UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC20549

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 September 30, 2010

OR

¨ 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 ofincorporation or organization)	(I.R.S. EmployerIdentification 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.  T  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).  ¨  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 xSmaller 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:  3,291,586 shares of common stock were outstanding as of November 12, 2010.

COMMUNITY BANK SHARES OF INDIANA, INC.

INDEX

		Page
Part I	Financial Information
Item 1.	Financial Statements
	Consolidated Balance Sheets	3
	Consolidated Statements of Operations and Comprehensive Income (Loss)	4
	Consolidated Statement of Changes in Shareholders Equity	6
	Consolidated Statements of Cash Flows	7
	Notes to Consolidated Financial Statements	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	40
Item 4.	Controls and Procedures	43
Part II	Other Information
Item 1.	Legal Proceedings	44
Item 1a.	Risk Factors	44
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45
Item 6.	Exhibits	45
Signatures		46
Exhibit Index		47

2

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

	September 30, 2010			December 31, 2009
	(In thousands, except share data)
ASSETS
Cash and due from financial institutions	$	29,546		$	24,474
Interest-bearing deposits in other financial institutions		44,917			29,941
Securities available for sale		194,648			172,723
Loans held for sale		1,353			979
Loans, net of allowance for loan losses of $12,698 and $15,236		503,025			528,183
Federal Home Loan Bank and Federal Reserve stock		7,576			7,670
Accrued interest receivable		3,097			3,216
Premises and equipment, net		13,837			14,388
Company owned life insurance		19,029			18,490
Other intangible assets		1,168			1,352
Foreclosed and repossessed assets		3,565			5,190
Prepaid FDIC insurance premium		3,899			4,898
Other assets		6,851			7,655
Total Assets	$	832,511		$	819,159
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Non interest-bearing	$	138,463		$	110,247
Interest-bearing		480,666			482,176
Total deposits		619,129			592,423
Other borrowings		49,971			76,996
Federal Home Loan Bank advances		55,000			68,482
Subordinated debentures		17,000			17,000
Accrued interest payable		630			818
Settlement liability for security purchases		20,460			—
Other liabilities		4,785			3,490
Total liabilities		766,975			759,209
Commitments and contingent liabilities		—			—
Shareholders’ equity
Preferred stock, without par value; 5,000,000 shares authorized; none issued or outstanding		—			—
Preferred stock, series A, without par value; 19,500 shares authorized; 19,468 issued and outstanding; liquidation preference of $19,468		19,100			19,034
Common stock, $.10 par value per share; 10,000,000 shares authorized; 3,863,937 shares issued; 3,291,745 and 3,274,697 outstanding in 2010 and 2009, respectively		386			386
Additional paid-in capital		45,540			45,550
Retained earnings		7,391			3,891
Accumulated other comprehensive income		2,998			1,263
Treasury stock, at cost (2010- 572,192 shares, 2009- 589,245 shares)		(9,879	)		(10,174	)
Total shareholders’ equity		65,536			59,950
Total Liabilities and Shareholders’ Equity	$	832,511		$	819,159

See accompanying notes to consolidated financial statements.

3

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended  September 30,
	2010			2009			2010			2009
Interest and dividend income
Loans, including fees	$	7,263		$	8,162		$	22,537		$	24,842
Taxable securities		972			1,111			3,004			3,403
Tax-exempt securities		516			477			1,544			998
Federal Home Loan Bank and Federal Reserve dividends		33			46			119			222
Interest-bearing deposits in other financial institutions		17			21			41			119
Interest and dividend income		8,801			9,817			27,245			29,584
Interest expense
Deposits		1,331			2,370			4,189			7,605
Other borrowings		212			227			624			671
Federal Home Loan Bank advances		352			1,012			1,123			3,524
Subordinated debentures		113			116			315			423
Interest expense		2,008			3,725			6,251			12,223
Net interest income		6,793			6,092			20,994			17,361
Provision for loan losses		605			30			2,908			15,440
Net interest income (expense) after provision for loan losses	____ 6,188			____ 6,062			____ 18,086			____ 1,921
Non-interest income
Service charges on deposit accounts		906			949			2,563			2,559
Commission income		33			8			92			48
Net gain on sales of available for sale securities		197			83			1,438			1,290
Mortgage banking income		59			56			206			244
Gain on sale of loans		-			-			-			197
Earnings on company owned life insurance		182			187			540			558
Interchange income		226			209			675			627
Other-than-temporary impairment loss
Total impairment loss		(146	)		(1,906	)		(784	)		(1,906	)
Loss recognized in other comprehensive income (loss)		-			806			424			806
Net impairment loss recognized in earnings		(146	)		(1,100	)		(360	)		(1,100	)
Other income		113			86			348			341
Non-interest income		1,570			478			5,502			4,764
Non-interest expense
Salaries and employee benefits		2,627			2,584			7,863			8,653
Occupancy		520			576			1,547			1,835
Equipment		299			360			916			1,102
Data processing		617			656			1,893			1,862
Marketing and advertising		100			96			267			395
Legal and professional service fees		375			353			1,034			1,160
FDIC insurance premiums		391			310			1,118			1,321
Goodwill and other intangible asset impairment		-			-			-			16,154
Prepayment penalties on extinguishment of debt		-			28			335			279
Foreclosed assets, net		174			(14	)		327			530
Other expense		545			552			1,579			1,777
Total non-interest expense		5,648			5,501			16,879			35,068
Income (loss) before income taxes		2,110			1,039			6,709			(28,383	)
Income tax expense (benefit)		433			82			1,425			(5,093	)
Net income (loss)		1,677			957			5,284			(23,290	)
Preferred stock dividends and discount accretion		(266	)		(265	)		(799	)		(356	)
Net income (loss) available(attributable) to common shareholders	$	1,411		$	692		$	4,485		$	(23,646	)

4

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(Unaudited)

	Three Months Ended September 30,				Nine Months Ended  September 30,
	2010		2009		2010		2009
Earnings (Loss) per common share:
Basic	$	0.43	$	0.21	$	1.37	$	(7.27	)
Diluted	$	0.42	$	0.21	$	1.35	$	(7.27	)
Dividends per common share	$	0.10	$	0.10	$	0.30	$	0.45
Comprehensive income (loss)	$	3,084	$	4,676	$	7,019	$	(20,816	)

See accompanying notes to consolidated financial statements.

5

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

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			Treasury Stock			Total Shareholders’ Equity
Balance, January 1, 2010	$	19,034	$	386	$	45,550		$	3,891		$	1,263		$	(10,174	)	$	59,950
Comprehensive income:
Net income		—		—		—			5,284			—			—			5,284
Change in unrealized gains (losses) on securities available for sale for which a portion of an other-than-temporary impairment has been recognized in earnings, net of reclassifications and tax effects		—		—		—			—			(210	)		—			(210	)
Change in unrealized gain (gains) losses on securities available for sale, net of reclassifications and tax effects		—		—		—			—			1,943			—			1,943
Unrealized gain on pension benefits, net of tax effects		—		—		—			—			2			—			2
Total comprehensive income		—		—		—			5,284			1,735			—			7,019
Cash dividends declared on common stock ($0.30 per share)		—		—		—			(985	)		—			—			(985	)
Dividends on preferred stock		—		—		—			(733	)		—			—			(733	)
Issuance of treasury stock under dividend reinvestment plan		—		—		(144	)		—			—			295			151
Amortization of preferred stock discount		66							(66	)		—			—			—
Stock award expense		—		—		134			—			—			—			134
Balance, September 30, 2010	$	19,100	$	386	$	45,540		$	7,391		$	2,998		$	(9,879	)	$	65,536

See accompanying notes to consolidated financial statements.

