N E D / P A I D A N D Y I E L D ( I N T H O U S A N D S ) Loans (2) (3) Federal Funds Sold Held to maturity: Taxable Non taxable (1) Available for sale: Taxable Non taxable (1) Other Total Savings and demand, interest bearing Time deposits Federal funds purchased and securities sold under agreements to repurchase Borrowings from FHLB Total Net tax-equivalent yield on earning assets Loans (2) (3) Federal Funds Sold Held to maturity: Taxable Non taxable (1) Available for sale: Taxable Non taxable (1) Other Total Savings and demand, interest bearing Time deposits Federal funds purchased and securities sold under agreements to repurchase Borrowings from FHLB Total Net tax-equivalent yield on earning assets 2008 2007 Average Balance 463,505 $ 5,694 Interest Earned/Paid Rate 5.80 $ 26,874 2.14 122 Average Balance $ 428,447 5,763 Interest Earned/Paid $ 33,642 295 3,691 304,536 24,394 3,022 804,842 251,792 191,904 $ $ 230 15,331 1,433 148 $ 44,138 $ 3,856 6,094 210,049 10,993 $ 664,738 4,521 492 $ 14,963 6.23 5.03 5.87 4.90 5.48 1.53 3.18 2.15 4.48 2.25 3.62 21,443 4,780 388,577 18,864 5,264 $ 873,138 $ 268,710 213,167 1,082 302 19,822 1,109 199 $ 56,451 $ 5,358 9,356 225,246 8,794 $ 715,917 10,212 526 $ 25,452 2007 2006 $ Average Balance 428,447 5,763 Interest Earned/Paid Rate 7.85 $ 33,642 5.12 295 Average Balance 377,172 $ 15,440 Interest Earned/Paid $ 28,735 778 21,443 4,780 388,577 18,864 5,264 873,138 268,710 213,167 $ $ 1,082 302 19,822 1,109 199 $ 56,451 $ 5,358 9,356 225,246 8,794 715,917 $ 10,212 526 $ 25,452 5.05 6.32 5.10 5.88 3.78 6.46 1.99 4.39 4.53 5.98 3.56 3.55 137,707 5,791 262,940 15,213 4,940 $ 819,203 $ 303,239 154,956 6,449 401 11,886 897 189 49,335 $ $ 5,408 5,977 178,663 8,213 $ 645,071 6,916 484 $ 18,785 (1) All interest earned is reported on a taxable equivalent basis using a tax rate of 34% in 2008 and 35% in 2007 and 2006. (2) Loan fees of $786, $854 and $592 for 2008, 2007 and 2006, respectively, are included in these figures. (3) Includes nonaccrual loans. Rate 7.85 5.12 5.05 6.32 5.10 5.88 3.78 6.46 1.99 4.39 4.53 5.98 3.56 3.55 Rate 7.62 5.04 4.68 6.92 4.52 5.90 3.83 6.02 1.78 3.86 3.87 5.89 2.91 3.73 3 PPrroovviissiioonn ffoorr LLooaann LLoosssseess In the normal course of business, the Company assumes risk in extending credit to its customers. This credit risk is managed through compliance with the loan policy (the “policy”), which is approved by the Board of Directors. The policy establishes guidelines relating to underwriting standards, including but not limited to financial analysis, collateral valuation, lending limits, pricing considerations and loan grading. A loan review process further assists with evaluating credit quality and assessing potential performance issues. Loan delinquencies and deposit overdrafts are closely monitored in order to identify developing problems as early as possible. In addition, the Company continuously monitors its relationships with its loan customers in concentrated industries such as gaming and hotel/motel, as well as the exposure for out of area loans and commercial real estate concentrations, and their direct and indirect impact on its operations. A watch list of credits which pose a potential loss to the Company is prepared based on the loan grading system. This list forms the foundation of the Company’s allowance for loan loss computation. Hurricane Katrina hit the Mississippi Gulf Coast on August 29, 2005, potentially impacting the continued performance of loans within the Company’s trade area. Based on an evaluation using existing methodology conducted after the storm, the Company recorded a provision for loan losses of $5,055,000 during the third quarter of 2005. The Company continued to closely monitor its portfolio during the quarters that followed, considering the impact of federal assistance, insurance availability and affordability, the pace of recovery, increasing construction costs and the length of time which has passed since August of 2005. Based on these factors and its ongoing analysis, the Company recorded a negative provision of $1,250,000 during the third quarter of 2007, effectively reversing approximately 25% of the provision recorded in 2005. The credit crisis our nation is now facing has affected the Company’s loan portfolio. Management relies on its guidelines and existing methodology to monitor the performance of its loan portfolio and identify potential losses. During 2008, this on-going, systematic evaluation identified potential losses and resulted in the Company recording a provision of $2,347,000, of which $1,180,000 relates to two residential development loans with a total outstanding balance of $10,542,809. The allowance for loan losses is an estimate, and as such, events may occur in the future which may affect its accuracy. The Company anticipates that it is possible that additional information will be gathered in future quarters which may require an adjustment to the allowance for loan losses. Management will continue to closely monitor its portfolio and take such action as it deems appropriate to accurately report its financial condition and results of operations. NNoonn--iinntteerreesstt iinnccoommee Total non-interest income decreased $2,499,043 in 2008 as compared with 2007. During 2008, the Company recorded a charge to earnings for the other-than-temporary impairment of its investment in FHLMC preferred stock of $2,964,000. During 2008, a gain of $397,852 from sales, calls and liquidation of available for sale securities was recorded as compared with a loss of $605,813 from such activity in 2007. Also during 2008, the Company recorded a loss of $270,676 from its investment in a low income housing partnership. Total non-interest income decreased $2,541,197 for 2007 as compared with 2006. During 2006, a gain of $3,792,942 was realized as a result of the settlement of the Company’s insurance claims arising from the significant damage to six of the bank subsidiary’s branch locations during Hurricane Katrina in 2005. During 2007, an increase in service charges on deposit accounts was attributable to an increase in the number of ATMs, an increase in the number of ATM transactions, an increase in per transaction ATM surcharge fees and the increase in per transaction NSF fees. NNoonn--iinntteerreesstt eexxppeennssee Total non-interest expense increased $1,257,896 for 2008 as compared with 2007. Equipment rentals, depreciation and maintenance expense increased by $645,221 in 2008, primarily as a result of depreciation expense on banking premises which were placed into service after March 31, 2007. Other expense increased $601,086 during 2008 primarily as a result of an increase in accounting and legal fees of $537,645. These increases were the result of the outsourcing of the I/T internal audit function, an increase in external audit fees and legal fees associated with litigation and other matters in the ordinary course of the Company’s business. Total non-interest expense increased $2,212,806 for 2007 as compared with 2006. Expenses associated with salaries and employee benefits increased $1,251,424 as the Company increased salaries and incentives to its employees in order to reward performance and retain personnel. Additionally, a reduction in the discount rate used in computing the liability for deferred compensation plans provided to certain officers and directors resulted in an increase in the accrual for such liabilities in 2007. During 2007, increased expenses of $748,000 related to the costs associated with ATM activity. FF II NN AA NN CC II AA LL CC OO NN DD II TT II OO NN Available for sale securities decreased $45,566,853 at December 31, 2008, compared with December 31, 2007. The Federal Reserve reduced interest rates by 400 basis points during 2008, which resulted in more than $184,000,000 of the Company’s U.S. Agency securities being called during the year. Proceeds from these calls have provided funding for lending and liquidity requirements, and excess funds have been invested in U.S. Agency securities. The Company’s held to maturity portfolio was invested solely in debt securities issued by state and political subdivisions at December 31, 2008 and December 31, 2007. The decrease in these securities of $1,235,780 since December 31, 2007 is the result of maturities. During 2008, the Company invested $3,160,000 as the limited partner in an investment in low-income housing in its trade area. Gross loans increased $16,384,965 at December 31, 2008 as compared with December 31, 2007. The Company’s real estate portfolio increased $50 million during 2008. Approximately 40%, or $20 million of this increase, was in improved property which is commercial owner-occupied and/or income producing real estate. The commercial and industrial loan portfolio decreased $33 million as several large loans paid off during the third quarter of 2008. Interest-earning assets, particularly available for sale securities, have decreased since January 1, 2008 along with a decrease in interest rates earned on these assets. These trends directly impact accrued interest receivable, which decreased $1,926,449 during 2008. Total deposits decreased $58,654,943 at December 31, 2008, as compared with December 31, 2007. Fluctuations among the different types of deposits represent recurring activity for the Company. Since December 31, 2007, however, time deposits of $100,000 or more have decreased by $61,538,361. This significant decrease primarily resulted from the Company’s decision to not match higher rates offered to our customers by competitors. The Company anticipates that deposits will continue at or near their present level during 2009. 