Your Community Bankshares, Inc. - FORM 10-Q

Attached files

file	filename
EX-31.1 - EXHBIT 31.1 - Your Community Bankshares, Inc.	v319544_ex31-1.htm
EX-32.1 - EXHBIT 32.1 - Your Community Bankshares, Inc.	v319544_ex32-1.htm
EX-31.2 - EXHBIT 31.2 - Your Community Bankshares, Inc.	v319544_ex31-2.htm
EX-32.2 - EXHBIT 32.2 - Your Community Bankshares, Inc.	v319544_ex32-2.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from _______________ to _______________

Commission File No. 0-25766

Community Bank Shares of Indiana, Inc.

(Exact name of registrant as specified in its charter)

Indiana	35-1938254
(State or other jurisdiction of incorporation or
organization)	(I.R.S. Employer Identification Number)

101 W. Spring Street, New Albany, Indiana	47150
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code 812-944-2224

Not applicable

Former name, former address and former fiscal year, if changed since last report

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

Large Accelerated Filer ¨ Accelerated Filer ¨ Non- Accelerated Filer x Smaller Reporting Company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. ¨ Yes £ No

APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 3,362,553 shares of common stock were outstanding as of August 10, 2012.

COMMUNITY BANK SHARES OF INDIANA, INC.

INDEX

		Page
Part I	Financial Information

Item 1.	Financial Statements
	Consolidated Balance Sheets	3

	Consolidated Statements of Income	4

	Consolidated Statements of Comprehensive Income	6

	Consolidated Statement of Changes in Shareholders’ Equity	7

	Consolidated Statements of Cash Flows	8

	Notes to Consolidated Financial Statements	10

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	42

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	56

Item 4.	Controls and Procedures	59

Part II	Other Information

Item 1.	Legal Proceedings	60

Item 1a.	Risk Factors	60

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	60

Item 6.	Exhibits	60

Signatures		61

Exhibit Index		62

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

	June 30,			December 31,
	2012			2011
	(In thousands, except share data)
ASSETS
Cash and due from financial institutions	$	13,999		$	15,166
Interest-bearing deposits in other financial institutions		42,882			30,297
Securities available for sale		223,345			198,746
Loans held for sale		313			1,154
Loans, net of allowance for loan losses of $11,109 and $10,234		487,413			489,740
Federal Home Loan Bank and Federal Reserve stock		6,011			5,952
Accrued interest receivable		3,225			3,196
Premises and equipment, net		13,766			13,780
Company owned life insurance		20,356			20,012
Other intangible assets		749			865
Foreclosed and repossessed assets		5,371			5,076
Prepaid FDIC insurance premium		2,697			2,999
Settlement receivable for security sales		-			3,371
Other assets		6,750			7,000
Total Assets	$	826,877		$	797,354

LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Non interest-bearing	$	149,445		$	127,877
Interest-bearing		459,895			453,481
Total deposits		609,340			581,358
Other borrowings		56,004			50,879
Federal Home Loan Bank advances		55,000			55,000
Subordinated debentures		17,000			17,000
Accrued interest payable		300			329
Settlement liability for security purchases		-			6,914
Other liabilities		6,035			6,389
Total liabilities		743,679			717,869

Commitments and contingent liabilities		—			—

Shareholders’ equity
Preferred stock, without par value; 5,000,000 authorized; 28,000 shares issued and outstanding in 2012 and 2011, respectively; aggregate liquidation preference of $28,000		28,000			28,000
Common stock, $.10 par value per share; 10,000,000 shares authorized; 3,863,937 shares issued; 3,362,560 and 3,327,484 outstanding in 2012 and 2011, respectively		386			386
Additional paid-in capital		44,091			44,488
Retained earnings		15,847			13,201
Accumulated other comprehensive income		3,523			2,666
Treasury stock, at cost (2012- 501,377 shares, 2011- 536,453 shares)		(8,649	)		(9,256	)
Total shareholders’ equity		83,198			79,485
Total Liabilities and Shareholders’ Equity	$	826,877		$	797,354

See accompanying notes to consolidated financial statements.

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2012			2011			2012			2011
	(In thousands, except share data)
Interest and dividend income
Loans, including fees	$	6,774		$	6,849		$	13,620		$	13,762
Taxable securities		812			1,102			1,609			2,255
Tax-exempt securities		720			614			1,441			1,202
Federal Home Loan Bank and Federal Reserve dividends		50			46			98			95
Interest-bearing deposits in other financial institutions		14			6			25			15
Interest and dividend income		8,370			8,617			16,793			17,329

Interest expense
Deposits		608			1,051			1,208			2,222
Other borrowings		170			194			343			390
Federal Home Loan Bank advances		215			219			435			481
Subordinated debentures		110			102			223			204
Interest expense		1,103			1,566			2,209			3,297
Net interest income		7,267			7,051			14,584			14,032

Provision for loan losses		944			911			2,450			1,721

Net interest income after provision for loan losses		6,323			6,140			12,134			12,311

Non-interest income
Service charges on deposit accounts		838			871			1,708			1,623
Commission income		40			39			82			80
Net gain on sales of available for sale securities		438			469			1,165			1,053
Mortgage banking income		80			47			173			92
Earnings on company owned life insurance		173			173			344			334
Interchange income		266			245			514			485
Other income		144			94			301			229
Non-interest income		1,979			1,938			4,287			3,896

Non-interest expense
Salaries and employee benefits		2,980			2,893			6,138			5,952
Occupancy		594			607			1,126			1,164
Equipment		252			273			510			543
Data processing		553			599			1,135			1,143
Marketing and advertising		71			61			132			112
Legal and professional service fees		426			399			792			828
FDIC insurance premiums		140			244			317			510
Foreclosed assets, net		352			96			484			175
Other expense		609			515			1,225			1,107
Total non-interest expense		5,977			5,687			11,859			11,534
Income before income taxes		2,325			2,391			4,562			4,673

Income tax expense		371			536			773			1,030

Net income		1,954			1,855			3,789			3,643

Preferred stock dividend and discount accretion		(244	)		(267	)		(470	)		(533	)

Net income available to common shareholders	$	1,710		$	1,588		$	3,319		$	3,110

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2012		2011		2012		2011
	(In thousands, except share data)
Earnings per common share:
Basic	$	0.51	$	0.48	$	0.99	$	0.94
Diluted	$	0.51	$	0.46	$	0.99	$	0.91

Dividends per common share	$	0.10	$	0.10	$	0.20	$	0.20

See accompanying notes to consolidated financial statements.

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2012			2011			2012			2011
				(in thousands)
Net income	$	1,954		$	1,855		$	3,789		$	3,643

Other comprehensive income (loss), net of tax
Unrealized gain on securities:
Unrealized gain arising during the period (net of tax of $638 and $1,200 for the three months ended June 30, respectively and $828 and $1,800 for the six months ended June 30, respectively)		1,237			2,338			1,607			3,461
Reclassification adjustment for gains included in net income (net of tax of $149 and $160 for the three months ended June 30, respectively and $396 and $358 for the six months ended June 30, respectively)		(289	)		(309	)		(769	)		(695	)
Net unrealized gain on securities		948			2,029			838			2,766

Defined benefit pension plans:
Net gain (loss) arising during the period (net of tax benefit of $(14) and income tax expense $1 for the three months ended June 30, respectively and $10 and $5 for the six months ended June 30, respectively)		(28	)		(2	)		19			9

Total other comprehensive income		920			2,027			857			2,775

Comprehensive income	$	2,874		$	3,882		$	4,646		$	6,418

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollar amounts in thousands, except share data)

(Unaudited)

											Accumulated
					Additional						Other					Total
	Preferred		Common		Paid-In			Retained			Comprehensive		Treasury			Shareholders’
	Stock		Stock		Capital			Earnings			Income		Stock			Equity
Balance, January 1, 2012	$	28,000	$	386	$	44,488		$	13,201		$	2,666	$	(9,256	)	$	79,485
Net income		—		—		—			3,789			—		—			3,789
Change in unrealized gain (losses) on securities available for sale, net of reclassifications and tax effects		—		—		—			—			838		—			838
Unrealized gain on pension benefits, net of tax effects		—		—		—			—			19		—			19
Cash dividends declared on common stock ($0.10 per share)		—		—		—			(673	)		—		—			(673	)
Dividends on preferred stock		—		—		—			(470	)		—		—			(470	)
Issuance of treasury stock under dividend reinvestment plan		—		—		(4	)		—			—		109			105
Issuance of stock award shares		—		—		(498	)		—			—		498			—
Stock award expense		—		—		105			—			—		—			105
Balance, June 30, 2012	$	28,000	$	386	$	44,091		$	15,847		$	3,523	$	(8,649	)	$	83,198

See accompanying notes to consolidated financial statements.

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Six Months Ended
	June 30,
	2012			2011
	(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	3,789		$	3,643
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses		2,450			1,721
Depreciation and amortization		772			746
Net amortization of securities		628			411
Net gain on sales of available for sale securities		(1,165	)		(1,053	)
Mortgage loans originated for sale		(8,949	)		(5,531	)
Proceeds from mortgage loan sales		9,637			6,539
Net gain on sales of mortgage loans		(172	)		(89	)
Earnings on company owned life insurance		(344	)		(334	)
Shared based compensation expense		105			183
Net (gain) loss on disposition of premises and equipment		(32	)		-
Net (gain) loss on disposition of foreclosed and repossessed assets		150			(33	)
Net change in:
Accrued interest receivable		(29	)		(124	)
Accrued interest payable		(29	)		(127	)
Other assets		(4,257	)		1,454
Other liabilities		590			445
Net cash from operating activities		3,144			7,851
CASH FLOWS FROM INVESTING ACTIVITIES
Net change in interest-bearing deposits		(12,585	)		(11,853	)
Available for sale securities:
Sales		40,247			45,138
Purchases		(77,189	)		(29,127	)
Maturities, prepayments and calls		14,150			12,101
Loan originations and payments, net		(2,917	)		6,181
Proceeds from the sale of foreclosed and repossessed assets		2,368			851
Purchases of premises and equipment		(660	)		(552	)
Proceeds from the sale of premises and equipment		39			-
Investment in company owned life insurance		-			(117	)
Purchase of Federal Reserve and FHLB stock		(59	)		-
Proceeds from redemption of Federal Reserve and FHLB stock		-			883
Net cash from investing activities		(36,606	)		23,505
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits		27,982			(17,767	)
Net change in other borrowings		5,125			(2,168	)
Proceeds from Federal Home Loan Bank advances		10,000			20,000
Repayment of Federal Home Loan Bank advances		(10,000	)		(30,000	)
Cash dividends paid on preferred shares		(571	)		(486	)
Cash dividends paid on common shares		(566	)		(557	)
Net cash from financing activities		31,970			(30,978	)
Net change in cash and due from financial institutions		(1,167	)		378
Cash and due from financial institutions at beginning of period		15,166			11,658
Cash and due from financial institutions at end of period	$	13,999		$	12,036

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Six Months Ended
	June 30,
	2012		2011
	(In thousands)
Supplemental cash flow information:
Interest paid	$	2,238	$	3,424
Income taxes paid, net of refunds	$	1,563	$	330

Supplemental noncash disclosures:
Transfer from loans to foreclosed and repossessed assets	$	2,970	$	1,449
Issuance of treasury shares under dividend reinvestment plan	$	109	$	105
Sale and financing of foreclosed and repossessed assets	$	165	$	333

See accompanying notes to consolidated financial statements.

