Peoples Financial Corp.
Annual Report 2009

Plain-text annual report

P E O P L E S F I N A N C I A L C O R P O R A T I O N A N D S U B S I D I A R I E S 2 0 0 9 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 dis- cussion and analysis of the consolidated financial condition and results of operations of the Company and its consolidated subsidiaries for the years ended December 31, 2009, 2008 and 2007. 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 anticipat- ed 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 per- formance 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 inabil- ity 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 in 2007 and 2008, the continuing decline in the value of real estate and general economic downturn have affected the Company’s results. Managing the net inter- est margin in the Company’s highly competitive market and in context of the larger national economic conditions has been very challenging and will con- tinue to be so for the foreseeable future. Net income for 2009 was $3,220,473 compared with $5,033,690 for 2008. The results for 2009 included increased provisions for loan losses of $2,878,000 and FDIC insurance assessments of $1,259,560 as compared with 2008. Net interest income for 2009 was $1,721,687 less than the prior year as a result of the decrease in net yield. Earnings in 2008 included an impairment loss of $2,964,000 on the Company’s investment in Federal Home Loan Mortgage Corporation preferred stock. Monitoring asset quality and addressing potential losses in our loan portfolio continues to be emphasized during these tough economic times. During 2009, non-performing loans, particularly non-accrual loans, increased significantly. The Company charged-off $9,080,407 in loans during 2009 as com- pared with only $1,284,000 during 2008. Approximately 68% of the charge-offs in 2009 related to three credit relationships in the residential develop- ment industry. Nonaccrual loans increased to $22,005,748 at December 31, 2009 as compared with $15,553,447 at December 31, 2008. Nonaccrual loans at December 31, 2009 include one loan with a balance of $9,843,129, which is a performing loan, but was classified as nonaccrual by the banking regulators in their annual shared national credit review in the third quarter of 2009. Total assets decreased to $869,006,899 at December 31, 2009 from $896,407,501 at December 31, 2008. This decrease was primarily attributable to the net decrease in available for sale securities of $29,027,635 during 2009. As a result of decreasing interest rates, approximately $140,000,000 of these securi- ties were called in 2009. Proceeds from these calls, as well as from two sales of available for sale securities, funded liquidity needs and any remaining funds were re-invested in U.S. Agencies. 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. During 2007 and 2008, the Committee dropped the fed funds rate by a total of 500 basis points, which resulted in similar decreases in prime interest rates during this time. The fed funds rate did not change in 2009. 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 reductions was significant to the Company’s financial condition and results of operations. 2009 as compared with 2008 The Company’s average interest-earning assets increased approximately $14,784,000, or 2%, from approximately $804,842,000 for 2008 to approximate- ly $819,626,000 for 2009. Also as a result of the Committee’s actions, the average yield on earning assets decreased 122 basis points, from 5.48% for 2008 to 4.26% for 2009. 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. Average interest-bearing liabilities increased approximately $17,288,000, or 3%, from approximately $664,738,000 for 2008 to approximately $682,026,000 for 2009. The decrease in time deposits that began in 2008 as a result of rate competition was reversed by the acquisition of brokered deposits during 2009. The average rate paid on interest-bearing liabilities decreased 116 basis points, from 2.25% for 2008 to 1.09% for 2009. The Company’s net interest margin on a tax-equivalent basis, which is net interest income as a percentage of average earning assets, was 3.36% at December 31, 2009, down 26 basis points from 3.62% at December 31, 2008. 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 approximate- ly $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. Beginning in 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. As a result, retail time deposits of $100,000 or more decreased during 2008. This strategy resulted in a favorable improvement in the yield on interest-bearing liabilities as well as an overall reduction in total deposits in 2008 as compared with 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 3.62% at December 31, 2008, up 7 basis points from 3.55% at December 31, 2007. The tables on the following page analyze the changes in tax-equivalent net interest income for the years ended December 31, 2009 and 2008 and the years ended December 31, 2008 and 2007. 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 ) 2009 2008 Loans (2) (3) Federal Funds Sold Held to maturity: 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 Average Balance 467,992 $ 3,227 Interest Earned/Paid Rate 4.31 $ 20,189 0.25 8 3,265 307,332 34,437 3,373 819,626 232,916 192,893 $ $ 172 12,840 1,699 17 $ 34,925 $ 1,831 3,135 217,509 38,708 $ 682,026 1,905 530 $ 7,401 5.27 4.18 4.93 .50 4.26 .79 1.63 .88 1.37 1.09 3.36 Average Balance 463,505 $ 5,694 Interest Earned/Paid $ 26,874 122 3,691 230 304,536 24,394 3,022 $ 804,842 $ 251,792 191,904 15,331 1,433 148 $ 44,138 $ 3,856 6,094 210,049 10,993 $ 664,738 4,521 492 $ 14,963 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 (1) All interest earned is reported on a taxable equivalent basis using a tax rate of 34% in 2009 and 2008 and 35% in 2007. (2) Loan fees of $476, $786 and $854 for 2009, 2008 and 2007, respectively, are included in these figures. (3) Includes nonaccrual loans. Rate 5.80 2.14 6.23 5.03 5.87 4.90 5.48 1.53 3.18 2.15 4.48 2.25 3.62 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 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, 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 devel- oping 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, land, development, construction and commercial real estate loans, 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. Management relies on its guidelines and existing methodology to monitor the performance of its loan portfolio and to identify and estimate potential losses based on the best available information. The recent economic downturn and its impact in the housing market during the last eighteen months resulted in increased scrutiny of the Company’s residential development loan portfolio. At December 31, 2009, three residential development credit rela- tionships with a total balance of $6,542,612 represented $1,323,872 of total allowance of $7,827,806. During 2009, the Company’s on-going, systematic evaluation resulted in the Company recording a provision for loan losses of $5,225,000 and $2,347,000 in 2009 and 2008, respectively. In 2007, the Company recorded a negative provision of $1,405,000, effectively reversing part of the Katrina-related provision from 2005. 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 oper- ations. NNoonn--iinntteerreesstt iinnccoommee 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. This resulted in an increase in non-interest income in 2009 as compared with 2008 and a decrease in non-interest income in 2008 as com- pared with 2007. Total non-interest income increased $2,878,172 in 2009 as compared with 2008. In addition to the impact of the impairment loss, non-interest income in 2009 was affected by the change in trust department income and fees, gains on the liquidation, sale and calls of securities, gain (loss) on other invest- ments and other income. The decrease in trust department income and fees of $274,258 was the result of the decrease in market value, on which fees are based, of personal trust accounts. In 2009, the Company realized a gain on the sale of securities of $869,123 as compared with only $397,852 in 2008. In 2009, the Company’s investment in a low-income housing partnership resulted in a gain of $146,979 as compared with a loss of $270,676 in 2008 as a result of the completion of renovations in 2009 which resulted in increased occupancy. Other income in 2008 included a gain of $150,000 from the sale of the bank subsidiary’s merchant card portfolio. 