UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange

Act of 1934

For the Fiscal Year Ended December 31, 2012

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 of	(I.R.S. Employer
Incorporation or Organization)	Identification Number)

101 West Spring Street, New Albany, Indiana 47150

(Address of Principal Executive Offices) (Zip Code)

Registrant's telephone number, including area code: (812) 944-2224

Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class	Name of Each Exchange on Which Registered

Common Stock, par value $0.10 per share NASDAQ Capital Market

Securities Registered Pursuant to Section 12(g) of the Act:

None

Indicate by checkmark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ¨ NO x

Indicate by checkmark if the Registrant is not required to file requests pursuant to Section 13 or 15(d) of the Act. YES ¨ NO x

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 twelve months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such requirements for the past 90 days. YES x NO ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T during the preceding 12 months. YES x NO ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. S

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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x Smaller reporting company ¨

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

As of June 30, 2012, the aggregate market value of the Registrant’s common stock held by non-affiliates of the Registrant was $36,606,831 based on the closing sale price as reported on the National Association of Securities Dealers Automated Quotation System National Market System. Shares of common stock held by each officer, director, and holder of 10% or more of the outstanding common stock of the Registrant have been excluded from this calculation in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of March 22, 2013, there were issued and outstanding 3,385,595 shares of the Registrant's Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive Proxy Statement for its Annual Meeting of Stockholders to be held on May 21, 2013 are incorporated by reference into Items 10, 11, 12, 13 and 14 of Part III.

Form 10-K

Index

		Page
Part I:
Item 1.	Business	4
Item 1A.	Risk Factors	12
Item 1B.	Unresolved Staff Comments	19
Item 2.	Properties	20
Item 3.	Legal Proceedings	21
Part II:
Item 5.	Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	22
Item 6.	Selected Financial Data	24
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	25
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	46
Item 8.	Financial Statements and Supplementary Data	49
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosures	114
Item 9A.	Controls and Procedures	114
Item 9B	Other Information	116
Part III:
Item 10.	Directors and Executive Officers and Corporate Governance	116
Item 11.	Executive Compensation	116
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	116
Item 13.	Certain Relationships and Related Transactions, and Director Independence	116
Item 14.	Principal Accountant Fees and Services	116
Part IV:
Item 15.	Exhibits and Financial Statement Schedules	117
Signatures		118
Index of Exhibits		119

Part I

Item 1. Business

General

Community Bank Shares of Indiana, Inc. (the “Company”) is a bank holding company headquartered in New Albany, Indiana. The Company’s wholly-owned banking subsidiaries are Your Community Bank (“YCB”) and The Scott County State Bank (“SCSB”)(YCB and SCSB are at times collectively referred to as the “Banks”). 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. YCB is also regulated by the Federal Deposit Insurance Corporation (“FDIC”) and (with respect to its Kentucky branches) the Kentucky Department of Financial Institutions while SCSB is also regulated by the Federal Reserve. In addition, the Company wholly-owns a captive insurance company, CBIN Insurance, Inc. which issues policies to the Company’s banking subsidiaries.

YCB 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 the Bank.

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

The Company had total assets of $819.5 million, total deposits of $624.7 million, and stockholders' equity of $86.4 million as of December 31, 2012. The Company's principal executive office is located at 101 West Spring Street, New Albany, Indiana 47150, and the telephone number at that address is (812) 944-2224.

Business Strategy

The Company's current business strategy is to operate well-capitalized, profitable and independent community banks that have a significant presence in their primary market areas. The Company’s growth strategy is focused on expansion through organic growth within its market areas. The Company offers business and personal banking services through a full range of deposit products that include non-interest and interest-bearing checking accounts, ATM’s, mobile banking, debit cards, savings accounts, money market accounts, certificates of deposit and individual retirement accounts. The Company’s loan products include: secured and unsecured business loans of various terms to local businesses and professional organizations; consumer loans including home equity lines of credit, automobile and recreational vehicles, construction, and loans secured by deposit accounts; and residential real estate loans. In addition, the Company also offers non-deposit investment products such as stocks, bonds, mutual funds, and annuities to customers within its banking market areas through a strategic alliance with Axiom Financial Strategies Group of Wells Fargo Advisors.

Internal Growth. Management believes the optimum way to grow the Company is by attracting new loan and deposit customers within its existing markets through its extensive product offerings and attentive customer service. Management believes the Company’s customers seek a banking relationship with a service-oriented community banking institution and feels the Company’s banking centers have an atmosphere which facilitates personalized service and a broad range of product offerings to meet customers’ needs. However, the Company will consider acquisition opportunities that help advance its strategic objectives.

Branch Expansion. Management continues to consider opportunities for branch expansion and is focusing its current efforts within existing markets. Management considers a variety of criteria when evaluating potential branching opportunities. These include: the market location of the potential branch and demographics of the surrounding communities; the investment required and opportunity costs; staffing needs; and other criteria management deems of particular importance.

4

Lending Activities

Commercial Business Loans. The Company originates non-real estate related business loans to local businesses and professional organizations. This type of commercial loan has been offered at both variable rates and fixed rates and can be unsecured or secured by general business assets such as equipment, accounts receivable or inventory. Such loans generally have shorter terms and higher interest rates than commercial real estate loans. These commercial business loans involve a higher level of credit risk because of the type and nature of the collateral.

Commercial Real Estate Loans. The Company's commercial real estate loans are secured by improved property such as offices, small business facilities, apartment buildings, nursing homes, warehouses and other non-residential buildings, most of which are located in the Company's primary market area and some of which are to be used or occupied by the borrowers. Commercial real estate loans have been offered at adjustable interest rates and at fixed rates, typically with balloon provisions at the end of the term financing. The Company continues to offer commercial real estate loans, commercial real estate construction and development loans and land loans. Loans secured by commercial real estate generally involve a greater degree of risk than residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentrations of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multifamily and commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced, the borrower's ability to repay the loan may be impaired. The Company has sought to increase its origination of multi-family residential or commercial real estate loans over the last few years while attempting to decrease its exposure to development and land loans and has attempted to protect itself against the increased credit risk associated with these loans through its underwriting standards and ongoing monitoring processes.

Residential Real Estate Loans. The Company originates one-to-four family, owner-occupied, residential mortgage loans secured by property located in the Company's market area. While the Company currently sells a portion of its residential real estate loans into the secondary market, the Company does originate and retain a significant amount of these loans in its own portfolio. The majority of the Company's residential mortgage loans consist of loans secured by owner-occupied, single family residences. The Company currently offers residential mortgage loans for terms up to thirty years, with adjustable (“ARM”) or fixed interest rates. Origination of fixed-rate mortgage loans versus ARM loans is monitored continuously and is affected significantly by the level of market interest rates, customer preference, and loan products offered by the Company's competitors. Therefore, even if management's strategy is to emphasize ARM loans, market conditions may be such that there is greater demand for fixed-rate mortgage loans and/or fixed rate mortgage loans with balloon payment features.

