Summary of PEOPLES FINANCIAL CORP /MS/

Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations
GENERAL
The Company is a one-bank holding company headquartered in Biloxi, Mississippi. It has two operating subsidiaries, PFC Service Corp. and The Peoples Bank, Biloxi, Mississippi (the "Bank"). The Bank provides a full range of banking, financial and trust services to state, county and local government entities and individuals and small and commercial businesses in Harrison, Hancock, Stone and Jackson counties in Mississippi.
The following presents Management's discussion and analysis of the consolidated financial condition and results of operations of Peoples Financial Corporation and Subsidiaries. These comments should be considered in combination with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in this report on Form 10-Q and the Consolidated Financial Statements, Notes to Consolidated Financial Statements and Management's Discussion and Analysis included in the Company's Form 10-K for the year ended December 31, 2007.
Forward-Looking Information
Congress passed the Private Securities Litigation Act of 1995 in an effort to encourage corporations to provide information about a company's anticipated future financial performance. This act provides a safe harbor for such disclosure which protects the companies from unwarranted litigation if actual results are different from management expectations. This report contains forward-looking statements and reflects industry conditions, company performance and financial results. These forward-looking statements are subject to a number of factors and uncertainties which could cause the Company's actual results and experience to differ from the anticipated results and expectations expressed in such forward-looking statements. Such factors and uncertainties include, but are not limited to: changes in interest rates and market prices, changes in local economic and business conditions, increased competition for deposits and loans, a deviation in actual experience from the underlying assumptions used to determine and establish the allowance for loan losses, changes in the availability of funds resulting from reduced liquidity, changes in government regulations and acts of terrorism, weather or other events beyond the Company's control.
Emergency Economic Stabilization Act
The Emergency Economic Stabilization Act of 2008 was enacted on October 3, 2008. The purpose of this law is to restore liquidity and stability to the financial system, while minimizing any potential long term negative impact on taxpayers. The law authorizes the United States Secretary of Treasury to spend up to $700 billion to purchase distressed assets, especially mortgage-backed securities, from the nation's banks. The program under which the asset purchase will be administered is referred to as the Troubled Asset Relief Program ("TARP"). The Company does not expect to participate in TARP.
The law also temporarily raises the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. The higher insurance limits took effect immediately and will be in effect through December 31, 2009. Additionally, the Federal Deposit Insurance Corporation (FDIC) announced on October 14, 2008, a new program, the Temporary Liquidity Guarantee Program ("TLGP"), which guarantees newly issued senior unsecured debt of banks, thrifts, and certain holding companies, and provides full coverage of non-interest bearing deposit transaction accounts, regardless of dollar amount. The program provides a three year guarantee of newly issued debt and increased insurance coverage through December 31, 2009. This two-pronged program will be funded through special fees paid by the financial institutions participating. The Company must decide whether to participate in one, both or none of these phases of the program by December 5, 2008.

Critical Accounting Policies
Certain critical accounting policies affect the more significant estimates and assumptions used in the preparation of the consolidated financial statements. The Company's single most critical accounting policy relates to its allowance for loan losses, which reflects the estimated losses resulting from the inability of its borrowers to make loan payments. If there was a deterioration of any of the factors considered by Management in evaluating the allowance for loan losses, the estimate of loss would be updated, and additional provisions for loan losses may be required.
OVERVIEW
For the third quarter of 2008, the Company realized a net loss of $1,053,644, while it realized net income of $3,394,511 for the third quarter of 2007. This significant change is directly attributable to asset impairment charges recorded during the current quarter. A loss of $2,964,000 from the other-than-temporary impairment of the Company's investment in Federal Home Loan Mortgage Corporation ("FHLMC") preferred stock and a provision for loan losses of $2,001,000 were recorded during the third quarter of 2008. During the third quarter of 2007, the Company recorded a negative provision for loan losses of $1,197,000. Net income for the first nine months 2008 was $3,213,754 compared with $8,096,084 for the first nine months of 2007. This decline was the result of the asset impairment charges discussed in the previous paragraph.
Total assets decreased to $874,700,365 at September 30, 2008 from $927,356,573 at December 31, 2007. This decrease was primarily attributable to the net decrease in available for sale securities of $93,643,639 during the first nine months of 2008. This significant decrease was the result of calls of available for sale securities of more than $155,000,000 since January 1, 2008. Proceeds from these calls funded loan demand and liquidity needs with excess funds being invested primarily in U.S. Agency securities.