4 Borrowings from the Federal Home Loan Bank increased $29,837,381 at December 31, 2008 as compared with December 31, 2007. During the fourth quarter of 2008, the Company increased its borrowing lines with the Federal Home Loan Bank in order to expand its liquidity options. SS HH AA RR EE HH OO LL DD EE RR SS ’’ EE QQ UU II TT YY AA NN DD CC AA PP II TT AA LL AA DD EE QQ UU AA CC YY 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 prosperity of the Company and the security of its customers and shareholders. The primary and risk-based capital ratios are important indicators of the strength of a Company’s capital. These figures are presented in the Five-Year Comparative Summary of Selected Financial Information. The measure of capital adequacy which is currently used by Management to evaluate the strength of the Company’s capital is the primary capital ratio which was 12.81% at December 31, 2008, which is well above the regulatory minimum of 6.00%. Management continues to emphasize the importance of maintaining the appropriate capital levels of the Company and has established the 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. During 2008, significant transactions affecting shareholders’ equity are described in Note J. The Statement of Shareholders’ Equity also presents all activity in the Company’s equity accounts. LL II QQ UU II DD II TT YY 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 L 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 funding requirements in such a manner as to satisfy these demands and to provide the maximum return on its earning assets. The Company monitors its liquidity position diligently through a number of methods, including through 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 monitors its liquidity needs, particularly relating to potentially volatile deposits, 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 sources of funds, including borrowings from the Federal Home Loan Bank. The Company generally anticipates relying on deposits, purchases of federal funds and advances from the Federal Home Loan Bank for its liquidity needs in 2009. Proceeds from the large number of calls of investment securities since January 1, 2008 are also currently being used for liquidity needs. The Company has applied for eligibility to participate through the Federal Reserve’s Discount Window. OO FF FF -- BB AA LL AA NN CC EE SS HH EE EE TT AA RR RR AA NN GG EE MM EE NN TT SS The Company is a party to off-balance-sheet arrangements in the normal course of business to meet the financing needs of its customers. 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 monitors its liquidity needs and considers its 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. EE MM EE RR GG EE NN CC YY EE CC OO NN OO MM II CC SS TT AA BB II LL II ZZ AA TT II OO NN AA CC TT The Emergency Economic Stabilization Act of 2008 (the “Act”) was enacted on October 3, 2008. The purpose of this law is to restore liquidity and stability to the financial system, while minimizing any potential long term negative impact on taxpayers. The law authorizes the United States Secretary of the Treasury to spend up to $700 billion to purchase distressed assets, especially mortgage-backed securities, from the nation’s banks. The program under which the asset purchase will be administered is referred to as the Troubled Asset Relief Program (“TARP”). The Company did not participate in TARP. The Act also temporarily raises the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. The higher insurance limits took effect immediately and will be in effect through December 31, 2009. Additionally, the Federal Deposit Insurance Corporation (“FDIC”) announced on October 14, 2008, a new program, the Temporary Liquidity Guarantee Program (“TLGP”), which guarantees newly issued senior unsecured debt of banks, thrifts, and certain holding companies, and provides full coverage of non-interest bearing deposit transaction accounts, regardless of dollar amount. The program provides a three year guarantee of newly issued debt and increased insurance coverage through December 31, 2009. This two-pronged program will be funded through special fees paid by the participating financial institutions. The Company is participating in both programs available under TLGP. The Company did not have outstanding senior unsecured debt at December 31, 2008. Participation in the TLGP requires the payment of additional assessments to the FDIC. The quarterly assessment rate paid by the Company’s bank subsidiary will increase in 2009 as a result of the FDIC’s normal funding requirements. This increase, along with the additional assessment required by the TLGP, will not be material to the Company’s results of operations. 5 QQ UU AA NN TT II TT AA TT II VV EE AA NN DD QQ UU AA LL II TT AA TT II VV EE DD II SS CC LL OO SS UU RR EE AA BB OO UU TT MM AA RR KK EE TT RR II SS KK 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-balance sheet instruments to manage interest rate risk. The Company has risk management policies in place to monitor and limit exposure to market risk. The Asset/Liability Committee (“ALCO Committee”), whose members include the chief executive officer and senior and middle management from the financial, lending, investing, and deposit areas, is responsible for the day-to-day operating guidelines, approval of strategies 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/liability 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 to seven years or less with call provisions. The loan portfolio consists of a 40% /60% blend of fixed and floating rate loans. It is the general loan policy to offer loans with maturities of five years or less; however the market is now dictating floating rate terms to be extended to fifteen years. On the liability side, more than 68% of the deposits are demand and savings transaction accounts. Additionally, more than 80% 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 on the next page provide additional information about the Company’s financial instruments that are sensitive to changes in interest rates. The negative gap in 2009 is mitigated by the nature of the Company’s deposits, whose characteristics have been previously described. The tabular disclosure reflects contractual interest rate repricing dates and contractual maturity dates. Loan maturities have been adjusted for 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. 6 Interest rate sensitivity at December 31, 2008 was as follows (in thousands): 2 0 0 9 2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 B E Y O N D 1 2 / 3 1 / 0 8 F A I R V A L U E T O T A L $ 293,576 $ 33,159 $ 46,649 $ 37,308 $ 28,744 $ 16,827 $ 456,263 $ 461,113 Loans, net Average rate Securities Average rate Total Financial Assets Average rate Interest Bearing Deposits Average rate Federal funds purchased and securities sold under agreements to repurchase 226,609 Average rate Long-term funds Average rate Total Financial Liabilities Average rate 1.25% 30,178 0.80% 632,085 1.62% 6.27% 45,286 2.67% 78,445 4.95% 20,276 3.43% 5,177 6.46% 25,453 4.41% 6.03% 35,065 4.08% 81,714 5.37% 3,290 3.69% 177 4.86% 3,467 3.77% 6.21% 24,812 4.40% 62,120 5.63% 1,455 3.83% 177 4.86% 1,632 3.97% 6.92% 30,053 3.83% 58,797 5.79% 1,116 3.15% 177 4.86% 1,293 3.50% 5.17% 168,883 5.40% 185,710 5.38% 7 2.82% 1,052 4.86% 1,059 4.85% 5.80% 349,816 4.42% 806,079 5.29% 401,442 2.01% 349,860 810,973 402,361 226,609 226,609 1.25% 36,938 4.18% 664,989 2.11% 37,547 666,517 Interest rate sensitivity at December 31, 2007 was as follows (in thousands): 2 0 0 8 2 0 0 9 2 0 1 0 2 0 1 1 2 0 1 2 B E Y O N D 1 2 / 3 1 / 0 7 F A I R V A L U E T O T A L $ 288,348 $ 62,692 $ 20,709 $ 30,331 $ 32,107 $ 7,427 $ 441,614 $ 439,694 4.23% 45,717 3.44% 339,293 4.14% 375,298 1.80% 7.51% 62,995 4.56% 351,343 7.17% 434,515 3.33% Loans, net Average rate Securities Average rate Total Financial Assets Average rate Interest Bearing Deposits Average rate Federal funds purchased and securities sold under agreements to repurchase 231,225 Average rate Long-term funds Average rate Total Financial Liabilities Average rate 4.53% 172 4.86% 665,912 3.83% 6.27% 43,846 4.61% 106,538 5.71% 14,133 3.83% 178 4.86% 14,311 3.84% 6.77% 61,615 4.35% 82,324 5.18% 3,556 4.04% 7.17% 38,267 5.08% 68,598 6.18% 1,806 4.37% 7.88% 42,245 5.01% 74,352 6.57% 1,204 4.37% 5,177 6.50% 8,733 5.75% 177 4.86% 1,983 4.42% 177 4.86% 1,381 4.44% 7.07% 143,627 5.63% 151,054 5.72% \ 1,219 4.86% 1,219 4.85% 7.85% 392,595 5.07% 834,209 6.84% 455,214 3.36% 231,225 4.53% 7,100 5.98% 693,539 3.87% 392,641 832,335 456,490 231,225 7,811 695,526 7 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 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 $3,438,108 - 2008; $4,676,471 - 2007; $85,518,999 - 2006 Other investments Federal Home Loan Bank Stock, at cost Loans Less: Allowance for loan losses Loans, net Bank premises and equipment, net of accumulated depreciation Accrued interest receivable Cash surrender value of life insurance 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 Other liabilities Total liabilities Shareholders' Equity: Common Stock, $1 par value, 15,000,000 shares authorized, 5,279,268, 5,420,204 and 5,548,199 shares issued and outstanding at December 31, 2008, 2007 and 2006, respectively Surplus Undivided profits Accumulated other comprehensive income, net of tax Total shareholders' equity 2 0 0 8 2 0 0 7 2 0 0 6 $ 34,015,590 $ 34,665,370 $ 37,793,493 4,000 340,462,072 270,000 386,028,925 6,400,000 396,907,489 3,394,212 3,889,324 2,070,700 467,377,039 11,113,575 456,263,464 33,600,170 5,444,767 14,688,160 2,575,042 4,629,992 1,000,000 936,200 450,992,074 9,378,137 441,613,937 34,410,789 7,371,216 13,578,536 2,851,608 85,574,260 300,000 1,128,500 401,194,010 10,841,367 390,352,643 19,658,585 8,142,230 12,984,602 4,781,266 $ 896,407,501 $ 927,356,573 $ 964,023,068 $ 109,033,184 $ 113,916,041 $ 148,455,754 239,990,238 104,540,112 56,912,002 510,475,536 226,609,231 36,937,686 15,384,934 789,407,387 5,279,268 65,780,254 33,412,596 2,527,996 107,000,114 231,435,685 166,078,473 57,700,280 569,130,479 231,225,118 7,100,305 13,359,047 820,814,949 5,420,204 65,780,254 34,458,291 882,875 106,541,624 271,331,272 132,846,509 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 Total liabilities and shareholders' equity $ 896,407,501 $ 927,356,573 $ 964,023,068 See Notes to Consolidated Financial Statements. 