Your Community Bankshares, Inc. - FORM 10-Q

Attached files

file	filename
EX-31.1 - EXHIBIT 31.1 - Your Community Bankshares, Inc.	v385695_ex31-1.htm
EX-32.1 - EXHIBIT 32.1 - Your Community Bankshares, Inc.	v385695_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - Your Community Bankshares, Inc.	v385695_ex31-2.htm
EX-32.2 - EXHIBIT 32.2 - Your Community Bankshares, Inc.	v385695_ex32-2.htm
EXCEL - IDEA: XBRL DOCUMENT - Your Community Bankshares, Inc.	Financial_Report.xls

ARTICLE IUNITED 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, 2014

¨ 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: 3,443,614 shares of common stock were outstanding as of August 11, 2014.

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 (Loss)	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	44

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, 2014			December 31, 2013
	(In thousands, except share data)
ASSETS
Cash and due from financial institutions	$	19,350		$	15,393
Interest-bearing deposits in other financial institutions		18,727			10,896
Securities available for sale		199,071			195,327
Loans held for sale		246			68
Loans, net of allowance for loan losses of $8,481 and $8,009		579,679			552,926
Federal Home Loan Bank and Federal Reserve stock		5,964			5,955
Accrued interest receivable		3,144			3,149
Premises and equipment, net		18,204			18,557
Company owned life insurance		21,718			21,386
Other intangible assets		839			1,004
Foreclosed and repossessed assets		6,029			5,988
Settlement receivable for security sales		-			11,136
Other assets		2,945			4,950
Total Assets	$	875,916		$	846,735

LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Non interest-bearing	$	201,259		$	187,207
Interest-bearing		482,356			456,418
Total deposits		683,615			643,625
Other borrowings		37,459			45,722
Federal Home Loan Bank advances		40,000			50,000
Subordinated debentures		17,000			17,000
Accrued interest payable		87			106
Other liabilities		3,566			1,943
Total liabilities		781,727			758,396

Commitments and contingent liabilities		—			—

Shareholders’ equity
Preferred stock, without par value; 5,000,000 authorized; 28,000 shares issued and outstanding in 2013 and 2012; 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; 3,440,614 and 3,394,657 outstanding in 2014 and 2013 respectively		386			386
Additional paid-in capital		43,948			44,597
Retained earnings		28,403			25,184
Accumulated other comprehensive income (loss)		754			(1,733	)
Treasury stock, at cost (2014- 423,323 shares, 2013- 469,280 shares)		(7,302	)		(8,095	)
Total shareholders’ equity		94,189			88,339
Total Liabilities and Shareholders’ Equity	$	875,916		$	846,735

See accompanying notes to consolidated financial statements.

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014			2013
		(In thousands, except share data)
Interest and dividend income
Loans, including fees	$	7,098		$	6,924		$	13,722		$	13,080
Taxable securities		489			629			1,050			1,358
Tax-exempt securities		751			758			1,488			1,513
Federal Home Loan Bank and Federal Reserve dividends		63			48			116			104
Interest-bearing deposits in other financial institutions		9			16			35			44
Interest and dividend income		8,410			8,375			16,411			16,099

Interest expense
Deposits		267			302			520			631
Other borrowings		23			28			53			57
Federal Home Loan Bank advances		82			107			176			285
Subordinated debentures		101			102			200			204
Interest expense		473			539			949			1,177
Net interest income		7,937			7,836			15,462			14,922

Provision for loan losses		190			2,470			472			2,717

Net interest income after provision for loan losses		7,747			5,366			14,990			12,205

Non-interest income
Service charges on deposit accounts		835			859			1,627			1,606
Commission income		48			46			96			88
Net gain on sales of available for sale securities		1			509			296			515
Mortgage banking income		28			60			44			139
Earnings on company owned life insurance		168			170			332			338
Interchange income		330			299			600			562
Bargain purchase gain		-			1,879			-			1,879
Other income		130			147			222			266
Non-interest income		1,540			3,969			3,217			5,393

Non-interest expense
Salaries and employee benefits		3,366			3,347			6,733			6,645
Occupancy		549			559			1,249			1,084
Equipment		301			309			628			599
Data processing		663			662			1,329			1,261
Marketing and advertising		89			71			195			155
Legal and professional service fees		738			620			1,158			1,033
FDIC insurance premiums		129			211			293			355
Foreclosed assets, net		53			242			191			224
Other expense		641			690			1,304			1,441
Total non-interest expense		6,529			6,711			13,080			12,797
Income before income taxes		2,758			2,624			5,127			4,801

Income tax expense		610			420			867			690

Net income		2,148			2,204			4,260			4,111

Preferred stock dividend		(109	)		(288	)		(219	)		(509	)

Net income available to common shareholders	$	2,039		$	1,916		$	4,041		$	3,602

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
		(In thousands, except share data)
Earnings per common share:
Basic	$	0.59	$	0.57	$	1.18	$	1.06
Diluted	$	0.59	$	0.57	$	1.17	$	1.06

Dividends per common share	$	0.12	$	0.11	$	0.24	$	0.21

See accompanying notes to consolidated financial statements.

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014			2013
	(in thousands)
Net income	$	2,148		$	2,204		$	4,260		$	4,111

Other comprehensive income (loss), net of tax
Unrealized gain on securities:
Unrealized gain (losses) arising during the period		2,116			(6,753	)		4,045			(8,423	)
Reclassification adjustment for gains included in net income		(1	)		(509	)		(296	)		(515	)
Net unrealized gains (losses)		2,115			(7,262	)		3,749			(8,938	)
Tax effect		(711	)		2,469			(1,266	)		3,039
Net of tax		1,404			(4,793	)		2,483			(5,899	)

Defined benefit pension plans:
Net gain (loss) arising during the period		16			(15	)		6			29
Tax effect		(5	)		5			(2	)		(10	)
Net of tax		11			(10	)		4			19

Total other comprehensive income (loss)		1,415			(4,803	)		2,487			(5,880	)

Comprehensive income (loss)	$	3,563		$	(2,599	)	$	6,747		$	(1,769	)

See accompanying notes to consolidated financial statements.

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC.

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollar amounts in thousands, except per share data)

(Unaudited)

	Preferred Stock		Common Stock		Additional Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Treasury Stock			Total Shareholders’ Equity
Balance, January 1, 2014	$	28,000	$	386	$	44,597		$	25,184		$	(1,733	)	$	(8,095	)	$	88,339
Net income		—		—		—			4,260			—			—			4,260
Other comprehensive loss		—		—		—			—			2,487			—			2,487
Cash dividends declared on common stock ($0.24 per share)		—		—		—			(822	)		—			—			(822	)
Dividends on preferred stock		—		—		—			(219	)		—			—			(219	)
Issuance of treasury stock under dividend reinvestment plan		—		—		30			—			—			80			110
Issuance of stock award shares		—		—		(951	)		—			—			684			(267	)
Stock options exercised		—		—		(29	)								29			—
Stock award expense		—		—		201			—			—			—			201
Tax benefit from vesting of stock award shares		—		—		100			—			—			—			100
Balance, June 30, 2014	$	28,000	$	386	$	43,948		$	28,403		$	754		$	(7,302	)	$	94,189

See accompanying notes to consolidated financial statements.

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Six Months Ended June 30,
	2014			2013
		(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	4,260		$	4,111
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses		472			2,717
Depreciation and amortization		945			655
Net amortization of securities		240			492
Net gain on sales of available for sale securities		(296	)		(515	)
Mortgage loans originated for sale		(1,985	)		(5,915	)
Proceeds from mortgage loan sales		1,847			6,793
Net gain on sales of mortgage loans		(40	)		(141	)
Earnings on company owned life insurance		(332	)		(338	)
Shared based compensation expense		201			101
Bargain purchase gain		-			(1,879	)
Net loss on disposition of premises and equipment		3			99
Net (gain) loss on disposition of foreclosed and repossessed assets		(53	)		48
Net change in:
Accrued interest receivable		5			46
Accrued interest payable		(19	)		(111	)
Other assets		933			3,351
Other liabilities		1,591			1,122
Net cash from operating activities		7,772			10,636
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash received in FDIC assisted acquisition		-			19,714
Net change in interest-bearing deposits		(7,831	)		12,207
Available for sale securities:
Sales		32,757			49,704
Purchases		(28,886	)		(20,996	)
Maturities, prepayments and calls		7,230			15,091
Loan originations and payments, net		(28,359	)		(28,483	)
Proceeds from the sale of foreclosed and repossessed assets		1,289			2,034
Purchases of premises and equipment		(536	)		(1,084	)
Proceeds from the sale of premises and equipment		-			690
Additions to foreclosed and repossessed assets		(37	)		-
Purchase of Federal Reserve and FHLB stock		(9	)		-
Proceeds from redemption of Federal Reserve and FHLB stock		-			4,032
Net cash from investing activities		(24,382	)		52,909
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits		39,990			(37,368	)
Net change in other borrowings		(8,263	)		(7,338	)
Proceeds from Federal Home Loan Bank advances		110,000			33,000
Repayment of Federal Home Loan Bank advances		(120,000	)		(57,444	)
Taxes paid on stock award shares for employees		(267	)		-
Cash dividends paid on preferred shares		(181	)		(352	)
Cash dividends paid on common shares		(712	)		(603	)
Net cash from financing activities		20,567			(70,105	)
Net change in cash and due from financial institutions		3,957			(6,560	)
Cash and due from financial institutions at beginning of period		15,393			19,039
Cash and due from financial institutions at end of period	$	19,350		$	12,479

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Six Months Ended June 30,
	2014		2013
	(In thousands)
Supplemental cash flow information:
Interest paid	$	968	$	1,257
Income taxes paid, net of refunds		345		-

Supplemental noncash disclosures:
Transfer from loans to foreclosed and repossessed assets		1,240		5,398
Issuance of treasury shares under dividend reinvestment plan		80		111
Issuance of treasury shares for net settlement of stock options		29		-
Sale and financing of foreclosed and repossessed assets		-		275
Declared, unpaid dividends on preferred stock		110		288

See accompanying notes to consolidated financial statements.