RESULTS OF OPERATIONS
Net Interest Income
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.
During the first nine months of 2008, the Federal Open Market Committee (the "Committee") dropped the discount rate by a total of 225 basis points, which resulted in decreases in prime interest rates during this time. The Committee's actions were a part of the U.S. Government's larger plan to stabilize the national economy and address concerns of a looming recession. The impact of these rate reductions was significant to the Company's financial condition and results of operations.
Quarter Ended September 30, 2008 as Compared with Quarter Ended September 30, 2007
The Company's average interest earning assets decreased approximately $52,802,000, or 6%, from approximately $857,125,000 for the third quarter of 2007 to approximately $804,323,000 for the third quarter of 2008. As a direct result of the Committee's rate reductions, more than 20% of the Company's available for sale securities portfolio were called during 2008.
Also as a result of the Committee's actions, the average yield on earning assets decreased 136 basis points, from 6.75% for the third quarter of 2007 to 5.39% for the third quarter of 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 $41,493,000, or 6%, from approximately $703,633,000 for the third quarter of 2007 to approximately $662,140,000 for the third quarter of 2008. The average rate paid on interest bearing liabilities decreased 157 basis points, from 3.68% for the third quarter of 2007 to 2.11% for the third quarter of 2008.
The Company's trade area generally experiences a very competitive interest rate environment for deposits. During the last two quarters of 2007, this competition ramped up significantly. In some cases, the Company chose to not match higher rates offered to our customers by a competitor. This strategy has resulted in a favorable improvement in the yield on interest-bearing liabilities as well as an overall reduction in total deposits.
The Company's net interest margin on a tax-equivalent basis, which is net interest income as a percentage of average earning assets, was 3.66% at September 30, 2008, up 60 basis points from 3.06% at September 30, 2007.

Nine Months Ended September 30, 2008 as Compared with Nine Months Ended September 30, 2007
The Company's average interest earning assets decreased approximately $67,755,000, or 8%, from approximately $880,711,000 for the first nine months of 2007 to approximately $812,956,000 for the first nine months of 2008. As a direct result of the Committee's rate reductions, more than 20% of the Company's available for sale securities portfolio were called during 2008.
Also as a result of the Committee's actions, the average yield on earning assets decreased 88 basis points, from 6.47% for the first nine months of 2007 to 5.59% for the first nine months of 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 $50,114,000, or 7%, from approximately $720,333,000 for the first nine months of 2007 to approximately $670,219,000 for the first nine months of 2008. The average rate paid on interest bearing liabilities decreased 120 basis points, from 3.62% for the first nine months of 2007 to 2.42% for the first nine months of 2008. The Company's trade area generally experiences a very competitive interest rate environment for deposits. During the last two quarters of 2007, this competition ramped up significantly. In some cases, the Company chose to not match higher rates offered to our customers by a competitor. This strategy has resulted in a favorable improvement in the yield on interest-bearing liabilities as well as an overall reduction in total deposits.
The Company's net interest margin on a tax-equivalent basis, which is net interest income as a percentage of average earning assets, was 3.59% at September 30, 2008, up 8 basis points from 3.51% at September 30, 2007. The tables on the following pages analyze the changes in tax-equivalent net interest income for the quarters ended September 30, 2008 and 2007 and the nine months ended September 30, 2008 and 2007.

          Analysis of Average Balances, Interest Earned/Paid and Yield
                                 (In Thousands)

                                                    Three Months Ended September 30, 2008                                                Three Months Ended September 30, 2007
                                              Average Balance              Interest Earned/Paid                Rate                Average Balance              Interest Earned/Paid                Rate

Loans (2)(3)                                $         472,088               $             6,603                5.59 %            $         433,657               $             8,919                8.23 %

Federal Funds Sold                                     11,397                                50                1.75 %                        8,635                               108                5.00 %

HTM:
Taxable                                                                                                                                      5,237                                59                4.51 %

Non taxable (1)                                         3,393                                52                6.13 %                        4,629                                72                6.22 %

AFS:
Taxable                                               285,869                             3,738                5.23 %                      381,025                             4,944                5.19 %

Non taxable (1)                                        24,214                               362                5.98 %                       18,661                               276                5.92 %

Other                                                   7,362                                42                2.82 %                        5,281                                76                5.76 %


Total                                       $         804,323               $            10,847                5.39 %            $         857,125               $            14,454                6.75 %

Savings & interest- bearing DDA             $         254,513               $               972                1.53 %            $         265,333               $             1,441                2.17 %

CD's                                                  184,393                             1,303                2.83 %                      215,774                             2,421                4.49 %

Federal funds purchased                               215,548                             1,111                2.06 %                      213,200                             2,475                4.64 %

FHLB advances                                           7,686                               103                5.36 %                        9,326                               139                5.96 %


Total                                       $         662,140               $             3,489                2.11 %            $         703,633               $             6,476                3.68 %


Net tax-equivalent yield on
earning assets                                                                                                 3.66 %                                                                               3.06 %

(1) All interest earned is reported on a taxable equivalent basis using a tax rate of 34% in 2008 and 2007.