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. NNoonn--iinntteerreesstt eexxppeennssee Total non-interest expense increased $1,114,702 for 2009 as compared with 2008. The largest component of this increase was from FDIC assessments, which were $1,259,560 larger in 2009 than in 2008. Salaries and employee benefits decreased $198,477 for 2009 as compared with 2008. This change included a decrease in salaries and related payroll tax expense of $480,503 as a result of a hiring freeze and loss of employees through attrition and elimination of Management bonuses in 2009. This decrease was partially offset by an increase in costs of $180,209 for the Company’s liability for a deferred compensa- tion plan as the discount rate used to compute the liability was changed to bring the plan into alignment with other plans. Changes in other salaries and employee benefit components include the increase in health insurance costs of $317,490 and the increase of $196,400 for the retiree health plan. Net occu- pancy expense increased by $280,761 in 2009 as a result of the increase in property taxes of $102,132, the increase in insurance costs of $71,618 and the increase in telephone expense of $103,454. Property taxes increased as banking premises in Jackson County was reassessed and facilities in Pass Christian and Biloxi were added to the tax rolls. Like most other businesses on the Mississippi Gulf Coast, the Company’s insurance costs continue to rise. The cost of additional data line availability for technology upgrades in 2009 resulted in increased telephone expenses. 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 out- sourcing 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. 4 FF II NN AA NN CC II AA LL CC OO NN DD II TT II OO NN Available for sale securities decreased $29,027,635 at December 31, 2009, compared with December 31, 2008. The Committee reduced the fed funds rate by 400 basis points during 2008, which resulted in more than $140,000,000 of the Company’s U.S. Agency securities being called during the year. While some of these proceeds were reinvested in U.S. Agency securities, the remaining funds were utilized in the Company’s daily management of its liquidity needs. The Company’s held to maturity portfolio was invested solely in debt securities issued by state and political subdivisions at December 31, 2009 and December 31, 2008. The Company increased its investment in Federal Home Loan Bank common stock by $2,945,200 in order to increase its borrowing ability from that agency. Gross loans decreased $2,400,748 at December 31, 2009 as compared with December 31, 2008. During 2009, regularly schedule principal payments and maturities as well as charge-offs totaling $9,080,000 outpaced new loans. Other real estate increased by $1,124,131 at December 31, 2009 as compared with December 31, 2008. As problem loans increased during 2009, the Company was forced to foreclose on the collateral securing its loans more often. Other real estate increased to more than $3,000,000 during the year; however, the Company has been able to sell two large parcels worth more than $1,700,000 at a gain of $172,739. Accrued interest receivable decreased $798,015 at December 31, 2009 as compared with December 31, 2008 as a result of the decrease in yields earned on interest-earning assets. FDIC assessments increased by $4,906,212 as assessments for 2010 – 2012 were prepaid on December 30, 2009. Other assets decreased $985,902 at December 31, 2009 as compared with December 31, 2008. Prepaid expenses decreased by $694,938 at December 31, 2009 as compared with December 31, 2008 as multi-year payments amortized. At December 31, 2008, the Company recorded federal income taxes receivable of $704,146 as a result of overpayments during that year, while at December 31, 2009, the Company had a liability for federal income taxes of $118,000. Total deposits decreased $39,774,107 at December 31, 2009, as compared with December 31, 2008. Fluctuations among the different types of deposits represent recurring activity for the Company. 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 2010. Federal funds purchased and securities sold under agreements to repurchase decreased $52,178,354 at December 31, 2009 as compared with December 31, 2008 as the Company rested its correspondent lines of credit in favor of borrowing from the Federal Home Loan Bank at the end of 2009. The Company will continue to utilize federal funds purchased as an important source of liquidity. Borrowings from the Federal Home Loan Bank increased $67,332,766 at December 31, 2009 as compared with December 31, 2008. During 2009, 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 hallmarks 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 12.49% at December 31, 2009, 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. Significant transactions affecting shareholders’ equity during 2009 are described in Note K. The Statement of Shareholders’ Equity also presents all activ- ity 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. 5 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 generally anticipates using these sources of funds, as well as purchases of federal funds and borrowings from the Federal Home Loan Bank for its liquidity needs in 2010. During 2009, the Company received approval to participate in the Federal Reserve Bank’s Discount Window Primary Credit Program. The Company intends to use this program as a part of its liquidity contingency plans only. RR EE GG UU LL AA TT OO RR YY MM AA TT TT EE RR SS During 2009, Management identified opportunities for improving risk management, addressing asset quality concerns, managing concentrations of cred- it risk and ensuring sufficient liquidity at the Bank as a result of its own investigation as well as examinations performed by certain bank regulatory agen- cies. In concert with the regulators, the Company has identified specific corrective steps and actions to enhance its risk management, asset quality and liquidity policies, controls and procedures. The Company and the Bank may not declare or pay any cash dividends without the prior written approval of their regulators. 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 com- mitments and irrevocable letters of credit may expire without being drawn upon, the total amount does not necessarily represent future cash require- ments. 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 M. 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 to restore liquidity and stability to the financial system. The Troubled Asset Relief Program (“TARP”) is one of the provisions of the Act. The Company did not participate in TARP. The Act also temporarily raised the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor and will be in effect through December 31, 2013. 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 Company is participating in TLGP. 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 respon- sible 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 manage- ment 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 extend- ed 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 poli- cy 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. During 2009, the Company began including floors on variable rate loans in the management of its interest margin. On the liability side, more than 68% of the deposits are demand and savings transaction accounts. Additionally, approximately 65% 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 2010 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 the reserve for loan losses. There have been no adjustments for such factors as prepayment risk, early calls of investments, the effect of the maturity of balloon notes or the early withdrawal of deposits. The Company does not believe that the aforementioned factors have a significant impact on expected maturity. 