6

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	NineMonths Ended September 30,
	2010			2009
	(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$	5,284		$	(23,290	)
Adjustments to reconcile net income (loss) to net cash from operating activities:
Provision for loan losses		2,908			15,440
Depreciation and amortization		1,164			1,356
Net amortization of securities		540			73
Net gain on sales of available for sale securities		(1,438	)		(1,290	)
Other-than-temporary impairment loss		360			1,100
Debt prepayment penalties		335			279
Mortgage loans originated for sale		(11,831	)		(15,273	)
Proceeds from mortgage loan sales		11,654			14,977
Net gain on sales of mortgage loans		(197	)		(225	)
Earnings on company owned life insurance		(540	)		(558	)
Gain on sale of loans		-			(197	)
Goodwill and other intangible asset impairment		-			16,154
Sharedbased compensation expense		134			46
Net loss (gain) on disposition of foreclosed and repossessed assets		(104	)		168
Net gain on disposition of premises and equipment		-			(5	)
Net change in:
Accrued interest receivable		119			(65	)
Accrued interest payable		(188	)		(368	)
Other assets		1,803			(7,324	)
Other liabilities		323			1,835
Net cash from operating activities		10,326			2,833
CASH FLOWS FROM INVESTING ACTIVITIES
Net change in interest-bearing deposits		(14,976	)		(1,064	)
Available for sale securities:
Sales		83,753			71,977
Purchases		(98,510	)		(136,919	)
Maturities, prepayments and calls		16,457			16,640
Loan originations and payments, net		22,743			47,497
Proceeds from the sale of foreclosed and repossessed assets		1,346			1,227
Purchases of premises and equipment		(442	)		(600	)
Proceeds from the sale of premises and equipment		-			8
Proceeds from sale of loans held for investment		-			14,739
Purchase of Federal Reserve and FHLB stock		(10	)		-
Proceeds from redemption of Federal Reserve and FHLB stock		104			-
Net cash from investing activities		10,465			13,505
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits		26,706			15,564
Net change in other borrowings		(27,025	)		(25,741	)
Proceeds from Federal Home Loan Bank advances		45,000			-
Repayment of Federal Home Loan Bank advances		(58,835	)		(32,279	)
Proceeds from issuance of preferred stock and warrants		-			19,468
Cash dividends paid on preferred shares		(731	)		(206	)
Cash dividends paid on common shares		(834	)		(1,250	)
Net cash from financing activities		(15,719	)		(24,444	)
Net change in cash and due from financial institutions		5,072			(8,106	)
Cash and due from financial institutions at beginning of period		24,474			19,724
Cash and due from financial institutions at end of period	$	29,546		$	11,618

7

PART I - FINANCIAL INFORMATION

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	NineMonths Ended September 30,
	2010			2009
	(In thousands)
Supplemental cash flow information:
Interest paid	$	6,439		$	12,591
Income taxes paid, net of refunds	$	715		$	-
Supplemental noncash disclosures:
Transfer from loans to foreclosed and repossessed assets	$	3,819		$	5,045
Issuance of treasury shares under dividend reinvestment plan	$	151		$	213
Sale and financing of foreclosed and repossessed assets	$	4,281		$	202
Security transactions in suspense, net (payable) receivable	$	(20,460	)	$	-

See accompanying notes to consolidated financial statements.

8

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.Presentation of Interim Information

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

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

Your Community Bank also has a Community Development Entity (CDE) subsidiary formed in July 2002 named CBSI Development Fund, Inc.  The CDE enables Your Community Bank to participate in the federal New Markets Tax Credit (“NMTC”) Program.  The NMTC Program is administered by the Community Development Financial Institutions Fund of the United States Treasury and is designed to promote investment in low-income communities by providing a tax credit over seven years for equity investments in CDE’s.

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

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

In the opinion of management, the unaudited consolidated financial statements include all normal adjustments considered necessary to present fairly the financial position as of September 30, 2010, the results of operations for the three and ninemonths ended September 30, 2010 and 2009, and cash flows for the nine months ended September 30, 2010 and 2009.  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.

9

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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, 2009.  The consolidated financial statements include our accounts and our subsidiaries’ accounts.  All material intercompany balances and transactions have been eliminated in consolidation.

Reclassifications:  Some items in the prior financial statements were reclassified to conform to the current presentation.

2.   Securities

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

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In thousands)
September 30, 2010:
Securities available for sale:
State and municipal	$	47,018	$	4,310	$	(38	)	$	51,290
Residential mortgage-backed agencies issued by U.S. Government sponsored entities		138,091		3,560		(66	)		141,585
Collateralized debt obligations, including trust preferred securities		4,253		-		(2,734	)		1,519
Mutual funds		250		4		-			254
Total securities available for sale	$	189,612	$	7,874	$	(2,838	)	$	194,648
December 31, 2009:
Securities available for sale:
State and municipal	$	48,044	$	1,878	$	(113	)	$	49,809
Residential mortgage-backed agencies issued by U.S. Government sponsored entities		117,406		2,776		(98	)		120,084
Collateralized debt obligations, including trust preferred securities		4,614		-		(2,029	)		2,585
Mutual funds		250		-		(5	)		245
Total securities available for sale	$	170,314	$	4,654	$	(2,245	)	$	172,723

Sales of available for sale securities were as follows:

	ThreeMonths EndedSeptember 30					Nine MonthsEnded September 30
	2010			2009		2010			2009
	(In thousands)
Proceeds	$	25,092		$	21,060	$	83,753		$	71,977
Gross gains		206			83		1,447			1,290
Gross losses		(9	)		-		(9	)		-

The tax provision applicable to these realized net gains amounted to $67,000 and $489,000 for the three and nine months ended September 30, 2010, respectively, and $28,000 and $439,000 for the three and nine months ended September 30, 2009,respectively.

10

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The amortized cost and fair value of the contractual maturities of available for sale securities at September 30, 2010 were as follows.  Mortgage-backed agencies and mutual funds which do not have a single maturity date are shown separately.

	September 30,2010
	AmortizedCost		FairValue
	(In thousands)
Within one year	$	19	$	19
One to five years		1,449		1,543
Five to ten years		5,970		6,419
Beyond ten years		43,833		44,828
Residential mortgage-backed securities issued by U.S. Government sponsored entities		138,091		141,585
Mutual funds		250		254
Total	$	189,612	$	194,648

Securities with unrealized losses at September 30, 2010 and December 31, 2009, aggregated by investment category and length of time that individual securities have been in a continuous loss position are as follows:

	Lessthan12Months					12MonthsorMore					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Loss			Value		Loss			Value		Loss
	(In thousands)
September 30, 2010
State and municipal	$	779	$	(20	)	$	506	$	(18	)	$	1,285	$	(38	)
Residential mortgage-backed securities issued by U.S. Government sponsored entities		4,720		(66	)		-		-			4,720		(66	)
Collateralized debt obligations, including trust preferred securities		-		-			1,519		(2,734	)		1,519		(2,734	)
Total temporarily impaired	$	5,499	$	(86	)	$	2,025	$	(2,752	)	$	7,524	$	(2,838	)

11

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

	Lessthan12Months					12MonthsorMore					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Loss			Value		Loss			Value		Loss
	(In thousands)
December 31, 2009
State and municipal	$	3,022	$	(49	)	$	996	$	(64	)	$	4,018	$	(113	)
Residential mortgaged-backed securities issued by U.S. Government sponsored agencies		15,858		(98	)		-		-			15,858		(98	)
Collateralized debt obligations, including trust preferred securities		-		-			2,585		(2,029	)		2,585		(2,029	)
Mutual funds		-		-			245		(5	)		245		(5	)
Total temporarily impaired	$	18,880	$	(147	)	$	3,826	$	(2,098	)	$	22,706	$	(2,245	)

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

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

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

12

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

As of September 30, 2010, the Company’s security portfolio consisted of 199 securities, 9 of which were in an unrealized loss position. The majority of unrealized losses are related to the Company’s collateralized debt obligations, as discussed below:

Collateralized Debt Obligations

The Company’s unrealized losses on collateralized debt obligations relate to its investment in six pooled trust preferred securities. The decline in fair value is primarily attributable to temporary illiquidity and the financial crisis affecting these markets and not necessarily the expected cash flows of the individual securities.