The Company's fixed and adjustable rate residential mortgage loans are amortized on a monthly basis with principal and interest due each month. Residential real estate loans often remain outstanding for significantly shorter periods than their contractual terms because borrowers may refinance or prepay loans at their option.

The primary purpose of offering ARM loans is to make the Company's loan portfolio more interest rate sensitive. ARM loans, however, can carry increased credit risk because during a period of rising interest rates the risk of default on ARM loans may increase due to increases in borrowers’ monthly payments.

After the initial fixed rate period, the Company's ARM loans generally adjust annually with interest rate adjustment limitations of two percentage points per year and six percentage points over the life of the loan. The Company also makes ARM loans with interest rates that adjust every one, three or five years. Under the Company's current practice, after the initial fixed rate period the interest rate on ARM loans adjusts to the applicable index plus a spread. The Company's policy is to qualify borrowers for one-year ARM loans based on the initial interest rate plus the maximum annual rate increase.

The Company has used different indices for its ARM loans such as the National Average Median Cost of Funds, the Sixth District Net Cost of Funds Monthly Index, the National Average Contract Rate for Previously Occupied Homes, the average three year Treasury Bill Rate, and the Eleventh District Cost of Funds. Consequently, the adjustments in the Company's portfolio of ARM loans tend not to reflect any one particular change in any specific interest rate index, but general interest rate trends overall.

5

Secondary market regulations limit the amount that a bank may lend based on the appraised value of real estate. Such regulations permit a maximum loan-to-value ratio of 95% percent for residential property and from 65-90% for all other real estate related loans.

The Company occasionally makes real estate loans with loan-to-value ratios in excess of 80%. For the loans sold into the secondary market, individual investor requirements pertaining to private mortgage insurance apply. For the mortgage real estate loans retained by the Company with loan-to-value ratios of 80-90%, the Company may require the first 20% of the loan to be covered by private mortgage insurance. For the mortgage real estate loans retained by the Company with loan-to-value ratios of 90-95%, the Company may require private mortgage insurance to cover the first 25-30% of the loan amount. The Company requires fire and casualty insurance, as well as title insurance or an opinion of counsel regarding good title, on all properties securing real estate loans made by the Company.

Construction Loans. The Company originates loans to finance the construction of owner-occupied residential property. The Company makes construction loans to private individuals for the purpose of constructing a personal residence or to local real estate builders and developers. Construction loans generally are made with either adjustable or fixed-rate terms, typically up to 12 months. Loan proceeds are disbursed in increments as construction progresses and as inspections warrant. Construction loans are structured to be converted to permanent loans at the end of the construction period or to be terminated upon receipt of permanent financing from another financial institution.

Consumer Loans. The principal types of consumer loans offered by the Company are home equity lines of credit, auto loans, home improvement loans, and loans secured by deposit accounts. Home equity lines of credit are predominately made at rates which adjust periodically and are indexed to the prime rate and generally have rate floors. Some consumer loans are offered on a fixed-rate basis depending upon the borrower's preference. The Company's home equity lines of credit are generally secured by the borrower's principal residence and a personal guarantee.

The underwriting standards employed by the Company for consumer loans include a determination of the applicant's credit history and an assessment of the prospective borrower’s ability to meet existing obligations and payments on the proposed loan. The stability of the applicant's monthly income may be determined by verification of gross monthly income from primary employment and from any verifiable secondary income. The underwriting process also includes a comparison of the value of the collateral in relation to the proposed loan amount.

Mortgage-Banking Operations. The Company originates qualified government guaranteed loans and conventional secondary market loans which are sold with the servicing released. This arrangement provides necessary liquidity to the Company while providing additional loan products to the Company’s customers.

Loan Solicitation and Processing. Loans are originated through a number of sources including loan sales staff, real estate broker referrals, existing customers, borrowers, builders, attorneys and walk-in customers. Processing procedures are affected by the type of loan requested and whether the loan will be funded by the Company or sold into the secondary market.

Mortgage loans that are sold into the secondary market are submitted, when possible, for Automated Underwriting, which allows for faster approval and an expedited closing. The Company’s responsibility on these loans is the fulfillment of the loan purchaser's requirements. These loans require credit reports, appraisals, and income verification before they are approved or disapproved. Private mortgage insurance is generally required on loans with a ratio of loan to appraised value of greater than eighty percent. Property insurance and flood certifications are required on all real estate loans.

Installment loan documentation varies by the type of collateral offered to secure the loan. In general, an application and credit report is required before a loan is submitted for underwriting. The underwriter determines the necessity of any additional documentation, such as income verification or appraisal of collateral. An authorized loan officer approves or declines the loan after review of all applicable loan documentation collected during the underwriting process.

Commercial loans are underwritten by the commercial loan officer who makes the initial contact with the customer applying for credit. The underwriting of these loans is reviewed after the fact by the Risk Management area for compliance with the Company's general underwriting standards. A loan exceeding the authority of the underwriting loan officer requires the approval of other officers of the Banks based upon individual lending authorities, the Directors’ Loan Committee, or the Board of Directors of the Banks, depending on the loan amount.

6

Loan Commitments. The Company issues loan origination commitments to qualified borrowers primarily for the construction and purchase of residential real estate and commercial real estate. Such commitments are made with specified terms and conditions for periods of thirty days for commercial real estate loans and sixty days for residential real estate loans.

Employees

As of December 31, 2012, the Company employed 202 employees, 193 full-time and 9 part-time. None of these employees are represented by a collective bargaining group. Neither the Company nor any subsidiary has ever experienced a work stoppage.

Competition and Market Area Served

The banking business is highly competitive, and as such the Company competes not only with other commercial banks, but also with savings and loan associations, trust companies and credit unions for deposits and loans, as well as stock brokerage firms, insurance companies, and other entities providing one or more of the services and products offered by the Company. In addition to competition, the Company's business and operating results are affected by the general economic conditions prevalent in its market.

The Company’s primary market areas consist of Floyd, Clark, and Scott counties in Southern Indiana and Jefferson and Nelson counties in Kentucky. These are four (excluding Scott County) of the thirteen counties comprising the Louisville, Kentucky Standard Metropolitan Statistical Area, which has a population in excess of 1.2 million. The aggregate population of Floyd, Clark, and Scott counties is approximately 204,000 while the populations of Jefferson and Nelson Counties are approximately 714,000 and 43,000, respectively. The Company's headquarters are located in New Albany, Indiana, a city of 37,000 located approximately three miles from the center of Louisville.

Nature of Company’s Business

The business of the Company is not seasonal. The Company’s business does not depend upon a single customer, or a few customers, the loss of any one or more of which would have a material adverse effect on the Company. No material portion of the Company’s business is subject to renegotiation of profits or termination of contracts or subcontracts at the election of any governmental entity.