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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 Office of Financial Institutions. Scott County State Bank is also regulated by the Federal Reserve. The Company formed a captive insurance company in 2012, CBIN Insurance, Inc., which issues policies to the Company’s subsidiaries to cover gaps in coverage and other risks not insured by its third-party provider.

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, 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, 2014, the results of operations for the three and six months ended June 30, 2014 and 2013, and cash flows for the six months ended June 30, 2014 and 2013. 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, 2013. 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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Securities

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

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In thousands)
June 30, 2014:
Securities available for sale:
State and municipal	$	81,837	$	4,558	$	(398	)	$	85,997
U.S. Government sponsored entities and agencies		9,567		3		(438	)		9,132
Residential mortgage-backed agencies issued by U.S. Government sponsored entities		105,720		370		(2,394	)		103,696
Mutual funds		250		-		(4	)		246
Total securities available for sale	$	197,374	$	4,931	$	(3.234	)	$	199,071

December 31, 2013:
Securities available for sale:
State and municipal	$	77,103	$	2,744	$	(1,137	)	$	78,710
U.S. Government sponsored entities and agencies		9,702		5		(606	)		9,101
Residential mortgage-backed agencies issued by U.S. Government sponsored entities		110,324		382		(3,432	)		107,274
Mutual funds		250		-		(8	)		242
Total securities available for sale	$	197,379	$	3,131	$	(5,183	)	$	195,327

Sales of available for sale securities were as follows.

	Three Months Ended June 30						Six Months Ended June 30
	2014			2013			2014			2013
	(In thousands)
Proceeds	$	8,947		$	46,272		$	32,757		$	49,704
Gross gains		44			604			339			610
Gross losses		(43	)		(95	)		(43	)		(95	)

The tax provision applicable to these realized gains amounted to $15,000 and $115,000 for the three and six months ended June 30, 2014, respectively, and $173,000 and $175,000 for the three and six months ended June 30, 2013, respectively.

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Securities (Continued)

The amortized cost and fair value of the contractual maturities of available for sale securities at June 30, 2014 were as follows. Mortgage-backed agencies and mutual funds which do not have a single maturity date are shown separately.

	June 30, 2014
	Amortized Cost		Fair Value
	(In thousands)
Within one year	$	552	$	559
One to five years		4,955		4,956
Five to ten years		42,936		44,115
Beyond ten years		42,961		45,499
Residential mortgage-backed securities issued by U.S. Government sponsored entities		105,720		103,696
Mutual funds		250		246
Total	$	197,374	$	199,071

Securities with unrealized losses at June 30, 2014 and December 31, 2013, 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
	(In thousands)
June 30, 2014
State and municipal	$	1,780	$	(8	)	$	10,616	$	(390	)	$	12,396	$	(398	)
Residential mortgage-backed securities issued by U.S. Government sponsored entities		14,178		(126	)		62,043		(2,268	)		76,221		(2,394	)
U.S. Government sponsored entities and agencies		-		-			8,581		(438	)		8,581		(438	)
Mutual Funds		246		(4	)		-		-			246		(4	)
Total temporarily impaired	$	16,204	$	(138	)	$	81,240	$	(3,096	)	$	97,444	$	(3,234	)

	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Loss			Value		Loss			Value		Loss
	(In thousands)
December 31, 2013
State and municipal	$	18,492	$	(772	)	$	3,347	$	(365	)	$	21,839	$	(1,137	)
Residential mortgaged-backed securities issued by U.S. Government sponsored agencies		70,019		(2,306	)		20,440		(1,126	)		90,459		(3,432	)
U.S. Government sponsored entities and agencies		7,032		(468	)		1,383		(138	)		8,415		(606	)
Mutual funds		242		(8	)		-		-			242		(8	)
Total temporarily impaired	$	95,785	$	(3,554	)	$	25,170	$	(1,629	)	$	120,955	$	(5,183	)

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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. Investment securities are generally evaluated for OTTI under FASB ASC 320-10.

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.

As of June 30, 2014, the Company’s security portfolio consisted of 286 securities, 66 of which were in an unrealized loss position. The unrealized losses are related to the Company’s state and municipal, residential mortgage-backed securities issued by U.S. Government sponsored entities and agencies, and U.S. Government sponsored entities and agencies, as discussed below.

State and Municipal

At June 30, 2014 the Company had approximately $12.4 million of state and municipal securities with an unrealized loss of $398,000. Of the 189 state and municipal securities in the Company’s portfolio, 188 had an investment grade rating as of June 30, 2014 while 1 was not rated. The decline in value in these securities is attributable to interest rate and liquidity, and not credit quality. All of the state and municipal securities in the Company’s portfolio have a fair value as a percentage of amortized cost greater than 90%. The Company does not have the intent to sell its state and municipal securities and it is unlikely that we will be required to sell the securities before the anticipated recovery. The Company does not consider these securities to be other-than-temporarily impaired at June 30, 2014.

U.S. Government sponsored entities and agencies

At June 30, 2014, the unrealized losses in the Company’s U.S. Government sponsored entities and agencies securities portfolio were attributed to changes in interest rates and liquidity, and not due to credit quality. Because the company does not have the intent to sell these securities and it is not likely that they will be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired as of June 30, 2014.

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Securities (Continued)

Residential mortgage-backed Securities issued by U.S. Government sponsored entities

At June 30, 2014, all of the mortgage-backed securities held by the Company were issued by U.S. government-sponsored entities, primarily Fannie Mae and Freddie Mac, institutions which the government has affirmed its commitment to support. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at June 30, 2014.

Loans

Loans at June 30, 2014 and December 31, 2013 consisted of the following:

	June 30, 2014			December 31, 2013
	(In thousands)
Commercial	$	121,784		$	107,461
Construction		43,411			39,986
Commercial real estate:
Owner occupied nonfarm/residential		113,428			112,072
Other nonfarm/residential		91,898			86,405
Residential real estate:
Secured by first liens		177,661			172,833
Home equity		34,993			36,780
Consumer		4,985			5,398
Subtotal		588,160			560,935
Less:
Allowance for loan losses		(8,481	)		(8,009	)
Loans, net	$	579,679		$	552,926

During 2014 and 2013, substantially all of the Company’s residential and commercial real estate loans were pledged as collateral to the Federal Home Loan Bank to secure advances.

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Loans (Continued)

Purchased Credit Impaired Loans:

The Company has purchased loans, for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans is as follows:

	June 30, 2014		December 31, 2013
	(In thousands)
Commercial	$	243	$	252
Construction		36		36
Commercial Real Estate		3,310		4,032
Residential Real Estate		5,382		5,890
Carrying amount	$	8,971	$	10,210

There was no associated allowance for loan losses as of June 30, 2014 or December 31, 2013 for purchased credit impaired loans.

Accretable yield, or income expected to be collected, is as follows:

	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014			2013
	(In thousands)
Balance, beginning of period	$	491		$	1,103		$	545		$	-
New loans purchased		-			-			-			1,103
Accretion of income		(34	)		(168	)		(62	)		(168	)
Reclassifications from nonaccretable difference		419			-			419			-
Disposals		-			-			(26	)		-
Balance, end of period	$	876		$	935		$	876		$	935

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Loans (Continued)

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended June 30, 2014 and 2013 (in thousands):

Three Months Ended June 30, 2014:

	Commercial			Construction			Commercial Real Estate			Residential Real Estate			Consumer			Total

Beginning balance	$	1,948		$	2,460		$	1,374		$	2,523		$	73		$	8,378
Provision for loan losses		(227	)		(19	)		6			404			26			190
Loans charged-off		-			-			(23	)		(135	)		(52	)		(210	)
Recoveries		67			-			21			8			27			123
Ending balance	$	1,788		$	2,441		$	1,378		$	2,800		$	74		$	8,481

Three Months Ended June 30, 2013:

	Commercial			Construction			Commercial Real Estate		Residential Real Estate			Consumer			Total

Beginning balance	$	1,879		$	1,641		$	1,528	$	2,521		$	100		$	7,669
Provision for loan losses		120			1,979			227		126			18			2,470
Loans charged-off		(39	)		(156	)		-		(229	)		(44	)		(468	)
Recoveries		20			2			3		5			21			51
Ending balance	$	1,980		$	3,466		$	1,758	$	2,423		$	95		$	9,722

COMMUNITY BANK SHARES OF INDIANA, INC.