6 Interest rate sensitivity at December 31, 2009 was as follows (in thousands): 2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 B E Y O N D 1 2 / 3 1 / 0 9 F A I R V A L U E T O T A L $ 310,429 $ 42,856 $ 41,335 $ 28,025 $ 19,958 $ 14,545 $ 457,148 $ 460,588 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 4.33% 19,662 3.19% 330,091 4.28% 359,363 1.96% 4.23% 45,717 3.44% 339,293 4.14% 375,298 1.80% 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 174,431 Average rate Long-term funds Average rate Total Financial Liabilities Average rate 0.75% 102,178 4.86% 635,972 2.92% 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% 6.50% 6,276 4.42% 49,132 6.31% 7,756 2.80% 196 4.81% 7,952 2.88% 5.58% 14,394 3.80% 55,729 5.24% 4,168 3.07% 6.80% 30,719 3.24% 6.00% 20,480 3.23% 58,744 40,438 5.58% 1,723 2.68% 5.02% 1,149 2.68% 196 4.81% 4,364 3.19% 196 4.81% 1,919 3.04% 196 4.81% 1,345 3.18% 4.92% 232,157 4.68% 246,702 4.69% 1 2.52% 1,308 4.81% 1,309 4.81% 5.05% 323,688 4.28% 780,836 4.82% 374,160 2.03% 174,431 0.75% 104,270 4.86% 652,861 2.94% 323,828 784,426 375,052 174,431 105,815 655,298 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 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 $3,340,974 - 2009; $3,438,108 - 2008; $4,676,471 - 2007 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 Other real estate Accrued interest receivable Cash surrender value of life insurance Prepaid FDIC assessments 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, 5,151,697, 5,279,268 and 5,420,204 shares issued and outstanding at December 31, 2009, 2008 and 2007, respectively Surplus Undivided profits Accumulated other comprehensive income (loss), net of tax Total shareholders' equity 2 0 0 9 2 0 0 8 2 0 0 7 $ 29,155,294 $ 34,015,590 311,434,437 3,201,966 4,036,304 5,015,900 464,976,291 7,827,806 457,148,485 31,418,884 1,521,313 4,646,752 15,329,394 4,958,309 1,139,861 4,000 340,462,072 3,394,212 3,889,324 2,070,700 467,377,039 11,113,575 456,263,464 33,600,170 397,182 5,444,767 14,688,160 52,097 2,125,763 $ 34,665,370 270,000 386,028,925 4,629,992 1,000,000 936,200 450,992,074 9,378,137 441,613,937 34,410,789 19,508 7,371,216 13,578,536 15,702 2,816,398 $ 869,006,899 $ 896,407,501 $ 927,356,573 $ 96,541,387 $ 109,033,184 $ 113,916,041 206,167,484 117,347,663 50,644,895 470,701,429 174,430,877 104,270,452 16,016,204 765,418,962 5,151,697 65,780,254 32,853,346 (197,360) 103,587,937 239,990,238 104,540,112 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 Total liabilities and shareholders' equity $ 869,006,899 $ 896,407,501 $ 927,356,573 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 9 2 0 0 8 2 0 0 7 $ 20,189,200 $ 26,874,057 $ 33,642,030 1,229,237 10,043,869 1,566,573 1,234,917 17,347 8,159 34,289,302 4,965,439 530,082 1,905,383 7,400,904 26,888,398 5,225,000 21,663,398 1,363,489 6,661,209 869,123 (149,517) 146,979 1,255,348 10,146,631 14,250,002 2,501,431 3,766,582 7,117,541 27,635,556 4,174,473 954,000 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 55,970,979 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 $ 3,220,473 $ .62 $ 5,033,690 $ .94 $ 11,026,129 $ 2.01 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 Gain (loss) on other investments Gain from sale of bank premises 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 5,548,199 C o m m o n S t o c k $ 5,548,199 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 $ (2,349,583) I n c o m e T o t a l $ 98,232,695 Balance, January 1, 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 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 benefit 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 Comprehensive Income: Net income Net unrealized loss on available for sale securities, net of tax Reclassification adjustment for available for sale securities called or sold in current year, net of tax Gain from unfunded post-retirement obligation, net of tax Total comprehensive income Effect of stock retirement on accrued dividends Cash dividends ($ .20 per share) Dividend declared ($ .10 per share) Retirement of stock Balance, December 31, 2009 See Notes to Consolidated Financial Statements. (127,995) 5,420,204 (127,995) 5,420,204 65,780,254 (140,936) 5,279,268 (140,936) 5,279,268 65,780,254 2,527,996 (127,571) $ 5,151,697 (127,571) 5,151,697 10 $ 65,780,254 $ 32,853,346 $ (197,360) $ 103,587,937 P r o f i t s $ 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) 33,412,596 3,220,473 4,774 (1,030,339) (515,170) (2,238,988) 2,308,621 399,837 524,000 882,875 745,909 1,693,658 (794,446) $ 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 $ 3,220,473 (2,392,524) (2,392,524) (474,940) 142,108 (474,940) 142,108 $ 495,117 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) 107,000,114 3,220,473 (2,392,524) (474,940) 142,108 4,774 (1,030,339) (515,170) (2,366,559) N u m b e r o f C o m m o n S h a r e s 5,548,199 C o m m o n S t o c k $ 5,548,199 S u r p l u s $ 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 65,780,254 (127,571) 5,151,697 (127,571) $ 5,151,697 Balance, January 1, 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 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 benefit 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 Comprehensive Income: Net income Net unrealized loss on available for sale securities, net of tax Reclassification adjustment for available for sale securities called or sold in current year, net of tax Gain from unfunded post-retirement obligation, net of tax Total comprehensive income Effect of stock retirement on accrued dividends Cash dividends ($ .20 per share) Dividend declared ($ .10 per share) Retirement of stock Balance, December 31, 2009 See Notes to Consolidated Financial Statements. U n d i v i d e d P r o f i t s $ 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) 33,412,596 3,220,473 4,774 (1,030,339) (515,170) (2,238,988) 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 $ (2,349,583) C o m p r e h e n s i v e I n c o m e T o t a l $ 98,232,695 2,308,621 399,837 524,000 882,875 745,909 1,693,658 (794,446) $ 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 2,527,996 $ 3,220,473 (2,392,524) (2,392,524) (474,940) 142,108 (474,940) 142,108 $ 495,117 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) 107,000,114 3,220,473 (2,392,524) (474,940) 142,108 4,774 (1,030,339) (515,170) (2,366,559) $ 65,780,254 $ 32,853,346 $ (197,360) $ 103,587,937 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 investments (Gain) loss on other investments Gain on sales of other real estate (Gain) loss on sales, calls and liquidation of securities Gain on sale of bank premises 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 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 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 2 0 0 9 2 0 0 8 2 0 0 7 $ 3,220,473 $ 5,033,690 $ 11,026,129 2,390,912 5,225,000 149,517 (146,979) (150,058) (869,123) 798,015 (3,582,781) 2,975,089 10,010,065 277,022,490 (251,622,168) 195,000 (2,754) 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) 1,712,000 (1,045,000) (10,470) 605,813 (635,271) 771,014 (1,967,771) (3,167,174) 7,289,270 209,677,761 (195,300,371) 86,460,000 (5,515,732) (2,945,200) (1,134,500) (3,160,000) (700,000) 3,108,801 (10,192,895) (209,626) (627,636) 14,726,012 (46,314,551) 6,540,444 (2,614,119) (2,366,559) 377,346,745 (310,013,979) (52,178,354) (29,600,373) (4,864,296) 34,019,590 236,261 (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) 34,935,370 192,300 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 $ 29,155,294 $ 34,019,590 $ 34,935,370 12 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 finan- cial 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 state- ments and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. NNeeww AAccccoouunnttiinngg PPrroonnoouunncceemmeennttss In June 2009, the Financial Accounting Standards Board (“FASB”) issued an accounting standard which established the Accounting Standards Codification (“Codification” or “ASC”) to become the single source of authoritative U.S. generally accepted accounting principles (“GAAP”) recognized by the FASB to be applied by nongovernmental entities, with the exception of guidance issued by the SEC and its staff. All guidance contained in the Codification car- ries an equal level of authority. The Codification is not intended to change GAAP, but rather is expected to simplify accounting research by reorganizing current GAAP into approximately 90 accounting topics. The switch to the ASC affects the way companies refer to GAAP in financial statements and account- ing policies. Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure. The Company adopted this accounting standard in preparing the Consolidated Financial Statements for the period ended September 30, 2009. The adoption of this accounting standard, which was subsequently codified into ASC Topic 105, “Generally Accepted Accounting Principles,” had no impact on the Company’s financial statements. New authoritative accounting guidance under ASC Topic 815, “Derivatives and Hedging,” amends prior guidance to amend and enhance the disclosure requirements for derivatives and hedging to provide greater transparency about (i) how and why an entity uses derivative instruments, (ii) how deriva- tive instruments and related hedge items are accounted for under ASC Topic 815, and (iii) how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. To meet those objectives, ASC Topic 815 requires qualitative disclosures about objectives and strategies for using derivative instruments, quantitative disclosures about fair values of derivative instruments and their gains and losses and dis- closures about credit-risk-related contingent features of the derivative instruments and their potential impact on an entity’s liquidity. ASC Topic 815 was effective on January 1, 2009, and did not have a significant impact on the Company’s financial statements. New authoritative accounting guidance under ASC Topic 855, “Subsequent Events,” establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. ASC Topic 855 defines (i) the period after the balance sheet date during which a reporting entity’s management should evaluate events or transactions that may occur for potential recogni- tion or disclosure in the financial statements, (ii) the circumstances under which an entity should recognize events or transactions occurring after the bal- ance sheet date in its financial statements, and (iii) the disclosures an entity should make about events or transactions that occurred after the balance sheet date. ASC Topic 855 became effective for the Company’s financial statements for periods ending after June 15, 2009, and did not have a significant impact on the Company’s financial statements. New authoritative accounting guidance under ASC Topic 820, “Fair Value Measurements and Disclosures,” affirms that the objective of fair value when the market for an asset is not active is the price that would be received to sell the asset in an orderly transaction, and clarifies and includes additional fac- tors for determining whether there has been a significant decrease in market activity for an asset when the market for that asset is not active. ASC Topic 820 requires an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence. The new accounting guidance amended prior guidance to expand certain disclosure requirements. The Company adopted the new authoritative accounting guidance under ASC Topic 820 during the first quarter of 2009. Adoption of the new guidance did not have a significant impact on the Company’s financial statements. Further new authoritative accounting guidance (Accounting Standards Update No. 2009-5) under ASC Topic 820 provides guidance for measuring the fair value of a liability in circumstances in which a quoted price in an active market for the identical liability is not available. In such instances, a reporting entity is required to measure fair value utilizing a valuation technique that uses (i) the quoted price of the identical liability when traded as an asset, (ii) quoted prices for similar liabilities or similar liabilities when traded as assets, or (iii) another valuation technique that is consistent with the existing prin- ciples of ASC Topic 820, such as an income approach or market approach. The new authoritative accounting guidance also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restric- tion that prevents the transfer of the liability. The foregoing new authoritative accounting guidance under ASC Topic 820 became effective for the Company’s financial statements on October 1, 2009, and is not expected to have a significant impact on the Company’s financial statements. New authoritative accounting guidance under ASC Topic 825, “Financial Instruments,” requires an entity to provide disclosures about the fair value of financial instruments in interim financial information and amends prior guidance to require those disclosures in summarized financial information at interim reporting periods. The Company adopted this accounting standard in preparing its financial statements for the period ended June 30, 2009. As ASC Topic 825 amended only the disclosure requirements about the fair value of financial instruments in interim periods, the adoption had no impact on the Company’s financial statements. 13 New authoritative accounting guidance under ASC Topic 320, “Investments – Debt and Equity Securities,” amended other-than-temporary impairment (“OTTI”) guidance in GAAP for debt securities by requiring a write-down when fair value is below amortized cost in circumstances where: (1) an entity has the intent to sell a security; (2) it is more likely than not that an entity will be required to sell the security before recovery of its amortized cost basis; or (3) an entity does not expect to recover the entire amortized cost basis of the security. If an entity intends to sell a security or if it is more likely than not that the entity will be required to sell the security before recovery, an OTTI write-down is recognized in earnings equal to the entire difference between the security’s amortized cost basis and its fair value. If an entity does not intend to sell the security or it is not more likely than not that it will be required to sell the security before recovery, the OTTI write-down is separated into an amount representing credit loss, which is recognized in earnings, and an amount related to all other factors, which is recognized in other comprehensive income. This accounting standard does not amend existing recognition and measurement guidance related to OTTI write-downs of equity securities. This accounting standard also extends disclosure requirements related to debt and equity securities to interim reporting periods. ASC Topic 320 became effective for the Company’s financial statements for periods ending after June 15, 2009, and 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 $542,000, $696,000 and $19,964,000 for the years ending December 31, 2009, 2008 and 2007, respectively. The Company’s bank subsidiary maintained account balances in excess of amounts insured by the Federal Deposit Insurance Corporation. At December 31, 2009, the bank subsidiary had excess deposits of $8,635,587. 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 share- holders’ 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, or other comprehensive income, as appropriate. 