Our analysis of six of these investments falls within the scope of FASB ASC 325-40 and includes $4.3 million amortized cost of pooled trust preferred securities (CDOs). See the table below for a detail of the CDOs (in thousands):

	Current Rating	Par Value		Amortized Cost		Estimated FairValue		Previously Recognized OTTIRelatedto CreditLoss, Pre-Tax		FirstNineMonths of2010OTTI RelatedtoCredit Loss,Pre-Tax
Security 1	B+ (S&P)	$	2,000	$	2,000	$	947	$	-	$	-
Security 2	Ba3		332		184		184		-		146
Security 3	Ca		49		43		23		5		-
Security 4	Ca		317		282		149		35		-
Security 5	Ca		1,530		872		108		530		107
Security 6	Ca		1,530		872		108		530		107
		$	5,758	$	4,253	$	1,519	$	1,100	$	360

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COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The issuers in these securities are primarily banks, but some of the pools do include a limited number of insurance companies. The Company uses the OTTI evaluation model to evaluate the present value of expected cash flows. The OTTI model considers the structure and term of the CDO and the financial condition of the underlying issuers. Specifically, the model details interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults of underlying trust preferred securities. Assumptions used in the model include expected future default rates and prepayments. To develop our assumptions we reviewed the underlying issuers and determined the specific default rate by reviewing the financial condition of each issuer and whether they were currently in deferral or default.  We considered all defaults to be immediate.  We considered all relevant data in developing our assumptions, however, we specifically reviewed each issuer’s profitability, credit ratings, if available, credit ratios, and credit quality metrics for the loan portfolios (if a bank).  For those issuers we identified at risk of default, we estimated the amount of loss, net of any anticipated recoveries, which ranged from 100% for those issuers already in default at the evaluation date to 5.00%.   After four years we assume a 0.40% annual default rate until scheduled maturity of the underlying note.  Our analysis for September 30, 2010 indicated an other-than-temporary impairment charge of $146,000 on one security was necessary.  The security had two remaining issuers at the beginning of the third quarter of 2010, one of which redeemed in full its outstanding note in September while the other issuer announced in early October that it was deferring interest payments.  As a result, the security does not have any remaining performing issuers in the pool.  Management recorded an OTTI charge for the full remaining amortized cost in the security after receipt of the redemption proceeds which were received in October.  As a result, the security had an amortized cost and fair value of $184,000 as of September 30, 2010 which equaled the total proceeds received in October.  As of October 31, 2010, the Company had a fair value and amortized cost for the security of $0.  Thesecurity remained classified as available for sale at September 30, 2010, and together, the six securities subject to FASB ASC 325-40 accounted for the $2.7 million of unrealized loss in the collateralized debt obligations category at September 30, 2010.

The table below presents a rollforward of the credit losses recognized in earnings for the three and nine month periods ended September 30, 2010 (in thousands):

	Three Months Ended  September 30, 2010		Nine Months Ended  September 30, 2010
Beginning balance	$	1,314	$	1,100
Other-than-temporary impairment related credit losses		146		360
Ending balance	$	1,460	$	1,460

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COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.Loans

Loans at September 30, 2010and December 31, 2009 consisted of the following:

	September 30, 2010			December31, 2009
	(In thousands)
Commercial	$	92,399		$	94,168
Mortgage loans on real estate:
Residential		132,116			134,969
Commercial		173,906			193,577
Construction		51,264			51,592
Home equity		52,464			54,434
Loans secured by deposit accounts		1,208			1,003
Consumer		12,366			13,676
Subtotal		515,723			543,419
Less:
Allowance for loan losses		(12,698	)		(15,236	)
Loans, net	$	503,025		$	528,183

Activity in the allowance for loan losses was as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
	(In thousands)
Beginning balance	$	12,375		$	18,371		$	15,236		$	9,478
Charge-offs		(386	)		(916	)		(5,872	)		(7,563	)
Recoveries		104			38			426			168
Provision for loan losses		605			30			2,908			15,440
Ending balance	$	12,698		$	17,523		$	12,698		$	17,523

Information about impaired loansis presented below.

	September 30,		December 31,
	2010		2009
	(In thousands)
Impaired loans, including troubled debt restructurings of $9.6 million and $8.6 million	$	25,719	$	31,952
Amount of the allowance for loan losses allocated		3,394		3,474
Average impaired loans during the period		25,444		28,415
Interest income recognized and received during impairment		204		346

Nonperforming loans were as follows.

Loans past due over 90 days still on accrual	-	-
Non-accrual loans	15,343	22,653
Troubled debt restructurings	9,584	8,562

15

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Nonperforming loans includes both smaller balance homogenous loans that are collectively evaluated for impairment and individually classified loans.  The Company had $360,000 and $576,000 of impaired loans at September 30, 2010 and December 31, 2009 for which a specific reserve had not been recorded.  The Company had allocated $467,000 and $323,000 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of September 30, 2010 and December 31, 2009, respectively.  The Company did not have any commitments to originate or modify loans that would be considered troubled debt restructurings as of September 30, 2010.

4.Deposits

Deposits at September 30, 2010 and December 31, 2009 consisted of the following:

	September 30, 2010		December 31, 2009
	(In thousands)
Demand (NOW)	$	78,700	$	83,748
Money market accounts		128,619		119,991
Savings		33,974		31,721
Individual retirement accounts		32,863		32,583
Certificates of deposit, $100,000 and over		81,764		90,380
Other certificates of deposit		124,746		123,753
Total interest bearing deposits		480,666		482,176
Total non-interest bearing deposits		138,463		110,247
Total deposits	$	619,129	$	592,423

16

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

5.Earnings (Loss) Per Common Share

Earnings (loss) per common share were computed as follows:

	Three months ended September 30,						Nine months ended September 30,
	2010			2009			2010			2009
	(In thousands, except for share and per share amounts)
Basic:
Net income (loss)	$	1,677		$	957		$	5,284		$	(23,290	)
Less:  Preferred stock dividend and amortization of discount		(266	)		(265	)		(799	)		(356	)
Net income (loss) available (attributable) to common shareholders	$	1,411		$	692		$	4,485		$	(23,646	)
Average shares outstanding		3,288,116			3,258,483			3,282,703			3,254,139
Net income (loss) per common share, basic	$	0.43		$	0.21		$	1.37		$	(7.27	)
Diluted:
Net income (loss) available (attributable) to common shareholders	$	1,411		$	692		$	4,485		$	(23,646	)
Average shares:
Common shares outstanding for basic		3,288,116			3,258,483			3,282,703			3,254,139
Add: Dilutive effect of outstanding warrants		55,556			20,330			47,500			-
Average shares and dilutive potential common shares		3,343,672			3,278,813			3,330,203			3,254,139
Net income (loss) per common share, diluted	$	0.42		$	0.21		$	1.35		$	(7.27	)

Stock options for 223,900 shares of common stock were excluded from the calculation of diluted net income per common share for the three and nine months ended September 30, 2010 because their effect was antidilutive.  This compares to stock options for 243,620 and 262,970 share of common stock that were excluded from the calculation of diluted net loss per common share for the three and nine months ended September 30, 2009, respectively. Warrants for 386,270 shares of common stock were excluded from the calculation of diluted net loss per common share for thenine months ended September 30, 2009 due to the net loss for that period.

Performance units totaling 20,700 were excluded from the calculation of diluted net income (loss) per common share for the three and nine months ended September 30, 2009, respectively, because all of the conditions necessary for issuance of common stock had not been met as of those dates.

Deferred stock units totaling 38,000 were excluded from the calculation of diluted net income per common share for the three and nine months ended September 30, 2010, respectively, because all of the conditions necessary for issuance of common stock had not been met as of those dates.  This compares to deferred stock units excluded from the calculation of diluted net income (loss) per common share of 45,000 for the three and nine months ended September 30, 2009, respectively.

17

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Restricted share awards of 17,000 common shares were excluded from the calculation of diluted net income (loss) per common share for the three and nine months ended September 30, 2010 and 2009, respectively, because all of the conditions necessary for issuance of common stock had not been met as of those dates.