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, 2014 and 2013 (in thousands):

Six Months Ended June 30, 2014:

	Commercial			Construction		Commercial Real Estate			Residential Real Estate			Consumer			Total

Beginning balance	$	1,757		$	2,210	$	1,565		$	2,383		$	94		$	8,009
Provision for loan losses		(58	)		164		(259	)		587			38			472
Loans charged-off		(1	)		-		(23	)		(186	)		(111	)		(321	)
Recoveries		90			67		95			16			53			321
Ending balance	$	1,788		$	2,441	$	1,378		$	2,800		$	74		$	8,481

Six Months Ended June 30, 2013:

	Commercial			Construction			Commercial Real Estate			Residential Real Estate			Consumer			Total

Beginning balance	$	2,007		$	1,399		$	2,836		$	2,389		$	131		$	8,762
Provision for loan losses		(38	)		2,219			96			424			16			2,717
Loans charged-off		(39	)		(156	)		(1,208	)		(404	)		(95	)		(1,902	)
Recoveries		50			4			34			14			43			145
Ending balance	$	1,980		$	3,466		$	1,758		$	2,423		$	95		$	9,722

COMMUNITY BANK SHARES OF INDIANA, INC.

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 by portfolio segment and based on impairment method as of June 30, 2014 and December 31, 2013 (in thousands):

June 30, 2014:

	Commercial		Construction		Commercial Real Estate		Residential Real Estate		Consumer		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	327	$	1,010	$	75	$	1,276	$	20	$	2,708
Collectively evaluated for impairment		1,461		1,431		1,303		1,524		54		5,773
Acquired with deteriorated credit quality		-		-		-		-		-		-
Total ending allowance balance	$	1,788	$	2,441	$	1,378	$	2,800	$	74	$	8,481

Loans:
Loans individually evaluated for impairment	$	4,733	$	6,986	$	2,841	$	5,880	$	37	$	20,477
Loans collectively evaluated for impairment		116,808		36,389		199,175		201,392		4,948		558,712
Loans acquired with deteriorated credit quality		243		36		3,310		5,382		-		8,971
Total ending loans balance	$	121,784	$	43,411	$	205,326	$	212,654	$	4,985	$	588,160

December 31, 2013:

	Commercial		Construction		Commercial Real Estate		Residential Real Estate		Consumer		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	256	$	1,064	$	77	$	936	$	12	$	2,345
Collectively evaluated for impairment		1,501		1,146		1,488		1,447		82		5,664
Acquired with deteriorated credit quality		-		-		-		-		-		-
Total ending allowance balance	$	1,757	$	2,210	$	1,565	$	2,383	$	94	$	8,009

Loans:
Loans individually evaluated for impairment	$	4,485	$	7,092	$	2,072	$	6,047	$	62	$	19,758
Loans collectively evaluated for impairment		102,724		32,858		192,373		197,676		5,336		530,967
Loans acquired with deteriorated credit quality		252		36		4,032		5,890		-		10,210
Total ending loans balance	$	107,461	$	39,986	$	198,477	$	209,613	$	5,398	$	560,935

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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, 2014 (in thousands):

June 30, 2014:

	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated		Average Recorded Investment		Interest Income Recognized and Received
	(In thousands)
With no related allowance recorded:
Commercial	$	1,745	$	1,745	$	-	$	1,350	$	23
Construction		4,755		2,389		-		2,313		15
Commercial real estate:
Owner occupied nonfarm/nonresidential		912		912		-		807		24
Other nonfarm/nonresidential		1,746		1,746		-		1,354		5
Residential real estate:
Secured by first liens		2,840		2,765		-		2,457		6
Home equity		56		56		-		345		2
Consumer		4		4		-		11		-
Total	$	12,058	$	9,617	$	-	$	8,637	$	75

With an allowance recorded:
Commercial	$	2,988	$	2,988	$	327	$	2,991	$	1
Construction		4,932		4,597		1,010		4,764		82
Commercial real estate:
Owner occupied nonfarm/nonresidential		183		183		75		186		4
Other nonfarm/nonresidential		-		-		-		-		-
Residential real estate:
Secured by first liens		2,191		2,191		963		2,018		32
Home equity		868		868		313		932		22
Consumer		33		33		20		29		-
Total	$	11,195	$	10,860	$	2,708	$	10,920	$	141

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Loans (Continued)

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2013:

December 31, 2013:

	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
	(In thousands)
With no related allowance recorded:
Commercial	$	1,538	$	1,538	$	-
Construction		4,645		2,279		-
Commercial real estate:
Owner occupied nonfarm/nonresidential		704		704		-
Other nonfarm/nonresidential		1,180		1,180		-
Residential real estate:
Secured by first liens		2,536		2,461		-
Home equity		759		759		-
Consumer		23		23		-
Total	$	11,385	$	8,944	$	-

	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
	(In thousands)
With an allowance recorded:
Commercial	$	2,947	$	2,947	$	256
Construction		5,149		4,813		1,064
Commercial real estate:
Owner occupied nonfarm/nonresidential		188		188		77
Other nonfarm/nonresidential		-		-		-
Residential real estate:
Secured by first liens		1,784		1,775		508
Home equity		1,052		1,052		428
Consumer		39		39		12
Total	$	11,159	$	10,814	$	2,345

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, 2014:

	Average Recorded Investment		Interest Income Recognized and Received
	(In thousands)
With no related allowance recorded:
Commercial	$	1,255	$	23
Construction		2,330		8
Commercial real estate:
Owner occupied nonfarm/nonresidential		859		12
Other nonfarm/nonresidential		1,442		2
Residential real estate:
Secured by first liens		2,456		3
Home equity		138		1
Consumer		4		-
Total	$	8,484	$	49

	Average Recorded Investment		Interest Income Recognized and Received
	(In thousands)
With an allowance recorded:
Commercial	$	3,013	$	1
Construction		4,739		40
Commercial real estate:
Owner occupied nonfarm/nonresidential		184		2
Other nonfarm/nonresidential		-		-
Residential real estate:
Secured by first liens		2,140		20
Home equity		872		11
Consumer		24		-
Total	$	10,972	$	74

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Loans (Continued)

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, 2013:

	Three Months				Six Months
	Average Recorded Investment		Interest Income Recognized and Received		Average Recorded Investment		Interest Income Recognized and Received
	(In thousands)
With no related allowance recorded:
Commercial	$	609	$	5	$	655	$	11
Construction		5,373		12		4,858		17
Commercial real estate:
Owner occupied nonfarm/nonresidential		392		-		485		-
Other nonfarm/nonresidential		3,728		3		2,656		5
Residential real estate:
Secured by first liens		1,587		6		1,854		14
Home equity		665		7		682		14
Consumer		18		-		20		-
Total	$	12,372	$	33	$	11,210	$	61

With an allowance recorded:
Commercial	$	133	$	1	$	145	$	2
Construction		5,467		29		5,462		73
Commercial real estate:
Owner occupied nonfarm/nonresidential		560		2		685		16
Other nonfarm/nonresidential		1,246		-		4,051		-
Residential real estate:
Secured by first liens		2,592		13		2,558		34
Home equity		1,180		15		1,130		28
Consumer		25		-		17		-
Total	$	11,203	$	60	$	14,048	$	153

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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, 2014 and December 31, 2013:

	June 30, 2014				December 31, 2013
	Nonaccrual		Loans Past Due Over 90 Days Still Accruing		Nonaccrual		Loans Past Due Over 90 Days Still Accruing
	(In thousands)
Commercial	$	3,106	$	-	$	336	$	-
Construction		2,599		-		2,474		-
Commercial real estate:
Owner occupied nonfarm/nonresidential		300		-		-		-
Other nonfarm/nonresidential		964		-		1,706		-
Residential real estate:
Secured by first liens		2,309		-		2,669		-
Home equity		266		-		475		-
Consumer		45		-		128		-
Total	$	9,589	$	-	$	7,788	$	-

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Loans (Continued)

The following table presents the aging of the recorded investment in past due loans as of June 30, 2014 and December 31, 2013 by class of loans:

June 30, 2014:

	30 – 59 Days Past Due		60 – 89 Days Past Due		Greater than 89 Days Past Due		Total Past Due		Loans Not Past Due

Commercial	$	220	$	64	$	3,106	$	3,390	$	118,394
Construction		-		64		2,599		2,663		40,748
Commercial real estate:
Owner occupied nonfarm/nonresidential		76		687		300		1,063		112,365
Other nonfarm/nonresidential		-		-		941		941		90,957
Residential real estate:
Secured by first liens		460		946		1,677		3,083		174,578
Home equity		148		175		266		589		34,404
Consumer		62		46		43		151		4,834
Total	$	966	$	1,982	$	8,932	$	11,880	$	576,280

December 31, 2013:

	30 – 59 Days Past Due		60 – 89 Days Past Due		Greater than 89 Days Past Due		Total Past Due		Loans Not Past Due

Commercial	$	3,207	$	129	$	336	$	3,672	$	103,789
Construction		122		-		2,474		2,596		37,390
Commercial real estate:
Owner occupied nonfarm/nonresidential		151		428		-		579		111,493
Other nonfarm/nonresidential		-		-		1,706		1,706		84,699
Residential real estate:
Secured by first liens		3,513		533		2,354		6,400		166,433
Home equity		744		141		404		1,289		35,491
Consumer		78		24		72		174		5,224
Total	$	7,815	$	1,255	$	7,346	$	16,416	$	544,419

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Loans (Continued)

Troubled Debt Restructurings:

Troubled debt restructurings totaled $10.5 million at June 30, 2014 and December 31, 2013. Of the total TDRs, $2.8 million and $389,000 were on non-accrual as of June 30, 2014 and December 31, 2013. The Company has allocated $1.4 million and $1.2 million of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of June 30, 2014 and December 31, 2013. 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, 2014 and December 31, 2013.

The detail of outstanding TDRs by class and modification type as of June 30, 2014 and December 31, 2013 follows (in thousands):

June 30, 2014:

	Recorded Investment		Allowance for Loan Losses Allocated
Commercial:
Extended maturity	$	3,749	$	134
Multiple modifications		6		-
Interest only payments		556		-
Construction:
Interest rate reduction		1,386		233
Extended maturity		387		98
Multiple modifications		2,595		382
Commercial real estate:
Owner occupied nonfarm/nonresidential
Interest only payments		183		75
Other nonfarm/nonresidential
Interest only payments		195		-
Residential real estate:
Secured by first liens
Interest rate reduction		59		8
Interest only payments		88		50
Extended maturity		303		53
Multiple modifications		333		112
Home equity
Multiple modifications		661		210
Total	$	10,501	$	1,355

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Loans (Continued)

December 31, 2013:

	Recorded Investment		Allowance for Loan Losses Allocated
Commercial:
Extended maturity	$	4,099	$	134
Multiple modifications		63		3
Construction:
Interest rate reduction		1,386		113
Extended maturity		396		90
Multiple modifications		2,633		374
Commercial real estate:
Owner occupied nonfarm/nonresidential
Interest only		188		77
Other nonfarm/nonresidential
Interest only payments		198		-
Residential real estate:
Secured by first liens
Interest rate reduction		61		7
Extended maturity		307		36
Interest only payments		87		25
Multiple modifications		370		110
Home equity
Multiple modifications		675		217
Total	$	10,463	$	1,186

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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, 2014 and December 31, 2014 (in thousands):

June 30, 2014:

	TDRs Greater than 30 Days Past Due and Still Accruing		TDRs on Nonaccrual		Total TDRs Not Performing to Modified Terms
Commercial:
Extended maturity	$	-	$	2,749	$	2,749
Residential:
Secured by first liens
Interest only payments		-		88		88
Total	$	-	$	2,837	$	2,837

December 31, 2013:

	TDRs Greater than 30 Days Past Due and Still Accruing		TDRs on Nonaccrual		Total TDRs Not Performing to Modified Terms
Commercial:
Extended maturity	$	2,749	$	-	$	2,749
Residential:
Secured by first liens
Interest only payments		-		87		87
Multiple modifications		68		302		370
Total	$	2,817	$	389	$	3,206

There were no trouble debt restructurings that defaulted within 12 months of modifications during the three and six months ended June 30, 2014. During the three and six months ended June 30, 2013, there were two residential real estate loan secured by a first lien for $86,000 that defaulted within 12 months of modification.

During the quarter and six months ended June 30, 2014, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or adjustment of scheduled loan payments from principal and interest to interest only.

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.

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Loans (Continued)

The following table presents loans by class modified as troubled debt restructurings that occurred during the six months ended June 30, 2014 and 2013 and their performance, by modification type (in thousands):

	Number of Loans		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		TDRs Performing to Modified Terms		TDRs Not Performing to Modified Terms
June 30, 2014:
Commercial:
Interest only payments		1	$	556	$	556	$	556	$	-
Residential:
Secured by first liens
Multiple modifications		1		31		31		31		-

June 30, 2013:
Residential:
Secured by first liens
Interest only payments		2		81		81		-		81
Multiple modifications		1		68		68		68		-

There was no impact to the allowance for loan losses for TDRs that defaulted during the six months ended June 30, 2014 and 2013.

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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 greater 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:

The Company uses the following definitions for its classified loan 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.

The Company uses the following definitions for its criticized loan risk ratings:

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.

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, 2014 and December 31, 2013 is as follows:

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3. Loans (Continued)

June 30, 2014:

	Criticized		Classified		Pass		Total
	(In thousands)
Commercial	$	6,663	$	3,737	$	111,384	$	121,784
Construction		3,493		6,987		32,931		43,411
Commercial real estate:
Owner occupied nonfarm/residential		6,435		1,057		105,936		113,428
Other nonfarm/residential		8,169		941		82,788		91,898
Residential real estate:
Secured by first liens		12,144		4,834		160,683		177,661
Home equity		1,036		1,018		32,939		34,993
Consumer		-		69		4,916		4,985
Total	$	37,940	$	18,643	$	531,577	$	588,160

December 31, 2013:

	Criticized		Classified		Pass		Total
	(In thousands)
Commercial	$	4,612	$	3,207	$	99,642	$	107,461
Construction		3,337		7,129		29,520		39,986
Commercial real estate:
Owner occupied nonfarm/residential		6,199		704		105,169		112,072
Other nonfarm/residential		6,364		1,706		78,335		86,405
Residential real estate:
Secured by first liens		5,060		4,504		163,269		172,833
Home equity		129		1,929		34,722		36,780
Consumer		2		87		5,309		5,398
Total	$	25,703	$	19,266	$	515,966	$	560,935

Deposits

Deposits at June 30, 2014 and December 31, 2013 consisted of the following:

	June 30, 2014		December 31, 2013
	(In thousands)

Demand (NOW)	$	138,936	$	122,051
Money market accounts		158,305		141,073
Savings		47,236		45,117
Individual retirement accounts		24,691		25,418
Certificates of deposit, $100,000 and over		51,445		55,641
Other certificates of deposit		61,743		67,118
Total interest bearing deposits		482,356		456,418
Total non-interest bearing deposits		201,259		187,207
Total deposits	$	683,615	$	643,625

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Earnings Per Common Share

Earnings per share were computed as follows:

	Three months ended June 30,						Six months ended June 30,
	2014			2013			2014			2013
	(In thousands, except for share and per share amounts)
Basic:
Net income	$	2,148		$	2,204		$	4,260		$	4,111
Preferred stock dividend		(109	)		(288	)		(219	)		(509	)
Net income available to common shareholders	$	2,039		$	1,916		$	4,041		$	3,602
Average shares outstanding		3,438,794			3,386,701			3,430,025			3,384,205
Net income per common share, basic	$	0.59		$	0.57		$	1.18		$	1.06

Diluted:
Net income available to common shareholders	$	2,039		$	1,916		$	4,041		$	3,602
Average shares:
Common shares outstanding for basic		3,438,794			3,386,701			3,430,025			3,384,205
Add: Dilutive effects of outstanding stock options		16,669			-			26,129			-
Add: Dilutive effects of outstanding stock awards		12,961			-			5,134			-
Average dilutive potential common shares		3,468,424			3,386,701			3,461,288			3,384,205
Net income per common share, diluted	$	0.59		$	0.57		$	1.17		$	1.06

No stock options were excluded from the calculation of diluted net income per common share for the three months ended June 30, 2014. Stock options for 54,000 shares of common stock were excluded from the calculation of diluted net income per common share for the six months ended June 30, 2014 because their effect was antidilutive. This compares to stock options for 157,800 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, 2013.

No restricted share awards were excluded from the calculation of diluted net income per common share for the three and six months ended June 30, 2014. Restricted share awards of 49,599 common shares were excluded from the calculation of diluted net income per common share for the three and six months ended June 30, 2013 because all of the conditions necessary for issuance of common stock had not been met as of those dates.