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Presentation of Interim Information

Community Bank Shares of Indiana, Inc. (“we,” “our” or “us”) is a bank holding company headquartered in New Albany, Indiana. Our wholly-owned banking subsidiaries are Your Community Bank (“Your Community Bank” or “YCB”), and The Scott County State Bank (“Scott County State Bank”). YCB and SCSB (YCB and SCSB are at times collectively referred to herein as the “Banks”) are state-chartered commercial banks headquartered in New Albany, Indiana and Scottsburg, Indiana, respectively, and are both regulated by the Indiana Department of Financial Institutions. Your Community Bank is also regulated by the Federal Deposit Insurance Corporation and (with respect to its Kentucky branches) the Kentucky Department of Financial Institutions. Scott County State Bank is also regulated by the Federal Reserve.

Your Community Bank has three wholly-owned subsidiaries to manage its investment portfolio. CBSI Holdings, Inc. and CBSI Investments, Inc. are Nevada corporations which jointly own CBSI Investment Portfolio Management, LLC, a Nevada limited liability corporation which holds and manages investment securities previously owned by Your Community Bank.

In June 2004 and June 2006, we completed placements of floating rate subordinated debentures through two trusts that we formed, Community Bank Shares (IN) Statutory Trust I and Trust II (“Trusts”). Because the Trusts are not consolidated with us, our financial statements reflect the subordinated debt we issued to the Trusts.

To prepare financial statements in conformity with U.S. generally accepted accounting principles management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses, valuation of other intangible assets, valuation of foreclosed assets, fair value and impairment of securities and deferred tax assets are particularly subject to change.

In the opinion of management, the unaudited consolidated financial statements include all normal adjustments considered necessary to present fairly the financial position as of June 30, 2012, the results of operations for the three and six months ended June 30, 2012 and 2011, and cash flows for the six months ended June 30, 2012 and 2011. All of these adjustments are of a normal, recurring nature. Interim results are not necessarily indicative of results for a full year.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. GAAP for interim financial information and with the instructions for Form 10-Q. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

For further information, refer to the consolidated financial statements and footnotes included in our annual report on Form 10-K for the year ended December 31, 2011. The consolidated financial statements include our accounts and our subsidiaries’ accounts. All material intercompany balances and transactions have been eliminated in consolidation.

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. Securities

The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In thousands)
June 30, 2012:
Securities available for sale:
State and municipal	$	72,885	$	6,824	$	(55	)	$	79,654
U.S. Government sponsored entities and agencies		1,825		32		-			1,857
Residential mortgage-backed agencies issued by U.S. Government sponsored entities		138,269		2,416		(15	)		140,670
Collateralized debt obligations, including trust preferred securities		4,024		-		(3,118	)		906
Mutual funds		250		8		-			258
Total securities available for sale	$	217,253	$	9,280	$	(3,188	)	$	223,345

December 31, 2011:
Securities available for sale:
State and municipal	$	70,728	$	5,803	$	(4	)	$	76,527
Residential mortgage-backed agencies issued by U.S. Government sponsored entities		118,876		2,190		(39	)		121,027
Collateralized debt obligations, including trust preferred securities		4,069		-		(3,132	)		937
Mutual funds		250		5		-			255
Total securities available for sale	$	193,923	$	7,998	$	(3,175	)	$	198,746

Total other-than-temporary impairment recognized in accumulated other comprehensive income was $1.7 million and $1.6 million for securities at June 30, 2012 and December 31, 2011.

Sales of available for sale securities were as follows.

	Three Months Ended				Six Months Ended
	June 30				June 30
	2012		2011		2012		2011
	(In thousands)
Proceeds	$	15,917	$	31,603	$	40,247	$	45,138
Gross gains		438		469		1,165		1,053
Gross losses		-		-		-		-

The tax provision applicable to these realized gains amounted to $149,000 and $396,000 for the three and six months ended June 30, 2012, respectively, and $159,000 and $358,000 for the three and six months ended June 30, 2011, respectively.

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. Securities (Continued)

The amortized cost and fair value of the contractual maturities of available for sale securities at June 30, 2012 were as follows. Actual maturities may differ from contractual maturities if the issuers have the right to call their obligations. Mortgage-backed agencies and mutual funds which do not have a single maturity date are shown separately.

	June 30, 2012
	Amortized Cost		Fair Value
	(In thousands)
Within one year	$	59	$	59
One to five years		2,226		2,301
Five to ten years		17,243		18,778
Beyond ten years		59,206		61,279
Residential mortgage-backed securities issued by U.S. Government sponsored entities		138,269		140,670
Mutual funds		250		258
Total	$	217,253	$	223,345

Securities with unrealized losses at June 30, 2012 and December 31, 2011, aggregated by investment category and length of time that individual securities have been in a continuous loss position are as follows:

	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Loss			Value		Loss			Value		Loss
June 30, 2012	(In thousands)
State and municipal	$	4,231	$	(55	)	$	-	$	-		$	4,231	$	(55	)
Residential mortgaged-backed securities issued by U.S. Government sponsored agencies		5,142		(15	)		-		-			5,142		(15	)
Collateralized debt obligations, including trust preferred securities		-		-			906		(3,118	)		906		(3,118	)
Total temporarily impaired	$	9,373	$	(70	)	$	906	$	(3,118	)	$	10,279	$	(3,188	)

	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Loss			Value		Loss			Value		Loss
December 31, 2011	(In thousands)
State and municipal	$	561	$	(4	)	$	-	$	-		$	561	$	(4	)
Residential mortgaged-backed securities issued by U.S. Government sponsored agencies		26,297		(39	)		-		-			26,297		(39	)
Collateralized debt obligations, including trust preferred securities		-		-			937		(3,132	)		937		(3,132	)
Total temporarily impaired	$	26,858	$	(43	)	$	937	$	(3,132	)	$	27,795	$	(3,175	)

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. Securities (Continued)

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. The investment securities portfolio is evaluated for OTTI by segregating the portfolio into two general segments and applying the appropriate OTTI model. Investment securities are generally evaluated for OTTI under FASB ASC 320-10. However, certain purchased beneficial interests, including collateralized debt obligations that had credit ratings at the time of purchase of below AA are evaluated using the model outlined in FASB ASC 325-40.

In determining OTTI under the FASB ASC 320-10 model, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

The second segment of the portfolio uses the OTTI guidance provided by FASB ASC 325-40 that is specific to purchased beneficial interests that, on the purchase date, were rated below AA. Under the FASB ASC 325-40 model, the Company compares the present value of the remaining cash flows as estimated at the preceding evaluation date to the current expected remaining cash flows. An OTTI is deemed to have occurred if there has been an adverse change in the remaining expected cash flows.

As of June 30, 2012, the Company’s security portfolio consisted of 280 securities, 19 of which were in an unrealized loss position. The majority of the unrealized losses are in the Company’s collateralized debt obligations, as discussed below:

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. Securities (Continued)

Collateralized Debt Obligations

The Company’s unrealized losses on collateralized debt obligations relate to its investment in six pooled trust preferred securities.

Our analysis of six of these investments falls within the scope of FASB ASC 325-40 and includes $4.0 million amortized cost of pooled trust preferred securities (CDOs). See the table below for a detail of the CDOs (in thousands):

									Previously
									Recognized		Current Period
	Current								OTTI Related to		OTTI Related to
	Moody’s		Par		Amortized		Estimated		Credit Loss,		Credit Loss,
	Rating		Value		Cost		Fair Value		Pre-Tax		Pre-Tax

Security 1		B+ (S&P)	$	2,000	$	2,000	$	506	$	-	$	-
Security 2		C		151		-		-		146		-
Security 3		Caa2		49		42		19		5		-
Security 4		Caa2		317		282		125		35		-
Security 5		Ca		1,563		850		128		637		-
Security 6		Ca		1,563		850		128		637		-
			$	5,643	$	4,024	$	906	$	1,460	$	-

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

2. Securities (Continued)

The issuers in five of the six securities are banks and bank holding companies while one is comprised of insurance companies. The Company uses an OTTI evaluation model to evaluate the present value of expected cash flows. The OTTI model considers the structure and term of the CDO and the financial condition of the underlying issuers. Specifically, the model details interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities. Assumptions used in the model include expected future default rates and prepayments. To develop our assumptions we reviewed the underlying issuers and determined the specific default rate by reviewing the financial condition of each issuer and whether they were currently in deferral or default. We also estimate when the defaults will occur ranging from immediate to four years. We considered all relevant data in developing our assumptions, however, we specifically reviewed each issuer’s profitability, credit ratings, if available, credit ratios, and credit quality metrics for the loan portfolios (if a bank). For those issuers we identified at risk of default, we estimated the amount of loss, net of any anticipated recoveries, which ranged from 100% for those issuers already in default at the evaluation date to 5.00%. After four years we assume a 0.40% annual default rate until scheduled maturity of the underlying note. Additionally, we assumed that all bank and bank holding company issuers with total assets of greater than $15 billion would prepay their obligations before the phase-out period begins for inclusion in Tier 1 capital on January 1, 2013 in accordance with the Dodd-Frank Act. Upon completion of the analysis, our model indicated we did not have additional other-than-temporary impairment. At June 30, 2012 the six securities subject to FASB ASC 325-40 accounted for the $3.1 million of unrealized loss in the collateralized debt obligations category.

There were no credit losses recognized in earnings related to these securities for the three and six month periods ended June 30, 2012 and 2011. Prior to 2011, the Company had recognized credit losses of $1.5 million.

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. Loans

Loans at June 30, 2012 and December 31, 2011 consisted of the following:

	June 30,			December 31,
	2012			2011
	(In thousands)
Commercial	$	99,708		$	100,884
Construction		42,109			44,722
Commercial real estate:
Owner occupied nonfarm/residential		97,993			92,848
Other nonfarm/residential		81,574			77,875
Residential real estate:
Secured by first liens		126,077			131,054
Home equity		44,117			44,832
Consumer		6,944			7,759
Subtotal		498,522			499,974
Less:
Allowance for loan losses		(11,109	)		(10,234	)
Loans, net	$	487,413		$	489,740

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. Loans (Continued)

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended June 30, 2012 and 2011 (in thousands):

Three Months Ended June 30, 2012:

							Commercial			Residential
	Commercial			Construction			Real Estate			Real Estate			Consumer			Total

Beginning balance	$	2,825		$	1,100		$	4,054		$	2,669		$	193		$	10,841
Provision for loan losses		(43	)		63			958			(50	)		16			944
Loans charged-off		(164	)		(110	)		(198	)		(201	)		(49	)		(722	)
Recoveries		19			-			9			-			18			46
Ending balance	$	2,637		$	1,053		$	4,823		$	2,418		$	178		$	11,109

Three Months Ended June 30, 2011:

						Commercial			Residential
	Commercial			Construction		Real Estate			Real Estate			Consumer			Total

Beginning balance	$	3,002		$	1,830	$	2,826		$	2,872		$	351		$	10,881
Provision for loan losses		1,027			62		(179	)		(63	)		64			911
Loans charged-off		(615	)		-		-			(282	)		(75	)		(972	)
Recoveries		38			-		5			18			32			93
Ending balance	$	3,452		$	1,892	$	2,652		$	2,545		$	372		$	10,913

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. Loans (Continued)

The following table presents the activity in the allowance for loan losses by portfolio segment for the six months ended June 30, 2012 and 2011 (in thousands):

Six Months Ended June 30, 2012:

							Commercial			Residential
	Commercial			Construction			Real Estate			Real Estate			Consumer			Total

Beginning balance	$	2,999		$	1,112		$	3,207		$	2,681		$	235		$	10,234
Provision for loan losses		92			384			1,788			178			8			2,450
Loans charged-off		(506	)		(443	)		(198	)		(466	)		(116	)		(1,729	)
Recoveries		52			-			26			25			51			154
Ending balance	$	2,637		$	1,053		$	4,823		$	2,418		$	178		$	11,109