6.Stock-Based Compensation Plans

Our stock option plan provides for the granting of both incentive and nonqualified stock options at exercise prices not less than the fair market value of the common stock on the date of grant and expiration dates of up to ten years.  Terms of the options are determined by our Board of Directors at the date of grant and generally vest over periods of three to four years.  Payment of the option price may be in cash or shares of common stock at fair 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 197,417 shares of common stock. The aggregate intrinsic value for options outstanding and exercisable at September 30, 2010 and December 31, 2009 was $0. There was $0 and $21,000 in total compensation cost related to unvested options not recognized at September 30, 2010 and December 31, 2009, respectively, with a weighted-average period of 0.48 years over which the cost is expected to be recognized as of December 31, 2009.  The Company recognized $0 and $17,000 in expense for stock options for the three and nine months ended September 30, 2010, respectively, and $9,000 and $33,000 in expense during the three and nine months ended September 30, 2009, respectively.  The Company has vested options of 192,700 with aggregate intrinsic value of $0 and a weighted average remaining contractual term of 5.1 years as of September 30, 2010.  During the nine months ended September 30, 2010, no options were granted, 1,500 were forfeited, and 29,700 expired.

We may grant performance unit awards to employees for up to 275,000 shares of common stock.  The level of performance shares eventually distributed is contingent upon the achievement of specific performance criteria within a specified award period set at the grant date.  We recognized $0 in expense for performance unit awards for the three and nine months ended September 30, 2010 and reversed $0 and $66,000 of previously recognized expense for the three and nine months ended September 30, 2009, respectively.  We did not grant performance units during the nine months ended September 30, 2010 and no performance units were forfeited in 2010.

For the three and nine months ended September 30, 2010, we recognized $27,000 and $79,000 in expense for restricted stock awards, respectively.  During the first nine months of 2010, there were no restricted stock awards granted or forfeited.  For the three and nine months ended September 30, 2009, we recognized $9,000 and $62,000 in expense for restricted stock awards, respectively.

For the three and nine months ended September 30, 2010, we recognized $13,000 and $38,000 of expense for deferred stock units, respectively.  We recognized $0 in expense for the three and nine months ended September 30, 2009. During the first nine months of 2010 there were no deferred stock units granted or forfeited.

18

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

7. Other Comprehensive Income

Other comprehensive incomecomponents and related taxes were as follows (in thousands).

	Three months ended September 30,						Nine months ended  September 30,
	2010			2009			2010			2009
Unrealized holding gains  on available for sale securities	$	1,984		$	3,245		$	4,023		$	758
Unrealized holding gains (losses) on available for sale securities for which a portion of an other-than-temporary impairment has been recognized in earnings		134			1,308			(318	)		3,089
Less reclassification adjustments for other-than-temporary impairment related credit losses		146			1,100			360			1,100
Less reclassification adjustments for gains recognized in income		(197	)		(83	)		(1,438	)		(1,290	)
Net unrealized gains on securities available for sale,  net of reclassifications		2,067			5,570			2,627			3,657
Unrealized gain on pension benefits		52			67			4			97
Other comprehensive income before tax effects		2,119			5,637			2,631			3,754
Tax effect		(712	)		(1,918	)		(896	)		(1,280	)
Other comprehensive income	$	1,407		$	3,719		$	1,735		$	2,474

The following is a summary of the accumulated other comprehensive income balances, net of tax (in thousands):

	Balance at 12/31/09			Current Period Change		Balance at 9/30/10
Unrealized gains on securities available for sale, net of tax	$	1,590		$	1,733	$	3,323
Unrealized loss on pension benefits, net of tax		(327	)		2		(325	)
Total	$	1,263		$	1,735	$	2,998

19

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

8.   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, all but one of our collateralized debt obligations are now priced using Level 3 inputs (see next paragraph for discussion of other security).  Prior to 2010, the fair values of our collateralized debt obligations were determined by using pricing information provided by our bond accounting service as determined by Moody’s analysts.  Beginning in 2010, the fair values were determined by us utilizing an estimate of the expected cash flows based on our review of the underlying issuers’ financial condition and the anticipated deferral of payments and defaults of issuers.  We provide our estimate of default for each issuer, which ranges from 100% loss to 0.40% loss at September 30, 2010, to the capital market traders of our bond accountant who provide the cash flows we will receive based upon our assumptions.  To determine the discounted projected cash flows for our collateralized debt obligations, we utilize discount rates ranging from 8.93% to 27.49% (19.54% weighted average rate) depending on the security.  The discount rates were determined utilizing a risk free rate of three month Libor plus 300 bps (3.50% at 9/30/10), which includes a premium for market illiquidity, and a credit component based on the quality of the collateral and the deal structure.Management believes the new method results in a more accurate estimate of the fair value of our collateralized debt obligations.

20

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The fair value of one of our collateralized debt obligations was determined using Level 1 inputs as of September 30, 2010.  Previously, the fair value of this security was determined using Level 3 inputs as more fully described in the paragraph above.  In the third quarter, the Company recorded an other-than-temporary impairment charge on the security to adjust the amortized cost to the amount of cash that was received in October due to an early redemption.  The Company assigned the security a fair value of $183,000 as of September 30, 2010 which represented the cash received in October.  Subsequent to the redemption, the Company’s amortized cost and fair value for the security was $0.

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.  The fair value of real estate is primarily determined based on appraisals by qualified licensed appraisers.  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.  Impaired loans are evaluated quarterly for additional impairment.  Fair value of impaired loans is classified as Level 3 in the fair value hierarchy.

Foreclosed and Repossessed Assets:  Foreclosed and repossessed assets are initially recorded at fair value less estimated costs to sell when acquired.  The fair value of foreclosed and repossessed assets is primarily determined based on appraisals by qualified appraisers.  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.  Fair value of foreclosed and repossessed assets is classified as Level 3 in the fair value hierarchy.

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

			Fair Value Measurements Using
	Assets at Fair  Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
			(in thousands)
Assets (September 30, 2010):
Available for sale securities:
State and municipal	$	51,290	$	—	$	51,290	$	—
Residential mortgage-backed securities issued by U.S. Government sponsored entities		141,585		—		141,585		—
Collateralized debt obligations, including trust preferred securities		1,519		184		—		1,335
Mutual Funds		254		—		254		—
Total available for sale securities	$	194,648	$	184	$	193,129	$	1,335

21

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Assets (December 31, 2009):
Available for sale securities:
State and municipal	$	49,809	$	—	$	49,809	$	—
Residential mortgage-backed securities issued by U.S. Government sponsored entities		120,084		—		120,084		—
Collateralized debt obligations, including trust preferred securities		2,585		—		—		2,585
Mutual Funds		245		—		245		—
Total available for sale securities	$	172,723	$	—	$	170,138	$	2,585

The rollforward of activity for the Company’s significant unobservable inputs (Level 3) is as follows:

	Three Months Ended			Nine Months Ended
	September 30, 2010(in thousands)
Balance, beginning of period	$	1,489		$	2,585
Other-than-temporary impairment recognized in earnings		(146	)		(360	)
Transfer out of Level 3		(184	)		(184	)
Net unrealized gain (loss) included in other comprehensive income		177			(705	)
Balance, end of period	$	1,336		$	1,336

22

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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 (September 30, 2010):
Impaired loans	$	14,312	$	—	$	—	$	14,312
Assets (December 31, 2009):
Impaired loans	$	17,931	$	—	$	—	$	17,931
Acquired intangible assets		1,352		—		—		1,352
Foreclosed and repossessed assets		5,190		—		—		5,190

The Company measures loans for impairment using the fair value of the collateral for collateral-dependent loans.  The Company’s impaired loans totaled $25.7 million as of September 30, 2010, which included collateral-dependent loans with a carrying value of $17.5 million.  As of September 30, 2010, the Company’s collateral dependent loans had a valuation allowance of $3.2 million, resulting in a provision for loan losses of $1.1 million and $2.3 million for the three and nine months ended September 30, 2010, respectively.  The Company recognized provision for loan losses of $(313,000) and $4.7 million for the three and nine months ended September 30, 2009, respectively, for collateral dependent loans.

The Company evaluates the fair value of foreclosed and repossessed assets at the time they are transferred from loans and on a quarterly basis thereafter.  During the three and ninemonths ended September 30, 2010 and 2009, the Company did not recognizecharges to write down foreclosed and repossessed assets to their fair value.