8 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 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 8 2 0 0 7 2 0 0 6 $ 26,874,057 $ 33,642,030 $ 28,735,424 2,972,851 10,625,314 1,733,026 1,097,790 148,328 122,066 43,573,432 9,950,478 492,048 4,520,821 14,963,347 28,610,085 2,347,000 26,263,085 1,637,747 6,793,404 397,852 (2,964,000) (270,676) 142,607 1,531,525 7,268,459 14,051,655 2,220,670 3,749,274 6,499,255 26,520,854 7,010,690 1,977,000 4,320,309 15,519,419 1,064,149 931,292 198,968 294,812 5,725,317 12,610,083 856,450 188,965 777,742 55,970,979 48,893,981 14,713,824 526,369 10,212,201 25,452,394 30,518,585 (1,045,000) 31,563,585 1,791,417 6,709,142 (605,813) 635,271 1,237,485 9,767,502 14,284,532 1,976,204 3,104,053 5,898,169 25,262,958 16,068,129 5,042,000 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 $ 5,033,690 $ .94 $ 11,026,129 $ 2.01 $ 12,767,900 $ 2.30 Interest income: Interest and fees on loans Interest and dividends on securities: U.S. Treasury U.S. Government agencies Mortgage-backed securities States and political subdivisions Other securities 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 Non-interest income: Trust department income and fees Service charges on deposit accounts Gain (loss) on liquidation, sale and calls of securities Writedown of investments to market value Loss on other investments Gain from sale of bank premises Gain from settlement of insurance proceeds Other income Total non-interest income Non-interest expense: Salaries and employee benefits Net occupancy Equipment rentals, depreciation and maintenance Other expense Total non-interest expense Income before income taxes Income taxes Net income Basic and diluted earnings per share See Notes to Consolidated Financial Statements. 9 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 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 5,549,128 C o m m o n S t o c k $ 5,549,128 S u r p l u s $ 65,780,254 A c c u m u l a t e d O t h e r U n d i v i d e d C o m p r e h e n s i v e C o m p r e h e n s i v e I n c o m e $ (2,769,106) I n c o m e T o t a l $ 87,503,131 Balance, January 1, 2006 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 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 Gain from unfunded post-retirement benefit obligation, net of tax Total comprehensive income Cash dividends ($ .25 per share) Dividend declared ($ .27 per share) Retirement of stock Balance, December 31, 2007 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 obligation, net of tax Total comprehensive income Cumulative effect adjustment from adoption of EITF 06-04 Effect of stock retirement on accrued dividends Cash dividends ($ .29 per share) Dividend declared ($ .30 per share) Retirement of stock Balance, December 31, 2008 See Notes to Consolidated Financial Statements. (929) 5,548,199 (929) 5,548,199 65,780,254 (127,995) 5,420,204 (127,995) 5,420,204 65,780,254 (140,936) 5,279,268 (140,936) $ 5,279,268 10 $ 65,780,254 $ 33,412,596 $ 2,527,996 $ 107,000,114 P r o f i t s $ 18,942,855 12,767,900 (1,165,122) (1,276,086) (15,722) 29,253,825 11,026,129 (1,378,945) (1,463,455) (2,979,263) 34,458,291 5,033,690 (56,732) 8,816 (1,548,703) (1,588,465) (2,894,301) 1,158,333 12,017 (750,827) (2,349,583) 2,308,621 399,837 524,000 882,875 745,909 1,693,658 (794,446) $ 12,767,900 1,158,333 12,017 (750,827) $ 13,187,423 $ 11,026,129 2,308,621 399,837 524,000 $ 14,258,587 $ 5,033,690 745,909 1,693,658 (794,446) $ 6,678,811 12,767,900 1,158,333 12,017 (750,827) (1,165,122) (1,276,086) (16,651) 98,232,695 11,026,129 2,308,621 399,837 524,000 (1,378,945) (1,463,455) (3,107,258) 106,541,624 5,033,690 745,909 1,693,658 (794,446) (56,732) 8,816 (1,548,703) (1,588,465) (3,035,237) N u m b e r o f C o m m o n S h a r e s 5,549,128 C o m m o n S t o c k $ 5,549,128 S u r p l u s $ 65,780,254 Balance, January 1, 2006 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 Comprehensive Income: Net income Total comprehensive income Cash dividends ($ .25 per share) Dividend declared ($ .27 per share) Retirement of stock Balance, December 31, 2007 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 Gain from unfunded post-retirement benefit obligation, net of tax 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 obligation, net of tax Total comprehensive income Cumulative effect adjustment from adoption of EITF 06-04 Effect of stock retirement on accrued dividends Cash dividends ($ .29 per share) Dividend declared ($ .30 per share) Retirement of stock Balance, December 31, 2008 See Notes to Consolidated Financial Statements. (929) 5,548,199 (929) 5,548,199 65,780,254 (127,995) 5,420,204 (127,995) 5,420,204 65,780,254 (140,936) 5,279,268 (140,936) $ 5,279,268 U n d i v i d e d P r o f i t s $ 18,942,855 12,767,900 (1,165,122) (1,276,086) (15,722) 29,253,825 11,026,129 (1,378,945) (1,463,455) (2,979,263) 34,458,291 5,033,690 (56,732) 8,816 (1,548,703) (1,588,465) (2,894,301) 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 $ (2,769,106) C o m p r e h e n s i v e I n c o m e T o t a l $ 87,503,131 1,158,333 12,017 (750,827) (2,349,583) 2,308,621 399,837 524,000 882,875 745,909 1,693,658 (794,446) $ 12,767,900 1,158,333 12,017 (750,827) $ 13,187,423 $ 11,026,129 2,308,621 399,837 524,000 $ 14,258,587 $ 5,033,690 745,909 1,693,658 (794,446) $ 6,678,811 12,767,900 1,158,333 12,017 (750,827) (1,165,122) (1,276,086) (16,651) 98,232,695 11,026,129 2,308,621 399,837 524,000 (1,378,945) (1,463,455) (3,107,258) 106,541,624 5,033,690 745,909 1,693,658 (794,446) (56,732) 8,816 (1,548,703) (1,588,465) (3,035,237) $ 65,780,254 $ 33,412,596 $ 2,527,996 $ 107,000,114 11 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 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 Impairment loss on FHLMC preferred stock Loss on other investments Provision for losses on other real estate Gain on sales of other real estate (Gain) loss on sales, calls and liquidation of securities Gain on sale of bank premises Gain on settlement of insurance Change in accrued interest receivable Change in other assets Change in other liabilities Net cash provided by operating activities Cash flows from investing activities: Proceeds from maturities, sales, liquidation and calls of available for sale securities Investment in available for sale securities Proceeds from maturities of held to maturity securities Investment in held to maturity securities Purchases of other investments 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 provided by (used in) investing activities Cash flows from financing activities: Demand and savings deposits, net change Time deposits, net change 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 change Net cash provided by (used in) financing activities Net 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. 12 2 0 0 8 2 0 0 7 2 0 0 6 $ 5,033,690 $ 11,026,129 $ 12,767,900 2,451,966 2,347,000 2,964,000 270,676 (214,210) (397,852) (142,607) 1,926,449 314,965 85,281 14,639,358 257,886,217 (211,168,426) 1,240,000 (4,220) (3,160,000) (1,134,500) 236,261 (17,396,252) 266,812 (1,765,552) (1,083,450) 23,916,890 3,671,696 (62,326,639) (3,003,342) (3,035,237) 111,513,000 (81,675,619) (4,615,887) (39,472,028) (915,780) 34,935,370 1,712,000 (1,045,000) 1,606,000 141,000 (10,470) 605,813 (635,271) 771,014 (1,967,771) (3,167,174) 7,289,270 14,908 (153,400) (159,669) (3,792,942) (3,826,872) 330,657 9,750,102 16,677,684 209,677,761 (195,300,371) 86,460,000 55,190,291 (271,922,910) 265,074,303 (5,515,732) (216,601,604) (700,000) 192,300 55,000 (50,235,794) 1,020,247 (16,849,180) (575,724) 28,228,507 (74,435,300) 30,395,985 (2,655,031) (3,107,258) 47,900,375 (48,067,419) 5,192,748 (44,775,900) (9,258,123) 44,193,493 (300,000) (51,900) 344,000 (52,257,325) 5,400,045 (4,824,112) (493,320) (220,442,532) (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 $ 34,019,590 $ 34,935,370 $ 44,193,493 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T 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 NN OO TT EE AA -- BB UU SS II NN EE SS SS AA NN DD SS UU MM MM AA RR YY OO FF SS II GG NN II FF II CC AA NN TT AA CC CC OO UU NN TT II NN GG PP OO LL II CC II EE SS :: BBuussiinneessss ooff TThhee CCoommppaannyy Peoples Financial Corporation (the “Company”) is a one-bank holding company headquartered in Biloxi, Mississippi. Its two operating subsidiaries are The Peoples Bank, Biloxi, Mississippi (the “Bank”), and PFC Service Corp. Its principal subsidiary is The Peoples Bank, Biloxi, Mississippi, which provides a full range of banking, financial and trust services to state, county and local government entities and individuals and small and commercial businesses operating in Harrison, Hancock, Stone and Jackson counties. PPrriinncciipplleess ooff CCoonnssoolliiddaattiioonn The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. BBaassiiss ooff AAccccoouunnttiinngg The Company and its 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. NNeeww AAccccoouunnttiinngg PPrroonnoouunncceemmeennttss In March 2008, the Financial Accounting Standards Board (“FASB”) issued Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 amends Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), to amend and expand the disclosure requirements of SFAS 133 to provide greater transparency about how and why an entity uses derivative instruments, how derivative instruments and related hedge items are accounted for under SFAS 133 and its related interpretations and how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. To meet those objectives, SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. SFAS 