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 identifica- tion method is used to determine realized gains and losses on sales of securities, which are reported as gain (loss) on liquidation, sale and calls of secu- rities 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 estab- lishes guidelines relating to pricing, repayment terms, collateral standards including loan to value limits, appraisal and environmental standards, lend- ing 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 inter- est or principal so as to preclude the recognition in reported earnings of some or all of the contractual interest. Accrued interest on loans classified as nonaccrual is reversed at the time the loans are placed on nonaccrual. Interest received on nonaccrual loans is applied against principal. Loans are restored to accrual status when the obligation is brought current or has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. The Company considers a loan to be impaired when, based upon current information and events, Management 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 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 collectability. 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. 14 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 assess- ment of several factors: review and evaluations of specific loans, changes in the nature and volume of the loan portfolio, current and anticipated eco- nomic 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. 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 and qualitative factors as determined by Management. 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 contri- bution to consolidated taxable income. The provision for applicable income taxes is based upon reported income and expenses as adjusted for differ- ences 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 provi- sions 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, 5,170,430, 5,342,470 and 5,489,861 in 2009, 2008 and 2007, 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 $7,576,159, $14,961,180 and $24,853,712 in 2009, 2008 and 2007, respectively, for interest on deposits and borrowings. Income tax payments totaled $520,000, $1,635,000 and $4,819,000 in 2009, 2008 and 2007, respec- tively. Loans transferred to other real estate amounted to $4,082,874, $399,725 and $19,500 in 2009, 2008 and 2007, respectively. The income tax effect from the unrealized gain (loss) on available for sale securities on accumulated other comprehensive income was $(1,477,178), $1,277,519 and $1,395,266, at December 31, 2009, 2008 and 2007, respec- tively. The income tax effect from the gain (loss) from unfunded post-retirement benefit obligation on accumulated other comprehensive income was $(92,434) , $204,124 and $(282,000) at December 31, 2009, 2008 and 2007, respectively. FFaaiirr VVaalluuee MMeeaassuurreemmeenntt The Company reports certain assets and liabilities at their estimated fair value. These assets and liabilities are classified and disclosed in one of three cat- egories based on the inputs used to develop the measurements. The categories, which establish a hierarchy for ranking the quality and reliability of the information used to determine fair value, are: 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. SSuubbsseeqquueenntt EEvveennttss The Company has performed an evaluation of subsequent events through March 11, 2010, which is the date the financial statements were issued. 15 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, 2009, 2008 and 2007, respectively, are as follows (in thousands): December 31, 2009 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 Total available for sale securities Held to maturity securities: States and political subdivisions Total held to maturity securities 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 Total available for sale securities 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 Total available for sale securities Held to maturity securities: States and political subdivisions Total held to maturity securities Amortized Cost Gross Unrealized Gains Gross Unrealized Losses $ 23,987 216,473 30,035 39,291 309,786 650 $ 310,436 $ $ 3,202 3,202 $ 753 695 1,278 1,179 3,905 $ – (2,590) (51) (266) (2,907) $ 3,905 $ (2,907) $ 139 $ 139 $ $ – – Amortized Cost Gross Unrealized Gains Gross Unrealized Losses $ 64,963 208,918 28,993 31,594 334,468 650 $ 335,118 $ $ 3,394 3,394 $ 1,746 3,552 788 317 6,403 $ – (74) (985) (1,059) $ 6,403 $ (1,059) $ 52 $ 52 $ (8) $ (8) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses $ 71,952 252,130 33,343 22,698 380,123 4,229 $ 384,352 $ $ 4,630 4,630 $ 1,354 1,729 48 152 3,283 62 $ 3,345 $ 53 $ 53 $ – (60) (7) (367) (434) (1,234) $ (1,668) $ (7) $ (7) Estimated Fair Value $ 24,740 214,578 31,262 40,204 310,784 650 $ 311,434 $ $ 3,341 3,341 Estimated Fair Value $ 66,709 212,396 29,781 30,926 339,812 650 $ 340,462 $ $ 3,438 3,438 Estimated Fair Value $ 73,306 253,799 33,384 22,483 382,972 3,057 $ 386,029 $ 4,676 4,676 $ 16 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 on 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 spe- cific 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 with- in the fair value hierarchy as of December 31, 2009. December 31, 2009 Total $311,434,437 Level 1 Fair Value Measurement Using Level 2 Level 3 $311,434,437 Available for sale securities with an amortized cost of $310,436,523 were reported at a fair value, net of unrealized gains and losses, of $311,434,437 at December 31, 2009. The net change in unrealized gains and losses of $(2,867,464) was included in comprehensive income during 2009. The amortized cost and estimated fair value of debt securities at December 31, 2009, 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 $ $ $ $ 19,104 68,609 62,436 129,602 30,035 309,786 305 1,901 996 3,202 $ 19,357 69,968 62,484 127,713 31,262 310,784 $ $ 308 2,001 1,032 $ 3,341 Information pertaining to securities with gross unrealized losses at December 31, 2009, 2008 and 2007, 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, 2009 U.S. Government Agencies States and political subdivisions Mortgage-backed securities Total Fair Value $ 138,914 9,501 4,856 $ 153,271 Gross Unrealized Loss $ 2,590 148 51 2,789 $ Fair Value 2,826 $ 2,521 $ 2,521 Gross Unrealized Loss $ 254 118 $ 118 Fair Value Gross Unrealized Loss $ 2,590 $ 266 51 $ 2,907 138,914 12,022 4,856 $ 155,792 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 7 14,201 1,234 1,841 $ 1,675 $ 57,525 \ 17 At December 31, 2009, 29 of the 45 securities issued by U.S. Government agencies, 32 of 147 securities issued by state and political subdivisions and 1 of the 10 mortgage-backed securities 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 tradi- tionally 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 2009, 2008 and 2007 were $195,000, $1,240,000 and $86,460,000, respective- ly. There were no sales of held to maturity debt securities during 2009, 2008 and 2007. Proceeds from maturities, sales and calls of available for sale debt securities were $277,022,490, $257,886,217 and $209,677,761 during 2009, 2008 and 2007, respectively. Available for sale debt securities were sold in 2009 and 2007 for a realized gain (loss) of $869,123 and $(605,813). There were no sales of available for sale debt securities in 2008. The Company realized a gain of $249,000 from the liquidation of equity securities in 2008. During 2009, the Company recorded a loss of $149,517 from the other-than-temporary impairment of an equity investment. During 2008, the Company recorded a loss of $2,964,000 from the other-than-temporary impairment of its invest- ment in Federal Home Loan Mortgage Corporation Preferred Stock. Securities with an amortized cost of $296,176,580, $328,047,697 and $342,084,423 at December 31, 2009, 2008 and 2007, respectively, were pledged to secure public deposits, federal funds purchased and other balances as required by law. The Company invests in Federal Home Loan Bank (FHLB) common stock as a prerequisite for participation in certain FHLB programs. The amount to be invested in FHLB stock is calculated according to FHLB guidelines as a percentage of certain mortgage loans. Based on this calculation, the FHLB may peri- odically 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 2009 $ 94,460 299,403 1,755 52,250 9,049 7,891 168 $ 464,976 2009 11,114 569 (9,080) 5,225 7,828 $ $ $ 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 $ 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 out- standing concentrations were as follows (in thousands): December 31, Gaming Hotel/motel Out of area 2009 $69,938 47,714 46,697 2008 2007 $ 79,510 $ 74,595 35,962 44,458 23,234 31,325 During 2009, the Company began monitoring its exposure to land, development and construction loans. At December 31, 2009, this exposure totaled $95,060,478. 