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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 152,295 shares of common stock. The aggregate intrinsic value for options outstanding and exercisable at June 30, 2014 and December 31, 2013 was $49,000 and $1,000, respectively. There was no remaining compensation cost related to unvested options as of June 30, 2014 and December 31, 2013, respectively. The Company did not recognize expense for stock options for the three and six months ended June 30, 2014 and 2013, respectively. The Company has options vested and expected to vest of 126,500 with aggregate intrinsic value of $49,000 and a weighted average remaining contractual term of 2.2 years as of June 30, 2014. As of December 31, 2013, the Company had options vested and expected to vest of 153,200 which had an aggregate intrinsic value of $1,000 and a weighted average remaining contractual term of 2.3 years. During the six months ended June 30, 2014, there were no options granted or forfeited while 17,350 stock options were exercised. All stock options were exercised using the cashless option, with the Company issued net shares to the option holders.

For the three and six months ended June 30, 2014, we recognized $101,000 and $201,000 in expense for restricted stock awards, respectively. During the three months ended June 30, 2014, there were no restricted stock awards granted or forfeited. During the six months ended June 30, 2014, 34,550 awards granted to employees and no shares forfeited. The restricted share awards granted had an aggregate fair value of $766,000 at the date of grant. Of the total awards, 650 of awards vested at the grant date, 1,300 vest in 2015, 2,600 vest in 2016, and 10,000 vest in 2017, 2018, and 2019. The fair value of the restricted stock awards was calculated based on the Company’s stock price at the date of issuance. At June 30, 2014, there were 54,840 outstanding and unvested restricted stock awards. For the three and six months ended June 30, 2013, we recognized $43,000 and $101,000 in expense for restricted stock awards, respectively.

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

7. 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 were historically priced using Level 2 inputs. The decline in the level of observable inputs and market activity in this class of investments by the measurement date has been significant and resulted in unreliable external pricing. Broker pricing and bid/ask spreads, when available, vary widely. The once active market has become comparatively inactive. As such, these investments are now priced using Level 3 inputs.

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.

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

7. Fair Value (Continued)

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.

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value (Continued)

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, 2014):
Available for sale securities:
State and municipal	$	85,997	$	—		85,997	$	—
U.S. Government sponsored entities and agencies		9,132		—		9,132		—
Residential mortgage-backed securities issued by U.S. Government sponsored entities		103,696		—		103,696		—
Mutual Funds		246		—		246		—

Total available for sale securities	$	199,071	$	—	$	199,071	$	—

Assets (December 31, 2013):
Available for sale securities:
State and municipal	$	78,710	$	—	$	78,710	$	—
U.S. Government sponsored entities and agencies		9,101		—		9,101		—
Residential mortgage-backed securities issued by U.S. Government sponsored entities		107,274		—		107,274		—
Mutual Funds		242		—		242		—

Total available for sale securities	$	195,327	$	—	$	195,327	$	—

There were no transfers between Level 1 and Level 2 during 2014 or 2013.

COMMUNITY BANK SHARES OF INDIANA, INC.

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, 2014):
Impaired loans:
Commercial	$	2,661	$	—	$	—	$	2,661
Construction		2,022		—		—		2,022
Commercial real estate:
Owner Occupied nonfarm/nonresidential		108		—		—		108
Other nonfarm/nonresidential		—		—		—		—
Residential real estate:
Secured by first liens		1,176		—		—		1,176
Home equity		104		—		—		104
Consumer		13		—		—		13

Foreclosed and repossessed assets:
Construction		1,549		—		—		1,549
Commercial real estate:
Owner occupied nonfarm/nonresidential		588		—		—		588
Other nonfarm/nonresidential		3,409		—		—		3,409
Residential real estate:
Secured by first liens		483		—		—		483

Assets (December 31, 2013):
Impaired loans:
Commercial	$	2,631	$	—	$	—	$	2,631
Construction		2,153		—		—		2,153
Commercial real estate:
Owner Occupied nonfarm/nonresidential		111		—		—		111
Residential real estate:
Secured by first liens		1,213		—		—		1,213
Home equity		165		—		—		165
Consumer		27		—		—		27


Foreclosed and repossessed assets:
Construction		1,641		—		—		1,641
Commercial real estate:
Owner occupied nonfarm/nonresidential		875		—		—		875
Other nonfarm/nonresidential		2,425		—		—		2,425
Residential real estate:
Secured by first liens		1,026		—		—		1,026
Consumer		21		—		—		21

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value (Continued)

The Company measures for impairment using the fair value of the collateral less costs to sell for collateral-dependent loans. The Company’s collateral dependent impaired loans had a carrying value of $8.2 million as of June 30, 2014 with a valuation allowance of $2.1 million, resulting in provision for loan losses of $192,000 and $452,000 for the three and six months ended June 30, 2014. The Company recorded $2.2 million and $2.5 million in provision for loan losses for collateral-dependent impaired loans for the three and six months ended June 30, 2013. Impaired loans totaled $18.4 million as of December 31, 2013, which included collateral dependent loans with a carrying value of $8.0 million and a valuation allowance of $1.7 million.

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, 2014 and 2013, the Company recognized charges to write down foreclosed and repossessed assets to their fair value of $0 and $119,000, respectively.

COMMUNITY BANK SHARES OF INDIANA, INC.

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, 2014:

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
	(in thousands)
June 30, 2014:
Impaired Loans:
Commercial	$	2,661	Sales comparison approach	Adjustments for differences between comparable sales	24%-33% (33%)
Construction		2,022	Sales comparison approach	Adjustments for differences between comparable sales	14%-19% (15%)
Commercial real estate		108	Income capitalization approach	Capitalization rate	22%
Residential real estate		1,280	Sales comparison approach	Adjustments for differences between comparable sales	14%-54% (29%)
Consumer		13	Sales comparison approach	Adjustments for differences between comparable sales	29%
Foreclosed and repossessed assets:
Construction	$	1,549	Income capitalization approach	Capitalization rate	9%
			Sales comparison approach	Adjustments for differences between comparable sales	15%-45% (23%)
Commercial real estate		3,997	Income capitalization approach	Capitalization rate	4%
			Sales comparison approach	Adjustments for differences between comparable sales	10%-50% (32%)
Residential real estate		483	Sales comparison approach	Adjustments for differences between comparable sales	18%-60% (27%)

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value (Continued)

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range - (Weighted Average)
	(in thousands)
December 31, 2013:
Impaired Loans:
Commercial	$	2,631	Sales comparison approach	Adjustments for differences between comparable sales	24%-73% (72%)
Construction		2,153	Sales comparison approach	Adjustments for differences between comparable sales	14%-19% (15%)
Commercial real estate		111	Income capitalization approach	Capitalization rate	22%
Residential real estate		1,378	Sales comparison approach	Adjustments for differences between comparable sales	14%-40% (28%)
Consumer		27	Sales comparison approach	Adjustments for differences between comparable sales	29%
Foreclosed and repossessed assets:
Construction	$	1,641	Income capitalization approach	Capitalization rate	9%
			Sales comparison approach	Adjustments for differences between comparable sales	15%-45% (23%)
Commercial real estate		3,300	Sales comparison approach	Adjustments for differences between comparable sales	10%-50% (31%)
Residential real estate		1,026	Sales comparison approach	Adjustments for differences between comparable sales	18%-60% (25%)
Consumer		21	Sales comparison approach	Adjustments for differences between comparable sales	0%

COMMUNITY BANK SHARES OF INDIANA, INC.

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, 2014 and December 31, 2013 were as follows:

			Fair Value Measurements Using
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(in thousands)
June 30, 2014:
Financial assets:
Cash and due from financial institutions	$	19,350	$	19,350	$	—	$	—	$	19,350
Interest-bearing deposits in other financial institutions		18,727		18,727		—		—		18,727
Loans held for sale		246		—		290		—		290
Loans, net		579,679		—		—		591,337		591,337
Accrued interest receivable		3,144		—		1,050		2,094		3,144
Federal Home Loan Bank and Federal Reserve Stock		5,964		n/a		n/a		n/a		n/a

Financial liabilities:
Deposits		683,615		—		669,760		—		669,760
Other borrowings		37,459		—		37,455		—		37,455
Federal Home Loan Bank Advances		40,000		—		40,123		—		40,123
Subordinated debentures		17,000		—		—		9,836		9,836
Accrued interest payable		87		—		73		14		87

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value (Continued)

			Fair Value Measurements Using
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(in thousands)
December 31, 2013:
Financial assets:
Cash and due from financial institutions	$	15,393	$	15,393	$	—	$	—	$	15,393
Interest-bearing deposits in other financial institutions		10,896		10,896		—		—		10,896
Loans held for sale		68		—		69		—		69
Loans, net		552,926		—		—		562,882		562,882
Accrued interest receivable		3,149		—		987		2,161		3,149
Federal Home Loan Bank and Federal Reserve Stock		5,955		n/a		n/a		n/a		n/a

Financial liabilities:
Deposits		643,625		—		621,065		—		621,065
Other borrowings		45,722		—		45,717		—		45,717
Federal Home Loan Bank Advances		50,000		—		50,102		—		50,102
Subordinated debentures		17,000		—		—		9,878		9,878
Accrued interest payable		106				92		14		106

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.