Regulation and Supervision

As a bank holding company, the Company is regulated under the Bank Holding Company Act of 1956, as amended (the "Act"). The Act limits the business of bank holding companies to banking, managing or controlling banks and other subsidiaries authorized under the Act, performing certain servicing activities for subsidiaries and engaging in such other activities as the Board of Governors of the Federal Reserve System (“Federal Reserve Board”) may determine to be closely related to banking. The Company is registered with and is subject to regulation by the Federal Reserve Board. Among other things, applicable statutes and regulations require the Company to file an annual report and such additional information as the Federal Reserve Board may require pursuant to the Act and the regulations which implement the Act. The Federal Reserve Board also conducts examinations of the Company.

The Act provides that a bank holding company must obtain the prior approval of the Federal Reserve Board to acquire more than five percent of the voting stock or substantially all the assets of any bank or bank holding company. The Act also provides that, with certain exceptions, a bank holding company may not (i) engage in any activities other than those of banking or managing or controlling banks and other authorized subsidiaries, or (ii) own or control more than five percent of the voting shares of any company that is not a bank, including any foreign company. A bank holding company is permitted, however, to acquire shares of any company, the activities of which the Federal Reserve Board has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. A bank holding company may also acquire shares of a company which furnishes or performs services for a bank holding company and acquire shares of the kinds and in the amounts eligible for investment by national banking associations. In addition, the Federal Reserve Act restricts the Bank’s extension of credit to the Company.

7

The Dodd-Frank Wall Street Reform and Consumer Protection Act financial reform legislation (“Dodd-Frank”), which became law on July 21, 2010, significantly revised and expanded the rulemaking, supervisory and enforcement authority of federal bank regulators. Dodd-Frank impacts many aspects of the financial industry and, in many cases, will impact larger and smaller financial institutions and community banks differently over time. Dodd-Frank includes, among other provisions, the following:

· the creation of a Financial Stability Oversight Counsel to identify emerging systemic risks and improve interagency cooperation;

· the establishment of strengthened capital and liquidity requirements for banks and bank holding companies, including minimum leverage and risk-based capital requirements no less than the strictest requirements in effect for depository institutions as of the date of enactment;

· the requirement by statute that bank holding companies serve as a source of financial strength for their depository institution subsidiaries;

· the termination of investments by the U.S. Treasury under TARP;

· the elimination and phase out of trust preferred securities from Tier 1 capital for institutions with more than $15 billion in assets;

· a permanent increase of the previously implemented temporary increase of FDIC deposit insurance to $250,000 and an extension of federal deposit coverage until January 1, 2013 for the full net amount held by depositors in non-interest bearing transaction accounts;

· authorization for financial institutions to pay interest on business checking accounts;

· changes in the calculation of FDIC deposit insurance assessments, such that the assessment base will no longer be the institution’s deposit base, but instead, will be its average consolidated total assets less its average tangible equity;

· expanded restrictions on transactions with affiliates and insiders under Section 23A and 23B of the Federal Reserve Act and lending limits for derivative transactions, repurchase agreements and securities lending and borrowing transactions;

· provisions that affect corporate governance and executive compensation at most U.S. publicly traded companies, including: 1) stockholder advisory votes on executive compensation, 2) executive compensation “clawback” requirements for companies listed on national securities exchanges in the event of materially inaccurate statements of earnings, revenues, gains or other criteria, 3) enhanced independence requirements for compensation committee members, and 4) authority for the SEC to adopt proxy access rules which would permit stockholders of publicly traded companies to nominate candidates for election as director and have those nominees included in a company’s proxy statement; and

· the creation of a Consumer Financial Protection Bureau, which is authorized to promulgate consumer protection regulations relating to bank and non-bank financial products and examine and enforce these regulations on institutions with more than $10 billion in assets.

Many of the requirements of Dodd-Frank will be implemented over time and most will be subject to regulations to be implemented or which will not become fully effective for several years.

On November 12, 1999, Congress enacted the Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act permits bank holding companies to qualify as "financial holding companies" that may engage in a broad range of financial activities, including underwriting, dealing in and making a market in securities, insurance underwriting and agency activities and merchant banking. The Federal Reserve Board is authorized to expand the list of permissible financial activities. The Gramm-Leach-Bliley Act also authorizes banks to engage through financial subsidiaries in nearly all of the activities permitted for financial holding companies. The Company has not elected the status of financial holding company and at this time has no plans for these investments or broader financial activities.

As state-chartered commercial banks, the Company’s subsidiary banks are subject to examination, supervision and extensive regulation by the Federal Deposit Insurance Corporation (“FDIC”), the Indiana Department of Financial Institutions (“DFI”), with respect to YCB and its branch offices located in Kentucky, the Kentucky Department of Financial institutions (“KDFI), and by the Federal Reserve with respect to SCSB. The Banks are members of and own stock in the Federal Home Loan Bank (“FHLB”) of Indianapolis and Cincinnati. The FHLB institutions located in Indianapolis and Cincinnati are two of the twelve regional banks in the FHLB system. The Banks are also subject to regulation by the Federal Reserve Board, which governs reserves to be maintained against deposits and regulates certain other matters. The extensive system of banking laws and regulations to which the Banks are subject is intended primarily for the protection of the Company’s customers and depositors, and not its shareholders.

8

The FDIC, Federal Reserve, and DFI/KDFI regularly examine the Banks and prepare reports for the consideration of the Banks’ Board of Directors on any deficiencies that they may find in the Banks’ operations. The relationship of the Banks with their depositors and borrowers also is regulated to a great extent by both federal and state laws, especially in such matters as the form and content of the Banks’ mortgage documents and communication of loan and deposit rates to both existing and prospective customers.

The investment and lending authority of a state-chartered bank is prescribed by state and federal laws and regulations, and such banks are prohibited from engaging in any activities not permitted by such laws and regulations. These laws and regulations generally are applicable to all state chartered banks. The Banks may not lend to a single or related group of borrowers on an unsecured basis an amount in excess of the greater of $500,000 or fifteen percent of the Banks unimpaired capital and surplus on a disaggregated basis. An additional amount may be lent, equal to ten percent of unimpaired capital and surplus, if such loan is secured by readily marketable collateral, which is defined to include certain securities, but generally does not include real estate.

Federal Regulations

Sections 22(h) and (g) of the Federal Reserve Act place restrictions on loans to executive officers, directors and principal stockholders. Under Section 22(h), loans to a director, an executive officer and to a greater than ten percent stockholder of a bank, and certain affiliated interests of either, may not exceed, together with all other outstanding loans to such person and affiliated interests, the institution's loans to one borrower limit (15% of the Bank’s unimpaired capital and surplus). Section 22(h) also requires that loans to directors, executive officers and principal stockholders be made on terms substantially the same as offered in comparable transactions to other persons and also requires prior board of directors approval for certain loans. In addition, the aggregate amount of extensions of credit to all insiders cannot exceed the institution's unimpaired capital and surplus. At December 31, 2012 the Banks were in compliance with the above restrictions.

Safety and Soundness. The Federal Deposit Insurance Act (“FDIA”), as amended by the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) and the Riegle Community Development and Regulatory Improvement Act of 1994, requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to the internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest-rate-risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits and such other operational and managerial standards as the agencies may deem appropriate. The federal bank regulatory agencies adopted, effective August 9, 1995, a set of guidelines prescribing safety and soundness standards pursuant to FDICIA, as amended. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines.