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 collectability and do not include other unfavorable features. 18 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 2009 $ 7,800 1,128 (2,037) $ 6,891 2008 $ 7,318 2,743 (2,261) 7,800 $ 2007 $ 8,554 3,548 (4,784) $ 7,318 Performing loans totaling $8,354,210, $8,151,194 and $11,655,577 had specific reserves of $2,531,291, $3,582,298 and $5,598,107 at December 31, 2009, 2008 and 2007, respectively. Loans past due ninety days or more and still accruing were $4,217,835, $2,340,190 and $1,233,761 at December 31, 2009, 2008 and 2007, respectively. Impaired loans include nonaccrual loans which amounted to $22,005,748, $15,553,447 and $44,612 at December 31, 2009, 2008 and 2007, respectively. The total average recorded investment in impaired loans amounted to $25,551,787, $15,595,942 and $46,612 at December 31, 2009, 2008 and 2007, respective- ly. The Company had $1,895,414, $3,725,593 and $44,612 of specific allowance related to impaired loans at December 31, 2009, 2008, and 2007, respective- ly. No material interest income was recognized on impaired loans for the years ended December 31, 2009, 2008 and 2007, respectively. At each reporting period, the Company determines which loans are impaired. Accordingly, the Company’s impaired loans are reported at their estimat- ed 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 assump- tions 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. Impaired loans, which are measured at fair value on a non-recurring basis, by level within the hierarchy as of December 31, 2009 were as follows: December 31, 2009 Total $20,110,334 Level 1 Fair Value Measurement Using Level 2 Level 3 $20,110,334 At December, 31, 2009, impaired loans with a carrying amount of $22,005,748 were written down to their fair value of $20,110,334 through a $1,895,414 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 2009 $ 5,986 30,233 15,378 51,597 20,178 $ 31,419 2008 $ 5,978 30,427 14,982 51,387 17,787 $ 33,600 $ 2007 6,102 29,180 15,187 50,469 16,058 $ 34,411 NN OO TT EE EE –– OO TT HH EE RR RR EE AA LL EE SS TT AA TT EE :: Other real estate acquired through foreclosure is carried at fair value, less estimated costs to sell. 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. Accordingly, the Company’s other real estate is reported at its estimated fair value on a non-recurring basis. The balance of other real estate, which is measured at fair value on a non-recurring basis, by level within the hierarchy as of December 31, 2009 was as follows: Fair Value Measurement Using Level 2 Level 3 Level 1 Total December 31, 2009 $1,521,313 $1,521,313 NN OO TT EE FF -- DD EE PP OO SS II TT SS :: At December 31, 2009, the scheduled maturities of time deposits are as follows (in thousands): $ 153,196 7,756 4,168 1,723 1,149 1 167,993 2010 2011 2012 2013 2014 Beyond Total $ Time deposits of $100,000 or more at December 31, 2009 included brokered deposits of $30,030,000 which mature in 2010. Deposits held for related parties amounted to $9,889,556, $8,659,875 and $8,903,098 at December 31, 2009, 2008 and 2007, respectively. NN OO TT EE GG –– 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, 2009, the Company had facilities in place to purchase federal funds up to $57,000,000 under established credit arrangements. At December 31, 2009, 2008 and 2007, 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 $167,280,777, $176,909,231 and $172,925,118, 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. 19 NN OO TT EE HH -- BB OO RR RR OO WW II NN GG SS :: During 2009, the Company received approval to participate in the Federal Reserve Bank Discount Window Primary Credit Program. The borrowing limit, which was $41,216,000 at December 31, 2009, is based on the amount of collateral pledged, with certain loans from the Bank's portfolio serving as collat- eral. Borrowings bear interest at 25 basis points over the current fed funds rate and have a maturity of one day. There was no outstanding balance at December 31, 2009. At December 31, 2009, the Company had $104,270,452 outstanding in advances under a $133,693,944 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%. One advance in the amount of $30,000,000 bears interest at .15%. One advance in the amount of $12,000,000 bears interest at a fixed rate of .09%. One advance in the amount of $10,000,000 bears interest at a fixed rate of .12%. One advance in the amount of $45,000,000 bears interest at a fixed rate of .10%. All of these advances mature in 2010. The remaining balance consists of smaller advances bearing interest from 3.35% to 7.00% with maturity dates from 2015 - 2040. The advances are collateralized by a blanket floating lien on the Company's residential first mortgage loans. NN OO TT EE II -- NN OO TT EE SS PP AA YY AA BB LL EE :: The Company had a $5,000,000 unsecured line of credit with Silverton Bank, N.A. The line bore interest at .50% under Wall Street Journal Prime and required interest only payments quarterly with all principal and accrued interest due at maturity, which was July 6, 2009. There was no outstanding bal- ance on this line at December 31, 2008. At December 31, 2007, the outstanding balance on this line was $150,000, which was included in Other Liabilities. The Company has a $2,500,000 unsecured line of credit with Mississippi National Bankers Bank. The line bears interest at Wall Street Journal Prime with a floor of 4.00% and requires interest only payments quarterly with all principal and accrued interest due at maturity, which is March 11, 2010. There was no outstanding balance on this line at December 31, 2009. NN OO TT EE JJ -- II NN CC OO MM EE TT AA XX EE SS :: Deferred taxes (or deferred charges) as of December 31, 2009, 2008 and 2007, 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 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 2009 2008 2007 $ 2,661 $ 3,779 3,005 1,225 299 540 7,730 339 6,547 489 7,375 2,579 1,011 419 316 8,104 1,817 6,093 35 7,945 $ 3,282 2,268 891 123 327 6,891 589 6,094 36 6,719 √$ 355 $ 159 $ 172 2009 2008 $ (208) $ 2,897 1,162 (920) $ 954 $ 1,977 2007 $ 2,435 2,607 $ 5,042 Income taxes amounted to less than the amounts computed by applying the U.S. Federal income tax rate of 34.0% for 2009 and 2008 and 35.0% for 2007 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 Income from BOLI Federal tax credits Deferred expense adjustment Other Total income taxes 2009 Amount $ 1,419 (385) (183) (129) 228 4 $ º954 % 34.0 (9.2) (4.4) (3.1) 5.5 0.1 22.9 2008 Amount $ 2,384 (365) (168) % 34.0 (5.2) (2.4) 2007 Amount $ 5,624 (303) (177) 126 1.8 (102) $ 1,977 28.20 $ 5,042 % 35.0 (1.9) (1.1) (0.6) 31.40 The Company has reviewed its income tax positions and specifically considered the recognition and measurement requirements 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, 2009, 2008 and 2007. 20 NN OO TT EE KK -- 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, 2009, approximately $23,194,000 of undistributed earn- ings of the bank subsidiary included in consolidated surplus and retained earnings was available for future distribution to the Company as dividends. Dividends paid by the Company are subject to the approval of the Federal Reserve Bank. 