Six Months Ended June 30, 2011:

							Commercial			Residential
	Commercial			Construction			Real Estate			Real Estate			Consumer			Total

Beginning balance	$	3,245		$	1,893		$	2,499		$	2,803		$	424		$	10,864
Provision for loan losses		1,329			16			157			186			33			1,721
Loans charged-off		(1,197	)		(19	)		(16	)		(463	)		(186	)		(1,881	)
Recoveries		75			2			12			19			101			209
Ending balance	$	3,452		$	1,892		$	2,652		$	2,545		$	372		$	10,913

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. Loans (Continued)

The following table presents the balance in the allowance for loan losses and the recorded investment in loans, which includes the unpaid principal balance, net of partial charge-offs of $6.1 million and $6.5 million as of June 30, 2012 and December 31, 2011, by portfolio segment and based on impairment method as of June 30, 2012 and December 31, 2011 (in thousands):

June 30, 2012:

					Commercial		Residential
	Commercial		Construction		Real Estate		Real Estate		Consumer		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	298	$	833	$	3,207	$	280	$	15	$	4,633
Collectively evaluated for impairment		2,339		220		1,616		2,138		163		6,476
Total ending allowance balance	$	2,637	$	1,053	$	4,823	$	2,418	$	178	$	11,109

Loans:
Loans individually evaluated for impairment	$	1,163	$	11,746	$	20,900	$	3,357	$	197	$	37,363
Loans collectively evaluated for impairment		98,545		30,363		158,667		166,837		6,747		461,159
Total ending loans balance	$	99,708	$	42,109	$	179,567	$	170,194	$	6,944	$	498,522

December 31, 2011:

					Commercial		Residential
	Commercial		Construction		Real Estate		Real Estate		Consumer		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	517	$	815	$	1,749	$	563	$	17	$	3,661
Collectively evaluated for impairment		2,482		297		1,458		2,118		218		6,573
Total ending allowance balance	$	2,999	$	1,112	$	3,207	$	2,681	$	235	$	10,234

Loans:
Loans individually evaluated for impairment	$	1,548	$	13,902	$	20,899	$	3,811	$	146	$	40,306
Loans collectively evaluated for impairment		99,336		30,820		149,824		172,075		7,613		459,668
Total ending loans balance	$	100,884	$	44,722	$	170,723	$	175,886	$	7,759	$	499,974

There were no impaired loans at June 30, 2012 and December 31, 2011 which did not have allocated allowance for loan losses.

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. Loans (Continued)

The following table presents information related to loans individually evaluated for impairment by class of loans as of and for the six month period ending June 30, 2012:

					Allowance for		Average		Interest Income
	Unpaid Principal		Recorded		Loan Losses		Recorded		Recognized and
	Balance		Investment		Allocated		Investment		Received
	(In thousands)
Commercial	$	2,673	$	1,163	$	298	$	1,296	$	8
Construction		15,413		11,746		833		13,005		90
Commercial real estate:
Owner occupied nonfarm/nonresidential		9,619		9,619		2,559		9,853		261
Other nonfarm/nonresidential		12,202		11,281		648		11,414		103
Residential real estate:
Secured by first liens		3,099		3,099		221		3,169		20
Home equity		258		258		59		341		1
Consumer		197		197		15		160		-
Total	$	43,461	$	37,363	$	4,633	$	39,238	$	483

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2011:

					Allowance for
	Unpaid Principal		Recorded		Loan Losses
	Balance		Investment		Allocated
	(In thousands)
Commercial	$	3,064	$	1,548	$	517
Construction		17,709		13,902		815
Commercial real estate:
Owner occupied nonfarm/nonresidential		9,719		9,719		924
Other nonfarm/nonresidential		12,299		11,180		825
Residential real estate:
Secured by first liens		3,491		3,416		297
Home equity		395		395		266
Consumer		146		146		17
Total	$	46,823	$	40,306	$	3,661

The recorded investment in loans excludes accrued interest receivable and loan origination fees, net due to immateriality. For purposes of this disclosure, the unpaid principal balance is not reduced for net charge-offs.

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. Loans (Continued)

The following table presents the information related to loans individually evaluated for impairment by class of loans for the three month period ending June 30, 2012:

	Average		Interest Income
	Recorded		Recognized and
	Investment		Received
	(In thousands)
Commercial	$	1,170	$	4
Construction		12,557		32
Commercial real estate:
Owner occupied nonfarm/nonresidential		9,920		130
Other nonfarm/nonresidential		11,532		35
Residential real estate:
Secured by first liens		3,046		7
Home equity		315		1
Consumer		167		-
Total	$	38,707	$	209

The following table presents information related to loans individually evaluated for impairment by class of loans for the three and six month periods ending June 30, 2011:

	Three Months				Six Months
	Average		Interest Income		Average		Interest Income
	Recorded		Recognized and		Recorded		Recognized and
	Investment		Received		Investment		Received
	(In thousands)
Commercial	$	175	$	1	$	206	$	2
Construction		9,997		1		9,614		2
Commercial real estate:
Owner occupied nonfarm/nonresidential		665		-		700		1
Other nonfarm/nonresidential		11,066		68		11,164		156
Residential real estate:
Secured by first liens		4,237		19		4,354		42
Home equity		131		-		128		-
Consumer		196		-		200		-
Total	$	26,467	$	89	$	26,366	$	203

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. Loans (Continued)

The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of June 30, 2012 and December 31, 2011:

	June 30, 2012				December 31, 2011
			Loans Past				Loans Past
			Due Over 90				Due Over 90
			Days Still				Days Still
	Nonaccrual		Accruing		Nonaccrual		Accruing
	(In thousands)
Commercial	$	886	$	-	$	1,040	$	-
Construction		8,517		-		7,457		-
Commercial real estate:
Owner occupied nonfarm/nonresidential		735		-		1,036		-
Other nonfarm/nonresidential		2,395		-		2,290		-
Residential real estate:
Secured by first liens		2,575		-		3,427		-
Home equity		178		-		372		-
Consumer		261		-		150		-
Total	$	15,547	$	-	$	15,772	$	-

The following table presents the aging of the recorded investment in past due loans as of June 30, 2012 and December 31, 2011 by class of loans:

June 30, 2012:

					Greater
	30 – 59		60 – 89		than 90						Loans Past
	Days		Days		Days		Total				Due Over
	Past		Past		Past		Past		Loans Not		90 Days Still
	Due		Due		Due		Due		Past Due		Accruing
	(In thousands)
Commercial	$	532	$	18	$	886	$	1,436	$	98,272	$	-
Construction		233		-		9,088		9,321		32,788		-
Commercial real estate:
Owner occupied nonfarm/nonresidential		50		57		165		272		97,721		-
Other nonfarm/nonresidential		-		-		2,395		2,395		79,179		-
Residential real estate:
Secured by first liens		1,875		497		2,608		4,980		121,097		-
Home equity		530		66		295		891		43,226		-
Consumer		164		22		110		296		6,648		-
Total	$	3,384	$	660	$	15,547	$	19,591	$	478,931	$	-

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. Loans (Continued)

December 31, 2011:

					Greater
	30 – 59		60 – 89		than 90						Loans Past
	Days		Days		Days		Total				Due Over
	Past		Past		Past		Past		Loans Not		90 Days Still
	Due		Due		Due		Due		Past Due		Accruing
	(In thousands)
Commercial	$	263	$	457	$	953	$	1,673	$	99,211	$	-
Construction		154		-		8,027		8,181		36,541		-
Commercial real estate:
Owner occupied nonfarm/nonresidential		299		-		466		765		92,083		-
Other nonfarm/nonresidential		209		42		2,290		2,541		75,334		-
Residential real estate:
Secured by first liens		1,181		238		3,391		4,810		126,244		-
Home equity		800		152		409		1,361		43,471		-
Consumer		213		14		147		374		7,385		-
Total	$	3,119	$	903	$	15,683	$	19,705	$	480,269	$	-

Troubled Debt Restructurings:

Troubled debt restructurings (“TDRs”) totaled $26.3 million and $26.6 million at June 30, 2012 and December 31, 2011. Of the total TDRs, $5.1 million and $2.4 million were on non-accrual as of June 30, 2012 and December 31, 2011. The Company has allocated $3.7 million and $2.4 million of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of June 30, 2012 and December 31, 2011. The Company did not have any commitments to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructurings as of June 30, 2012 and December 31, 2011.

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. Loans (Continued)

The detail of outstanding TDRs by class and modification type as of June 30, 2012 and December 31, 2011 follows (in thousands):

June 30, 2012:

			Allowance for
	Recorded		Loan Losses
	Investment		Allocated
Commercial:
Interest only payments	$	458	$	167
Extended maturity		269		64
Multiple modifications		168		7
Construction:
Extended maturity		1,011		86
Multiple modifications		5,322		322
Commercial real estate:
Owner occupied nonfarm/nonresidential
Interest only payments		8,909		2,543
Other nonfarm/nonresidential
Interest rate reduction		8,070		430
Interest only payments		203		4
Multiple modifications		1,127		30
Residential real estate:
Secured by first liens
Interest rate reduction		98		1
Interest only payments
Extended maturity		306		7
Multiple modifications		370		60
Home equity
Interest rate reduction		29		1
Total	$	26,340	$	3,722

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. Loans (Continued)

December 31, 2011:

			Allowance for
	Recorded		Loan Losses
	Investment		Allocated
Commercial:
Interest only payments	$	500	$	24
Extended maturity		489		281
Multiple modifications		332		12
Construction:
Extended maturity		926		320
Multiple modifications		5,333		80
Commercial real estate:
Owner occupied nonfarm/nonresidential
Interest only		8,710		887
Other nonfarm/nonresidential
Interest rate reduction		8,070		616
Interest only payments		206		4
Multiple modifications		1,127		87
Residential real estate:
Secured by first liens
Interest rate reduction		100		7
Interest only payments		124		8
Extended maturity		307		4
Multiple modifications		373		29
Home equity
Interest rate reduction		30		1
Consumer
Interest rate reduction		8		-
Total	$	26,635	$	2,360

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. Loans (Continued)

A loan is considered in payment default once it is 30 days contractually past due under the modified terms. The following table summarizes the Company’s TDR’s by class, modification type and performance as of June 30, 2012 and December 31, 2011 (in thousands):

June 30, 2012:					Total TDRs
					Not
	TDRs Greater than				Performing		Total TDRs
	30 Days Past Due				to		Defaulted Within
	and		TDRs on		Modified		12 Months of
	Still Accruing		Nonaccrual		Terms		Modification
Commercial:
Interest only	$	-	$	458	$	458	$	458
Multiple modifications		-		100		100		100
Construction:
Extended maturity		-		595		595		595
Multiple modifications		-		2,656		2,656		2,656
Commercial real estate:
Other nonfarm/nonresidential
Multiple modifications		-		1,127		1,127		1,127
Residential:
Secured by first liens
Extended maturity		306		-		306		306
Multiple modifications		-		202		202		-
Total	$	306	$	5,138	$	5,444	$	5,242

December 31, 2011:					Total TDRs
					Not
	TDRs Greater than				Performing		Total TDRs
	30 Days Past Due				to		Defaulted Within
	and		TDRs on		Modified		12 Months of
	Still Accruing		Nonaccrual		Terms		Modification
Commercial:
Interest only	$	-	$	500	$	500	$	500
Extended maturity		1		248		249		249
Multiple modifications		262		-		262		262
Construction:
Extended maturity		-		510		510		510
Commercial real estate:
Owner occupied nonfarm/nonresidential		-		-		-		-
Other nonfarm/nonresidential
Multiple modifications		-		1,127		1,127		1,127
Residential:
Secured by first liens
Multiple modifications		111		-		111		-
Home equity		-		-		-		-
Consumer		-		-		-		-
Total	$	374	$	2,385	$	2,759	$	2,648

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. Loans (Continued)

During the period ending June 30, 2012, the terms of 1 loan were modified as a troubled debt restructuring. The modification of the term of the loan was from principal and interest payments to interest only payments for a period of 4 months.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the company’s internal underwriting policy.