23

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair value of Financial Instruments

Carrying amount and estimated fair values of financial instruments, not previously presented, at September 30, 2010 and December 31, 2009 were as follows.

	September 30,2010				December 31,2009
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(In thousands)
Financial assets
Cash and due from financial institutions	$	29,546	$	29,546	$	24,474	$	24,474
Interest-bearing deposits in other financial institutions		44,917		44,917		29,941		29,941
Loans held for sale		1,353		1,368		979		989
Loans, net of allowance for loan losses and impaired loans		477,306		497,546		496,231		527,279
Accrued interest receivable		3,097		3,097		3,216		3,216
Federal Home Loan Bank and Federal Reserve Stock		7,576		n/a		7,670		n/a
Financial liabilities
Deposits		619,129		609,474		592,423		571,863
Other borrowings		49,971		46,710		76,996		77,830
Federal Home Loan Bank Advances		55,000		56,476		68,482		69,581
Subordinated debentures		17,000		9,887		17,000		9,973
Accrued interest payable		630		630		818		818

The methods and assumptions used to estimate fair value are described as follows:

The estimated fair value equals the carrying amount for cash and due from banks, interest-bearing deposits in other financial institutions, accrued interest receivable and payable, demand deposits, other borrowings, and variable rate loans or deposits that reprice frequently and fully.  For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life.  Loans are reported net of the allowance for loan losses.  Fair value of loans held for sale is based on market quotes.  It is not practical to determine the fair value of FHLB and Federal Reserve stock due to restrictions placed on transferability.  Fair value of FHLB advances and subordinated debentures are based on current rates for similar financing.  The fair value of off-balance-sheet items is based on current fees or costs that would be charged to enter into or terminate such arrangements and is not material.

24

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

10. Recently Issued Accounting Standards

New Accounting Standards:

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166, Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140 (FASBASC 810).  The new accounting requirement amends previous guidance relating to the transfers of financial assets and eliminates the concept of a qualifying special purpose entity. This Statement must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. This Statement must be applied to transfers occurring on or after the effective date. Additionally, on and after the effective date, the concept of a qualifying special-purpose entity is no longer relevant for accounting purposes. Therefore, formerly qualifying special-purpose entities should be evaluated for consolidation by reporting entities on and after the effective date in accordance with the applicable consolidation guidance. Additionally, the disclosure provisions of this Statement were also amended and apply to transfers that occurred both before and after the effective date of this Statement. This guidance has been adopted and did not have an effect on the Company’s consolidated financial statements.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation No. 46(R) (FASB ASC 810),  which amended guidance for consolidation of variable interest entities by replacing the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. This Statement also requires additional disclosures about an enterprise’s involvement in variable interest entities. This Statement will be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Early adoption is prohibited. This guidance has been adopted and did not have an effect on the Company’s consolidated financial statements.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Safe Harbor Statement for Forward-Looking Statements

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

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

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

Financial Condition

Total assets increased to $832.5 million as of September 30, 2010 from $819.2 million at December31, 2009 due to increases in interest-bearing deposits in other financial institutions of $15.0 million and securities available for sale of $21.9 million, offset by decreases in net loans of $25.2 million.  Total deposits increased by $26.7 million to $619.1 million at September 30, 2010 from $592.4 million at December 31, 2009 as non-interest bearing deposits increased by $28.2 million while interest bearing deposits decreased by $1.5 million over the nine month period.  Other borrowings and FHLB advances decreased by $27.0 million and $13.5 million to $50.0 million and $55.0 million, respectively, as of September 30, 2010.

Net loans decreased to $503.0 million as of September 30, 2010 from $528.2 million as of December 31, 2010 as all loan categories declined with the exception loans secured by consumer deposits.  The decrease in net loans over the period was due, in part, to $5.9 million of charge-offs during the nine month period (see the “Allowance and Provision for Loan Losses” section of management’s discussion and analysis for further information on charge-off activity and credit quality) and also  an increase in foreclosure of collateral securing its loans.  The most significant cause of the decline in net loans was loan repayments in excess of new loan originations.  The Company continues to have weak loan demand from qualified borrowers given the local economic conditions.

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PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Securities available for sale increased from December 31, 2009to $194.6 million as of September 30, 2010 primarily due to purchases of $119.0 million, offset primarily by sales of $83.8 million and maturities, prepayments and calls of $16.5 million.  The securities portfolio serves as a source of liquidity and earnings and plays an important part in the management of interest rate risk.  The current strategy for the investment portfolio is to maintain an overall average repricing term between 3.0 and 3.5 years to limit exposure to rising interest rates.

Net Income.Net income available to common shareholders was $1.4 million for the three months ended September 30, 2010 compared to $692,000 for the equivalent period in 2009.  Basic and diluted earnings percommon share increased to $0.43 and $0.42 per common share, respectively, for the third quarter of 2010 from $0.21 per common share for 2009.  The increase in earnings from the third quarter of 2009 was due to an increase in net interest income of $701,000 and an increase in non-interest income of $1.1 million, most of which was related to an other-than-temporary impairment charge on securities available for sale of $1.1 million in the third quarter of 2009 as compared to $146,000 for the same period in 2010.  The annualized return on average assets and average shareholders’ equity were 0.81% and 10.30% for the three months ended September 30, 2010, respectively.

Net income available to common shareholders for the nine month period ended September 30, 2010 was $4.5 million as compared to a net loss available to common shareholders of $(23.6) million for 2009.  Basic and diluted income per common share were $1.37 and $1.35, respectively, for the first nine months of 2010 compared to basic and diluted loss per common share of $(7.27) for the same period in 2009.  The improvement in earnings was due to a decrease in non-interest expense of $18.2 million, $16.2 million of which was attributable to a goodwill and other intangible asset impairment charge recorded in the second quarter of 2009 that was not repeated to 2010.  Also contributing to the increase in earnings was a decrease in provision for loan losses from $15.4 million for the first nine months of 2009 to $2.9 million for the equivalent period in 2010.

Net interest income.  Net interest income for the three months ended September 30, 2010 increased by $701,000 to $6.8 million from $6.1 million for the third quarter of 2009.  The Company’s net interest margin on a taxable equivalent basis increased to 3.76% for the thirdquarter of 2010 as compared to 3.24% in 2009.  The increase in net interest margin for the quarter was due to a significant reduction in the cost of interest bearing liabilities from 2.24% to 1.30% as the Company was able to decrease the costs of its FHLB advances through pre-payments of callable advances which lowered the average cost from 5.01% on an average balance of $80.3 million for the three month period ended September 30, 2009 to 2.51% on an average balance of $55.9 million.  Beginning in 2009 and continuing into the first quarter of 2010, the Company prepaid $67.0 million of FHLB advances that had a weighted average cost of 6.03% which was significantly higher than alternative funding sources.  Also contributing to the decrease in the cost of interest-bearing liabilities was the decrease in the cost of time deposits from 2.92% for the third quarter of 2009 to 1.67% for the same period in 2010.  The Company has lowered its offering rates on maturing and new time deposit accounts due to the current rate environment and high level of on-balance sheet liquidity.  The Company’s yield on interest earning assets has continued to be negatively impacted by a high level of interest bearing deposits in other financial institutions which had an average balance of $40.2 million for the third quarter of 2010 and an average yield of 0.17%.

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PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Net interest income for the first nine months of 2010 increased to $21.0 million from $17.4 million for 2009 while the net interest margin on a taxable equivalent basis increased to 4.00% from 3.08% over the respective periods.  As previously noted, the Company’s net interest margin was significantly impacted in 2009 by the high cost of putable FHLB advances which were prepaid over the course of 2009 and the first quarter of 2010.  Also, contributing to the increase in the net interest margin was an increase in the yield on loans to 5.72%.  Beginning in 2009, management began to emphasize adding appropriate rate floors on the Company’s adjustable rate loans upon maturity which has had a positive impact on the margin.  Also, enhanced analysis of new customer and existing customer relationships and continued focus on obtaining non-interest bearing deposits has also contributed to the increase in net interest income.