161 is effective for the Company on January 1, 2009 and is not expected to have a significant impact on the Company’s financial statements. In May 2008, FASB issued Statement No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. The hierarchical guidance provided by SFAS 162 did not have a significant impact on the Company’s financial statements. CCaasshh aanndd DDuuee ffrroomm BBaannkkss 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 $696,000, $19,964,000 and $24,539,000 for the years ending December 31, 2008, 2007 and 2006, respectively. The Company’s bank subsidiary maintained account balances in excess of amounts insured by the Federal Deposit Insurance Corporation. At December 31, 2008, the bank subsidiary had excess deposits of $4,983,215. SSeeccuurriittiieess 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 discounts to maturity, determined using the interest method. Such amortization 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 estimating 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, especially 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 sufficient 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 liquidity, sale and calls of securities in non-interest income. OOtthheerr IInnvveessttmmeennttss Other investments include a low income housing partnership in which the Company is a 99% limited partner. The partnership has qualified to receive annual low income housing federal tax credits that are recognized as a reduction of the current tax expense. The investment is accounted for using the equity method. FFeeddeerraall HHoommee LLooaann BBaannkk SSttoocckk Federal Home Loan Bank Stock has no readily determined market value and is carried at cost. Due to the redemption provisions of the investment, the fair value equals cost and no impairment exists. LLooaannss 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 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 13 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 material 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 them to a current status or foreclosure or in the process of collection, those loans deemed uncollectible are charged off against the allowance account. AAlllloowwaannccee ffoorr LLooaann LLoosssseess 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 anticipated 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 underlying collateral, an estimate of the possibility of loss based on the risk characteristics of the portfolio, adverse situations that may affect the borrower’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 general component of the allowance relates to loans that are not classified and is based on historical loss experience. BBaannkk PPrreemmiisseess aanndd EEqquuiippmmeenntt Bank premises and equipment are stated at cost, less accumulated depreciation. Depreciation is computed by the straight-line method based on the estimated useful lives of the related assets. OOtthheerr RReeaall EEssttaattee Other real estate acquired through foreclosure is carried at fair 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 subsequent adjustments are charged to expense. Costs of operating and maintaining the properties, net of related income and gains (losses) on their disposition, are charged to expense as incurred. TTrruusstt DDeeppaarrttmmeenntt IInnccoommee aanndd FFeeeess Corporate trust fees are accounted for on an accrual basis and personal trust fees are recorded when received. IInnccoommee TTaaxxeess The Company files a consolidated tax return with its wholly-owned subsidiaries. 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’ life insurance; depreciation for income tax purposes over (under) that reported for financial statements and gains on the sale of bank premises which were structured under the provisions of Section 1031 of the Internal Revenue Code. LLeeaasseess All leases are accounted for as operating leases in accordance with the terms of the leases. EEaarrnniinnggss PPeerr SShhaarree Basic and diluted earnings per share are computed on the basis of the weighted average number of common shares outstanding, 5,342,470, 5,489,861 and 5,548,300 in 2008, 2007 and 2006, respectively. SSttaatteemmeennttss ooff CCaasshh FFlloowwss The Company has defined cash and cash equivalents to include cash and due from banks and federal funds sold. The Company paid $14,961,180, $24,853,712 and $18,444,672 in 2008, 2007 and 2006, respectively, for interest on deposits and borrowings. Income tax payments totaled $1,635,000, $4,819,000 and $5,310,000 in 2008, 2007 and 2006, respectively. Loans transferred to other real estate amounted to $399,725, $19,500 and $144,000 in 2008, 2007 and 2006, respectively. The income tax effect from the unrealized gain on available for sale securities on accumulated other comprehensive income was $1,277,519, $1,395,266 and $602,907, at December 31, 2008, 2007 and 2006, respectively. The income tax effect from the (gain) loss from unfunded post-retirement benefit obligation on accumulated other comprehensive income was $204,124, $(282,000) and $407,201 at December 31, 2008, 2007 and 2006, respectively. FFaaiirr VVaalluuee MMeeaassuurreemmeenntt The Company adopted Financial Accounting Standards Board Statement No. 157, “Fair Value Measurement” (“SFAS 157”) at January 1, 2008. There was no material impact to the financial statements presented herein as a result of this adoption. SFAS 157 applies to all assets and liabilities that are being measured and reported on a fair value basis. SFAS 157 requires new disclosure that establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States of America, and expands disclosure about fair value measurements. This statement enables the reader of the financial statements to assess the inputs used to develop those measurements by establishing a hierarchy for ranking the quality and reliability of the information used to determine fair values. The statement requires that assets and liabilities carried at fair value will be classified and dis- closed in one of the following three categories: Level 1 – Quoted market prices in active markets for identical assets or liabilities, Level 2 – Observable mar- ket based inputs or unobservable inputs that are corroborated by market data, or Level 3 – Unobservable inputs that are not corroborated by market data. In determining the appropriate levels, a detailed analysis of the assets and liabilities that are subject to SFAS 157 is performed. 14 RReeccllaassssiiffiiccaattiioonnss 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. NN OO TT EE BB -- SS EE CC UU RR II TT II EE SS :: The amortized cost and estimated fair value of securities at December 31, 2008, 2007 and 2006, respectively, are as follows (in thousands): December 31, 2008 Available for sale securities: Debt securities: U.S. Treasury U.S. Government agencies Mortgage-backed securities States and political subdivisions Total debt securities Equity securities Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value $ 64,963 $ 208,918 28,993 31,594 334,468 650 1,746 3,552 788 317 6,403 $ – (74) (985) (1,059) $ 66,709 212,396 29,781 30,926 339,812 650 Total available for sale securities $ 335,118 $ 6,403 $ (1,059) $ 340,462 $ $ 3,394 3,394 $ 52 $ 52 $ (8) $ (8) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses $ 3,438 $ 3,438 Estimated Fair Value $ – $ 73,306 $ 71,952 $ 252,130 33,343 22,698 380,123 4,229 1,354 1,729 48 152 3,283 62 $ $ 4,630 4,630 $ 53 $ 53 (60) (7) (367) (434) (1,234) $ (1,668) $ (7) $ (7) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses 253,799 33,384 22,483 382,972 3,057 $ 386,029 $ 4,676 $ 4,676 Estimated Fair Value Total available for sale securities $ 384,352 $ 3,345 Held to maturity securities: States and political subdivisions Total held to maturity securities December 31, 2007 Available for sale securities: Debt securities: U.S. Treasury U.S. Government agencies Mortgage-backed securities States and political subdivisions Total debt securities Equity securities Held to maturity securities: States and political subdivisions Total held to maturity securities December 31, 2006 Available for sale securities: Debt securities: U.S. Treasury U.S. Government agencies States and political subdivisions Total debt securities Equity securities $ 73,937 $ 304,156 17,001 395,094 4,228 81 304 247 632 62 694 - - 62 62 $ (364) $ 73,654 (1,950) (163) (2,477) (632) 302,510 17,085 393,249 3,658 $ (3,109) $ 396,907 $ (70) $ 53,447 (29) (18) 26,941 5,131 $ (117) $ 85,519 Total available for sale securities $ 399,322 Held to maturity securities: U.S. Treasury U.S. Government agencies States and political subdivisions Total held to maturity securities $ 53,517 26,970 5,087 $ 85,574 $ $ $ 15 The Company’s available for sale securities are reported at their estimated fair value, which is determined utilizing several sources. The primary source is Interactive Data Corporation, which utilizes pricing models that vary based by asset class and include available trade, bid and other market information and whose methodology includes broker quotes, proprietary models and vast descriptive databases. The other source for determining fair value is matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. The table below presents the balances of available for sale securities, which are the only assets measured at fair value on a recurring basis, by level within the fair value hierarchy as of December 31, 2008. Available for sale securities December 31, 2008 $340,462,072 Level 1 Fair Value Measurement Using Level 2 Level 3 $340,462,072 In accordance with FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Investments”, available for sale securities with an amortized cost of $335,117,237 were reported at December 31, 2008 at a fair value, net of unrealized gains and losses, of $340,462,072. The net change in unrealized