(2) Loan fees of $183,079 and $375,548 for 2008 and 2007, respectively, are included in these figures.

(3) Includes nonaccrual loans.

          Analysis of Average Balances, Interest Earned/Paid and Yield
                                 (In Thousands)

                                                Nine Months Ended September 30, 2008                                             Nine Months Ended September 30, 2007
                                          Average Balance             Interest Earned/Paid                   Rate          Average Balance             Interest Earned/Paid                   Rate

Loans (2)(3)                             $        461,948             $             20,711               5.98 %           $        421,795             $             25,132               7.94 %

Federal Funds Sold                                  7,024                              112               2.12 %                      4,839                              189               5.21 %

HTM:
Taxable                                                                                                                             28,085                            1,060               5.03 %

Non taxable (1)                                     3,791                              178               6.26 %                      4,830                              229               6.32 %

AFS:
Taxable                                           309,603                           11,939               5.14 %                    397,409                           15,161               5.09 %

Non taxable (1)                                    23,166                            1,008               5.80 %                     18,382                              811               5.89 %

Other                                               7,424                              143               2.57 %                      5,371                              183               4.54 %


Total                                    $        812,956             $             34,091               5.59 %           $        880,711             $             42,765               6.47 %

Savings & interest- bearing DDA          $        253,197             $              3,032               1.60 %           $        276,246             $              4,225               2.04 %

CD's                                              201,571                            5,080               3.36 %                    206,536                            6,869               4.43 %

Federal funds purchased                           207,612                            3,731               2.40 %                    228,248                            8,045               4.70 %

FHLB advances                                       7,839                              343               5.83 %                      9,303                              418               5.99 %


Total                                    $        670,219             $             12,186               2.42 %           $        720,333             $             19,557               3.62 %

Net tax-equivalent yield on
earning assets                                                                                           3.59 %                                                                           3.51 %

(1) All interest earned is reported on a taxable equivalent basis using a tax rate of 34% in 2008 and 2007.

(2) Loan fees of $592,391 and $682,574 for 2008 and 2007, respectively, are included in these figures.

(3) Includes nonaccrual loans.

Provision for Loan Losses
In the normal course of business, the Company assumes risk in extending credit to its customers. This credit risk is managed through compliance with the loan policy (the "policy"), which is approved by the Board of Directors. The policy establishes guidelines relating to underwriting standards, including but not limited to financial analysis, collateral valuation, lending limits, pricing considerations and loan grading. A loan review process further assists with evaluating credit quality and assessing potential performance issues. Loan delinquencies and deposit overdrafts are closely monitored in order to identify developing problems as early as possible. In addition, the Company continuously monitors its relationships with its loan customers in concentrated industries such as gaming and hotel/motel, as well as the exposure for out of area loans, and 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.
Since Hurricane Katrina hit the Mississippi Gulf Coast in August of 2005, the Company has modified its procedures to analyze its loan portfolio in light of the extraordinary impact of the storm on its trade area. Specific consideration of credits and their underlying collateral were conducted within weeks of the hurricane's landfall. Based on its evaluation, the Company recorded a provision for loan losses of $5,055,000 during the third quarter of 2005. The Company continued to closely monitor its portfolio during the quarters that followed, making note of the potential impact of federal assistance, insurance availability and affordability, the pace of recovery in the region and increasing construction costs. Another factor which was given serious consideration was the length of time which has passed since August of 2005, since research has proven that a window of approximately two years usually passes before potential losses from catastrophic events such as Hurricane Katrina become apparent. Based on these factors and its ongoing analysis, the Company recorded a negative provision of $1,250,000 during the third quarter of 2007, effectively reversing approximately 25% of the provision recorded in 2005. The credit crisis our nation is now facing has affected the Bank's loan portfolio. The Company relies on its guidelines and existing methodology to monitor the performance of its loan portfolio and identify potential losses. For the quarter ended September 30, 2008, this on-going, systematic evaluation identified potential losses and resulted in the Company recording a provision of $2,001,000 for the third quarter of 2008, of which $1,180,000 relates to two residential development loans with a total outstanding balance of $10,594,320. The allowance for loan losses is an estimate, and as such, events may occur in the future which may affect its accuracy. The Company anticipates that it is possible that additional information will be gathered in future quarters which may require an adjustment to the allowance for loan losses. Management will continue to closely monitor its portfolio and take such action as it deems appropriate to accurately report its financial condition and results of operations.