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PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

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

	Three Months Ended September 30,
	2010									2009
	Average Balance			Interest			Average Yield/Cost			Average Balance			Interest			Average Yield/Cost
	(In thousands)									(In thousands)
ASSETS
Earning assets:
Interest-bearing deposits with banks	$	40,203		$	17			0.17	%	$	49,568		$	21			0.17	%
Taxable securities		132,860			972			2.91			107,476			1,111			4.11
Tax-exempt securities		46,412			782			6.70			43,049			723			6.68
Total loans and fees (1) (2)		520,472			7,263			5.55			570,253			8,162			5.69
FHLB and Federal Reserve stock		7,576			33			1.74			8,472			46			2.14
Total earning assets		747,523			9,067			4.83			778,818			10,063			5.14
Less: Allowance for loan losses		(13,302	)								(19,334	)
Non-earning assets:
Cash and due from banks		39,505									29,821
Bank premises and equipment, net		13,995									14,726
Other assets		44,381									35,153
Total assets	$	832,102								$	839,184
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Savings and other	$	247,014		$	306			0.49	%	$	228,206		$	332			0.58	%
Time deposits		244,531			1,025			1.67			277,420			2,038			2.92
Other borrowings		52,003			212			1.62			58,471			227			1.54
FHLB advances		55,880			352			2.51			80,272			1,012			5.01
Subordinated debentures		17,000			113			2.63			17,000			116			2.71
Total interest-bearing liabilities		616,428			2,008			1.30			661,369			3,725			2.24
Non-interest bearing liabilities:
Non-interest demand deposits		145,445									111,599
Accrued interest payable and other liabilities		5,087									8,288
Stockholders’ equity		65,142									57,928
Total liabilities and stockholders’ equity	$	832,102								$	839,184
Net interest income (taxable equivalent basis)				$	7,059								$	6,338
Less: taxable equivalent adjustment					(266	)								(246	)
Net interest income				$	6,793								$	6,092
Net interest spread								3.53	%								2.90	%
Net interest margin								3.76									3.24

(1) The amount of direct loan origination cost included in interest on loans was $92and $133for the three months ended September 30, 2010 and 2009.

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

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PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

	Nine Months Ended September 30,
	2010									2009
	Average Balance			Interest			Average Yield/Cost			Average Balance			Interest			Average Yield/Cost
	(In thousands)									(In thousands)
ASSETS
Earning assets:
Interest-bearing deposits with banks	$	32,710		$	41			0.17	%	$	42,460		$	119			0.38	%
Taxable securities		115,954			3,004			3.47			97,843			3,403			4.66
Tax-exempt securities		46,434			2,339			6.75			30,332			1,512			6.68
Total loans and fees (1) (2)		527,784			22,537			5.72			599,978			24,842			5.55
FHLB and Federal Reserve stock		7,582			119			2.11			8,472			222			3.51
Total earning assets		730,464			28,040			5.15			779,085			30,098			5.18
Less: Allowance for loan losses		(14,295	)								(12,609	)
Non-earning assets:
Cash and due from banks		36,817									27,824
Bank premises and equipment, net		14,196									14,904
Other assets		45,856									39,736
Total assets	$	813,038								$	848,940
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Savings and other	$	238,993		$	866			0.49	%	$	217,340		$	1,015			0.63	%
Time deposits		245,045			3,323			1.82			281,905			6,590			3.13
Other borrowings		55,131			624			1.52			62,973			671			1.43
FHLB advances		54,299			1,123			2.77			92,793			3,524			5.09
Subordinated debentures		17,000			315			2.48			17,000			423			3.34
Total interest-bearing liabilities		610,468			6,251			1.37			672,011			12,223			2.44
Non-interest bearing liabilities:
Non-interest demand deposits		133,997									108,606
Accrued interest payable and other liabilities		5,573									4,734
Stockholders’ equity		63,000									63,589
Total liabilities and stockholders’ equity	$	813,038								$	848,940
Net interest income (taxable equivalent basis)				$	21,789								$	17,875
Less: taxable equivalent adjustment					(795	)								(514	)
Net interest income				$	20,994								$	17,361
Net interest spread								3.77	%								2.74	%
Net interest margin								4.00									3.08

(1) The amount of direct loan origination cost included in interest on loans was $406 and $528 for the nine months ended September 30, 2010 and 2009.

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

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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 September 30, 2010compared to Three Months Ended September 30, 2009 Increase/(Decrease) Due to									Nine Months Ended September 30, 2010 compared to Nine Months Ended September 30, 2009 Increase/(Decrease) Due to
	Total Net Change			Volume			Rate			Total Net Change			Volume			Rate
	(In thousands)									(In thousands)
Interest income:
Interest-bearing deposits with banks	$	(4	)	$	(4	)	$	-		$	(78	)	$	(23	)	$	(55	)
Taxable securities		(139	)		228			(367	)		(399	)		562			(961	)
Tax-exempt securities		59			57			2			827			811			16
Total loans and fees		(899	)		(699	)		(200	)		(2,305	)		(3,063	)		758
FHLB and Federal Reserve stock		(13	)		(5	)		(8	)		(103	)		(21	)		(82	)
Total increase (decrease) in interest income		(996	)		(423	)		(573	)		(2,058	)		(1,734	)		(324	)
Interest expense:
Savings and other		(26	)		26			(52	)		(149	)		94			(243	)
Time Deposits		(1,013	)		(219	)		(794	)		(3,267	)		(776	)		(2,491	)
Other borrowings		(15	)		(26	)		11			(47	)		(87	)		40
FHLB advances		(660	)		(249	)		(411	)		(2,401	)		(1,144	)		(1,257	)
Subordinated debentures		(3	)		-			(3	)		(108	)		-			(108	)
Total increase (decrease) in interest expense		(1,717	)		(468	)		(1,249	)		(5,972	)		(1,913	)		(4,059	)
Increase (decrease) in net interest income	$	721		$	45		$	676		$	3,914		$	179		$	3,735

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

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

Summary of Loan Loss Experience:

	Three Months Ended September 30,						Nine Months Ended  Setember 30,
	2010			2009			2010			2009
	(In thousands)
Activity for the period ended:
Beginning balance	$	12,375		$	18,371		$	15,236		$	9,478
Charge-offs:
Residential real estate		(61	)		(169	)		(604	)		(317	)
Commercial real estate		—			(66	)		(1,527	)		(116	)
Construction		—			(22	)		(2,312	)		(5,181	)
Commercial business		(173	)		(506	)		(748	)		(944	)
Home equity		(97	)		(7	)		(443	)		(552	)
Consumer		(55	)		(146	)		(238	)		(453	)
Total		(386	)		(916	)		(5,872	)		(7,563	)
Recoveries:
Residential real estate		2			1			6			32
Commercial real estate		17			1			95			13
Construction		—			—			22			—
Commercial business		67			2			197			30
Home equity		3			1			46			4
Consumer		15			33			60			89
Total		104			38			426			168
Net loan charge-offs		(282	)		(878	)		(5,446	)		(7,395	)
Provision for loan losses		605			30			2,908			15,440
Ending balance	$	12,698		$	17,523		$	12,698		$	17,523

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PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Provision for loan losses increased to $605,000 for the three months ended September 30, 2010 from $30,000 for the same period in 2009 and decreased to $2.9 million for the nine months ended September 30, 2010 from $15.4 million from 2009.  Net charge-offs decreased to $282,000 and $5.5 million for the three and nine months ended September 30, 2010, respectively, from $878,000 and $7.4 million for the same periods in 2009.  Non-performing loans were $24.9 million at September 30, 2010, down from $31.2 million at December 31, 2009 due primarily to net-charge offs previously mentioned and the transfer of loans to foreclosed and repossessed assets. The Company’s allowance for loan losses to total loans as of September 30, 2010 decreased to 2.46% from 2.80% at December 31, 2009.  The decrease in the allowance was due to the charge-off of credits during 2010 that had been fully provided for in previous periods.  The provision for loan losses for both the three and nine months in 2010 was due to continued elevated non-performing loans and increasing loss exposure in the Company’s classified loans which totaled $70.4 million as of September 30, 2010 as compared to $72.0 million as of December 31, 2009.  Of the $70.4 million classified at September 30, 2010, $14.8 million were classified as “doubtful” which is the Company’s most severe rating and typically includes loans on non-accrual and in the process of foreclosure.  Management has continued to attempt to reduce the non-performing assets by proactively identifying borrowers experiencing financial difficulty to identify solutions and pricing foreclosed assets at their current fair value.  While management has observed a general slowing in the identification of new classified credits in 2010, there continues to be elevated risk in the loan portfolio, specifically the commercial and commercial real estate portfolios as the continued softness in the local economy presents a challenge to the Company’s customers.