(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.

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value (Continued)

(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.

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Accumulated other comprehensive income (loss)

The changes in accumulated other comprehensive income (loss) by component, net of tax, is presented below for the three month periods ended June 30, 2014 and 2013 (in thousands):

	Unrealized Gains and Losses on Available- for-Sale Securities			Defined Benefit Pension Items			Total
June 30, 2014:
Balance, beginning of period	$	(285	)	$	(376	)	$	(661	)
Other comprehensive loss before reclassifications		1,405			11			1,416
Reclassification for gains included in net income		(1	)		-			(1	)
Balance, end of period	$	1,119		$	(365	)	$	754

June 30, 2013:
Balance, beginning of period	$	2,901		$	(505	)	$	2,396
Other comprehensive income (loss) before reclassifications		(4,457	)		(10	)		(4,467	)
Reclassification for gains included in net income		(336	)		-			(336	)
Balance, end of period	$	(1,892	)	$	(515	)	$	(2,407	)

The changes in accumulated other comprehensive income (loss) by component, net of tax, is presented below for the six month periods ended June 30, 2014 and 2013 (in thousands):

	Unrealized Gains and Losses on Available- for-Sale Securities			Defined Benefit Pension Items			Total
June 30, 2014:
Balance, beginning of period	$	(1,364	)	$	(369	)	$	(1,733	)
Other comprehensive income (loss) before reclassifications		2,678			4			2,682
Reclassification for gains included in net income		(195	)		-			(195	)
Balance, end of period	$	1,119		$	(365	)	$	754

June 30, 2013:
Balance, beginning of period	$	4,007		$	(534	)	$	3,473
Other comprehensive income before reclassifications		(5,559	)		19			(5,540	)
Reclassification for gains included in net income		(340	)		-			(340	)
Balance, end of period	$	(1,892	)	$	(515	)	$	(2,407	)

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC.

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 $29.2 million to $875.9 million as of June 30, 2014 from $846.7 million as of December 31, 2013. The increase in total assets was primarily due to an increase in net loans of $26.8 million and interest-bearing deposits in other financial institutions of $7.8 million.

Net loans increased to $580.0 million at June 30, 2014 from $552.9 million as of December 31, 2013. During the second quarter of 2013, the Company acquired First Federal of Lexington, Kentucky in an FDIC-assisted transaction. Subsequent to the acquisition, the Company hired two lenders in Lexington which has boosted the Company’s new loan originations and contributed to the increase in net loans during the period.

Securities available for sale increased by $3.7 million to $199.1 million as of June 30, 2014 from $195.3 million at December 31, 2013 primarily due to purchases of $28.9 million, offset by sales of $32.8 million and maturities, prepayments and calls of $7.2 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.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC.

Total deposits increased by $40.0 million to $683.6 million as of June 30, 2014 from $643.6 million at December 31, 2013. Interest bearing deposits increased by $25.9 million during the period while non interest-bearing deposits increased by $14.1 million as the Company continued to effectively deploy its funding strategy by emphasizing growth in non-interest bearing deposits and pricing its interest bearing deposits at an appropriate level given on-balance sheet liquidity and the amount of unpledged securities in its investment portfolio.

Net Income Available to Common Shareholders. Net income available to common shareholders increased to $2.0 million for the three months ended June 30, 2014 from $1.9 million for the same period in 2013. Basic and diluted earnings per common share increased to $0.59 per share for the second quarter of 2014 as compared to $0.57 per common share for the second quarter of 2013. The increase in net income available to common shareholders was attributable to an increase in net interest income of $101,000 and decreases in provision for loan loss expense of $2.3 million, non-interest expense of $182,000, and preferred stock dividends of $179,000, offset by a decrease in non-interest income of $2.4 million. The annualized return on average assets and average shareholders’ equity were 1.00% and 9.25% for the three months ended June 30, 2014, respectively, compared to 1.04% and 10.05% for the equivalent period in 2013.

Net income available to common shareholders for the six month period ended June 30, 2014 increased to $4.0 million from $3.6 million in the equivalent period in 2013. Basic earnings per share was $1.18 and diluted earnings per common share was $1.17 in 2014, an increase from basic and diluted earnings per share of $1.06 in 2013. The increase in net income available to common shareholders was due to an increase in net interest income of $540,000 and decreases in provision for loan loss expense of $2.2 million and preferred stock dividends of $290,000, offset by a decrease in non-interest income of $2.2 million and an increase in non-interest expense of $283,000. The primary factor for the decrease in non-interest income is due to the bargain purchase gain recognized from the acquisition of First Federal Bank of Lexington, Kentucky during the second quarter of 2013 which was not repeated in 2014. The annualized return on average assets and shareholders’ equity were 1.01% and 9.36% for the six months ended June 30, 2014, respectively, compared to 1.00% and 9.47% for the equivalent period in 2013.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC.

Net interest income. Net interest income increased slightly from $7.8 million for the three months ended June 30, 2014 to $7.9 million in 2013, while the Company’s net interest margin on a fully taxable equivalent basis decreased to 4.19% from 4.23%. The decrease in net interest margin was the result of a lower yield on interest earning assets that was not fully offset by a decline in the cost of funds. The yield on interest-earning assets declined to 4.43% for the second quarter of 2014 from 4.50% in 2013 while the average balance of interest-earning assets increased to $796.5 million from $780.7 million over the respective period. The primary reason for the decline was the yield on loans, which decreased to 4.88% in 2014 from 5.25% in 2013. In the current rate environment, higher yielding loans are maturing or renewing at lower rates which has pressured the Company’s net interest margin. As a result, interest income from loans has remained relatively flat, increasing by $174,000 from the second quarter of 2013, while the average balance of loans over the same period has increased by $54.7 million. The average cost of funds declined to 0.33% for the second quarter of 2014 from 0.37% in 2013. The decrease in the cost of funds was achieved through reductions in the average cost of time deposits and the average balance as the Company’s deposit mix has shifted to lower costing savings and other transaction type accounts. In addition, the Company has been lowering offering rates for its deposit products given the level of on-balance sheet liquidity which has resulted in some time deposit runoff with the average balance for time deposits decreasing to $144.3 million in 2014 from $170.9 million in 2013.

Net interest income for the six months ended June 30, 2013 increased to $15.5 million from $14.9 million in 2013 while the net interest margin on a fully taxable equivalent basis remained consistent at 4.14%. Net interest margin for 2014 was impacted by a decline in the yield on interest earning assets from 4.45% to 4.38%, offset by a decrease in the cost of interest-bearing liabilities to 0.34% for the first six months of 2014 from 0.42% in 2013. The largest component of the Company’s interest earning assets, loans, had an average balance of $574.0 million and an average yield of 4.82% for 2014 as compared to an average balance and yield of $497.6 million and 5.30% in 2013 as the Company continues to experience maturation, renewals, and originations at lower rates. The cost of interest bearing liabilities declined compared to 2013 with the most significant decrease in time deposits with an average cost of 0.30% on an average balance of $146.4 million in 2014 from 0.42% and $167.8 million in 2013. The Company has lowered its offering rates for time deposits which has resulted in a lower average cost, but has also to a reduction in accounts and average balances. Cost of funds on FHLB advances also decreased to 0.78% on an average balance of $45.2 million in 2014 from 1.82% and $31.6 million in 2013, which was a result of the maturation of higher yielding advances during second half of 2013 and the first six months of 2014.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC.