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, which was completed during 2009, 132,588 shares were repurchased and retired. On February 25, 2009, the Board approved the repurchase of up to 3% of the outstanding shares of the Company’s common stock. As a result of this repurchase plan, 19,245 shares were repurchased and retired as of December 31, 2009. The Company must receive approval from the Federal Reserve Bank before repurchasing additional shares. On December 4, 2009, the Company’s Board of Directors approved a semi-annual dividend of $.10 per share. This dividend has a record date of January 8, 2010 and a distribution date of January 15, 2010. The bank subsidiary is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capi- tal 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 cer- tain off-balance sheet items as calculated under regulatory accounting practices. The bank subsidiary’s capital amounts and classification are also sub- ject 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, 2009, 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 cap- ital 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 2009, 2008 and 2007, are as follows (in thousands): Actual For Capital Adequacy Purposes December 31, 2009: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) 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) Amount $ 111,060 103,785 103,785 $ 111,714 104,472 104,472 $ 112,510 105,345 105,345 Ratio 19.08% 17.83% 11.47% 19.28% 18.03% 11.61% 19.63% 18.38% 10.93% Amount $46,559 23,280 36,194 $46,348 23,174 35,983 $45,854 22,927 38,555 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 2009, 2008 and 2007, are as follows (in thousands): December 31, 2009: Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Average Assets) 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) Actual Ratio 18.31% 17.06% 10.94% 18.83% 17.58% 11.31% 19.51% 18.26% 10.84% Amount $ 105,728 98,512 98,512 $ 108,207 101,022 101,022 $ 111,413 104,276 104,276 21 For Capital Adequacy Purposes Ratio Amount $46,184 23,092 36,006 $45,984 22,992 35,743 $45,676 22,838 38,481 8.00% 4.00% 4.00% 8.00% 4.00% 4.00% 8.00% 4.00% 4.00% NN OO TT EE LL -- 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 Increase in cash surrender value of life insurance 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 FDIC and state assessments Other Totals $ 2009 83 484 535 153 $ 1,255 2009 $ 583 380 518 2,038 90 326 1,429 1,754 $ 7,118 2008 $ 117 538 494 383 $ 1,532 2008 $ 636 344 680 2,024 176 356 169 2,114 $6,499 2007 $ 171 345 505 216 $ 1,237 2007 $ 597 457 452 1,814 90 421 129 1,938 $5,898 NN OO TT EE MM -- 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, ele- ments 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 nonperfor- mance by the other party to the financial instrument for commitments to extend credit and irrevocable letters of credit is represented by the contractu- al amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-bal- ance-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, 2009, 2008 and 2007, the Company had outstanding irrevocable letters of credit aggregating $6,037,976, $7,201,053 and $7,128,972, respectively. At December 31, 2009, 2008 and 2007, the Company had outstanding unused loan commitments aggregating $97,882,869, $116,091,000 and $133,771,000, respectively. Approximately $63,298,000, $69,684,000 and $72,208,000 of outstanding commitments were at fixed rates and the remainder were at variable rates at December 31, 2009, 2008 and 2007, respectively. NN OO TT EE NN -- 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 settle- ment, pursuant to which the bank subsidiary did not admit any wrongdoing. This settlement effectively concluded 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 are expected, in the opinion of Management, to have a material adverse effect upon the financial position or results of operations of the Company. 22 NN OO TT EE OO -- 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 2009 2008 2007 $ 98,467 $ 103,701 $ 105,592 1 1,103 4,694 1 496 4,552 1 528 2,226 $ 104,265 $ 108,750 $ 108,347 $ 677 677 103,588 $ 104,265 $ 1,750 1,750 107,000 $ 108,750 $ 1,805 1,805 106,542 $ 108,347 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 expense (benefit) Net income 2009 2008 2007 $ 5,800 (2,511) 7 3,296 71 71 3,225 5 $ 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) $ 3,220 $ 5,034 $ 11,026 23 C O N D E N S E D S T A T E M E N T S O F C A S H F L O W S ( I N T H O U S A N D S ) : Years Ended December 31, Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by (used in) operating activities: Gain on liquidation of investment (Gain) loss on other investments Impairment loss on equity investments Net income of consolidated subsidiaries Change in assets and liabilities: Other assets Net cash provided by (used in) operating activities Cash flows from investing activities: Investment in equity securities Proceeds from liquidation of investment Dividends from unconsolidated subsidiary Net cash provided by investing activities 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 2009 2008 2007 $ 3,220 $ 5,034 $ 11,026 (147) 150 (3,290) 5 (62) (150) 5,800 5,650 1,500 (1,500) (2,367) (2,614) (4,981) 607 496 (249) 270 (5,039) (11,050) (3) 13 (3,160) 753 8,550 6,143 300 (450) (3,035) (3,003) (6,188) (32) 528 9 (15) (700) 6,800 6,100 950 (800) (3,107) (2,655) (5,612) 473 55 $ 1,103 $ 496 $ 528 Peoples Financial Corporation paid income taxes of $520,000, $1,650,000 and $4,819,000 in 2009, 2008 and 2007, respectively. No interest was paid dur- ing the three years ended December 31, 2009. NN OO TT EE PP -- 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, $400,000 and $410,000 in 2009, 2008 and 2007, respectively. Compensation expense of $9,091,240, $9,504,193 and $9,207,514 was the basis for determining the ESOP contribution allocation to participants for 2009, 2008 and 2007, respectively. The ESOP held 445,884, 445,741 and 445,038 allocated shares at December 31, 2009, 2008 and 2007, 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 officer, 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 retirement 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 $14,167,091, $13,648,077 and $12,648,035 at December 31, 2009, 2008 and 2007, respectively. The present value of accumulated benefits under these plans, using an interest rate of 6.00% in 2009, 2008 and 2007 and the interest ramp-up method for 2009, 2008 and 2007, has been accrued. The accrual amounted to $7,768,888, $6,798,774 and $5,796,097 at December 31, 2009, 2008 and 2007, respectively, and is included in Other Liabilities. 24 The Company also has additional plans for post-retirement benefits for certain key executives. The Company has acquired insurance policies, with the bank subsidiary as owner and beneficiary, which 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 $793,434, $687,407 and $593,946 at December 31, 2009, 2008 and 2007, respectively. The present value of accumulated benefits under these plans using an interest rate of 6.00% in 2009 and 7.50% in 2008 and 2007 and the projected unit cost method has been accrued. The accrual amounted to $835,249, $584,699 and $534,205 at December 31, 2009, 2008 and 2007, 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 ben- efit to the participants’ beneficiaries. These contracts are carried at their cash surrender value, which amounted to $241,059, $233,903 and $226,417 at December 31, 2009, 2008 and 2007, respectively. Beginning in 2008, the Company was required to accrue the post-retirement benefit payable under these contacts and accordingly recorded a liability of $56,832 on January 1, 2008. The present value of accumulated benefits under these plans using an inter- est rate of 6.00% in 2009 and 2008 and the projected unit cost method has been accrued. The accrual amounted to $66,717 and $60,232 at December 31, 2009 and 2008, respectively, and is included in Other Liabilities. The Company has additional plans for 