The following table presents loans by class modified as TDRs during the six months ending June 30, 2012 and their performance, by modification type (in thousands):

Pre-

Post-

Modification

TDRs

TDRs Not

Outstanding

Performing

Performing to

Number of

Recorded

to Modified

Modified

Loans

Investment

Terms

Commercial real estate:

Owner occupied nonfarm/nonresidential

Interest only

201

There were no loans modified during the three months June 30, 2012 that were classified as TDRs.

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. Loans (Continued)

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. On a monthly basis, the Company reviews its loans that are risk rated Watch, Special Mention, Substandard, or Doubtful to determine they are properly classified. In addition, the Company reviews loans rated as a “pass” that have exhibited signs that may require a classification change, such as past due great than 30 days and other relevant information including: loan officer recommendations, knowledge of specific borrower circumstances, and receipt of borrower financial statements. The Company uses the following definitions for risk ratings:

Watch. Loans classified as watch are not considered “rated” or “classified” for regulatory purposes, but are considered criticized assets which exhibit modest deterioration in financial performance or external threats.

Special Mention. Loans classified as special mention exhibit potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan, or in the Company’s credit position at some future date. Economic or market conditions exist which may affect the borrower more severely than other companies in its industry.

Substandard. Loans classified as substandard are characterized by having well defined financial weakness. Substandard loans are usually evidenced by chronic or emerging past due performance and serious deficiencies in the primary source of repayment.

Doubtful. Loans classified as doubtful have a well-defined and documented financial weaknesses. They have all the weaknesses of a substandard loan with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. Generally, loans classified as doubtful are on non-accrual.

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. Loans (Continued)

Loans not meeting the criteria above that are listed as pass are included in groups of homogeneous loans. The risk category of loans by class of loans based on the most recent analysis performed as of June 30, 2012 and December 31, 2011 is as follows:

June 30, 2012:

			Special
	Watch		Mention		Substandard		Doubtful		Pass		Total
	(In thousands)
Commercial	$	8,915	$	630	$	633	$	803	$	88,727	$	99,708
Construction		9,370		-		3,626		8,664		20,449		42,109
Commercial real estate:
Owner occupied nonfarm/nonresidential		1,494		199		1,121		9,419		85,760		97,993
Other nonfarm/nonresidential		5,941		-		8,399		2,909		64,325		81,574
Residential real estate:
Secured by first liens		2,109		306		2,930		2,246		118,486		126,077
Home equity		194		-		1,079		110		42,734		44,117
Consumer		30		-		124		42		6,748		6,944
Total	$	28,053	$	1,135	$	17,912	$	24,193	$	427,229	$	498,522

December 31, 2011:

			Special
	Watch		Mention		Substandard		Doubtful		Pass		Total
	(In thousands)
Commercial	$	5,261	$	653	$	742	$	1,209	$	93,019	$	100,884
Construction		9,787		-		3,225		8,153		23,557		44,722
Commercial real estate:
Owner occupied nonfarm/nonresidential		1,835		988		9,075		1,009		79,941		92,848
Other nonfarm/nonresidential		5,779		213		8,648		2,705		60,530		77,875
Residential real estate:
Secured by first liens		2,145		385		3,813		1,720		122,991		131,054
Home equity		1,149		-		386		300		42,997		44,832
Consumer		87		-		176		27		7,469		7,759
Total	$	26,043	$	2,239	$	26,065	$	15,123	$	430,504	$	499,974

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Deposits

Deposits at June 30, 2012 and December 31, 2011 consisted of the following:

	June 30, 2012		December 31, 2011
	(In thousands)

Demand (NOW)	$	98,164	$	92,683
Money market accounts		125,913		134,818
Savings		38,396		36,010
Individual retirement accounts		27,966		28,375
Certificates of deposit, $100,000 and over		77,789		69,873
Other certificates of deposit		91,667		91,722

Total interest bearing deposits		459,895		453,481

Total non-interest bearing deposits		149,445		127,877

Total deposits	$	609,340	$	581,358

Earnings Per Common Share

Earnings per common share were computed as follows:

	Three months ended June 30,						Six months ended June 30,
	2012			2011			2012			2011
	(In thousands, except for share and per share amounts)
Basic:
Net income	$	1,954		$	1,855		$	3,789		$	3,643
Less: Preferred stock dividend and amortization of discount		(244	)		(267	)		(470	)		(533	)
Net income available to common shareholders	$	1,710		$	1,588		$	3,319		$	3,110
Average shares outstanding		3,359,829			3,313,947			3,358,148			3,310,222
Net income per common share, basic	$	0.51		$	0.48		$	0.99		$	0.94

Diluted:
Net income available to common shareholders	$	1,710		$	1,588		$	3,319		$	3,110
Average shares:
Common shares outstanding for basic		3,359,829			3,313,947			3,358,148			3,310,222
Add: Dilutive effect of outstanding warrants		-			109,997			-			122,952
Average shares and dilutive potential common shares		3,359,829			3,423,944			3,358,148			3,433,174
Net income per common share, diluted	$	0.51		$	0.46		$	0.99		$	0.91

Stock options for 168,100 shares of common stock were excluded from the calculation of diluted net income per common share for the three and six months ended June 30, 2012 because their effect was antidilutive. This compares to stock options for 189,200 and 192,700 shares of common stock that were excluded from the calculation of diluted net income per common share for the three and six months ended June 30, 2011.

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Earnings Per Common Share (Continued)

Deferred stock units totaling 38,000 were excluded from the calculation of diluted net income per common share for the three and six months ended June 30, 2011 because all of the conditions necessary for issuance of common stock had not been met as of those dates.

Restricted share awards of 37,022 and 33,022 common shares were excluded from the calculation of diluted net income per common share for the three and six months ended June 30, 2012 and 2011, respectively, because all of the conditions necessary for issuance of common stock had not been met as of those dates.

6. Stock-Based Compensation Plans

Our stock option plan provides for the granting of both incentive and nonqualified stock options at exercise prices not less than the fair market value of the common stock on the date of grant and expiration dates of up to ten years. Terms of the options are determined by our Board of Directors at the date of grant and generally vest over periods of three to four years. Payment of the option price may be in cash or shares of common stock at fair market value on the exercise date at the election of the employee. Non-employee directors are eligible to receive only nonqualified stock options. We may grant stock options under the current plan for an additional 163,195 shares of common stock. The aggregate intrinsic value for options outstanding and exercisable at June 30, 2012 and December 31, 2011 was $0. There was $0 in total compensation cost related to unvested options not recognized at June 30, 2012 and December 31, 2011, respectively. The Company recognized $0 in expense for stock options for the three and six months ended June 30, 2012 and 2011. The Company has options vested of 168,100 with aggregate intrinsic value of $0 and a weighted average remaining contractual term of 3.7 years as of June 30, 2012. During the six months ended June 30, 2012, no options were granted, forfeited, or expired.

For the three and six months ended June 30, 2012, we recognized $47,000 and $105,000 in expense for restricted stock awards, respectively. We did not grant restricted stock awards during the first six months of 2012. The fair value of the restricted stock awards was calculated based on the Company’s stock price at the date of issuance. There were no forfeitures during the first six months of 2012. At June 30, 2012, there were 37,022 outstanding and unvested restricted stock awards. For the three and six months ended June 30, 2011, we recognized $41,000 and $68,000 in expense for restricted stock awards, respectively.

For the three and six months ended June 30, 2012, we recognized $0 of expense for deferred stock units. For the three and six months ended June 30, 2011, we recognized $78,000 and $115,000 of expense for deferred stock units, respectively. During the first six months of 2012 there were no deferred stock units granted or forfeited.

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate fair value.

Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market participants. These valuation methods are classified as Level 2 in the fair value hierarchy.

Collateralized debt obligations which are collateralized by financial institutions and insurance companies are determined by us utilizing an estimate of the expected cash flows based on our review of the underlying issuers’ financial condition and the anticipated deferral of payments and defaults of issuers. The fair values of our collateralized debt obligations are determined by the Company’s accounting department and reviewed by the Chief Financial Officer (CFO). We provide our estimate of default for each issuer, which ranges from 100% loss to 0.40% loss at June 30, 2012, to the capital market traders of our bond accountant who provide the cash flows we will receive based upon our assumptions. To determine the discounted projected cash flows for our collateralized debt obligations, we utilize discount rates ranging from 11.96% to 35.11% (26.95% weighted average rate) depending on the security. The discount rates were determined utilizing a risk free rate of three month Libor plus 300 bps (3.46% at 6/30/12), which includes a premium for market illiquidity, and a credit component based on the quality of the collateral and the deal structure.

The significant unobservable inputs used in the fair value measurement of the Company’s collateralized debt obligations are probabilities of specific-issuer defaults and deferrals and specific-issuer recovery assumptions. Significant increases in specific-issuer default assumptions or decreases in specific-issuer recovery assumptions would result in a significantly lower fair value measurement. Conversely, decreases in specific-issuer default assumptions or increases in specific-issuer recovery assumptions would result in a higher fair value measurement.

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value (Continued)

Impaired Loans: Impaired loans are evaluated at the time the loan is identified as impaired and are recorded at the lower of the carrying amount of the loan or the fair value of the underlying collateral. For collateral dependent loans, the fair value of real estate is primarily determined based on appraisals by qualified licensed appraisers. These appraisals may use a single valuation approach or a combination depending on the type of collateral including the comparable sales or income capitalization approach. The appraisals are discounted to reflect management’s estimate of the fair value of the collateral given the current circumstances and condition of the collateral including the market for the particular collateral and management’s experience with similar types of collateral. Impaired loans are evaluated quarterly for additional impairment. Fair value of impaired loans is classified as Level 3 in the fair value hierarchy.

Foreclosed and Repossessed Assets: Foreclosed and repossessed assets are initially recorded at fair value less estimated costs to sell when acquired. The fair value of foreclosed and repossessed assets is primarily determined based on appraisals by qualified appraisers whose qualifications have been reviewed by the Company. The appraisals are discounted to reflect management’s estimate of the fair value of the collateral given the current circumstances of the collateral and reduced by management’s estimate of costs to dispose of the asset. Also, management reviews the assumptions included the appraisals and makes adjustments where circumstances warrant such as recent experience with similar assets. Fair value of foreclosed and repossessed assets is classified as Level 3 in the fair value hierarchy.

Assets measured at fair value on a recurring basis are summarized below:

			Fair Value Measurements Using
	Assets at Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
			(in thousands)
Assets (June 30, 2012):
Available for sale securities:
State and municipal	$	79,654	$	—	$	79,595	$	59
U.S. Government sponsored entities and agencies		1,857		—		1,857		—
Residential mortgage-backed securities issued by U.S. Government sponsored entities		140,670		—		140,670		—
Collateralized debt obligations, including trust preferred securities		906		—		—		906
Mutual Funds		258		—		258		—

Total available for sale securities	$	223,345	$	—	$	222,380	$	965

Assets (December 31, 2011):
Available for sale securities:
State and municipal	$	76,527	$	—	$	76,375	$	152
Residential mortgage-backed securities issued by U.S. Government sponsored entities		121,027		—		121,027		—
Collateralized debt obligations, including trust preferred securities		937		—		—		937
Mutual Funds		255		—		255		—

Total available for sale securities	$	198,746	$	—	$	197,657	$	1,089

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value (Continued)

There were no transfers between Level 1 and Level 2 during 2012 or 2011.