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,
	2014									2013
	Average Balance			Interest			Average Yield/Cost			Average Balance			Interest			Average Yield/Cost
	(In thousands)									(In thousands)
ASSETS
Earning assets:
Interest-bearing deposits with banks	$	13,433		$	9			0.26	%	$	10,325		$	16			0.63	%
Taxable securities		112,139			489			1.75			154,220			629			1.64
Tax-exempt securities		81,619			1,138			5.59			79,778			1,148			5.77
Total loans and fees (1) (2)		583,345			7,098			4.88			528,635			6,924			5.25
FHLB and Federal Reserve stock		5,962			63			4.24			7,749			48			2.46
Total earning assets		796,498			8,797			4.43			780,707			8,765			4.50

Less: Allowance for loan losses		(8,501	)								(7,768	)
Non-earning assets:
Cash and due from banks		16,788									18,876
Bank premises and equipment, net		18,376									13,684
Other assets		39,963									45,488
Total assets	$	863,124								$	850,987

LIABILITIES AND STOCKHOLDERS’ EQUITY

Interest-bearing liabilities:
Savings and other	$	329,190		$	162			0.20	%	$	321,149		$	147			0.18	%
Time deposits		144,331			105			0.29			170,854			155			0.36
Other borrowings		39,813			23			0.23			46,432			28			0.24
FHLB advances		43,187			82			0.76			26,940			107			1.59
Subordinated debentures		17,000			101			2.38			17,000			102			2.40
Total interest-bearing liabilities		573,521			473			0.33			582,375			539			0.37

Non-interest bearing liabilities:
Non-interest demand deposits		191,466									173,330
Accrued interest payable and other liabilities		4,968									7,362
Stockholders’ equity		93,169									87,920
Total liabilities and stockholders’ equity	$	863,124								$	850,987

Net interest income (taxable equivalent basis)				$	8,324								$	8,226
Less: taxable equivalent adjustment					(387	)								(390	)
Net interest income				$	7,937								$	7,836
Net interest spread								4.10	%								4.13	%
Net interest margin								4.19									4.23

(1)

The amount of direct loan origination cost included in interest on loans was $99 and $90 for the three months ended June 30, 2014 and 2013.

(2)

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

(3)

The amount of accretion recorded for acquired loans included in interest income was $61 and $181 for the three months ended June 30, 2014 and 2013.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC.

	Six Months Ended June 30,
	2014									2013
	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	$	13,304		$	35			0.53	%	$	17,485		$	44			0.50	%
Taxable securities		116,686			1,050			1.81			163,248			1,358			1.68
Tax-exempt securities		80,301			2,254			5.66			78,956			2,292			5.85
Total loans and fees (1) (2)		574,042			13,722			4.82			497,558			13,080			5.30
FHLB and Federal Reserve stock		5,959			116			3.92			6,878			104			3.06
Total earning assets		790,292			17,177			4.38			764,125			16,878			4.45

Less: Allowance for loan losses		(8,491	)								(8,257	)
Non-earning assets:
Cash and due from banks		13,446									17,510
Bank premises and equipment, net		18,425									13,863
Other assets		40,701									45,840
Total assets	$	854,373								$	833,081

LIABILITIES AND STOCKHOLDERS’ EQUITY

Interest-bearing liabilities:
Savings and other	$	319,487		$	304			0.19	%	$	305,423		$	284			0.19	%
Time deposits		146,383			216			0.30			167,821			347			0.42
Other borrowings		42,586			53			0.25			46,436			57			0.25
FHLB advances		45,249			176			0.78			31,555			285			1.82
Subordinated debentures		17,000			200			2.37			17,000			204			2.42
Total interest-bearing liabilities		570,705			949			0.34			568,235			1,177			0.42

Non-interest bearing liabilities:
Non-interest demand deposits		187,298									170,252
Accrued interest payable and other liabilities		4,592									7,034
Stockholders’ equity		91,778									87,560
Total liabilities and stockholders’ equity	$	854,373								$	833,081

Net interest income (taxable equivalent basis)				$	16,228								$	15,701
Less: taxable equivalent adjustment					(766	)								(779	)
Net interest income				$	15,462								$	14,922
Net interest spread								4.04	%								4.03	%
Net interest margin								4.14									4.14

(1)

The amount of direct loan origination cost included in interest on loans was $198 and $173 for the six months ended June 30, 2014 and 2013.

(2)

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

(3)

The amount of accretion recorded for acquired loans included in interest income was $106 and $184 for the six months ended June 30, 2014 and 2013.

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, 2014 compared to Three Months Ended June 30, 2013 Increase/(Decrease) Due to									Six Months Ended June 30, 2014 compared to Six Months Ended June 30, 2013 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	$	(7	)	$	4		$	(11	)	$	(9	)	$	(11	)	$	2
Taxable securities		(140	)		(181	)		41			(308	)		(412	)		104
Tax-exempt securities		(10	)		26			(36	)		(38	)		39			(77	)
Total loans and fees		174			686			(512	)		642			1,896			(1,254	)
FHLB and Federal Reserve stock		15			(13	)		28			12			(15	)		27
Total increase (decrease) in interest income		32			522			(490	)		299			1,497			(1,198	)
Interest expense:
Savings and other		15			4			11			20			13			7
Time Deposits		(50	)		(22	)		(28	)		(131	)		(40	)		(91	)
Other borrowings		(5	)		(4	)		(1	)		(4	)		(5	)		1
FHLB advances		(25	)		46			(71	)		(109	)		93			(202	)
Subordinated debentures		(1	)		-			(1	)		(4	)		-			(4	)
Total increase (decrease) in interest expense		(66	)		24			(90	)		(228	)		61			(289	)
Increase (decrease) in net interest income	$	98		$	498		$	(400	)	$	527		$	1,436		$	(909	)

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC.

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:	2014			2013			2014			2013
	(In thousands)
Beginning balance	$	8,378		$	7,669		$	8,009		$	8,762
Charge-offs:
Residential real estate		(93	)		(202	)		(144	)		(372	)
Commercial real estate		(23	)		-			(23	)		(1,208	)
Construction		-			(156	)		-			(156	)
Commercial business		-			(39	)		(1	)		(39	)
Home equity		(42	)		(27	)		(42	)		(32	)
Consumer		(52	)		(44	)		(111	)		(95	)
Total		(210	)		(468	)		(321	)		(1,902	)

Recoveries:
Residential real estate		2			3			7			10
Commercial real estate		21			3			95			34
Construction		-			2			67			4
Commercial business		67			20			90			50
Home equity		6			2			9			4
Consumer		27			21			53			43
Total		123			51			321			145
Net loan charge-offs		(87	)		(417	)		-			(1,757	)
Provision for loan losses		190			2,470			472			2,717

Ending balance	$	8,481		$	9,722		$	8,481		$	9,722

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC.

Provision for loan losses decreased to $190,000 and $472,000 for the three and six months ending June 30, 2014 from $2.5 million and $2.7 million for the same periods in 2013. Net charge-offs for the three and six months ended June 30, 2014 were $87,000 and $0 compared to $417,000 and $1.8 million in 2013. Net-charge-offs for the six months ended June 30, 2014 decreased from 2013 due to a $1.2 million charge-off for one credit relationship, or the full amount of allocated reserves during 2013. The Company’s non-performing loans increased to $9.6 million as of June 30, 2014 from $7.8 million as of December 31, 2013 due primarily to one loan with a balance of $2.7 million being placed on non-accrual in the first quarter of 2014. As of June 30, 2014, the Company had allocated $134,000 for loan losses which was recorded in 2013. The decrease in the Company’s provision for loan losses for the three and six months ended June 30, 2014 was due primarily to the allocation of $2.0 million for one credit in the second quarter of 2013 that was not repeated in 2014. Subsequently, in the fourth quarter of 2013, the Company charged-off the allocated allowance leaving a remaining balance of $814,000 as of June 30, 2014. Currently, the Company does not have an allocation for loan losses for this credit. Additionally, the provision for loan losses was positively impacted by lower net charge-off activity during the period. The Company allocates allowance for loan losses for loans collectively evaluated for impairment by using its average three year charge-off history, adjusted for certain qualitative factors. As the Company’s charge-offs decrease, the amount allocated decreases as well.

The Company’s classified loans (substandard and doubtful) decreased to $18.6 million as of June 30, 2014 from $19.3 million as of December 31, 2013 while criticized loans (watch and special mention) increased to $38.0 million from $25.7 million. The same trend was present in the Company’s level of past due credits as total past due loans declined to $11.9 million at the end of second quarter from $16.4 million at December 31, 2013. At June 30, 2014, there are still a few large impaired credit relationships which could significantly impact provision for loan losses in the future should the value of underlying credit erode further or loss mitigation tactics be unsuccessful. Due to the aforementioned provision and charge-off activity, the allowance for loan losses as a percentage of loans increased to 1.44% of loans as of June 30, 2014 from 1.43% at December 31, 2013.

Asset Quality. 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 $10.5 million at June 30, 2014 and December 31, 2013, while $2.8 million and $389,000 were included in the Company’s non-accrual loans as of the same dates, respectively.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC.

The Company’s non-performing assets as of June 30, 2014 and December 31, 2013 were as follows:

	June 30, 2014			December 31, 2013
	(In thousands)

Loans on non-accrual status	$	9,589		$	7,788
Loans past due over 90 days still on accrual		-			-
Total non-performing loans		9,589			7,788
Foreclosed and repossessed assets		6,029			5,988
Total non-performing assets	$	15,618		$	13,776

Non-performing loans to total loans		1.63	%		1.39	%
Non-performing assets to total loans		2.66			2.46
Allowance as a percent of non-performing loans		88.45			102.84
Allowance as a percent of total loans		1.44			1.43

Non-interest income. Non-interest income decreased to $1.5 million for the second quarter of 2014 from $4.0 million for 2013, a decrease of $2.4 million. The decrease was due to a bargain purchase gain of $1.9 million related to the acquisition of First Federal in Lexington, Kentucky recorded in the second quarter of 2013 and a decrease in net gains on sales of available for sale securities of $508,000. The bargain purchase gain was recorded as the difference between the fair value of the assets acquired and liabilities assumed in the Company’s FDIC assisted acquisition of First Federal. Associated with the acquisition, the Company sold securities to provide liquidity for the reduction in deposits at First Federal. The Company sold $46.3 million of securities in the second quarter of 2013, realizing net gains of $509,000.