gains and losses of $2,439,567 was included in comprehensive income during 2008. The amortized cost and estimated fair value of debt securities at December 31, 2008, 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 (in thousands): 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 Mortgage-backed securities 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 Totals $ $ 45,115 130,261 41,283 88,816 28,993 334,468 $ $ 195 1,844 1,355 3,394 $ 45,522 133,372 41,632 89,505 29,781 339,812 $ $ 196 1,868 1,374 $ 3,438 Information pertaining to securities with gross unrealized losses at December 31, 2008, 2007 and 2006, respectively, 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 December 31, 2008 U.S. Government Agencies States and political subdivisions Total Fair Value 10,781 $ 16,545 $ 27,326 Gross Unrealized Loss $ 74 740 $ 814 Fair Value 2,826 $ 2,826 2,826 $ Gross Unrealized Loss $ 254 253 $ 253 Fair Value Gross Unrealized Loss $ 74 $ 993 $ 1,067 10,781 19,371 $ 30,152 Less than twelve months Over twelve months Total December 31, 2007 U.S. Government Agencies States and political subdivisions Mortgage-backed securities FHLMC preferred stock Total Fair Value 10,974 $ 5,998 14,201 $ 31,173 Gross Unrealized Loss $ 24 249 7 $ 280 Fair Value $ 17,464 7,047 1,841 $ 26,352 Gross Unrealized Loss $ 36 125 1,234 $ 1,395 Fair Value Gross Unrealized Loss $ 60 $ 28,438 374 13,045 14,201 7 1,234 1,841 $ 1,675 $ 57,525 Less than twelve months Over twelve months Total December 31, 2006 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 $ 332 1,779 166 632 $ 2,909 Fair Value Gross Unrealized Loss $ 434 $ 95,105 1,979 206,580 181 9,986 632 2,443 $ 3,226 $ 314,114 16 At December 31, 2008, 2 of the 48 securities issued by U.S. Government agencies and 61 of the 131 securities issued by state and political subdivisions contained unrealized losses. 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. 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 during 2008, 2007 and 2006 were $1,240,000, $86,460,000 and $265,074,303, respectively. There were no sales of held to maturity debt securities during 2008, 2007 and 2006. Proceeds from maturities, sales and calls of available for sale debt securities were $257,886,217, $209,677,761 and $55,190,291 during 2008, 2007 and 2006, respectively. Available for sale debt securities were sold in 2007 for a realized loss of $605,813. There were no sales of available for sale debt securities during 2008 and 2006. The Company realized a gain of $249,000 from the liquidation of equity securities in 2008. During 2008, the Company recorded a loss of $2,964,000 from the other-than-temporary impairment of its investment in Federal Home Loan Mortgage Corporation Preferred Stock. Securities with an amortized cost of $328,047,697, $342,084,423 and $269,627,563 at December 31, 2008, 2007 and 2006, respectively, were pledged to secure public deposits, federal funds purchased and other balances as required by law. Federal Home Loan Bank (FHLB) common stock was purchased during 1999 and 2008 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. NN OO TT EE CC -- LL OO AA NN SS :: The composition of the loan portfolio was as follows (in thousands): December 31, Real estate, construction Real estate, mortgage Loans to finance agricultural production Commercial and industrial loans Loans to individuals for household, family and other consumer expenditures Obligations of states and political subdivisions All other loans Totals Transactions in the allowance for loan losses were as follows (in thousands): Balance, January 1 Recoveries Loans charged off Provision for allowance for loan losses Balance, December 31 2008 $ 118,455 290,458 3,178 43,312 10,202 1,733 39 $ 467,377 $ 2008 9,378 673 (1,284) 2,347 $ 11,114 2007 $ 93,739 265,465 2,545 76,267 11,173 1,747 56 $ 450,992 2007 10,841 266 (684) (1,045) 9,378 $ $ $ 2006 24,317 300,807 2,502 57,796 13,415 2,094 263 $ 401,194 2006 $ 10,966 463 (729) 141 $ 10,841 As a part of its evaluation of the quality of the loan portfolio, Management 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 2008 2007 2006 $ 79,510 $ 74,595 $ 60,105 35,962 44,458 23,234 31,325 24,907 19,357 $ 159,930 $ 129,154 $ 104,369 In the ordinary course of business, the Company’s subsidiary extends loans to certain officers and directors and their personal business interests at, in the opinion of Management, the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans of similar credit risk with persons not related to the Company or its subsidiaries. These loans do not involve more than normal risk of collectibility and do not include other unfavorable features. 17 An analysis of the activity with respect to such loans to related parties is as follows (in thousands): Years Ended December 31, Balance, January 1 New loans and advances Repayments Balance, December 31 2008 $ 7,318 2,733 (2,258) $ 7,793 2007 $ 8,554 3,548 (4,784) 7,318 $ 2006 $ 8,670 10,248 (10,364) $ 8,554 Loans past due ninety days or more and still accruing were $2,340,190, $1,233,761 and $3,295,423 at December 31, 2008, 2007 and 2006, respectively. Impaired loans include performing and non-performing loans for which full payment of principal or interest is not expected. Performing loans which were classified as impaired loans totaled $11,864,285, $11,655,572 and $12,346,433 at December 31, 2008, 2007 and 2006, respectively. Non-performing loans which were classified as impaired loans included nonaccrual loans which amounted to $15,553,447, $44,612 and $349,335 at December 31, 2008, 2007 and 2006, respectively. The total average recorded investment in impaired loans amounted to $28,189,747, $11,092,658 and $15,877,328 at December 31, 2008, 2007 and 2006, respectively. The Company had $7,345,022, $5,642,719 and $4,389,390 of specific allowance related to impaired loans at December 31, 2008, 2007, and 2006, respectively. Interest income recognized on impaired loans was $833,055, $621,290 and $990,222 for the years ended December 31, 2008, 2007 and 2006, respectively. Interest income recognized on impaired loans if the Company had used the cash-basis method of accounting would have been $686,129, $669,971 and $899,852 for the years ended December 31, 2008, 2007 and 2006, respectively. At each reporting period, the Company determines which loans are impaired. Accordingly, the Company’s impaired loans are reported at their estimated fair value on a non-recurring basis. An allowance for each impaired loan, which are generally collateral-dependent, is calculated based on the fair value of its collateral. The fair value of the collateral is based on appraisals performed by third-party valuation specialists. Factors including the assumptions and techniques utilized by the appraiser are considered by Management. If the recorded investment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses. The table below presents the balances of impaired loans, which are the only assets measured at fair value on a non-recurring basis, by level within the fair value hierarchy as of December 31, 2008. Imparied loans December 31, 2008 $20,072,210 Level 1 Fair Value Measurement Using Level 2 Level 3 $20,072,210 In accordance with the provisions of FASB Statement No. 114, “Accounting by Creditors for Impairment of a Loan”, impaired loans with a carrying amount of $27,417,732 were written down to their fair value of $20,072,210 through a $7,345,022 charge to the provision for loan losses in prior periods. NN OO TT EE DD -- BB AA NN KK PP RR EE MM II SS EE SS AA NN DD EE QQ UU II PP MM EE NN TT :: Bank premises and equipment are shown as follows (in thousands): December 31, Land Buildings Furniture, fixtures and equipment Totals, at cost Less: Accumulated depreciation Totals Estimated Useful Lives 5 – 40 years 3 – 10 years 2008 $ 5,978 30,427 14,982 51,387 17,787 $ 2007 6,102 29,180 15,187 50,469 16,058 2006 $ 5,720 14,731 13,806 34,257 14,598 $ 33,600 $ 34,411 $ 19,659 NN OO TT EE EE -- DD EE PP OO SS II TT SS :: At December 31, 2008, the scheduled maturities of time deposits are as follows (in thousands): 2009 2010 2011 2012 2013 Beyond Total $ 135,308 20,276 3,290 1,455 1,116 7 $ 161,452 Deposits held for related parties amounted to $8,659,875, $8,903,098 and $15,399,924 at December 31, 2008, 2007 and 2006, respectively. NN OO TT EE FF –– FF EE DD EE RR AA LL FF UU NN DD SS PP UU RR CC HH AA SS EE DD AA NN DD SS EE CC UU RR II TT II EE SS SS OO LL DD UU NN DD EE RR AA GG RR EE EE MM EE NN TT SS TT OO RR EE PP UU RR CC HH AA SS EE :: At December 31, 2008, the Company had facilities in place to purchase federal funds up to $66,000,000 under established credit arrangements. At December 31, 2008, 2007 and 2006, federal funds purchased and securities sold under agreements to repurchase included funds invested by customers in a non-deposit product of the bank subsidiary of $176,909,231, $172,925,118 and $226,032,370, respectively. These accounts are non-insured, non-deposit accounts which allow customers to earn interest on their account with no restrictions as to the number of transactions. They are set up as sweep accounts with no check-writing capabilities and require the customer to have at least one operating deposit account. 