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended June 30:

	Collateralized Debt Obligations, Including Trust Preferred Securities					State and Municipal Securities
	2012			2011		2012			2011
	(in thousands)
Balance, beginning of period	$	846		$	1,395	$	96		$	-
Principal paydowns		(18	)		-		(37	)		-
Net unrealized gain (loss) included in other comprehensive income		78			72		-			-
Balance, end of period	$	906		$	1,467	$	59		$	-

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended June 30:

	Collateralized Debt Obligations, Including Trust Preferred Securities					State and Municipal Securities
	2012			2011		2012			2011
	(in thousands)
Balance, beginning of period	$	937		$	1,359	$	152		$	-
Principal paydowns		(44	)		-		(93	)		-
Net unrealized gain (loss) included in other comprehensive income		13			108		-			-
Balance, end of period	$	906		$	1,467	$	59		$	-

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value (Continued)

The table below summarizes changes in unrealized gains and losses recorded in earnings for the three month periods ended June 30 for level 3 assets that are still held at June 30:

	Changes in Unrealized Gains/Losses Relating to Assets Still Held at Reporting Date for the Three Months Ended June 30 Collateralized Debt Obligations, Including Trust Preferred Securities				Changes in Unrealized Gains/Losses Relating to Assets Still Held at Reporting Date for the Three Months Ended June 30 State and Municipal Securities
	2012		2011		2012		2011
	(in thousands)				(in thousands)

Interest income on securities	$	32	$	15	$	1	$	-
Other changes in fair value		-		-		-		-
Total	$	32	$	15	$	1	$	-

The table below summarizes changes in unrealized gains and losses recorded in earnings for the six month periods ended June 30 for level 3 assets that are still held at June 30:

	Changes in Unrealized Gains/Losses Relating to Assets Still Held at Reporting Date for the Six Months Ended June 30 Collateralized Debt Obligations, Including Trust Preferred Securities				Changes in Unrealized Gains/Losses Relating to Assets Still Held at Reporting Date for the Six Months Ended June 30 State and Municipal Securities
	2012		2011		2012		2011
	(in thousands)				(in thousands)

Interest income on securities	$	48	$	29	$	2	$	-
Other changes in fair value		-		-		-		-
Total	$	48	$	29	$	2	$	-

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value (Continued)

Assets measured at fair value on a nonrecurring basis are summarized below.

	Fair Value Measurements Using
	Assets at Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
			(in thousands)
Assets (June 30, 2012):
Impaired loans:
Commercial	$	588	$	—	$	—	$	588
Construction		5,349		—		—		5,349
Commercial real estate:
Owner Occupied nonfarm/nonresidential		7,319		—		—		7,319
Other nonfarm/nonresidential		8,297		—		—		8,297
Residential real estate:
Secured by first liens		1,074		—		—		1,074
Home equity		30		—		—		30
Consumer		36		—		—		36

Foreclosed and repossessed assets:
Construction		1,962		—		—		954
Commercial real estate:
Owner Occupied nonfarm/nonresidential		499		—		—		499
Other nonfarm/nonresidential		1,671		—		—		1,671
Residential real estate:
Secured by first liens		1,228		—		—		1,228
Consumer		11		—		—		11

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value (Continued)

	Fair Value Measurements Using
	Assets at Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
			(in thousands)
Assets (December 31, 2011):
Impaired loans:
Commercial	$	872	$	—	$	—	$	872
Construction		6,248		—		—		6,248
Commercial real estate:
Owner Occupied nonfarm/nonresidential		8,096		—		—		8,096
Other nonfarm/nonresidential		9,375		—		—		9,375
Residential real estate:
Secured by first liens		1,336		—		—		1,336
Home equity		23		—		—		23
Consumer		34		—		—		34

Foreclosed and repossessed assets:
Construction		2,118		—		—		2,118
Commercial real estate:
Other nonfarm/nonresidential		1,865		—		—		1,865
Residential real estate:
Secured by first liens		1,092		—		—		1,092
Consumer		1		—		—		1

The Company measures loans for impairment using the fair value of the collateral for collateral-dependent loans. The Company’s impaired loans totaled $37.4 million as of June 30, 2012, which included collateral-dependent loans with a carrying value of $28.3 million. As of June 30, 2012, the Company’s collateral dependent loans had a valuation allowance of $4.5 million, resulting in a provision for loan losses of $922,000 and $2.1 million for the three and six months ended June 30, 2012, respectively. The Company recognized provision for loan losses of $353,000 and $959,000 for the three and six months ended June 30, 2011, respectively, for collateral dependent loans.

The Company evaluates the fair value of foreclosed and repossessed assets at the time they are transferred from loans and on a quarterly basis thereafter. During the three and six months ended June 30, 2012 and 2011, the Company did not recognize charges to write down foreclosed and repossessed assets to their fair value.

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value (Continued)

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at June 30, 2012:

	Fair Value		Valuation	Unobservable	Range (Weighted
	(in thousands)		Technique(s)	Input(s)	Average)
Impaired Loans:
Commercial	$	588	Sales comparison approach	Adjustments for differences between comparable sales	0%-60% (15%)
Construction		7,319	Income capitalization approach	Capitalization rate	18%-23% (21%)
			Sales comparison approach	Adjustments for differences between comparable sales	12%
Commercial real estate		14,771	Income capitalization approach	Capitalization rate	12%-38% (32%)
			Sales comparison approach	Adjustments for differences between comparable sales	23%-36% (24%)
Residential real estate		1,104	Sales comparison approach	Adjustments for differences between comparable sales	14%-36% (25%)
Consumer		36	Sales comparison approach	Adjustments for differences between comparable sales	14%-36% (25%)
Foreclosed and repossessed assets:
Construction	$	1,962	Income capitalization approach	Capitalization rate	9%
			Sales comparison approach	Adjustments for differences between comparable sales	10%-68% (38%)
Commercial real estate		2,170	Sales comparison approach	Adjustments for differences between comparable sales	0%-50% (27%)
Residential real estate		1,228	Sales comparison approach	Adjustments for differences between comparable sales	0%-71% (24%)
Consumer		11	Sales comparison approach	Adjustments for differences between comparable sales	42%

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value (Continued)

Fair value of Financial Instruments

Carrying amount and estimated fair values of financial instruments, not previously presented, at June 30, 2012 and December 31, 2011 were as follows:

			Fair Value Measurements Using
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(in thousands)
June 30, 2012:
Financial assets:
Cash and due from financial institutions	$	13,999	$	13,999	$	—	$	—	$	13,999
Interest-bearing deposits in other financial institutions		42,882		42,882		—		—		42,882
Loans held for sale		313		—		316		—		316
Loans, net		487,413		—		—		501,015		501,015
Accrued interest receivable		3,225		—		1,090		2,135		3,244
Federal Home Loan Bank and Federal Reserve Stock		6,011		n/a		n/a		n/a		n/a

Financial liabilities:
Deposits		609,340		—		610,143		—		610,143
Other borrowings		56,004		—		54,678		—		54,678
Federal Home Loan Bank Advances		55,000		—		54,768		—		54,768
Subordinated debentures		17,000		—		—		10,256		10,256
Accrued interest payable		300				284		16		300

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value (Continued)

	Carrying Amount		Fair Value
	(in thousands)
December 31, 2011:
Financial assets
Cash and due from financial institutions	$	15,166	$	15,166
Interest-bearing deposits in other financial institutions		30,297		30,297
Loans held for sale		1,154		1,166
Loans, net of allowance for loan losses and impaired loans		460,302		472,612
Accrued interest receivable		3,196		3,196
Federal Home Loan Bank and Federal Reserve Stock		5,952		n/a

Financial liabilities
Deposits		581,358		569,892
Other borrowings		50,879		49,165
Federal Home Loan Bank Advances		55,000		55,825
Subordinated debentures		17,000		10,403
Accrued interest payable		329		329

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

(a) Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.

(b) FHLB and FRB Stock

It is not practical to determine the fair value of FHLB and FRB stock due to restrictions placed on transferability.

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value (Continued)

(c) Loans

Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

(e) Deposits

The fair value disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date resulting in a Level 2 classification. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

(f) Other Borrowings

The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

The fair values of the Company’s Subordinated Debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

(g) Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification depending upon the classification of the associated asset or liability.

(i) Off-balance Sheet Instruments

Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Safe Harbor Statement for Forward-Looking Statements

This report may contain forward-looking statements within the meaning of the federal securities laws. These statements are not historical facts, but rather statements based on our current expectations regarding our business strategies and their intended results and our future performance. Forward-looking statements are preceded by terms such as “expects,” “believes,” “anticipates,” “intends” and similar expressions.

Forward-looking statements are not guarantees of future performance. Numerous risks and uncertainties could cause or contribute to our actual results, performance, and achievements to be materially different from those expressed or implied by the forward-looking statements. Factors that may cause or contribute to these differences include, without limitation, general economic conditions, including changes in market interest rates and changes in monetary and fiscal policies of the federal government; legislative and regulatory changes; competitive conditions in the banking markets served by our subsidiaries; the adequacy of the allowance for losses on loans and the level of future provisions for losses on loans; and other factors disclosed periodically in our filings with the Securities and Exchange Commission.

Because of the risks and uncertainties inherent in forward-looking statements, readers are cautioned not to place undue reliance on them, whether included in this report or made elsewhere from time to time by us or on our behalf. We assume no obligation to update any forward-looking statements.

Financial Condition

Total assets increased by $29.5 million to $826.9 million as of June 30, 2012 from $797.4 million at December 31, 2011. The increase was mostly attributable to increases in interest-bearing deposits in other financial institutions of $12.6 million and $24.6 million in securities available for sale. Total deposits increased by $28.0 million as non interest-bearing deposits increased by $21.6 million to $149.4 million and interest-bearing deposits increased to $459.9 million as of June 30, 2012. During the first six months of 2012, the Company utilized the net cash inflows from the growth in deposits to increase interest bearing deposits in other financial institutions and securities available for sale.

Net loans decreased to $487.4 million as of June 30, 2012 from $489.7 million as of December 31, 2011. The decrease in net loans was due to soft loan demand in the Company’s market area as loan originations have not kept pace with repayments. In addition, the Company charged-off $1.7 million in loans, recorded provision for loan losses of $2.5, and transferred $3.0 million in loans to foreclosed assets during the first half of 2012 (see the “Allowance and Provision for Loan Losses” section of management’s discussion and analysis for further information on charge-off activity and credit quality).

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Securities available for sale increased from December 31, 2011 to $223.3 million as of June 30, 2012 as purchases totaled $77.2 million for the first six months of 2012 while sales equaled $40.2 million and maturities, prepayments and calls were $14.2 million. The securities portfolio serves as a source of liquidity and earnings and plays an important part in the management of interest rate risk. The current strategy for the investment portfolio is to maintain an overall average repricing term between 3.0 and 3.5 years to limit exposure to rising interest rates.

Net Income. Net income available to common shareholders was $1.7 million for the three months ended June 30, 2012 as compared to $1.6 million for the equivalent period in 2011. Basic and diluted earnings per common share increased to $0.51 per common share for the second quarter of 2012 from $0.48 and $0.46 per common share in the same period in 2011, respectively. The increase in net income available to common shareholders was due to an increase in net interest income of $216,000 and a decrease in income tax expense of $165,000 offset primarily by an increase in non-interest expense of $290,000. The annualized return on average assets and average shareholders’ equity were 0.96% and 9.47% for the three months ended June 30, 2012, respectively.