Non-interest income
Total non-interest income increased $307,199 for the third quarter of 2008 as compared with the third quarter of 2007. During the third quarter of 2008, the Company recorded a net gain on the sale, liquidation or call of securities of $249,000 as compared with a net gain of $4,688 during the third quarter of 2007. Total non-interest income increased $864,031 for the first nine months of 2008 as compared with the first nine months of 2007. During the first nine months of 2008, the Company recorded a net gain on the sale, liquidation or call of securities of $364,277 as compared with a net loss of $614,327 during the first nine months of 2007.
Non-interest expense
Total non-interest expense increased $3,039,230 for the third quarter of 2008 as compared with the third quarter of 2007. During the third quarter of 2008, the Company recorded a charge to earnings for the impairment of its investment in FHLMC preferred stock of $2,964,000, which is included in Other Expense. Total non-interest expense increased $3,762,031 for the first nine months of 2008 as compared with the first nine months of 2007 as equipment rentals, depreciation and maintenance expense and other expense increased.
Equipment rentals, depreciation and maintenance expenses increased $315,027 for the first nine months of 2008 compared with the first nine months of 2007. Contributing to this increase was an increase in depreciation expense of $347,500 on banking premises which were placed into service after March 31, 2007.
Included in the increase of $3,311,258 in other expense for the first nine months of 2008 as compared with the first nine months of 2007 are the impairment charge on the FHLMC preferred stock and increases in ATM and accounting and auditing costs. The increase in expense of $186,818 for offsite ATMs was caused by an increase in the number of such ATMs and in the number of transactions at such ATMs. The increase in accounting and auditing fees of $123,082 was due to the outsourcing of the I/T internal audit function and the increase in audit fees for 2008.
FINANCIAL CONDITION
Available for sale securities decreased $93,643,639 at September 30, 2008, compared with December 31, 2007. The Federal Reserve reduced interest rates by 225 basis points during 2008, which resulted in more than $155,00,000 of the Company's U.S. Agency securities being called during the first nine months of the year. Proceeds from these calls have provided funding for lending and liquidity requirements, and excess funds have been invested in U.S. Agency securities. The following schedule reflects the mix of available for sale securities at September 30, 2008 and December 31, 2007:

                                          September 30, 2008      December 31, 2007

   Available for sale securities:
   U.S. Treasury                          $       66,392,175      $      73,306,340

   U.S. Government agencies and corp.            170,324,369            253,799,811

   Mortgage-backed securities                     29,917,772             33,383,897

   States and political subdivisions              25,017,133             22,482,364

   Equity securities                               1,733,837              4,056,513


   Total available for sale securities    $      293,385,286      $     387,028,925

The Company's held to maturity portfolio was invested solely in debt securities issued by state and political subdivisions at September 30, 2008 and December 31, 2007. The decrease in these securities of $1,236,486 since December 31, 2007 is the result of maturities. The composition of the loan portfolio was as follows:

                                                                    September 30, 2008          December 31, 2007

Real estate, construction                                          $      114,222,465          $      93,739,256
Real estate, mortgage                                                     290,467,377                265,463,768
Loans to finance agricultural production                                    3,094,971                  2,545,169
Commercial and industrial loans                                            42,332,888                 76,267,162
Loans to individuals for household, family and other
consumer expenditures                                                      11,027,296                 11,173,054
Obligations of states and political subdivisions                            1,408,852                  1,747,293
All other loans                                                                   979                     56,372


Total                                                              $      462,554,828          $     450,992,074

Interest earning assets, particularly available for sale securities, have decreased since January 1, 2008 along with a decrease in interest rates earned on these assets. These trends directly impact accrued interest receivable, which decreased $2,280,314 during the first half of 2008.
Other assets increased $1,830,631 at September 30, 2008 as compared with December 31, 2007 as a result of increased deferred taxes of $1,997,645 on unrealized losses on available for sale securities and the impairment charge on the FHLMC preferred stock.
Total deposits decreased $31,593,222 at September 30, 2008, as compared with December 31, 2007. Fluctuations among the different types of deposits represent recurring activity for the Company. Since December 31, 2007, however, time deposits of $100,000 or more have decreased by $67,997,227. This significant decrease primarily resulted from the Company's decision to not match higher rates offered to our customers by competitors. The

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