18 NN OO TT EE GG -- BB OO RR RR OO WW II NN GG SS FF RR OO MM FF EE DD EE RR AA LL HH OO MM EE LL OO AA NN BB AA NN KK :: At December 31, 2008, the Company had $36,937,686 outstanding in advances under a $90,790,505 line of credit with the Federal Home Loan Bank of Dallas (“FHLB”). One advance in the amount of $5,000,000 bears interest at a fixed rate of 6.50% and matures in May 2010. One advance in the amount of $30,000,000 bears interest at a fixed rate of .80% and matures in January 2009. The remaining balance consists of smaller advances bearing interest from 3.35% to 7.00% with maturity dates from 2015 – 2030. The advances are collateralized by a blanket floating lien on the Company’s residential first mortgage loans. NN OO TT EE HH -- NN OO TT EE SS PP AA YY AA BB LL EE :: The Company has a $5,000,000 unsecured line of credit with Silverton Bank, N.A. The line bears interest at 1/2% under Wall Street Journal Prime and requires interest only payments quarterly with all principal and accrued interest due at maturity, which is July 6, 2009. There was no outstanding balance on the line at December 31, 2008 and at December 31, 2007, the outstanding balance on the line was $150,000, which was included in Other Liabilities. NN OO TT EE II -- II NN CC OO MM EE TT AA XX EE SS :: Deferred taxes (or deferred charges) as of December 31, 2008, 2007 and 2006, 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 to equity Earned retiree health benefits plan liability Unearned retiree health benefits plan liability Other Deferred tax assets Deferred tax liabilities: Unrealized gain on available for sale securities, charged to equity 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 2008 2007 2006 $ 3,779 2,579 $ 3,282 2,268 $ 4,089 2,030 1,011 419 316 8,104 1,817 6,093 35 7,945 891 123 327 6,891 589 6,094 36 6,719 911 798 435 356 8,619 3,989 39 4,028 √$ 159 $ 172 $ 4,591 2008 $ 2,897 (920) $ 1,977 2007 $ 2,435 2,607 $ 5,042 2006 $ 6,511 (52) $ 6,459 Income taxes amounted to less than the amounts computed by applying the U.S. Federal income tax rate of 34.0% for 2008 and 35.0% for 2007 and 2006 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 2008 Amount $ 2,384 (420) 13 $ 1,977 % 34.0 (5.9) (0.1) 28.0 2007 Amount % 2006 Amount $ 5,624 35.0 $ 6,729 % 35.0 (341) (241) $ 5,042 (2.1) (1.5) 31.4 (292) (1.5) 22 $ 6,459 0.1 33.6 FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109” (“FIN 48”). This interpretation clarifies the accounting and disclosure for uncertainty in income tax positions and was effective for the year beginning January 1, 2007. The Company has considered the recognition and measurement requirements of FIN 48 of the benefits recorded in its financial statements for tax positions taken or expected to be taken in its tax returns. Based on its evaluation of these tax positions for its open tax years, the Company has not recorded any tax liability for uncertain tax positions as of December 31, 2008 and 2007. 19 NN OO TT EE JJ -- SS HH AA RR EE HH OO LL DD EE RR SS ’’ EE QQ UU II TT YY :: Shareholders’ equity of the Company includes the undistributed earnings of the bank subsidiary. Dividends to the Company’s shareholders can generally be paid only from dividends paid to the Company by its bank subsidiary. Consequently, dividends are dependent upon the earnings, capital needs, regulatory policies and statutory limitations affecting the bank subsidiary. Dividends paid by the bank subsidiary are subject to the approval of the Commissioner of Banking and Consumer Finance of the State of Mississippi. At December 31, 2008, $25,703,213 of undistributed earnings of the bank subsidiary was available for future distribution to the Company as dividends. On November 26, 2002 the Company’s Board of Directors (the “Board”) approved the repurchase of up to 2.50% of the Company’s common stock. On November 22, 2005, the Board approved a three year extension of the plan originally approved on November 26, 2002. As a result of this repurchase plan, which was completed during 2007, 139,475 shares were repurchased and retired. On July 25, 2007, the Board approved the repurchase of up to 2.50% of the outstanding shares of the Company’s common stock. As a result of this repurchase plan, which was completed during 2008, 135,987 shares were repurchased and retired. On September 24, 2008, the Board approved the repurchase of up to 2.50% of the outstanding shares of the Company’s common stock. As a result of this repurchase plan, 24,263 shares were repurchased and retired as of December 31, 2008. On December 16, 2008, the Company’s Board of Directors approved a semi-annual dividend of $.30 per share. This dividend has a record date of January 9, 2009 and a distribution date of January 16, 2009. The bank subsidiary is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by the regulators that, if undertaken, could have a direct material effect on the bank subsidiary’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the bank subsidiary must meet specific capital guidelines that involve quantitative measures of the bank subsidiary’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The bank subsidiary’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the bank subsidiary to maintain minimum amounts and ratios of Total and Tier 1 capital to risk-weighted assets, and Tier 1 capital to average assets. As of December 31, 2008, the most recent notification from the Federal Deposit Insurance Corporation categorized the bank subsidiary as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the bank subsidiary must have a Total risk-based capital ratio of 10.00% or greater, a Tier 1 risk-based capital 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 Management believes have changed the bank subsidiary’s category. The Company’s actual capital amounts and ratios and required minimum capital amounts and ratios for 2008, 2007 and 2006, are as follows (in thousands): Actual For Capital Adequacy Purposes December 31, 2008: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) December 31, 2007: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) December 31, 2006: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) Amount $ 111,714 104,472 104,472 $ 112,510 105,345 105,345 $ 102,480 96,415 96,415 Ratio 19.28% 18.03% 11.61% 19.63% 18.38% 10.93% 21.12% 19.87% 10.60% Amount $46,348 23,174 35,983 $45,854 22,927 38,555 $38,818 19,409 36,374 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 2008, 2007 and 2006, are as follows (in thousands): December 31, 2008: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) December 31, 2007: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) December 31, 2006: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) Actual Ratio 18.83% 17.58% 11.31% 19.51% 18.26% 10.84% 21.06% 19.80% 9.98% Amount $ 108,207 101,022 101,022 $ 111,413 104,276 104,276 $ 102,111 95,991 95,991 20 For Capital Adequacy Purposes Ratio Amount $45,984 22,992 35,743 $45,676 22,838 38,481 $38,791 19,396 38,482 8.00% 4.00% 4.00% 8.00% 4.00% 4.00% 8.00% 4.00% 4.00% NN OO TT EE KK -- OO TT HH EE RR II NN CC OO MM EE AA NN DD EE XX PP EE NN SS EE SS :: Other income consisted of the following (in thousands): Years Ended December 31, Other service charges, commissions and fees Rentals Other Totals Other expenses consisted of the following (in thousands): Years Ended December 31, Advertising Data processing Legal and accounting ATM expense Consulting fees Trust expense Other Totals 2008 $ 117 538 877 $ 1,532 2008 $ 636 344 680 2,024 176 356 2,283 $6,499 2007 $ 171 345 721 $ 1,237 2007 $ 597 457 452 1,814 90 421 2,067 $5,898 2006 $ 223 257 798 $1,278 2006 $ 587 315 492 1,066 429 426 1,995 $5,310 NN OO TT EE LL -- FF II NN AA NN CC II AA LL II NN SS TT RR UU MM EE NN TT SS WW II TT HH OO FF FF -- BB AA LL AA NN CC EE -- SS HH EE EE TT RR II SS KK :: The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and irrevocable letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the bank subsidiary has in particular classes of financial instruments. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and irrevocable letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any conditions established in the agreement. Irrevocable letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Commitments and irrevocable letters of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments and irrevocable letters of credit may expire without being drawn upon, the total amounts do not necessarily represent future cash requirements. The Company evaluated each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on Management’s credit evaluation of the customer. Collateral obtained varies but may include equipment, real property and inventory. The Company generally grants loans to customers in its primary trade area of Harrison, Hancock, Jackson and Stone counties. At December 31, 2008, 2007 and 2006, the Company had outstanding irrevocable letters of credit aggregating $7,201,053, $7,128,972 and $3,038,096, respectively. At December 31, 2008, 2007 and 2006, outstanding unused loan commitments were approximately $116,091,000, $133,771,000 and $149,457,000, respectively. Approximately $69,684,000, $72,208,000 and $67,621,000 of outstanding commitments were at fixed rates and the remainder were at variable rates at December 31, 2008, 2007 and 2006, respectively. NN OO TT EE MM -- CC OO NN TT II NN GG EE NN CC II EE SS :: In 2007, USF&G filed a civil action against the Company’s bank subsidiary and other non-related parties alleging fraud in connection with the outcome of a lawsuit between the bank subsidiary and USF&G. On December 29, 2008, the Company’s bank subsidiary and USF&G reached an out of court settlement, pursuant to which the bank subsidiary did not admit any wrongdoing. This settlement effectively concludes the matter between USF&G and the bank subsidiary only. 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 matters is expected, in the opinion of Management, to have a material adverse effect upon the financial position or results of operations of the Company. 