Net income available to common shareholders for the six month period ended June 30, 2012 increased to $3.3 million from $3.1 million in the equivalent period in 2011. Basic and diluted earnings per common share were $0.99 in 2012, an increase from $0.94 and $0.90 in 2011. The increase in earnings was due to an increase in net interest income of $552,000 and non-interest income of $391,000 and a decrease in income tax expense $257,000, offset by increases in provision for loan losses of $729,000 and non-interest expense of $325,000. The annualized return on average assets and shareholders’ equity were 0.95% and 9.27% for the six months ended June, 2012.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Net interest income. Net interest income for the second quarter of 2012 increased to $7.3 million from $7.1 million in 2011 while the Company’s net interest margin on a fully taxable equivalent basis increased to 4.09% from 4.08%. The increase in net interest income was achieved through a reduction on the average cost of interest-bearing liabilities to 0.75% in 2012 from 1.06% in 2011 while the yield on interest earning assets decreased to 4.68% from 4.95% for the same periods. The Company’s yield on loans increased slightly in 2012 to 5.44% from 5.42% in 2011 due to measures taken to maintain loan yield in a low rate environment including rate floors and pricing discipline on new credits. The yield on taxable securities declined from 3.00% in 2011 to 2.12%in 2012 while the average balances increased to $153.4 million in 2012 from $147.3 million in 2011. The Company sold securities throughout 2012 and 20112 resulting in gains of $438,000 in the second quarter of 2012 and $469,000 in 2011 to augment income and reinvested the proceeds in securities. The result has been a compression of the yield in the taxable security portfolio as higher-yielding taxable securities have been replaced with lower securities. The most significant reason for the increase in the Company’s net interest income and margin was the reduction in cost of interest-bearing, specifically the cost of time deposits and savings and other deposit costs. The cost of time deposits decreased from 1.39% for the second quarter of 2011 to 0.81% in 2012 as the Company lowered its offering rates for new and maturing accounts while the cost of savings and other deposit accounts decreased to 0.31% from 0.48% over the same period. Due to net loan repayments and positive cash flows from operations, management has been able to lower its offering rates on all deposit products while maintaining the average balance at relatively consistent levels.

Net interest income for the six months ended June 30, 2012 increased to $14.6 million from $14.0 million in 2011 while the net interest margin on a fully taxable equivalent basis increased to 4.17% in 2012 from 4.04% in 2011. The increase in net interest margin was the result of a decrease in the cost of interest-bearing liabilities to 0.76% for the first six months of 2012 from 1.11% in 2011, offset by a decrease in the yield on interest earning assets from 4.94% to 4.77% over the same period. The largest component of the Company’s interest earning assets, loans, had an average balance of $499.9 million and an average yield of 5.46% for 2012 as compared to an average balance and yield of $507.4 million and 5.47% in 2011. The yield on taxable investment securities declined to 2.23% for the six months ended 2012 from 3.03% in 2011 due to sales of higher yielding securities that were replaced by lower yielding purchases. During the first half of 2012, the Company sold $40.2 million of securities, realizing gains of $1.2 million and purchased $77.2 million of securities during the same period. The cost of interest bearing liabilities declined during the same period as most categories were lower in 2012 as compared to 2011, most significant of which were time deposits and savings and other. The cost of time deposits declined to 0.83% on an average balance of $197.5 million in 2012 from 1.45% and $219.5 million in 2011. The Company has lowered its offering rates for time deposits which has resulted in a lower average cost, but has also led to a reduction in accounts.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Average Balance Sheets. The following tables set forth certain information relating to our average balance sheets and reflect the average yields earned and rates paid. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented. Average balances are computed on daily average balances. For analytical purposes, net interest margin and net interest spread are adjusted to a taxable equivalent adjustment basis to recognize the income tax savings on tax-exempt assets, such as state and municipal securities. A tax rate of 34% was used in adjusting interest on tax-exempt assets to a fully taxable equivalent (“FTE”) basis. Loans held for sale and loans no longer accruing interest are included in total loans.

	Three Months Ended June 30,
	2012									2011
	Average Balance			Interest			Average Yield/Cost			Average Balance			Interest			Average Yield/Cost
	(In thousands)									(In thousands)
ASSETS
Earning assets:
Interest-bearing deposits in other financial institutions	$	18,756		$	14			0.29	%	$	5,815		$	6			0.40	%
Taxable securities		153,384			812			2.12			147,270			1,102			3.00
Tax-exempt securities		71,094			1,091			6.16			57,519			930			6.48
Total loans and fees (1) (2)		499,216			6,774			5.44			507,224			6,849			5.42
FHLB and Federal Reserve stock		6,003			50			3.31			6,642			46			2.76
Total earning assets		748,453			8,741			4.68			724,470			8,933			4.95

Less: Allowance for loan losses		(10,863	)								(11,022	)
Non-earning assets:
Cash and due from banks		15,630									15,481
Bank premises and equipment, net		13,759									13,616
Other assets		45,608									38,950
Total assets	$	812,587								$	781,495

LIABILITIES AND STOCKHOLDERS’ EQUITY

Interest-bearing liabilities:
Savings and other	$	258,838		$	202			0.31	%	$	266,606		$	322			0.48	%
Time deposits		201,045			406			0.81			210,613			729			1.39
Other borrowings		54,634			170			1.25			51,797			194			1.50
FHLB advances		55,000			215			1.57			45,055			219			1.95
Subordinated debentures		17,000			110			2.60			17,000			102			2.41
Total interest-bearing liabilities		586,517			1,103			0.75			591,071			1,566			1.06

Non-interest bearing liabilities:
Non-interest demand deposits		137,577									120,096
Accrued interest payable and other liabilities		5,767									3,664
Stockholders’ equity		82,726									66,664
Total liabilities and stockholders’ equity	$	812,587								$	781,495

Net interest income (taxable equivalent basis)				$	7,638								$	7,367
Less: taxable equivalent adjustment					(371	)								(316	)
Net interest income				$	7,267								$	7,051
Net interest spread								3.93	%								3.88	%
Net interest margin								4.09									4.08

(1)

The amount of direct loan origination cost included in interest on loans was $72 and $182 for the three months ended June 30, 2012 and 2011.

(2)

Calculations include non-accruing loans in the average loan amounts outstanding.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

	Six Months Ended June 30,
	2012									2011
	Average Balance			Interest			Average Yield/Cost			Average Balance			Interest			Average Yield/Cost
	(In thousands)									(In thousands)
ASSETS
Earning assets:
Interest-bearing deposits in other financial institutions	$	16,484		$	25			0.30	%	$	11,719		$	15			0.26	%
Taxable securities		144,427			1,609			2.23			149,892			2,255			3.03
Tax-exempt securities		70,757			2,183			6.19			56,181			1,821			6.54
Total loans and fees (1) (2)		499,945			13,620			5.46			507,429			13,762			5.47
FHLB and Federal Reserve stock		5,978			98			3.28			6,724			95			2.84
Total earning assets		737,591			17,535			4.77			731,945			17,948			4.94

Less: Allowance for loan losses		(10,660	)								(10,894	)
Non-earning assets:
Cash and due from banks		14,563									13,764
Bank premises and equipment, net		13,730									13,625
Other assets		44,495									38,592
Total assets	$	799,720								$	787,032

LIABILITIES AND STOCKHOLDERS’ EQUITY

Interest-bearing liabilities:
Savings and other	$	258,158		$	392			0.30	%	$	265,893		$	644			0.49	%
Time deposits		197,534			816			0.83			219,525			1,578			1.45
Other borrowings		53,260			343			1.29			50,749			390			1.55
FHLB advances		54,835			435			1.59			45,884			481			2.11
Subordinated debentures		17,000			223			2.63			17,000			204			2.42
Total interest-bearing liabilities		580,787			2,209			0.76			599,051			3,297			1.11

Non-interest bearing liabilities:
Non-interest demand deposits		130,983									120,147
Accrued interest payable and other liabilities		5,956									2,578
Stockholders’ equity		81,994									65,256
Total liabilities and stockholders’ equity	$	799,720								$	787,032

Net interest income (taxable equivalent basis)				$	15,326								$	14,651
Less: taxable equivalent adjustment					(742	)								(619	)
Net interest income				$	14,584								$	14,032
Net interest spread								4.00	%								3.83	%
Net interest margin								4.17									4.04

(1)

The amount of direct loan origination cost included in interest on loans was $146 and $377 for the six months ended June 30, 2012 and 2011.

(2)

Calculations include non-accruing loans in the average loan amounts outstanding.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Rate/Volume Analysis. The table below illustrates the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities affected our interest income and interest expense on a fully taxable equivalent basis during the periods indicated. Information is provided in each category with respect to (i) changes attributable to changes in volume (changes in volume multiplied by prior rate), (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume), and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.

	Three Months Ended June 30, 2012 compared to Three Months Ended June 30, 2011 Increase/(Decrease) Due to									Six Months Ended June 30, 2012 compared to Six Months Ended June 30, 2011 Increase/(Decrease) Due to
	Total Net Change			Volume			Rate			Total Net Change			Volume			Rate
	(In thousands)									(In thousands)
Interest income:
Interest-bearing deposits in other financial institutions	$	8		$	10		$	(2	)	$	10		$	7		$	3
Taxable securities		(290	)		44			(334	)		(646	)		(80	)		(566	)
Tax-exempt securities		161			210			(49	)		362			453			(91	)
Total loans and fees		(75	)		(109	)		34			(142	)		(204	)		62
FHLB and Federal Reserve stock		4			(5	)		9			3			(11	)		14
Total increase (decrease) in interest income		(192	)		150			(342	)		(413	)		165			(578	)
Interest expense:
Savings and other		(120	)		(9	)		(111	)		(252	)		(18	)		(234	)
Time Deposits		(323	)		(32	)		(291	)		(762	)		(145	)		(617	)
Other borrowings		(24	)		10			(34	)		(47	)		19			(66	)
FHLB advances		(4	)		43			(47	)		(46	)		84			(130	)
Subordinated debentures		8			-			8			19			-			19
Total increase (decrease) in interest expense		(463	)		12			(475	)		(1,088	)		(60	)		(1,028	)
Increase (decrease) in net interest income	$	271		$	138		$	133		$	675		$	225		$	450

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Allowance and Provision for Loan Losses. Our financial performance depends on the quality of the loans we originate and management’s ability to assess the degree of risk in existing loans when it determines the allowance for loan losses. An increase in loan charge-offs or non-performing loans or an inadequate allowance for loan losses could have an adverse effect on net income. The allowance is determined based on the application of loss estimates to graded loans by categories.