Federal regulations require insured institutions to classify their assets on a regular basis.  The regulations provide for three categories of classified loans:  substandard, doubtful and loss.  The regulations also contain a special mention and a specific allowance category.  Special mention is defined as loans that do not currently expose an insured institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving management’s close attention.  Assets classified as substandard or doubtful require the institution to establish allowances for loan losses, if appropriate.  If an asset or portion thereof is classified as loss, the insured institution must either establish specified allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge off such amount.  The Company continues to closely monitor its loan portfolio to identify any additional problem credits, deterioration in underlying collateral values, and credits requiring further downgrades in accordance with the Company’s internal policies.  As of September 30, 2010, management has provided for probable incurred losses within the loan portfolio based on information currently available to the Company.

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PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Non-performing assets.Loans, including impaired loans, are placed on non-accrual status when they become past due ninety days or more as to principal or interest, unless they are adequately secured and in the process of collection.  When these loans are placed on non-accrual status, all unpaid accrued interest is reversed and the loans remain on non-accrual status until the loan becomes current or the loan is deemed uncollectible and is charged off.  Impaired loans are those loans for which it is probable that all scheduled interest and principal payments will not be received based on the contractual terms of the loan agreement.  A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Loans, for which the terms have been modified, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.

	September 30, 2010			December 31, 2009
	(In thousands)
Loans on non-accrual status	$	15,343		$	22,653
Loans past due over 90 days still on accrual		-			-
Troubled debt restructurings		9,584			8,562
Foreclosed and repossessed assets		3,565			5,190
Total non-performing assets	$	28,492		$	36,405
Non-performing loans to total loans		4.83	%		5.74	%
Non-performing assets to total loans		5.52			6.70
Allowance as a percent of non-performing loans		50.94			48.81
Allowance as a percent of total loans		2.46			2.80

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Non-interest income.Non-interest income increased to $1.6 million for the three months ended September 30, 2010 from $478,000 for the same period in 2009.  The increase was due to an other-than-temporary impairment (“OTTI”) charge of $1.1 million in 2009 as compared to an OTTI charge of $146,000 in the third quarter of 2010 (see Footnote 2 to the Company’s consolidated financial statements for further information on the OTTI charge).Also impacting non-interest income during the quarter were net gains on sales of available for sale securities of $197,000 in the third quarter of 2010 as compared to net gains of $83,000 in the equivalent period in 2009.  Management continues to evaluate the Company’s investment portfolio for opportunities to increase the yield by reinvesting sales proceeds in securities that meet the Company’s liquidity and yield specifications.

Non-interest income for the nine month period ended September 30, 2010 increased to $5.5 from $4.8 million in 2009.  The increase was primarily due to the reduction in OTTI charges between the periods, offset by a gain on sale of loans in 2009 that was not repeated in 2010.  In the second quarter of 2009, the Company sold $14.5 million of fixed rate 1-4 family loans for a gain of $197,000.  The Company sold the loans to reduce its fixed rate portfolio and decrease its exposure to rising rates.

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PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Non-interest expense.  Non-interest expense increased to $5.6 million for the three months ended September 30, 2010 from $5.5 million for the same period in 2009 as increases in salary and employee benefits, FDIC insurance premiums, and foreclosed assets, net, were offset primarily by decreases in occupancy and equipment expense.  Salaries and employee benefits, the largest component of non-interest expense, increased slightly to $2.6 million as pay raises were offset partially by a decrease in full time equivalent employees (“FTE”).  The Company had 201 FTE’s as of September 30, 2010, resulting in expense per FTE for the third quarter of $13,070 as compared to 209 FTE’s as of September 30, 2009, or $12,364 expense per FTE. Also factoring into the increase in salaries and employees benefits, was an increase in expense for performance based awards, including deferred stock units.  FDIC insurance premiums were $391,000 for the three months ended September 30, 2010 as compared to $310,000 for the same period in 2009.  The increase was mostly due to an increase in the assessment rate for the Company’s subsidiary banks late in the third quarter of 2009 as a result of the completion of regulatory examinations.  Foreclosed assets, net, increased to $174,000 for the third quarter of 2010 from $(14,000) in 2009.  In the third quarter of 2009, the Company was reimbursed by a borrower for delinquent property taxes paid on their behalf in the second quarter of 2009, resulting in a large reduction in expense.  Occupancy expense declined to $520,000 for the three months ended September 30, 2010 from $576,000 in 2009 as a result of a reduction of property taxes paid on Company owned locations.  Equipment expense decreased to $299,000 for the quarter ended September 30, 2010 from $360,000 for the same period in 2009 due to reductions in expenditures for repairs and maintenance and depreciation expense for computer equipment and software.

Non-interest expense for the nine months ended September 30, 2010 was $16.9 million as compared to $35.1 million for the same period in 2009 as most categories of non-interest expense declined, primarily salaries and employee benefits, occupancy expense, FDIC insurance premiums, goodwill and other intangible asset impairment, and foreclosed assets, net.  The most significant factor in the reduction on non-interest expense was the reduction in goodwill and other intangible asset impairment.  In the second quarter of 2009, the Company recorded a goodwill and other intangible asset impairment charge of $16.2 million which was not repeated in 2010.  After the charge, the Company did not have any recorded goodwill and has $1.2 million of remaining unamortized intangible assets subject to impairment analysis (see the Company’s 10-Q for the second quarter of 2009 or the 10-K for 2009 for further discussion of the charge).  Salaries and employee benefits declined to $7.9 million for the first nine months of 2010 from $8.7 million in 2009 as the number of FTE’s decreased from 253 at the beginning of 2009 to 201 as of September 30, 2010.  Occupancy expense decreased to $1.5 million for the nine months ended September 30, 2010 from $1.8 million in 2009 due to decreases in property taxes on bank owned branch locations, utilities expense, and leasehold improvement depreciation.  FDIC insurance premiums declined to $1.1 million for 2010 from $1.3 million in 2009. The decrease was attributable to a special assessment the FDIC levied in the second quarter of 2009 to all insured institutions.  The Company accrued $372,000 for the assessment as of June 30, 2009 which was paid in the third quarter.  Foreclosed assets, net, decreased to $327,000 for the first nine months of 2010 from $530,000 due mostly to net gains recognized on sales of foreclosed assets of $104,000 in 2010 as compared to net losses incurred in 2009 of $168,000.

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PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

Income tax expense.  Income tax expense was $433,000 for the three month period ended September 30, 2010 as compared to $82,000 for the equivalent period in 2009.  The effective tax rate for the quarter ended September 30, 2010 was 20.5% as compared to 7.9% in 2009.  The change in effective tax rates was due to lower income before taxes in 2009 which was more fully offset by certain tax preference items.

Income tax expense for the nine months ended September 30, 2010 was $1.4 million with an effective tax rate of 21.2% compared to an income tax benefit of $(5.1) million with an effective tax rate of (17.9)% in 2009.  The change in income tax expense and effective tax rate was due to the substantial loss incurred before income taxes in 2009.

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 September 30, 2010, we had cash and interest-bearing deposits with banks of $74.5 million and securities available-for-sale with a fair value of $194.6 million.  If we require funds beyond the funds we are able to generate internally, we have $88.7 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 $33.0 million.  Currently, the Company does not have the ability to declare and pay dividends without prior regulatory approval due to significant net losses at its subsidiaries in 2009.  The holding company had $3.8 million in a correspondent account as of September 30, 2010.