The FDIC generally is authorized to take enforcement action against a financial institution that fails to meet its capital requirements; such action may include restrictions on operations and banking activities, the imposition of a capital directive, a cease and desist order, civil money penalties or harsher measures such as the appointment of a receiver or conservator or a forced merger into another institution. In addition, under current regulatory policy, an institution that fails to meet its capital requirements is prohibited from paying any dividends. Except under certain circumstances, further disclosure of final enforcement action by the FDIC is required.

9

Prompt Corrective Action. Under Section 38 of the FDIA, as amended by the FDICIA, each federal banking agency was required to implement a system of prompt corrective action for institutions which it regulates. The federal banking agencies, including the FDIC, adopted substantially similar regulations to implement Section 38 of the FDIA, effective as of December 19, 1992. Under the regulations, an institution is deemed to be (i) "well-capitalized" if it has total risk-based capital of 10.0% or more, a Tier 1 risk-based capital ratio of 6.0% or more, a Tier 1 leverage capital ratio of 5.0% or more and is not subject to any order or final capital directive to meet and maintain a specific capital level for any capital measure, (ii) "adequately-capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 4.0% or more and a Tier 1 leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well-capitalized," (iii) "undercapitalized" if it has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is less than 4.0% or a Tier 1 leverage capital ratio that is less than 4.0% (3.0% under certain circumstances), (iv) "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0%, a Tier 1 risk-based capital ratio that is less than 3.0% or a Tier II average capital ratio that is less than 3.0%, and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Section 38 of the FDIA and the regulations promulgated thereunder also specify circumstances under which a federal banking agency may reclassify a well-capitalized institution as adequately-capitalized and may require an adequately-capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category (except that the FDIC may not reclassify a significantly undercapitalized institution as critically undercapitalized). At December 31, 2012, the Company and the Banks were deemed well-capitalized for purposes of the above regulations. As discussed above, Dodd-Frank may result in more stringent capital requirements in the future.

Federal Home Loan Bank System. The Banks are members of the FHLB of Indianapolis. The FHLB of Indianapolis is one of the 12 regional FHLB's that lend money to its members to finance housing and economic development. With the enactment of the Housing and Economic Recovery Act on July 30, 2008, the Federal Housing Finance Agency (“FHFA”) was created to oversee the secondary mortgage market. The Act empowered the FHFA with the powers to oversee and regulate Fannie Mae, Freddie Mac, and the FHLBs.

As members of the FHLB system, the Banks are required to purchase and maintain stock in the FHLB in an amount equal to the greater of one percent of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year, or 1/20 (or such greater fraction as established by the FHLB) of outstanding FHLB advances. At December 31, 2012, $5.5 million of FHLB stock was outstanding for the Banks, which were in compliance with this requirement. In past years, the Banks have received dividends on its FHLB stock.

Insurance of Accounts. The FDIC is an independent federal agency that insures deposits, up to prescribed statutory limits, of federally insured banks and savings institutions and safeguards the safety and soundness of the banking and savings industries. The FDIC insures our customer deposits through the Deposit Insurance Fund (the “DIF”) up to prescribed limits for each depositor. Pursuant to Dodd-Frank, the maximum deposit insurance amount has been permanently increased to $250,000. The amount of FDIC assessments paid by each DIF member institution is based on its relative risk of default as measured by regulatory capital ratios and other supervisory factors. Due to the greatly increased number of bank failures and losses incurred by DIF, as well as the recent extraordinary programs in which the FDIC has been involved to support the banking industry generally, the FDIC’s DIF was substantially depleted and the FDIC has incurred substantially increased operating costs. In November, 2009, the FDIC adopted a requirement for institutions to prepay in 2009 their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011, and 2012. The Banks prepaid their assessments based on the calculations of the projected assessments at that time.

As required by Dodd-Frank, the FDIC adopted a new DIF restoration plan which became effective on January 1, 2011. Among other things, the plan: (1) raises the minimum designated reserve ratio, which the FDIC is required to set each year, to 1.35 percent (from the former minimum of 1.15 percent) and removes the upper limit on the designated reserve ratio (which was formerly capped at 1.5 percent) and consequently on the size of the fund; (2) requires that the fund reserve ratio reach 1.35 percent by 2020; (3) requires that, in setting assessments, the FDIC "offset the effect of (requiring that the reserve ratio reach 1.35 percent by September 30, 2020 rather than 1.15 percent by the end of 2016) on insured depository institutions with total consolidated assets of less than $10.0 billion; (4) eliminates the requirement that the FDIC provide dividends from the fund when the reserve ratio is between 1.35 percent and 1.5 percent; and (5) continues the FDIC’s authority to declare dividends when the reserve ratio at the end of a calendar year is at least 1.5 percent, but grants the FDIC sole discretion in determining whether to suspend or limit the declaration or payment of dividends. The FDI Act continues to require that the FDIC’s Board of Directors consider the appropriate level for the designated reserve ratio annually and, if changing the designated reserve ratio, engage in notice-and-comment rulemaking before the beginning of the calendar year. The FDIC has set a long-term goal of getting its reserve ratio up to 2% of insured deposits by 2027.

10

Effective April 1, 2011, the FDIC changed the deposit insurance assessment system from one that is based on total domestic deposits to one that is based on average consolidated total assets minus average tangible equity. In addition, the final rule creates a scorecard-based assessment system for larger banks (those with more than $10 billion in assets). Larger insured depository institutions will likely pay higher assessments to the DIF than under the old system. The FDIC suspended dividends indefinitely; however, in lieu of dividends, and pursuant to its authority to set risk-based assessments, the FDIC adopted progressively lower assessment rate schedules that will take effect when the reserve ratio exceeds 1.15 percent, 2 percent, and 2.5 percent. Additionally, the final rule included a new adjustment for depository institution debt whereby an institution pays an additional premium equal to 50 basis points on every dollar of long-term, unsecured debt held as an asset that was issued by another insured depository institution (excluding debt guaranteed under the TLGP). to the extent that all such debt exceeds 3 percent of the other insured depository institution’s Tier 1 capital.

The Federal Reserve System. The Federal Reserve Board requires all depository institutions to maintain reserves against their transaction accounts and non-personal time deposits. Banks are authorized to borrow from the Federal Reserve Bank "discount window," but Federal Reserve Board regulations require banks to exhaust other reasonable alternative sources of funds, including FHLB advances, before borrowing from the Federal Reserve Bank.

SCSB is required to purchase and maintain stock in the Federal Reserve. At December 31, 2012, SCSB had $499,000 of Federal Reserve stock outstanding, which was in compliance with requirements. In past years, SCSB has received dividends on its Federal Reserve stock.