21 NN OO TT EE NN -- CC OO NN DD EE NN SS EE DD PP AA RR EE NN TT CC OO MM PP AA NN YY OO NN LL YY FF II NN AA NN CC II AA LL II NN FF OO RR MM AA TT II OO NN :: 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 ) : 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 2008 2007 2006 $ 103,701 $ 105,592 $ 98,147 1 496 4,552 1 528 2,226 1 55 1,535 $ 108,750 $ 108,347 $ 99,738 $ 1,750 1,750 107,000 $ 108,750 $ 1,805 1,805 106,542 $ 108,347 $ 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 Total expenses Income before income taxes Income tax benefit Net income 2008 2007 2006 $ 8,550 $ 6,800 (3,511) 4 75 5,118 87 87 5,031 (3) 4,250 6 43 11,099 90 90 11,009 (17) $ 2,800 10,014 5 25 12,844 93 93 12,751 (17) $ 5,034 $ 11,026 $ 12,768 22 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 used in operating activities: Gain on liquidation of investment Loss on other investments Net income of unconsolidated subsidiaries Change in other assets Net cash provided by (used in) operating activities Cash flows from investing activities: Purchase of other investments Proceeds from liquidation of investment Dividends from unconsolidated subsidiary Net cash provided by investing activities Cash flows from financing activities: Advances on line of credit Principal payments on line of credit Retirement of stock Dividends paid Net cash used in financing activities Net increase (decrease) in cash Cash, beginning of year Cash, end of year 2008 2007 2006 $ 5,034 $ 11,026 $ 12,768 (249) 270 (5,039) (3) 13 (3,160) 753 8,550 6,143 300 (450) (3,035) (3,003) (6,188) (32) 528 (11,050) 9 (15) (700) 6,800 6,100 950 (800) (3,107) (2,655) (5,612) 473 55 (12,814) 8 (38) (700) 2,800 2,100 (17) (2,275) (2,292) (230) 285 $ 496 $ 528 $ 55 Peoples Financial Corporation paid income taxes of $1,650,000, $4,819,000 and $5,310,000 in 2008, 2007 and 2006, respectively. No interest was paid during the three years ended December 31, 2008. NN OO TT EE OO -- EE MM PP LL OO YY EE EE BB EE NN EE FF II TT PP LL AA NN SS :: 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) Profit Sharing 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 by the employee (up to 6% of compensation). Contributions are determined by the Board of Directors and may be paid either in cash or Peoples Financial Corporation capital stock. Total contributions to the plans charged to operating expense were $400,000, $410,000 and $460,000 in 2008, 2007 and 2006, respectively. Compensation expense of $9,504,193, $9,207,514 and $8,245,151 was the basis for determining the ESOP contribution allocation to participants for 2008, 2007 and 2006, respectively. The ESOP held 445,741, 445,038 and 457,691 allocated shares at December 31, 2008, 2007 and 2006, respectively. The Company established an Executive Supplemental Income Plan and a Directors’ Deferred Income Plan, which provide for pre-retirement and post-retirement benefits to certain key executives and directors. Benefits under the Executive Supplemental Income Plan are based upon the position and salary of the officer at retirement or death. Normal retirement benefits under the plan are equal to 67% of salary for the president and chief executive offi- cer, 58% of salary for the executive vice president and 50% of salary for all other executive officers and are payable monthly over a period of fifteen years. Under the Directors’ Deferred Income Plan, the directors are given an opportunity to defer receipt of their annual directors’ fees until age sixty-five. For those who choose to participate, benefits are payable monthly for ten years beginning the first day of the month following the director’s normal retire- ment date. The normal retirement date is the later of the normal retirement age (65) or separation from service. Interest on deferred fees accrues at an annual rate of ten percent, compounded annually. The Company has acquired insurance policies, with the bank subsidiary as owner and beneficiary, that it may use as a source to pay potential benefits to the plan participants. These contracts are carried at their cash surrender value, which amounted to $13,648,077, $12,648,035 and $12,157,922 at December 31, 2008, 2007 and 2006, respectively. The present value of accumulated benefits under these plans, using an interest rate of 6.00% in 2008 and 2007 and 7.00% in 2006 and the interest ramp-up method for 2008, 2007 and 2006, has been accrued. The accrual amounted to $6,798,774, $5,796,097 and $4,769,461 at December 31, 2008, 2007 and 2006, respectively, and is included in Other Liabilities. 23 The Company has additional plans for non-vested post-retirement benefits for certain key executives. The Company has acquired insurance policies, with the bank subsidiary as owner and beneficiary, that it may use as a source to pay potential benefits to the plan participants. These contracts are carried at their cash surrender value, which amounted to $687,407, $593,946 and $506,565 at December 31, 2008, 2007 and 2006, respectively. The present value of accumu- lated benefits under these plans using an interest rate as prescribed by the plan of 7.50% in 2008, 2007 and 2006 and the projected unit cost method has been accrued. The accrual amounted to $584,699, $534,205 and $468,568 at December 31, 2008, 2007 and 2006, respectively, and is included in Other Liabilities. Additionally, there are two endorsement split dollar policies, with the bank subsidiary as owner and beneficiary, which provide a guaranteed death benefit to the participants’ beneficiaries. These contracts are carried at their cash surrender value, which amounted to $233,903, $226,417 and $218,341 at December 31, 2008, 2007 and 2006, respectively. The Company adopted Emerging Issue Task Force Issue No. 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements,” (“EITF 06-4”) on January 1, 2008. EITF 06-4 requires the accrual of the post-retirement benefit over the service period for deferred compensation plans funded through endorsement split-dollar life insurance. As a result of adopting EITF 06-4 at January 1, 2008, a cumulative effect adjustment to undivided profits of $56,732 was recorded. The present value of accumulated benefits under these plans using an interest rate of 6.00% and the projected unit cost method has been accrued. The accrual amounted to $60,232 at December 31, 2008 and is included in Other Liabilities. The Company has additional plans for non-vested post-retirement benefits for directors. The Company has acquired insurance policies, with the bank subsidiary as owner and beneficiary, that it may use as a source to pay potential benefits to the plan participants. These contracts are carried at their cash surrender value, which amounted to $118,773, $110,138 and $101,874 at December 31, 2008, 2007 and 2006, respectively. The present value of accumulated benefits under these plans using an interest rate as prescribed by the plan of 6.00% in 2008 and 7.50% in 2007 and 2006 and the projected unit cost method has been accrued. The accrual amounted to $142,088, $150,587 and $144,942 at December 31, 2008, 2007 and 2006, respectively, and is included in Other Liabilities. The Company provides post-retirement health insurance to certain of its retired employees. Employees are eligible to participate in the retiree health plan if they retire from active service no earlier than their Social Security normal retirement age, which varies from 65 to 67 based on the year of birth. In addition, the employee must have at least 25 continuous years of service with the Company immediately preceding retirement. However, any active employee who was at least age 65 as of January 1, 1995, does not have to meet the 25 years of service requirement. The accumulated post-retirement benefit obligation at January 1, 1995, was $517,599, which the Company elected to amortize over 20 years. The Company reserves the right to modify, reduce or eliminate these health benefits. The Company has chosen to not offer this post-retirement benefit to individuals entering the employ of the Company after December 31, 2006. 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 2008 $ 179,330 159,316 20,600 $ 359,246 2007 $ 275,345 175,700 20,600 $ 471,645 2006 $ 315,561 175,982 20,600 $ 512,143 The discount rate used in determining the accumulated post-retirement benefit obligation was 6.00% in 2008, 6.50% in 2007, and 6.00% in 2006. The assumed health care cost trend rate used in measuring the accumulated post-retirement benefit obligation was 10.00% in 2003. The rate was assumed to decrease gradually to 5.00% for 2013 and remain at that level thereafter. If the health care cost trend rate assumptions were increased 1.00%, the accumulated post-retirement benefit obligation as of December 31, 2008, would be increased by 23.93%, 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 increased by 26.25%. If the health care cost trend rate assumptions were decreased 1.00%, the accumulated post-retirement benefit obligation as of December 31, 2008, would be decreased by 18.48%, 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 19.93%. The following table presents the estimated benefit payments for each of the next five years and in the aggregate for the next five years: Year 2009 2010 2011 2012 2013 2014 – 2018 $ 58,000 63,000 72,000 74,000 92,000 925,000 The Company adopted FASB 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”) at December 31, 2006. SFAS 158 requires the recognition of the funded status of the Company’s postretirement benefit plan in its Statement of Condition, with corresponding adjustment to accumulated other comprehensive income, net of tax. 24 The following is a reconciliation of the accumulated post-retirement benefit obligation, which is included in Other Liabilities: Accumulated post-retirement benefit obligation as of December 31, 2007 Service cost Interest cost Actuarial loss Plan amendment Benefits paid Accumulated post-retirement benefit obligation as of December 31, 2008 $ 2,473,520 179,330 159,316 298,577 1,181,872 (84,186) $ 4,208,429 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 Amounts recognized in Accumulated Other Comprehensive Income, net of tax, were: December 31, Net loss Transition obligation Prior service cost Total accumulated other comprehensive income 2008 2007 2006 $ $ 84,186 (84,186) $ $ 80,122 (80,122) $ $ 73,202 (73,202) 2008 2007 2006 $ 159,662 81,574 780,036 $ 1,021,272 $ 134,749 92,078 $645,600 105,227 $ 226,827 $750,827 Amounts recognized in the accumulated post-retirement benefit obligation and other comprehensive income were: For the year ended December 31, Unrecognized actuarial loss Unrecognized prior service cost Amortization of transition obligation Total accumulated other comprehensive income 2008 $ 298,577 1,181,872 (20,600) $1,459,849 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 during 2009 is $78,929 and $20,600, respectively. NN OO TT EE PP -- FF AA II RR VV AA LL UU EE OO FF FF II NN AA NN CC II AA LL II NN SS TT RR UU MM EE NN TT SS :: 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. 