Summary of Loan Loss Experience:

	Three Months Ended June 30,						Six Months Ended June 30,
Activity for the period ended:	2012			2011			2012			2011
	(In thousands)
Beginning balance	$	10,841		$	10,881		$	10,234		$	10,864
Charge-offs:
Residential real estate		(128	)		(282	)		(183	)		(364	)
Commercial real estate		(198	)		-			(198	)		(16	)
Construction		(110	)		-			(443	)		(19	)
Commercial business		(164	)		(615	)		(506	)		(1,197	)
Home equity		(73	)		-			(283	)		(99	)
Consumer		(49	)		(75	)		(116	)		(186	)
Total		(722	)		(972	)		(1,729	)		(1,881	)

Recoveries:
Residential real estate		-			6			-			7
Commercial real estate		9			6			26			12
Construction		-			-			-			2
Commercial business		19			38			52			75
Home equity		-			11			25			12
Consumer		18			32			51			101
Total		46			93			154			209
Net loan charge-offs		(676	)		(879	)		(1,575	)		(1,672	)
Provision for loan losses		944			911			2,450			1,721

Ending balance	$	11,109		$	10,913		$	11,109		$	10,913

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Provision for loan losses increased to $944,000 for the second quarter of 2012 from $911,000 in 2011 and to $2.5 million from $1.7 million for the first six weeks of 2012. Net charge-offs for the three month period ended June 30, 2012 decreased to $676,000 from $879,000 in 2011 and decreased to $1.6 million for the six month period in 2012 from $1.7 million in 2011. The Company’s provision for loan losses for the three and six month periods continues to be impacted by elevated levels of non-performing loans of $15.5 million other problem loan credits and changes in loss exposure for specific credits. In addition, the previously mentioned levels of non-performing and problem loans have all remained at elevated levels as compared to December 31, 2011 resulting in added provision to cover the probable incurred credit losses. As of June 30, 2012 and December 31, 2011, the Company had a total of $71.3 million in classified loans, with a large increase in the amount of loans classified as “doubtful”, the Company’s most severe loan classification (see Note 3 to the Company’s consolidated financial statements for a description of loan classifications and other loan information). The increase in doubtful loans was primarily due to the migration of a large commercial real estate relationship of $8.7 million to doubtful during the period which contributed the majority of the $1.8 million in provision for loan losses in the commercial real estate portfolio. The relationship is classified as a troubled debt restructuring and was current as of June 30, 2012. Non-accrual loans have decreased slightly to $15.5 million as of June 30, 2012 from $15.8 million at December 31, 2011. Non-accrual construction loans continue to have the highest rate of delinquency as compared to the Company’s other classes of loans, with $8.4 million of the $15.5 million loans on non-accrual, or 54.8% of the total. The Company has allocated $1.1 million as of June 30, 2012 for probable incurred losses on construction loans. As of June 30, 2012, the Company had allocated $6.5 million for loans collectively evaluated for impairment and $4.6 million for loans individually evaluated for impairment as compared to $6.6 million and $3.7 million at December 31, 2011, respectively. The increase in the allocation for loans individually evaluated for impairment from December 31, 2011 to June 30, 2012 was primarily attributable to the aforementioned commercial real estate relationship.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Federal regulations require insured institutions to classify their assets on a regular basis. The regulations provide for three categories of classified loans: substandard, doubtful and loss. The regulations also contain a special mention and a specific allowance category. Special mention is defined as loans that do not currently expose an insured institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving management’s close attention. Assets classified as substandard or doubtful require the institution to establish general allowances for loan losses. If an asset or portion thereof is classified as loss, the insured institution must either establish specified allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge off such amount. The Company continues to closely monitor its loan portfolio to identify any additional problem credits, deterioration in underlying collateral values, and credits requiring further downgrades in accordance with the Company’s internal policies. As of June 30, 2012, management has provided for probable incurred losses within the loan portfolio based on information currently available to the Company.

Non-performing assets. Loans, including impaired loans, are placed on non-accrual status when they become past due ninety days or more as to principal or interest, unless they are adequately secured and in the process of collection. When these loans are placed on non-accrual status, all unpaid accrued interest is reversed and the loans remain on non-accrual status until the loan becomes current or the loan is deemed uncollectible and is charged off. Impaired loans are those loans for which it is probable that all scheduled interest and principal payments will not be received based on the contractual terms of the loan agreement. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans, for which the terms have been modified, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. TDR’s totaled $26.3 million and $26.6 million at June 30, 2012 and December 31, 2011, while $5.1 million and $2.4 million were included in the Company’s non-accrual loans as of the same dates, respectively.

	June 30, 2012			December 31, 2011
	(In thousands)

Loans on non-accrual status	$	15,547		$	15,772
Loans past due over 90 days still on accrual		-			-
Total non-performing loans		15,547			15,772
Foreclosed and repossessed assets		5,371			5,076
Total non-performing assets	$	20,918		$	20,848

Non-performing loans to total loans		3.12	%		3.15	%
Non-performing assets to total assets		2.53			2.61
Allowance as a percent of non-performing loans		71.45			64.89
Allowance as a percent of total loans		2.23			2.05

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Non-interest income. Non-interest income for the second quarter in 2012 was $2.0 million as compared to $1.9 million in 2011, an increase of $41,000. The increase was attributable to an increase in mortgage banking income of $33,000 and other income of $50,000, offset by decreases in service charges on deposit accounts of $33,000 and net gains on sales of securities available for sale of $31,000. Mortgage banking income increased to $80,000 for the second quarter of 2012 as compared to $47,000 in 2011 as the Company’s volume of loans sold has increased due to historically low interest rates. Other income increased to $144,000 in 2012 compared to $94,000 in 2011 due to an increase income associated with its card payment processor as the result of renegotiating the contract. Services charges on deposit accounts decreased to $838,000 in 2012 from $871,000 in 2011 mostly due to a decline in non-sufficient funds fee income due to recently enacted regulatory changes. The Company has implemented new fees to offset the decrease including paper statement fees which has mitigated most of the decline. The Company recognized gains on sales of securities available for sale of $438,000 in 2012 on sales of $15.9 million during the quarter as compared to $469,000 in 2011 (see further discussion in Net Interest Margin section of Management’s Discussion and Analysis).

Non-interest income for the six months ended June 30, 2012 and 2011 was $4.3 million and $3.9 million, respectively, as all categories increased during 2012, the most significant of which were service charges on deposit accounts, net gains on sales of available for sale securities, mortgage banking income, and other income. Service charges on deposit accounts increased to $1.7 million in 2012 from $1.6 million in 2011 as a decrease in non-sufficient fee income was fully offset by increases in account fees on deposits and surcharges for ATM usage. The Company’s gains on sales of securities available for sale increased to $1.2 million for 2012 on sales of $40.2 million as compared to gains $1.1 million on $45.1 million in sales in 2011 (see further discussion in Net Interest Margin section of Management’s Discussion and Analysis). Mortgage banking income increased to $173,000 in 2012 from $92,000 for the equivalent period in 2011 due to low interest rates which generated higher demand. Other income was $301,000 for the first six months of 2012, an increase of $72,000 from 2011 due to the aforementioned renegotiated contract with its card payment processor.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Non-interest expense. Non-interest expense for the three months ended June 30, 2012 was $6.0 million compared to $5.7 million for the same period in 2011 as increases in salaries and employee benefits of $87,000, foreclosed assets, net of $256,000, and other expenses of $94,000 were offset by reductions in FDIC insurance premiums of $104,000. Salaries and employee benefits increased to $3.0 million in 2012 from $2.9 million as the number of full time equivalent employees remained at 195. The increase was attributable to increases in base compensation for employees and bonus accrual, offset by a reduction in stock based compensation. Foreclosed assets, net expense increased to $352,000 in 2012 from $96,000 in 2011 as the Company incurred net losses on sales of $104,000 and other expenses of $251,000 (including payments for property taxes and maintenance) in 2012. The increase was attributable to the payment of delinquent property taxes during the quarter for one property. Other expenses increased to $609,000 in the second quarter of 2012 as compared to $515,000 for the same period in 2011 due mostly to an increase in debit card losses during the period. FDIC insurance premiums declined to $140,000 for the three month period ended June 30, 2012 from $244,000 in 2011 due to changes in the method of assessment between the periods. Beginning with the second quarter of 2011, the FDIC changed the base on which premiums were assessed from the amount of deposits to average assets less tangible average equity and the corresponding assessment rate which significantly lowered the amount of premiums paid by the Company.

Non-interest expense for the six months ended June 30, 2012 increased to $11.9 million from $11.5 million in 2011 as increases in salaries and employee benefits of $186,000, foreclosed assets, net of $309,000, and other expenses of $118,000 were offset by decreases in FDIC insurance premiums of $193,000. Salaries and employee benefits increased to $6.1 million for the first six months of 2012 as compared to $6.0 million in 2011 due mostly to increases in base compensation and accrued expense for bonuses, offset by a decrease in stock based compensation. Foreclosed assets, net increased to $484,000 for the first six months of 2012 from $175,000 in 2011 due to net losses incurred in 2012 of $150,000 compared to net gains of $20,000 in 2011 and other foreclosed asset expenditures (property taxes and maintenance) of $344,000 as compared to $216,000, respectively. Other expenses increased to $1.2 million in 2012 from $1.1 million due to increases in conferences and training expenditures and debit card and robbery losses. FDIC insurance premiums decreased to $317,000 for the first six months in 2012 as compared to $510,000 for the same period in 2011 due to changes in the both the assessment methodology described above.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Income tax expense. Income tax expense was $371,000 for the three month period ended June 30, 2012 as compared to $536,000 for the equivalent period in 2011. The effective tax rate for the quarter ended June 30, 2012 was 16.0% as compared to 22.4% in 2011. The decrease in effective tax rate and income tax provision between the two periods was due to the tax benefits recorded in the second quarter associated with the Company’s investment in a low income housing project and the associated tax credits. In addition, the Company’s tax exempt income from municipal securities increased from 2011 by $106,000.

Income tax expense for the six months ended June 30, 2012 was $773,000, with an effective tax rate of 16.9% compared to $1.0 million with an effective tax rate of 22.0% in 2011. The change in income tax expense and effective tax rate was the same as discussed in the income tax expense for the three month periods above.

Liquidity and Capital Resources

Liquidity levels are adjusted in order to meet funding needs for deposit outflows, repayment of borrowings, and loan commitments and to meet asset/liability objectives. Our primary sources of funds are customer deposits, customer repurchase agreements, proceeds from loan repayments, maturing securities and FHLB advances. While loan repayments and maturities are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, general economic conditions and competition. At June 30, 2012, we had cash and interest-bearing deposits with banks of $56.9 million and securities available-for-sale with a fair value of $223.3 million. If we require funds beyond the funds we are able to generate internally, we have $55.0 million in additional aggregate borrowing capacity with the Federal Home Loan Bank of Indianapolis based on our current FHLB stock holdings, unused federal funds lines of credit with various nonaffiliated financial institutions of $34.0 million.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

The Banks are required to maintain specific amounts of capital pursuant to regulatory requirements. As of June 30, 2012, Your Community Bank and Scott County State Bank were each well capitalized under regulatory capital requirements and were in compliance with all regulatory capital requirements that were effective as of such date with capital ratios as follows:

June 30, 2012:

	Total Capital To Risk-weighted Assets			Tier 1 Capital To Risk-weighted Assets			Tier 1 Capital To Average Assets
Consolidated		17.9	%		16.6	%		11.8	%
Your Community Bank		17.7	%		16.5	%		11.9	%
Scott County State Bank		19.8	%		18.5	%		12.0	%

Minimum for banks to be well capitalized under regulatory capital requirements:		10.0	%		6.0	%		5.0	%

December 31, 2011:

	Total Capital To Risk-weighted Assets			Tier 1 Capital To Risk-weighted Assets			Tier 1 Capital To Average Assets
Consolidated		17.5	%		16.3	%		11.7	%
Your Community Bank		17.1	%		15.9	%		11.7	%
Scott County State Bank		20.0	%		18.8	%		12.2	%

Minimum for banks to be well capitalized under regulatory capital requirements:		10.0	%		6.0	%		5.0	%

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

We have been repurchasing shares of our common stock since May 21, 1999. A net total of 501,377 shares at an aggregate cost of $8.6 million have been repurchased since that time under both the current and prior repurchase plans. Our Board of Directors authorized a share repurchase plan in June 2007 under which a maximum of $5.0 million of our common stock may be purchased. Through June 30, 2012, a total of $1.6 million had been expended to purchase 85,098 shares under the current repurchase plan. As a condition for participating in SBLF, the Company may only declare and pay a dividend on the common stock or other stock junior to the SBLF Preferred Stock, or repurchase shares of any such class or series of stock, if, after payment of such dividend, the dollar amount of the Company’s Tier 1 Capital would be at least 90% of the Tier 1 Capital of the Company as of September 15, 2011, excluding any subsequent net charge-offs and any redemption of the SBLF Preferred Stock (the “Tier 1 Dividend Threshold”). Beginning on the first day of the eleventh dividend period, the amount of the Tier 1 Dividend Threshold will be reduced by 10% for each one percent increase in QSBL from the baseline level through the ninth dividend period. Under the terms of the SBLF Preferred Stock, no repurchases may be effected, and no dividends may be declared or paid on preferred shares ranking pari passu with the SBLF Preferred Stock, junior preferred shares, or other junior securities (including the common stock) during the current quarter and for the next three quarters following the failure to declare and pay dividends on the SBLF Preferred Stock, except that, in any such quarter in which the dividend is paid, dividend payments on shares ranking pari passu may be paid to the extent necessary to avoid any resulting material covenant breach.