Federal Taxation. For federal income tax purposes, the Company and its subsidiaries file a consolidated federal income tax return on a calendar year basis. Consolidated returns have the effect of eliminating intercompany distributions, including dividends, from the computation of consolidated taxable income for the taxable year in which the distributions occur.

The Company and its subsidiaries are subject to the rules of federal income taxation generally applicable to corporations under the Internal Revenue Code of 1986, as amended (the "Code").

Income from the Company’s subsidiary, CBIN Insurance, Inc., is not subject to federal income tax.

Indiana Taxation. The Company is subject to an income tax imposed by the State of Indiana. The tax is imposed at the rate of 8.5 percent of the Company's adjusted gross income. In computing adjusted gross income, no deductions are allowed for municipal interest and U.S. Government interest. In 2000, the Indiana financial institution tax law was amended to treat resident financial institutions the same as nonresident financial institutions by providing for apportionment of Indiana income based on receipts in Indiana. This revision allowed for the exclusion of receipts from out of state sources and federal government and agency obligations.

Currently, income from YCB’s subsidiaries CBSI Holdings, Inc., CBSI Investments, Inc. and CBSI Investment Portfolio Management, LLC and the Company’s CBIN Insurance, Inc. is not subject to the Indiana income tax.

Kentucky Taxation. The Company is subject to a franchise tax imposed by the Commonwealth of Kentucky on its operations in Kentucky. The tax is imposed at a rate of 1.1% on taxable net capital, which equals capital stock paid in, surplus, undivided profits and capital reserves, and accumulated other comprehensive income or loss, less an amount equal to the same percentage of the total as the book value of United States obligations and Kentucky obligations bears to the book value of the total assets of the financial institution. A financial institution whose business activity is taxable within and without Kentucky must apportion its net capital based on the three factor apportionment formula of receipts, property and payroll unless the Kentucky Revenue Cabinet has granted written permission to use another method.

11

Participation in the Capital Purchase Program. Throughout 2008, the United States Federal Government launched a series of financial initiatives aimed at stabilizing the economy. The United States Department of the Treasury (“Treasury”) launched one of its largest initiatives, the Capital Purchase Program (“CPP”), under the Emergency Economic Stabilization Act (“EESA”) in October 2008. The CPP is a voluntary program which offered qualifying banks and bank holding companies the opportunity to sell preferred securities and warrant to the Treasury. The same terms generally applied to all public company participants in the plan. By providing capital to financial institutions through the CPP, Treasury aimed to enhance market confidence in the entire banking system by stabilizing the financial markets, thereby increasing the capacity of these institutions to lend to U.S. businesses and consumers and to support the U.S. economy under the difficult financial market conditions. On May 29, 2009, we entered into a letter agreement with the Treasury under the CPP by which we sold to the Treasury our preferred securities and warrant. In 2011, the Company repurchased its preferred shares and warrant issued in connection with its participation in CPP in connection with our participation in the Treasury’s Small Business Lending Fund. For a description of the transaction, see Note 12 to the Consolidated Financial Statements.

Participation in the Small Business Lending Fund. The Small Business Lending Fund (“SBLF”) is a dedicated investment fund that encourages lending to small businesses by providing capital to qualified community banks with assets of less than $10 billion. Enacted into law as part of the Small Business Jobs Act of 2010, under the SBLF Treasury makes a capital investment into community banks the dividend payment on which is adjusted depending on the growth in the bank’s qualifying small business lending. On September 15, 2011, as part of the SBLF program, the Company sold $28.0 million of Non-Cumulative Perpetual Preferred Stock, Series B (the “SBLF Preferred Stock”), to the Secretary of the Treasury (the “Secretary”), and used the proceeds from the sale of the SBLF Preferred Stock to redeem the 19,468 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “CPP Preferred Stock”), issued in 2009 to the Treasury under the CPP, plus the accrued and unpaid dividends owed on the CPP Preferred Stock. As a result of its redemption of the CPP Preferred Stock, the Company is no longer subject to the limits on executive compensation and other restrictions stipulated under CPP. The Company will be subject to all terms, conditions and other requirements for participation in SBLF for as long as any SBLF Preferred Stock remains outstanding.

Available Information. The Company files annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports with the Securities and Exchange Commission (“SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. The public may read and copy any material the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549 and may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC on its website at www.sec.gov. The Company makes available through its website, www.yourcommunitybank.com, its annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K.

Item 1A. Risk Factors

There are a number of factors, including those specified below, that may adversely affect our business, financial results or stock price. Additional risks that we currently do not know about or currently view as immaterial may also impair our business or adversely impact our financial results or stock price.

As used in this Item 1A of the Form 10-K, the terms “we”, “us” and “our” refer to Community Bank Shares of Indiana, Inc., an Indiana corporation and its subsidiaries (unless the context clearly implies otherwise).

12

Industry Risk Factors

Economic Conditions. Our earnings are affected by the general economic conditions in the United States, and to a lesser extent, general international economic conditions. Economic conditions in the United States and abroad deteriorated significantly in the latter part of 2008 which has continued into 2013. Business activity across a wide range of industries and regions in the United States was greatly reduced. Although economic conditions have improved, certain sectors, such as real estate, remain weak and unemployment remains high. Many businesses are still in serious difficulty due to reduced consumer spending and continued liquidity challenges in the credit markets. Many financial institutions and institutional investors have tightened the availability of credit to borrowers and other financial institutions, which, in turn, results in more loan defaults and decreased business activity. While we have seen some signs of improvement, we do not expect significant improvement in the economy in the near future.

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. Government efforts to strengthen the U.S. financial system have resulted in the imposition of additional regulatory requirements, including expansive financial services regulatory reform legislation. Dodd-Frank sets out sweeping regulatory changes. Changes imposed by Dodd-Frank include, among others: (i) new requirements on banking, derivative and investment activities, including modified capital requirements, the repeal of the prohibition on the payment of interest on business demand accounts, and debit card interchange fee requirements; (ii) corporate governance and executive compensation requirements; (iii) enhanced financial institution safety and soundness regulations, including increases in assessment fees and deposit insurance coverage; and (iv) the establishment of new regulatory bodies, such as the Bureau of Consumer Financial Protection. Many of the requirements of Dodd-Frank are still being implemented and will not become fully effective for several years. 

Current and future legal and regulatory requirements, restrictions and regulations, including those imposed under Dodd-Frank, may adversely impact our profitability and may have a material and adverse effect on our business, financial condition, and results of operations. These requirements, restrictions and regulations may require us to invest significant management attention and resources to evaluate and make any changes required by the legislation and accompanying rules and may make it more difficult for us to attract and retain qualified executive officers and employees. See previous discussion under “Regulation and Supervision” for more information on Dodd-Frank.

Changes in the laws, regulations and policies governing financial services companies could alter our business environment and adversely affect our operations. The Board of Governors of the Federal Reserve System regulates the supply of money and credit in the United States. Its fiscal and monetary policies determine in a large part our cost of funds for lending and investing and the return that can be earned on those loans and investments, both of which affect our net interest margin. Federal Reserve Board policies can also materially affect the value of financial instruments that we hold, such as debt securities.