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, that amounted to $127,810, $118,773 and $110,138 at December 31, 2009, 2008 and 2007, respectively. The present value of accumulated benefits under these plans using an interest rate of 6.00% in 2009 and 2008 and 7.50% in 2007, and the projected unit cost method has been accrued. The accrual amount- ed to $163,173, $142,088 and $150,587 at December 31, 2009, 2008 and 2007, 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 addi- tion, the employee must have at least 25 continuous years of service with the Company immediately preceding retirement. However, any active employ- ee 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 obli- gation 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 elim- inate 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, 2009 2008 Service cost, including amortization of loss $ 396,918 $ 179,330 Interest cost Amortization of net transition obligation 245,511 20,600 159,316 20,600 Net periodic post-retirement benefit cost $ 663,029 $ 359,246 2007 $ 275,345 175,700 20,600 $ 471,645 The discount rate used in determining the accumulated post-retirement benefit obligation was 6.05% in 2009, 6.00% in 2008 and 6.50% in 2007. 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 accumu- lated post-retirement benefit obligation as of December 31, 2009, would be increased by 22.61%, and the aggregate of the service and interest cost com- ponents of the net periodic post-retirement benefit cost for the year then ended would have increased by 25.75%. If the health care cost trend rate assump- tions were decreased 1.00%, the accumulated post-retirement benefit obligation as of December 31, 2009, would be decreased by 17.59%, and the aggre- gate of the service and interest cost components of the net periodic post-retirement benefit cost for the year then ended would have decreased by 19.59%. 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 2010 2011 2012 2013 2014 $ 64,000 73,000 74,000 87,000 4,000 2015 – 2019 1,092,000 25 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, 2008 Service cost Interest cost Actuarial gain Benefits paid Accumulated post-retirement benefit obligation as of December 31, 2009 $ 4,208,429 313,509 245,511 (111,305) (57,257) $ 4,598,887 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 2009 2008 2007 $ $ 57,257 (57,257) $ $ 84,186 (84,186) $ $ 80,122 (80,122) 2009 2008 2007 $ 86,201 67,965 724,998 $ 879,164 $159,662 81,574 780,036 $ 1,021,272 $ 134,749 92,078 $226,827 Amounts recognized in the accumulated post-retirement benefit obligation and other comprehensive income were: For the year ended December 31, Unrecognized actuarial gain Amortization of prior service cost Amortization of transition obligation Total accumulated other comprehensive income 2009 $ (111,305) (83,409) (20,600) $ (215,314) 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 2010 is $83,409 and $20,600, respectively. NN OO TT EE QQ -- 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. Certain financial instruments and all nonfinancial instruments are excluded from these dis- closure requirements. Significant assets and liabilities that are not considered financial instruments include deferred income taxes and bank premises and equipment. 26 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 esti- mates 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 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 dis- count 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 loss- es 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 cred- it 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 auto- matic 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. 27 The following table presents carrying amounts and estimated fair values for financial assets and financial liabilities at December 31, 2009, 2008 and 2007 (in thousands): 2009 2008 2007 Carrying Amount Fair Value $ 29,155 $ 29,155 311,434 3,341 4,036 5,016 460,588 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 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 311,434 3,202 4,036 5,016 457,148 15,329 96,541 374,160 470,701 174,431 104,270 15,329 14,688 14,688 13,579 13,579 96,541 375,052 471,593 174,431 105,815 109,033 401,442 510,475 109,033 402,361 511,394 113,916 455,214 569,130 113,916 456,490 570,406 226,609 226,609 231,255 231,255 36,938 37,547 7,100 7,811 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 Peoples Financial Corporation and subsidiaries’ (the “Company”) internal control over financial reporting as of December 31, 2009, 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 assess- ment 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 weak- ness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included per- forming 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 report- ing and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s inter- nal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accu- rately 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 expendi- tures 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 com- pliance with the policies or procedures may deteriorate. In our opinion, Peoples Financial Corporation and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, 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, 2009, 2008 and 2007, and the related statements of income, sharehold- ers’ equity and cash flows for the years then ended, and our report dated February 24, 2010, expressed an unqualified opinion on those consolidated finan- cial statements. Atlanta, Georgia February 24, 2010 29 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, 2009, 2008 and 2007, 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, 2009, 2008 and 2007, 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 also have 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, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2010, expressed an unqualified opin- ion on the effectiveness of Peoples Financial Corporation’s internal control over financial reporting. Atlanta, Georgia February 24, 2010 30 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 2009 2008 2007 2006 2005 $ 869,007 $ 896,408 $ 927,357 $ 964,023 $ 845,325 311,434 3,202 464,976 470,701 104,270 103,588 340,642 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 $ 34,289 $ 43,573 $ 55,971 $ 48,894 $ 32,343 7,401 26,888 5,225 21,663 10,147 27,636 4,174 954 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 ª25,263 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 20,468 7,948 2,604 538 $ 3,220 $ 5,034 $ 11,026 $ 12,768 $ 5,882 Basic and diluted earnings per share $ .62 $ .94 $ 2.01 $ 2.30 $ 1.06 Basic and diluted earnings per share before extraordinary gain Dividends per share Book value .62 .50 20.11 .94 .56 20.27 2.01 .52 19.56 2.30 .44 17.71 .96 .38 15.77 Weighted average number of shares 5,170,430 5,342,470 5,489,861 5,548,300 5,550,477 Selected Ratios Return on average assets Return on average equity Primary capital to average assets Risk-based capital ratios: Tier 1 Total .36% 3.06% 12.49% 17.83% 19.08% .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% 31 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, 2009 Interest income Net interest income Provision for loan losses Income before income taxes Net income Basic and diluted earnings per share Quarter Ended, 2008 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 $ 8,568 June 30 $ 8,595 September 30 December 31 $ 8,671 $ 8,455 6,274 348 1,993 1,703 .33 6,569 1,502 151 201 .04 7,019 1,875 1,069 974 .19 7,026 1,500 961 342 .06 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 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 2009 2008 Quarter High Low Dividend per share $ 20.00 $ 15.76 $ .30 21.49 21.49 21.39 16.00 17.30 15.35 .20 $ 25.49 $ 19.89 $ .27 23.35 23.57 22.60 20.50 18.00 17.80 .29 1st 2nd 3rd 4th 1st 2nd 3rd 4th 32 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 33 

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