37

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

The Banksare required to maintain specific amounts of capital pursuant to regulatory requirements.  As of September 30, 2010, Your Community Bank and Scott County State Bank were eachwell 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:

September 30, 2010:

	Total Capital To Risk-weighted Assets			Tier 1 Capital To Risk-weighted Assets			Tier 1 Capital To Average Assets
Consolidated		14.7	%		13.4	%		9.2	%
Your Community Bank		14.6	%		13.4	%		9.5	%
Scott County State Bank		16.4	%		15.1	%		9.5	%
Minimum for banks to be well capitalized under regulatory capital requirements:		10.0	%		6.0	%		5.0	%

December 31, 2009:

	Total Capital To Risk-weighted Assets			Tier 1 Capital To Risk-weighted Assets			Tier 1 Capital To Average Assets
Consolidated		13.1	%		11.9	%		8.6	%
Your Community Bank		12.7	%		11.4	%		8.6	%
Scott County State Bank		14.6	%		13.4	%		8.7	%
Minimum for banks to be well capitalized under regulatory capital requirements:		10.0	%		6.0	%		5.0	%

We have been repurchasing shares of our common stock since May 21, 1999.  A net total of 572,192 shares at an aggregate cost of $9.9 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 September 30, 2010, 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 the U.S. Treasury’s Troubled Asset Relief Program Capital Purchase Program, the Company is prohibited from repurchasing our common stock.

38

PART I - ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

COMMUNITY BANK SHARES OF INDIANA, INC. AND SUBSIDIARIES

During June 2004 and 2006, we completedplacements of $7.0 million and $10.0 million floating rate subordinated debentures through Community Bank Shares (IN) Statutory Trust I and Trust II,(trustswe 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 supportour 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 September 30, 2010 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, 2009.

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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, 2009 and September 30, 2010within 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 September 30, 2010 our net interest income would decrease by an estimated 0.1%, or $14,000, over the one year forecast horizon.  As of December 31, 2009, in the Up 200 Scenario we estimated that net interest income would decrease 6.3%, or $1.9 million, over a one year forecast horizon ending December 31, 2010.

40

PART I - ITEM 3

QUANTITATIVE AND QUALITATIVE

DISCLOSURES ABOUT MARKET RISK

The projected results are withinour 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 oneyear 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 September 30, 2010and December 31, 2009, 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 oneyear net interest income sensitivity profile based on the asset/liability model as of September 30, 2010 and ending on September 30, 2011:

	Interest Rate Sensitivity as of September 30, 2010
	Base		Gradual Increase in Rates of 200 Basis Points
Projected interest income:
Loans	$	29,258	$	30,146
Investments		6,717		6,938
FHLB and FRB stock		116		116
Interest-bearing bank deposits		63		301
Federal funds sold		19		183
Total interest Income		36,173		37,684
Projected interest expense:
Deposits		4,594		5,528
Federal funds purchased, line of credit and repurchase agreements		694		1,114
FHLB advances		1,059		1,088
Subordinated debentures		408		550
Total interest expense		6,755		8,280
Net interest income	$	29,418	$	29,404
Change from base				(14	)
Percent change from base				(0.05	)%

41

PART I - ITEM 3

QUANTITATIVE AND QUALITATIVE

DISCLOSURES ABOUT MARKET RISK

The following table illustrates our estimated oneyear net interest income sensitivity profile based on the asset/liability model as of December 31, 2009 and ending December 31, 2010:

	Interest Rate Sensitivity as of December 31, 2009
	Base		Gradual Increase in Rates of 200 Basis Points
Projected interest income:
Loans	$	30,973	$	32,002
Investments		6,943		7,078
FHLB and FRB stock		432		432
Interest-bearing deposits in other financial Institutions		7		23
Federal funds sold		26		252
Total interest income		38,381		39,787
Projected interest expense:
Deposits		4,939		7,416
Federal funds purchased, line of credit and Repurchase agreements		748		1,450
FHLB advances		1,335		1,365
Subordinated debentures		401		543
Total interest expense		7,423		10,774
Net interest income	$	30,958	$	29,013
Change from base			$	(1,945	)
% Change from base				(6.28	)%

42

PART I – ITEM 4

CONTROLS AND PROCEDURES

Our management, including our Chief Executive Officer (serving as the principal executive officer) and Chief Financial Officer (serving as the principal financial officer), have conducted an evaluation of the effectiveness of disclosure controls and procedures pursuant to Securities Exchange Act of 1934 Rule 13a-15 as of the end of the period covered by this Form 10-Q. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the disclosure controls and procedures are effective in ensuring that all material information required to be filed in this quarterly report has been made known to them in a timely fashion. There have been no significant changes in internal controls, or in other factors that could significantly affect internal controls, subsequent to the date the Chief Executive Officer and the Chief Financial Officer completed their evaluation.

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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

Except as noted below, management is not aware of any material changes to the risk factors discussed in Part 1, Item 1A of the Annual Report on Form 10-K for the year ended December 31, 2009.  In addition to the other information set forth in this report, you should carefully consider the risk factors discussed in Part I, Item 1A of the Annual Report on Form 10-K for the year ended December 31, 2009, which could materially and adversely affect the Company’s business, financial condition and results of operations. The risks described in the Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not presently known to management or that management currently believes to be immaterial may also materially and adversely affect our business, financial condition or results of operations.

Enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the promulgation of regulations thereunder could significantly increase our compliance and operating costs or otherwise have a material and adverse effect on the Company’s financial position, results of operations, or cash flows.

On July 21, 2010, the President of the United States signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act financial reform legislation. This legislation includes, among other things, (i) the creation of a Financial Services Oversight Counsel to identify emerging systemic risks and improve interagency cooperation; (ii) the elimination of the Office of Thrift Supervision and the transfer of oversight of federally chartered thrift institutions and their holding companies to the Office of the Comptroller of the Currency and the Federal Reserve; (iii) the creation of a Consumer Financial Protection Agency authorized to promulgate and enforce consumer protection regulations relating to financial products that would affect banks and non-bank finance companies; (iv) the establishment of new capital and prudential standards for banks and bank holding companies, including the elimination of the ability to treat trust preferred securities as Tier 1 capital; (v) the termination of investments by the Treasury under the Troubled Assets Relief Program (TARP); (vi) enhanced regulation of financial markets, including the derivatives, securitization and mortgage origination markets; (vii) the elimination of certain proprietary trading and private equity investment activities by banks; (viii) the elimination of barriers to de novo interstate branching by banks; (ix) a permanent increase of the previously implemented temporary increase of FDIC deposit insurance to $250,000; (x) the authorization of interest-bearing transaction accounts, and (xi) changes in the calculation of FDIC deposit insurance assessments and an increase in the minimum designated reserve ratio for the Deposit Insurance Fund.

44

PART II

OTHER INFORMATION

Certain provisions of the legislation are not immediately effective or are subject to required studies and implementing regulations. Further, community banks with less than $10 billion in assets (less than $15 billion with respect to trust preferred securities) are exempt from certain provisions of the legislation. Management cannot predict how this new legislation may be interpreted and enforced nor how implementing regulations and supervisory policies may affect the Company. There can be no assurance that these or future reforms will not significantly increase the Company’s compliance or operating costs or otherwise have a material and adverse effect on the Company’s financial position, results of operations, or cash flows.

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

The Company did not purchase its common shares during the nine months ended September 30, 2010.

The Board of Directors of the Company authorized a share repurchase plan in June 2007 under which a maximum of $5.0 million of the Company’s common stock can be purchased.  As of September 30, 2010, 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 the U.S. Treasury’s Troubled Asset Relief Program Capital Purchase Program, the Company is prohibited from repurchasing our common stock.

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.

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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:November 15, 2010	BY:	/s/ James D. Rickard
		James D. Rickard
		President and
		Chief Executive Officer
		(Principal Executive Officer)
Dated:November 15, 2010	BY:	/s/ Paul. A. Chrisco
		Paul A. Chrisco
		Executive Vice-President and
		Chief Financial Officer
		(Principal Financial Officer)

46

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

47