We, along with our subsidiaries, are heavily regulated at the federal and state levels. This regulation is to protect depositors, federal deposit insurance funds and the banking system as a whole. Congress and state legislatures and federal and state agencies continually review banking laws, regulations and policies for possible changes. Changes in statutes, regulations or policies could affect us in substantial and unpredictable ways, including limiting the types of financial services and products that we offer and/or increasing the ability of non-banks to offer competing financial services and products. We cannot predict whether any of this potential legislation will be enacted, and if enacted, the effect that it or any regulations would have on our financial condition or results of operations.

The financial services industry is highly competitive, and competitive pressures could intensify and adversely affect our financial results. We operate in a highly competitive industry that could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. We compete with other commercial banks, savings and loan associations, mutual savings banks, finance companies, mortgage banking companies, credit unions and investment companies. In addition, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks. Many of our competitors have fewer regulatory constraints and some have lower cost structures. Also, the potential need to adapt to industry changes in information technology systems, on which we and the financial services industry are highly dependent, could present operational issues and require capital spending.

13

Changes in consumer use of banks and changes in consumer spending and saving habits could adversely affect our financial results. Technology and other changes now allow many consumers to complete financial transactions without using banks. For example, consumers can pay bills and transfer funds directly without going through a bank. This “disintermediation” could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits. In addition, changes in consumer spending and saving habits could adversely affect our operations, and we may be unable to timely develop competitive new products and services in response to these changes that are accepted by new and existing customers.

Risks associated with unpredictable economic and political conditions may be amplified as a result of our limited market area. Commercial banks and other financial institutions are affected by economic and political conditions, both domestic and international, and by governmental monetary policies. Conditions such as inflation, value of the dollar, recession, unemployment, high interest rates, short money supply, scarce natural resources, international disorders, terrorism and other factors beyond our control may adversely affect profitability. In addition, almost all of our primary business area is located in Southern Indiana and Jefferson County, Kentucky. A significant downturn in this regional economy may result in, among other things, deterioration in our credit quality or a reduced demand for credit and may harm the financial stability of our customers. Due to the regional market area, these negative conditions may have a more noticeable effect on us than would be experienced by an institution with a larger, more diverse market area.

Changes in the domestic interest rate environment could reduce our net interest income. Interest rate volatility could significantly harm our business. Our results of operations are affected by the monetary and fiscal policies of the federal government and the regulatory policies of governmental authorities. A significant component of earnings is net interest income, which is the difference between the income from interest-earning assets, such as loans, and the expense of interest-bearing liabilities, such as deposits. A change in market interest rates could adversely affect earnings if market interest rates change such that the interest we pay on deposits and borrowings increases faster than the interest we collect on loans and investments. Consequently, along with other financial institutions generally, we are sensitive to interest rate fluctuations.

Company Risk Factors

Our allowance for loan losses may not be adequate to cover actual losses. Like all financial institutions, we maintain an allowance for loan losses to provide for probable incurred losses due to loan defaults, non-performance, and other qualitative factors. Our allowance for loan losses is based on our historical loss experience as well as an evaluation of the risks associated with our loan portfolio, including the size and composition of the loan portfolio, loan portfolio performance, fair value of collateral securing the loans, current economic conditions and geographic concentrations within the portfolio. Our allowance for loan losses may not be adequate to cover actual loan losses, and future provisions for loan losses could materially and adversely affect its financial results.

We may suffer losses in our loan portfolio despite our underwriting practices. Our results of operations are significantly affected by the ability of borrowers to repay their loans. Lending money is an essential part of the banking business. However, borrowers do not always repay their loans. The risk of non-payment is historically small, but if nonpayment levels are greater than anticipated, our earnings and overall financial condition, as well as the value of our common stock, could be adversely affected. No assurance can be given that our underwriting practices or monitoring procedures and policies will reduce certain lending risks. Loan losses can cause insolvency and failure of a financial institution and, in such an event, our stockholders could lose their entire investment. In addition, future provisions for loan losses could materially and adversely affect profitability. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on these loans.

14

Our loan portfolio is predominantly secured by real estate and thus we have a higher degree of risk from a downturn in our real estate markets. A further downturn in our real estate markets could hurt our business because many of our loans are secured by real estate. Real estate values and real estate markets are generally affected by changes in national, regional or local economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies and acts of nature. Substantially all of our real estate collateral is located in Southern Indiana, Scottsburg, Indiana, and Louisville and Bardstown, Kentucky. If real estate values, including values of land held for development, continue to decline, the value of real estate collateral securing our loans could be significantly reduced. Our ability to recover on defaulted loans by foreclosing and selling the real estate collateral would then be diminished and we would be more likely to suffer losses on defaulted loans. Commercial real estate loans typically involve large balances to single borrowers or group of related borrowers. Since payments on these loans are often dependent on the successful operation or management of the properties, as well as the business and financial condition of the borrower, repayment of such loans may be subject to adverse conditions in the real estate market, adverse economic conditions or changes in applicable government regulations.

Additional risks associated with our construction loan portfolio include failure of contractors to complete construction on a timely basis or at all, market deterioration during construction, cost overruns and failure to sell or lease the security underlying the construction loans so as to generate the cash flow anticipated by our borrower. Continued declines in real estate values, coupled with the current economic downturn and an associated increase in unemployment, may result in higher than expected loan delinquencies or problem assets, a decline in demand for our products and services, or a lack of growth or decrease in deposits, which may cause us to incur losses, adversely affect our capital or hurt our business.

We may incur losses in our investments portfolio. Our investment portfolio is comprised of state and municipal securities, residential mortgage-backed agencies issued by U.S. Government sponsored entities securities, trust preferred securities, and mutual funds. We must evaluate these securities for other-than-temporary impairment loss (“OTTI”) on a periodic basis. In 2009 and 2010, we recognized an OTTI charge on five of our six trust preferred securities holdings. Our remaining trust preferred securities, including those for which we recognized an OTTI charge, still exhibit signs of weakness which may necessitate an OTTI charge in the future should the financial condition of the underling issuers in the pools deteriorate further. Also, given the current economic environment we may need to record an OTTI charges in our other investments the future should the issuers of those securities experience financial difficulties. Any future OTTI charges could significantly impact our earnings.

Maintaining or increasing our market share may depend on lowering prices and market acceptance of new products and services. Our success depends, in part, on our ability to adapt our products and services to evolving industry standards. There is increasing pressure to provide products and services at lower prices. Lower prices can reduce our net interest margin and revenues from our fee-based products and services. In addition, the widespread adoption of new technologies, including internet services, could require us to make substantial expenditures to modify or adapt our existing products and services. Also, these and other capital investments in our businesses may not produce expected growth in earnings anticipated at the time of the expenditure. We might not be successful in introducing new products and services, achieving market acceptance of its products and services, or developing and maintaining loyal customers.