25 Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. In preparing these disclosures, Management made highly sensitive estimates and assumptions in developing 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 estimates do not reflect any premium or discount that could result from offering 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 liabilities 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. CCaasshh aanndd DDuuee ffrroomm BBaannkkss The carrying amount shown as cash and due from banks approximates fair value. FFeeddeerraall FFuunnddss SSoolldd The carrying amount shown as federal funds sold approximates fair value. AAvvaaiillaabbllee ffoorr SSaallee SSeeccuurriittiieess The fair value of available for sale securities is based on quoted market prices. HHeelldd ttoo MMaattuurriittyy SSeeccuurriittiieess The fair value of held to maturity securities is based on quoted market prices. OOtthheerr IInnvveessttmmeennttss The carrying amount shown as other investments approximates fair value. FFeeddeerraall HHoommee LLooaann BBaannkk SSttoocckk The carrying amount shown as Federal Home Loan Bank Stock approximates fair value. LLooaannss The fair value of 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 factors 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. CCaasshh SSuurrrreennddeerr VVaalluuee ooff LLiiffee IInnssuurraannccee The carrying amount of cash surrender value of bank-owned life insurance approximates fair value. DDeeppoossiittss 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. FFeeddeerraall FFuunnddss PPuurrcchhaasseedd aanndd SSeeccuurriittiieess SSoolldd uunnddeerr AAggrreeeemmeennttss ttoo RReeppuurrcchhaassee The carrying amount shown as federal funds purchased and securities sold under agreements to repurchase approximates fair value. BBoorrrroowwiinnggss ffrroomm FFeeddeerraall HHoommee LLooaann BBaannkk 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. CCoommmmiittmmeennttss ttoo EExxtteenndd CCrreeddiitt aanndd SSttaannddbbyy LLeetttteerrss ooff CCrreeddiitt Because commitments to extend credit and standby letters of credit are generally short-term and at variable rates, the contract value and estimated value associated with these instruments are immaterial. 26 The following table presents carrying amounts and estimated fair values for financial assets and financial liabilities at December 31, 2008, 2007 and 2006 (in thousands): Financial Assets: Cash and due from banks Federal funds sold Available for sale securities Held to maturity securities Other investments Federal Home Loan Bank Stock Loans, net Cash surrender value of life insurance Financial Liabilities: Deposits: Non-interest bearing Interest bearing Total deposits Federal funds purchased and securities sold under agreements to repurchase Borrowings from Federal Home Loan Bank 2008 2007 2006 Carrying Amount $ 34,016 4 340,462 3,394 3,889 2,071 456,263 Fair Value $ 34,016 4 340,462 3,438 3,889 2,071 461,113 Carrying Amount $ 34,665 270 386,029 4,630 1,000 936 441,614 Fair Value $ 34,665 270 386,029 4,676 1,000 936 439,694 Carrying Amount $ 37,793 6,400 396,907 85,574 300 1,129 390,353 Fair Value $ 37,793 6,400 396,907 85,519 300 1,129 389,072 14,688 14,688 13,579 13,579 12,985 12,985 109,033 401,442 510,475 109,033 402,361 511,394 113,916 455,214 569,130 113,916 456,490 570,406 148,456 464,714 613,170 148,456 464,873 613,329 226,609 226,609 231,255 231,255 226,032 226,032 36,938 37,547 7,100 7,811 7,267 8,002 27 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 R E P O R T O F I N D E P E N D E N T R E G I S T E R E D P U B L I C A C C O U N T I N G F I R M To the Board of Directors Peoples Financial Corporation Biloxi, Mississippi We have audited Peoples Financial Corporation and subsidiaries’ (the “Company”) internal control over financial reporting as of December 31, 2008, based on criteria established 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 effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Controls over Financial Reporting. Our responsibility is to express an opinion on 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, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures 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 external purposes in accordance with generally accepted accounting principles. 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 recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting 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 deteriorate. In our opinion, Peoples Financial Corporation and subsidiaries maintained effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Frameworkissued by COSO. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of condition of Peoples Financial Corporation and subsidiaries as of December 31, 2008, 2007 and 2006, and the related statements of income, shareholders’ equity and cash flows for the years then ended, and our report dated March __, 2009, expressed an unqualified opinion on those consolidated financial statements. Atlanta, Georgia March __, 2009 28 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 R E P O R T O F I N D E P E N D E N T R E G I S T E R E D P U B L I C A C C O U N T I N G F I R M To the Board of Directors Peoples Financial Corporation Biloxi, Mississippi We have audited the accompanying consolidated statements of condition of Peoples Financial Corporation and subsidiaries (“the Company”) as of December 31, 2008, 2007 and 2006, and the related consolidated statements of income, shareholders’ equity and cash flows for the years 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 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 estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. 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 as of December 31, 2008, 2007 and 2006, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Peoples Financial Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March __, 2009, expressed an unqualified opinion on the effectiveness of Peoples Financial Corporation’s internal control over financial reporting. Atlanta, Georgia March __, 2009 29 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 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 2008 2007 2006 2005 2004 $ 896,408 $ 927,357 $ 964,023 $ 845,325 $ 577,441 340,642 3,394 467,377 510,476 36,938 107,000 386,029 4,630 450,992 569,130 7,100 106,542 396,907 85,574 401,194 613,170 7,267 98,233 178,394 134,047 349,346 592,217 7,352 87,503 173,030 6,588 334,193 389,192 7,203 85,801 $ 43,573 $ 55,971 $ 48,894 $ 32,343 $ 24,566 14,963 28,610 2,347 26,263 7,268 (26,520) 7,011 1,977 25,452 30,519 (1,045) 31,564 9,767 ª(25,263) 16,068 5,042 18,785 30,109 141 29,968 12,309 (23,050) 19,227 6,459 7,550 24,793 3,614 21,179 7,237 5,091 19,475 448 19,027 9,563 (20,468) (20,765) 7,948 2,604 538 7,825 2,031 $ 5,034 $ 11,026 $ 12,768 $ 5,882 $ 5,794 Basic and diluted earnings per share $ .94 $ 2.01 $ 2.30 $ 1.06 $ 1.04 Basic and diluted earnings per share before extraordinary gain Dividends per share Book value .94 .56 20.27 2.01 .52 19.56 2.30 .44 17.71 .96 .38 15.77 1.04 .32 15.44 Weighted average number of shares 5,342,470 5,489,861 5,548,300 5,550,477 5,556,251 Selected Ratios Return on average assets Return on average equity Primary capital to average assets Risk-based capital ratios: Tier 1 Total .55% 4.73% 12.81% 18.03% 19.28% 1.15% 10.77% 12.13% 18.38% 19.63% 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% 30 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, 2008 Interest income Net interest income Provision for loan losses Income before income taxes Net income Basic and diluted earnings per share Quarter Ended, 2007 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 $ 12,081 June 30 $ 10,901 September 30 December 31 $ 10,706 $ 9,885 7,201 46 3,128 2,089 .39 7,084 48 3,262 2,178 .41 7,217 2,001 (1,658) (1,053) (.20) 7,108 252 2,279 1,820 .35 March 31 $ 13,795 June 30 $ 14,280 September 30 December 31 $ 14,336 $ 13,560 7,429 49 4,003 2,715 .49 7,565 51 3,196 1,986 .36 7,860 (1,197) 4,975 3,395 .62 7,665 52 3,894 2,930 .54 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 Stock Market. Year 2008 2007 Quarter High Low Dividend per share $ 25.49 $ 19.89 $ .27 23.35 23.57 22.60 20.50 18.00 17.80 .29 $ 27.05 $ 25.00 $ .23 26.36 25.50 22.78 24.15 18.20 19.99 .25 1st 2nd 3rd 4th 1st 2nd 3rd 4th 31 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 C O R P O R A T E I N F O R M A T I O N 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 Corporate Stock Shareholder Information 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 The common stock of Peoples Financial Corporation is traded on the NASDAQ Capital Market under the symbol: PFBX. S.E.C. Form 10-K Requests The current market makers are: A copy of the Annual Report on Form 10-K, as filed with the FIG Partners FTN Midwest Research Secs. Howe Barnes Hoefer & Arnett Knight Equity Markets, L.P. Morgan Keegan & Company, Inc. Sterne, Agee & Leach, Inc. Stifel Nicolaus & Co. Securities and Exchange Commission, may be obtained without charge by directing a written request to: 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 32