Non-interest income decreased by $2.2 million to $3.2 million for the six months ended June 30, 2014 from $5.4 million in 2013 due to a bargain purchase gain of $1.9 million recorded in 2013 that was not repeated in 2014 and decreases in net gains on sales of available for sale securities of $219,000 and mortgage banking income of $95,000. As previously discussed, the Company recorded a $1.9 million bargain purchase gain associated with its acquisition of First Federal in the second quarter of 2013 and sold securities, primarily during the second quarter of 2013 to fund reduction in deposits. The decrease in mortgage banking income was due to a strategy shift during 2013 to begin retaining a higher percentage of originated 1-4 family mortgages as opposed to selling into the secondary market. As a result, the amount of loans sold has declined substantially from 2013 along with the corresponding income.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC.

Non-interest expense. Non-interest expense for the three months ended June 30, 2014 decreased by $182,000 to $6.5 million from $6.7 million in 2013 due to decreases in FDIC insurance premiums and foreclosed and repossessed assets, net expense, offset by an increase in legal and professional services. FDIC insurance premiums decreased to $129,000 in 2014 from $211,000 in 2013 as a result of a lower assessment associated with the Company’s subsidiary banks improving loan portfolio credit quality. Foreclosed and repossessed asset net of expense was $53,000 in 2014 compared to $242,000 in 2013 as the Company recognized gains on sales of $68,000 in 2014 as compared to losses of $123,000 in 2013. Legal and professional fees increased by $118,000 to $738,000 during 2014 from $620,000 in 2013 due to expenditures incurred related to the Company’s pending acquisition of First Financial Service Corporation in Elizabethtown, Kentucky (“FFKY”). During the second quarter of 2014, the Company incurred $323,000 of expense, primarily legal, associated with preparation of agreements and related SEC filings. The Company anticipates incurring significant professional service fees for the FFKY acquisition including legal, accounting, and valuation services for the remainder of 2014 and into 2015.

Non-interest expense was $13.1 million for the six months ended June 30, 2014, an increase of $283,000 from $12.8 million in 2013 as increases in salaries and employee benefits, legal and professional service fees, and occupancy expense were offset by a decrease in foreclosed and repossessed assets, net, FDIC insurance premiums, and other expenses. Salaries and employee benefits increased to $6.7 million in 2014 from $6.6 million in 2013 due to an increase in the number of employees, pay rate increases, health insurance premiums, which was offset by a decrease in the accrual for incentive compensation. Occupancy expense increased to $1.2 million in 2014 from $1.1 million for the same period in 2013 related to the additional branch locations in Lexington, Kentucky as part of the First Federal Savings Bank acquisition in 2013 as well as increased snow removal and associated utility costs. Legal and professional service fees increased $125,000 to $1.2 million for the six months ended June 30, 2014 from $1.0 million as the Company incurred $370,000 for consulting and legal fees associated with its pending acquisition of FFKY. Foreclosed and repossessed, net, decreased by $33,000 to $191,000 for the six months ended June 30, 2014 from $224,000 as the Company recognized net gains on sales of $53,000 in 2014 compared to net losses of $48,000 in 2013. FDIC insurance premiums decreased by $62,000 to $293,000 for 2014 from $355,000 for the same period in 2013 due to a decrease in the assessment rates for the Company’s subsidiary banks due to their improving loan portfolio credit quality. Other expenses decreased from $1.4 million for the six months ended June 30, 2014 to $1.3 million for the same period in 2013 due to a $100,000 loss incurred in 2013 on the disposal of land previously held for future development.

Income tax expense. Income tax expense for the three months ended June 30, 2014 was $610,000 as compared to $420,000 for the equivalent period in 2013 while the effective tax rate was 22.0% and 16.0% for the respective periods. The increase in income tax expense was primarily due to $323,000 of acquisition related expenditures incurred in the second quarter of 2014 which are non-deductible.

Income tax expense for the six months ended June 30, 2014 increased to $867,000 from $690,000 in 2013 while the effective tax rate increased to 16.9% in 2014 from 14.4% in 2013. The increase in income tax expense and effective tax rate was due to expenditures associated with the FFKY acquisition of $370,000 recognized in 2014 which are non-deductible.

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC.

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, 2014, we had cash and interest-bearing deposits with banks of $38.1 million and securities available-for-sale with a fair value of $199.1 million. If we require funds beyond the funds we are able to generate internally, we have $150.0 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 $31.5 million. Management believes the Company’s liquidity sources are adequate to meet its operational needs.

The Banks are required to maintain specific amounts of capital pursuant to regulatory requirements. As of June 30, 2014, Your Community Bank and Scott County State Bank were each considered 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, 2014:

	Total Capital To Risk-weighted Assets			Tier 1 Capital To Risk-weighted Assets			Tier 1 Capital To Average Assets
Consolidated		18.7	%		17.4	%		12.6	%
Your Community Bank		15.9	%		14.6	%		11.0	%
Scott County State Bank		20.3	%		19.4	%		11.9	%

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

December 31, 2013:

	Total Capital To Risk-weighted Assets			Tier 1 Capital To Risk-weighted Assets			Tier 1 Capital To Average Assets
Consolidated		18.5	%		17.2	%		12.5	%
Your Community Bank		16.1	%		14.9	%		11.1	%
Scott County State Bank		20.0	%		19.0	%		11.8	%

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.

We have been repurchasing shares of our common stock since May 21, 1999. A net total of 423,323 shares at an aggregate cost of $7.3 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, 2014, 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, 2014 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, 2013.

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, 2013 and June 30, 2014 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, 2014 our net interest income would decrease by an estimated 0.7%, or $217,000, over the one year forecast horizon. As of December 31, 2013, in the Up 200 Scenario we estimated that net interest income would decrease $226,000, over a one year forecast horizon ending December 31, 2014.

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, 2014 and December 31, 2013, 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, 2014 and ending on June 30, 2015:

	Interest Rate Sensitivity as of June 30, 2014:
	Base		Gradual Increase in Rates of 200 Basis Points

Projected interest income:
Loans	$	28,174	$	29,182
Investments		5,241		5,343
FHLB and FRB stock		193		193
Interest-bearing deposits in other financial institutions		52		195
Total interest Income		33,660		34,913

Projected interest expense:
Deposits		1,104		1,945
Federal funds purchased, line of credit and repurchase agreements		131		567
FHLB advances		334		384
Subordinated debentures		397		540
Total interest expense		1,966		3,436
Net interest income	$	31,694	$	31,477

Change from base				(217	)
Percent change from base				(0.7	)%

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, 2013 and ending December 31, 2014:

	Interest Rate Sensitivity as of December 31, 2013
	Base		Gradual Increase in Rates of 200 Basis Points
Projected interest income:
Loans	$	26,757	$	27,848
Investments		5,245		5,312
FHLB and FRB stock		181		181
Interest-bearing deposits in other financial Institutions		5		25
Federal funds sold		15		54
Total interest income		32,203		33,420

Projected interest expense:
Deposits		974		1,745
Federal funds purchased, line of credit and Repurchase agreements		185		714
FHLB advances		329		329
Subordinated debentures		399		542
Total interest expense		1,887		3,330
Net interest income	$	30,316	$	30,090

Change from base			$	(226	)
% Change from base				(0.7	)%

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, 2014, 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, 2013.

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

The Company did not purchase its common shares during the six months ended June 30, 2014.

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 June 30, 2014, 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, 2014	BY:	/s/ James D. Rickard
		James D. Rickard
		President and
		Chief Executive Officer
		(Principal Executive Officer)

Dated: August 14, 2014	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, 2014, filed with the SEC on August 14, 2014, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets at June 30, 2014 and December 31, 2013, (ii) Consolidated Statements of Income for the three and six months ended June 30, 2014 and June 30, 2013, (iii) Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2014 and June 30, 2013 (iv) Consolidated Statement of Stockholders’ Equity for the six months ended June 30, 2014, (v) Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and June 30, 2013 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

*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 Act of 1933 and Section 18 of the Exchange Act of 1934, or otherwise subject to the liability of those sections, and shall not be deemed part of a registration statement, prospectus or other document filed under the Securities Act of 1933 or the Exchange Act of 1934, except as shall be expressly set forth by specific reference in such filings.

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