Because the nature of the financial services business involves a high volume of transactions, we face significant operational risks. Operational risk is the risk of loss resulting from our operations, including, but not limited to, the risk of fraud by employees or persons outside of the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements and business continuation and disaster recovery. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, we could suffer financial loss, face regulatory action and suffer damage to its reputation.

15

Acquisitions and the addition of branch facilities may not produce revenue enhancements or cost savings at levels or within timeframes originally anticipated and may result in unforeseen integration difficulties. We regularly explore opportunities to establish branch facilities and acquire other banks or financial institutions. New or acquired branch facilities and other facilities may not be profitable. We may not be able to correctly identify profitable locations for new branches. The costs to start up new branch facilities or to acquire existing branches, and the additional costs to operate these facilities, may increase our noninterest expense and decrease earnings in the short term. It may be difficult to adequately and profitably manage growth through the establishment of these branches. In addition, we can provide no assurance that these branch sites will successfully attract enough deposits to offset the expenses of operating these branch sites. Any new or acquired branches will be subject to regulatory approval, and there can be no assurance that we will succeed in securing such approvals.

We cannot predict the number, size or timing of acquisitions. Difficulty in integrating an acquired business or company may cause us not to realize expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from the acquisition. The integration could result in higher than expected deposit attrition (run-off), loss of key employees, disruption of our business or the business of the acquired company, or otherwise adversely affect our ability to maintain relationships with customers and employees or achieve the anticipated benefits of the acquisition. Also, the negative effect of any divestitures required by regulatory authorities in acquisitions or business combinations may be greater than expected.

Our business could suffer if we fail to attract and retain skilled people. Our success depends, in large part, on our ability to attract and retain key people. Competition can be intense for the best people in most activities in which we engage. We may not be able to hire the best people or to keep them.

Significant legal actions could subject us to substantial uninsured liabilities. We are from time to time subject to claims related to our operations. These claims and legal actions, including supervisory actions by our regulators, could involve large monetary claims and significant defense costs. To protect us from the cost of these claims, we maintain insurance coverage in amounts and with deductibles that we believe are appropriate for our operations. However, our insurance coverage may not cover all claims against us or continue to be available to us at a reasonable cost. As a result, we may be exposed to substantial uninsured liabilities, which could adversely affect our results of operations and financial condition.

We are exposed to risk of environmental liability when we take title to properties. In the course of our business, we may foreclose on and take title to real estate. As a result, we could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination or may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we become subject to significant environmental liabilities, our financial condition and results of operations could be adversely affected.

There is a limited trading market for our stock and you may not be able to resell your shares at or above the price you paid for them. The price of the common stock purchased may decrease significantly. Although our common stock is quoted on the Nasdaq Capital Market under the symbol "CBIN", trading activity in the stock historically has been sporadic. A public trading market having the desired characteristics of liquidity and order depends on the presence in the market of willing buyers and sellers at any given time. The presence of willing buyers and sellers depends on the individual decisions of investors and general economic conditions, all of which are beyond our control.

Liquidity risk could impair our ability to fund operations and jeopardize our financial condition. Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a material adverse effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us. Our ability to acquire deposits or borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole.

16

Our status as a holding company makes us dependent on dividends from our subsidiaries to meet our obligations. We are a bank holding company and conduct almost all of our operations through YCB, SCSB, and CBIN Insurance, Inc. We do not have any significant assets other than cash and the stock of YCB, SCSB, and CBIN Insurance, Inc. Accordingly, we depend on dividends from our subsidiaries to meet our obligations and obtain revenue. Our right to participate in any distribution of earnings or assets of our subsidiaries is subject to the prior claims of creditors of such subsidiaries. Under federal and state law, our bank subsidiaries are limited in the amount of dividends they may pay to us without prior regulatory approval. The Banks must maintain sufficient capital and liquidity and be in compliance with other general regulatory restrictions. Bank regulators have the authority to prohibit the subsidiary banks from paying dividends if the bank regulators determine the payment would be an unsafe and unsound banking practice. As of December 31, 2012, our subsidiaries had the ability to pay us dividends of $8.5 million without prior regulatory approval. CBIN Insurance, Inc. cannot pay dividends until 2015.

The FDIC’s restoration plan and the related increased assessment rate could affect our earnings. As a result of a series of financial institution failures and other market developments, the deposit insurance fund, or DIF, of the FDIC has been significantly depleted and reduced the ratio of reserves to insured deposits. In response to the recent economic conditions and the enactment of the Dodd-Frank Act, the FDIC has increased the deposit insurance assessment rates and thus raised deposit premiums for insured depository institutions. If these increases are insufficient for the DIF to meet its funding requirements, further special assessments or increases in deposit insurance premiums may be required which we may be required to pay. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures or if the FDIC otherwise determines, we may be required to pay even higher FDIC premiums than the recently increased levels. Any future additional assessments, increases or required prepayments in FDIC insurance premiums may materially adversely affect our results of operations and could have a materially adverse effect on the value or market for our common stock.

Our results of operations and financial condition may be negatively affected if we are unable to meet a debt covenant and, correspondingly, unable to obtain a waiver regarding the debt covenant from the lender. From time to time we may obtain financing from other lenders. The loan documents reflecting the financing often require us to meet various debt covenants. If we are unable to meet one or more of our debt covenants, then we will typically attempt to obtain a waiver from the lender. If the lender does not agree to a waiver, then we will be in default under our borrowing obligation. This default could affect our ability to fund various strategies that we may have implemented resulting in a negative impact in our results of operations and financial condition.

Our business may be adversely affected by internet fraud. The Company is inherently exposed to many types of operational risk, including those caused by the use of computer, internet and telecommunications systems. These risks may manifest themselves in the form of fraud by employees, by customers, other outside entities targeting us and/or our customers that use our internet banking, electronic banking or some other form of our telecommunications systems. Given the growing level of use of electronic, internet-based, and networked systems to conduct business directly or indirectly with our clients, certain fraud losses may not be avoidable regardless of the preventative and detection systems in place.

We may experience interruptions or breaches in our information system security. We rely heavily on communications and information systems to conduct our business. Any failure or interruption of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure or interruption of these information systems, there can be no assurance that any such failures or interruptions will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures or interruptions of these information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

A failure in or breach, including cyber attacks, of our operational or security systems, or those of our third party vendors and other service providers, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses. As a financial institution, we are susceptible to fraudulent activity that may be committed against us or our clients and that may result in financial losses to us or our clients, privacy breaches against our clients, or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, and other dishonest acts. In recent periods, there has been a rise in electronic fraudulent activity within the financial services industry, especially in the commercial banking sector, due to cyber criminals targeting commercial bank accounts. Consistent with industry trends, we have also experienced an increase in attempted electronic fraudulent activity in recent periods.