During June 2004 and 2006, we completed placements of $7.0 million and $10.0 million floating rate subordinated debentures through Community Bank Shares (IN) Statutory Trust I and Trust II, (trusts we formed), respectively. These securities are reported as liabilities for financial reporting, but Tier 1 Capital for regulatory purposes. We used the proceeds for general business purposes and to support our future opportunities for growth.

Off Balance Sheet Arrangements and Contractual Obligations

The amount and nature of our off balance sheet arrangements and contractual obligations at June 30, 2012 were not significantly different from the information that was reported in the Company’s annual report on Form 10-K for the year ended December 31, 2011.

PART I - ITEM 3

QUANTITATIVE AND QUALITATIVE

DISCLOSURES ABOUT MARKET RISK

Asset/liability management is the process of balance sheet control designed to ensure safety and soundness and to maintain liquidity and regulatory capital standards while maintaining acceptable net interest income. Interest rate risk is the exposure to adverse changes in net interest income as a result of market fluctuations in interest rates. Management continually monitors interest rate and liquidity risk so that it can implement appropriate funding, investment, and other balance sheet strategies. Management considers market interest rate risk to be our most significant ongoing business risk consideration.

We currently contract with an independent third party consulting firm to measure our interest rate risk position. The consulting firm utilizes an earnings simulation model to analyze net interest income sensitivity. Current balance sheet amounts, current yields and costs, corresponding maturity and repricing amounts and rates, other relevant information, and certain assumptions made by management are combined with gradual movements in interest rates of 200 basis points up at December 31, 2011 and June 30, 2012 within the model to estimate their combined effects on net interest income over a one-year horizon. In 2008, the Federal Open Market Committee lowered its target for the federal funds rate to 0-25 bps. A majority of our loans are indexed to the prime rate, therefore, the Company has excluded an evaluation of the effect on net interest income assuming a decrease in interest rates as further reductions in the prime rate are extremely unlikely. We feel that using gradual interest rate movements within the model is more representative of future rate changes than instantaneous interest rate shocks. Growth in amounts are not projected for any balance sheet category when constructing the model because of the belief that projected growth can mask current interest rate risk imbalances over the projected horizon. We believe that the changes made to the model’s interest rate risk measurement process have improved the accuracy of results of the process, consequently giving better information on which to base asset and liability allocation decisions going forward.

Assumptions based on the historical behavior of our deposit rates and balances in relation to changes in interest rates are incorporated into the model. These assumptions are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. We continually monitor and update the assumptions as new information becomes available. Actual results will differ from the model's simulated results due to timing, magnitude and frequency of interest rate changes, and actual variations from the managerial assumptions utilized under the model, as well as changes in market conditions and the application and timing of various management strategies.

The base scenario represents projected net interest income over a one year forecast horizon exclusive of interest rate changes to the simulation model. Given a gradual 200 basis point increase in the projected yield curve used in the simulation model (Up 200 Scenario), we estimated that as of June 30, 2012 our net interest income would decrease by an estimated 1.1%, or $318,000, over the one year forecast horizon. As of December 31, 2011, in the Up 200 Scenario we estimated that net interest income would decrease $55,000, over a one year forecast horizon ending December 31, 2012.

PART I - ITEM 3

QUANTITATIVE AND QUALITATIVE

DISCLOSURES ABOUT MARKET RISK

The projected results are within our asset/liability management policy limits which states that the negative impact to net interest income should not exceed 7% in a 100 or 200 basis point increase or decrease in the projected yield curve over a one year forecast horizon. The forecast results are heavily dependent on the assumptions regarding changes in deposit rates; we can minimize the reduction in net interest income in a period of rising interest rates to the extent that we can curtail raising deposit rates during this period. We continue to explore transactions and strategies to both increase our net interest income and minimize our interest rate risk.

Our interest sensitivity profile at any point in time will be affected by a number of factors. These factors include the mix of interest sensitive assets and liabilities as well as their relative repricing schedules. It is also influenced by market interest rates, deposit growth, loan growth, and other factors. The tables below illustrate our estimated annualized earnings sensitivity profile based on the above referenced asset/liability model as of June 30, 2012 and December 31, 2011, respectively. The tables below are representative only and are not precise measurements of the effect of changing interest rates on our net interest income in the future.

The following table illustrates our estimated one year net interest income sensitivity profile based on the asset/liability model as of June 30, 2012 and ending on June 30, 2013:

	Interest Rate Sensitivity as of June 30, 2012
	Base		Gradual Increase in Rates of 200 Basis Points

Projected interest income:
Loans	$	27,091	$	27,827
Investments		5,983		6,105
FHLB and FRB stock		163		163
Interest-bearing deposits in other financial institutions		103		414
Total interest Income		33,340		34,509

Projected interest expense:
Deposits		1,845		2,626
Federal funds purchased, line of credit and repurchase agreements		374		892
FHLB advances		770		816
Subordinated debentures		437		579
Total interest expense		3,426		4,913
Net interest income	$	29,914	$	29,596

Change from base				(318	)
Percent change from base				(1.06	)%

PART I - ITEM 3

QUANTITATIVE AND QUALITATIVE

DISCLOSURES ABOUT MARKET RISK

The following table illustrates our estimated one year net interest income sensitivity profile based on the asset/liability model as of December 31, 2011 and ending December 31, 2012:

	Interest Rate Sensitivity as of December 31, 2011
	Base		Gradual Increase in Rates of 200 Basis Points
Projected interest income:
Loans	$	27,912	$	28,741
Investments		5,969		6,110
FHLB and FRB stock		165		165
Interest-bearing deposits in other financial institutions		104		226
Total interest income		43		175
		34,193		35,417
Projected interest expense:
Deposits
Federal funds purchased, line of credit and Repurchase agreements		2,048		2,790
FHLB advances		603		1,028
Subordinated debentures		871		900
Total interest expense		453		536
Net interest income		3,975		5,254
	$	30,218	$	30,163
Change from base
% Change from base			$	(55	)
				-	%

PART I – ITEM 4

CONTROLS AND PROCEDURES

With the participation of the Chief Executive Officer (the principal executive officer) and the Chief Financial Officer (the principal financial officer) of Community Bank Shares of Indiana, Inc. (“CBIN”), CBIN’s management has evaluated the effectiveness of CBIN’s disclosure controls and procedures (as defined in Rule 13a-15(c) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the quarterly period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, CBIN’s Chief Executive Officer and Chief Financial Officer have concluded that CBIN’s disclosure controls and procedures are effective as of the end of the quarterly period covered by this Quarterly Report on Form 10-Q to ensure that information required to be disclosed by CBIN in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by CBIN in the reports that it files or submits under the Exchange Act is accumulated and communicated to CBIN’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There was no change in CBIN’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the fiscal quarter ended June 30, 2012, that has materially affected, or is reasonably likely to materially affect, CBIN’s internal control over financial reporting.

PART II

OTHER INFORMATION

Item 1. Legal Proceedings

There are various claims and lawsuits in which the Company or its subsidiaries are periodically involved, such as claims to enforce liens, foreclosure or condemnation proceedings on properties in which the Banks hold mortgages or security interests, claims involving the making and servicing of real property loans and other issues incidental to the Banks’ business. In the opinion of management, no material loss is expected from any such pending claims or lawsuits.

Item 1A. Risk Factors

In addition to the information set forth in this report, you should carefully consider the risk factors disclosed in Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The Company did not purchase its common shares during the nine months ended September 30, 2011.

The Board of Directors of the Company authorized a share repurchase plan in June 2007 under which a maximum of $5.0 million of the Company’s common stock can be purchased. As of September 30, 2011, the Company could repurchase up to $3.4 million of the Company’s common stock under the current repurchase plan. As a condition for participating in SBLF, the Company may only declare and pay a dividend on the common stock or other stock junior to the SBLF Preferred Stock, or repurchase shares of any such class or series of stock, if, after payment of such dividend, the dollar amount of the Company’s Tier 1 Capital would be at least 90% of the Tier 1 Capital of the Company as of September 15, 2011, excluding any subsequent net charge-offs and any redemption of the SBLF Preferred Stock (the “Tier 1 Dividend Threshold”). Beginning on the first day of the eleventh dividend period, the amount of the Tier 1 Dividend Threshold will be reduced by 10% for each one percent increase in QSBL from the baseline level through the ninth dividend period. Under the terms of the SBLF Preferred Stock, no repurchases may be effected, and no dividends may be declared or paid on preferred shares ranking pari passu with the SBLF Preferred Stock, junior preferred shares, or other junior securities (including the common stock) during the current quarter and for the next three quarters following the failure to declare and pay dividends on the SBLF Preferred Stock, except that, in any such quarter in which the dividend is paid, dividend payments on shares ranking pari passu may be paid to the extent necessary to avoid any resulting material covenant breach.

Item 6. Exhibits

Exhibits

The exhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index of this Form 10-Q and are filed as a part of this report.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed by the undersigned thereunto duly authorized.

	COMMUNITY BANK SHARES OF INDIANA, INC.
	(Registrant)

Dated: August 14, 2012	BY:	/s/ James D. Rickard
		James D. Rickard
		President and
		Chief Executive Officer
		(Principal Executive Officer)

Dated: August 14, 2012	BY:	/s/ Paul. A. Chrisco
		Paul A. Chrisco
		Executive Vice-President and
		Chief Financial Officer
		(Principal Financial Officer)

EXHIBIT INDEX

COMMUNITY BANK SHARES OF INDIANA, INC.

EXHIBIT INDEX

Exhibit No.		Description

31.1		Certification of Principal Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act

31.2		Certification of Principal Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act

32.1		Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101*		The following financial information from Community Bank Shares of Indiana, Inc. Quarterly Report on Form 10-Q for the period ended June 30, 2012, filed with the SEC on August 14, 2012, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets at June 30, 2012 and December 31, 2011, (ii) Consolidated Statements of Income for the three and six months ended June 30, 2012 and June 30, 2011, (iii) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2012 and June 30, 2011, (iv) Consolidated Statement of Stockholders’ Equity for the six months ended June 30, 2012, (v) Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and June 30, 2011 and (vi) Notes to Consolidated Financial Statements Pursuant to Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed to be “filed” for purposes of Sections 11 and 12 of the Securities

*To be filed by amendment within 30 days pursuant to Rule 405(a)(2)(ii) of Regulation S-T.

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