17

In addition, our operations rely on the secure processing, storage and transmission of confidential and other information on our computer systems and networks. Although we take numerous protective measures to maintain the confidentiality, integrity and availability of our and our clients’ information across all geographic and product lines, and endeavor to modify these protective measures as circumstances warrant, the nature of the threats continues to evolve. As a result, our computer systems, software and networks and those of our customers may be vulnerable to unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber attacks and other events that could have an adverse security impact and result in significant losses by us and/or our customers. Despite the defensive measures we take to manage our internal technological and operational infrastructure, these threats may originate externally from third parties, such as foreign governments, organized crime and other hackers, and outsource or infrastructure-support providers and application developers, or the threats may originate from within our organization. Given the increasingly high volume of our transactions, certain errors may be repeated or compounded before they can be discovered and rectified.

We also face the risk of operational disruption, failure, termination or capacity constraints of any of the third parties that facilitate our business activities, including exchanges, clearing agents, clearing houses or other financial intermediaries. Such parties could also be the source of an attack on, or breach of, our operational systems, data or infrastructure. In addition, as interconnectivity with our clients grows, we increasingly face the risk of operational failure with respect to our clients’ systems.

Although to date we have not experienced any material losses relating to cyber attacks or other information security breaches, there can be no assurance that we will not suffer such losses in the future. Our risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats, the outsourcing of some of our business operations, and the continued uncertain global economic environment. As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities.

We maintain an insurance policy which we believe provides sufficient coverage at a manageable expense for an institution of our size and scope with similar technological systems. However, we cannot assure that this policy will afford coverage for all possible losses or would be sufficient to cover all financial losses, damages, penalties, including lost revenues, should we experience any one or more of our or a third party’s systems failing or experiencing attack.

Our ability to pay dividends is subject to certain limitations and restrictions, and there is no guarantee that we will be able to continue paying the same level of dividends in the future that we paid in 2012 or that we will be able to pay future dividends at all. Our ability to pay dividends is limited by regulatory restrictions and the need to maintain sufficient consolidated capital. The ability of Your Community Bank and The Scott County Bank to pay dividends to us is limited by its obligations to maintain sufficient capital and liquidity and by other general restrictions on dividends that are applicable to these banks, including state regulatory requirements. The FDIC and other bank regulators have proposed guidelines and seek greater liquidity, and have been discussing increasing capital requirements. If these regulatory requirements are not met, our subsidiary banks will not be able to pay dividends to us, and we may be unable to pay dividends on our common stock.

In addition, as a bank holding company, our ability to declare and pay dividends is subject to the guidelines of the Federal Reserve regarding capital adequacy and dividends. The Federal Reserve guidelines generally require us to review the effects of the cash payment of dividends on common stock and other Tier 1 capital instruments (i.e., perpetual preferred stock and trust preferred debt) in light of our earnings, capital adequacy and financial condition. As a general matter, the Federal Reserve indicates that the board of directors of a bank holding company (including a financial holding company) should eliminate, defer or significantly reduce the dividends if:

• the company’s net income available to stockholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends;

• the prospective rate of earnings retention is inconsistent with the company’s capital needs and overall current and prospective financial condition; or

• the company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios.

18

On September 15, 2011, we issued shares of perpetual senior preferred stock to the Treasury as part of the Small Business Lending Fund. We are prohibited from continuing to pay dividends on our common stock unless we have fully paid all required dividends on the senior preferred stock. Although we expect to be able to pay all required dividends on the senior preferred stock, there is no guarantee that we will be able to do so.

If the Company is unable to redeem its Series B Preferred Stock after an initial four-and-one-half year period, the cost of this capital will increase substantially. If the Company is unable to redeem its Series B Preferred Stock prior to June 15, 2016, the cost of this capital to us will increase from approximately $764,000 annually (average dividend rate for 2012, or 2.7% per annum of the Series B preferred stock liquidation value) to $2.5 million annually (9.0% per annum of the Series B preferred stock liquidation value).  This increase in the annual dividend rate on the Series B preferred stock would have a material negative effect on the earnings the Company can retain for growth and to pay dividends on its common stock.

Item 1B. Unresolved Staff Comments

The Company has received no written communication from the staff of the SEC regarding its periodic or current reporting under the Exchange Act.

19

Item 2. Properties

The Company conducts its business through its corporate headquarters located in New Albany, Indiana. YCB operates a main office and eleven branch offices in Clark and Floyd Counties, Indiana, and five branch offices in Jefferson and Nelson Counties, Kentucky. SCSB operates a main office and three branch offices in Scott County, Indiana. The following table sets forth certain information concerning the main offices and each branch office at December 31, 2012. The Company’s aggregate net book value of premises and equipment was $14.1 million at December 31, 2012.

Location	Year Opened	Owned or Leased
Your Community Bank:
101 West Spring Street - Main Office	1937	Owned
New Albany, IN 47150
401 East Spring Street - Drive Thru for Main Office	2001	Owned
New Albany, IN 47150
2626 Charlestown Road	1995	Owned
New Albany, IN 47150
4328 Charlestown Road	2004	Leased
New Albany, IN 47150
480 New Albany Plaza	1974	Leased
New Albany, IN 47130
901 E. Lewis and Clark Pkwy	1981	Owned
Clarksville, IN 47130
701 Highlander Point Drive	1990	Owned
Floyds Knobs, IN 47119
102 Heritage Square	1992	Owned
Sellersburg, IN 47172
201 W. Court Avenue	1996	Owned
Jeffersonville, IN 4710
5112 Highway 62	1997	Owned
Jeffersonville, IN 47130
2917 E. 10th Street	2007	Leased
Jeffersonville, IN 47130
2910 Grantline Road	2002	Leased
New Albany, IN 47150
106A West John Rowan Boulevard. - Main Office	1997	Leased
Bardstown, KY 40004
119 East Stephen Foster Avenue	1972	Owned
Bardstown, KY 40004
4510 Shelbyville Road	2003	Leased
Louisville, KY 40207
13205 Magisterial Drive	2006	Leased
Louisville, KY 40223
471 West Main Street	2008	Leased
Louisville, KY 40202
The Scott County State Bank:
136 West McClain Avenue - Main Office	1890	Owned
Scottsburg, IN 47170
125 West Wardell - Drive Thru	1981	Owned
Scottsburg, IN 47170
1050 North Gardner	1974	Owned
Scottsburg, IN 47170
57 North Michael Drive	1998	Owned
Scottsburg, IN 47170

20

Item 3. Legal Proceedings

There are various claims and law suits 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 incident to the Banks’ business. In the opinion of management, no material loss is expected from any of such pending claims or lawsuits. Further, we maintain liability insurance to cover some, but not all, of the potential liabilities normally incident to the ordinary course of our businesses as well as other insurance coverage customary in our business, with coverage limits as we deem prudent.

21

Part II

Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters And Issuer Purchases of Equity Securities

Market Information

The Company’s common stock is traded on the Nasdaq Capital Market under the symbol “CBIN”. The quarterly range of low and high trade prices per share of the Company’s common stock for the periods indicated as reported on the Nasdaq Capital Market, as well as the per share dividend paid in each such quarter by the Company on its common stock is shown below.

2012							2011
QUARTER ENDED	HIGH		LOW		DIVIDEND		QUARTER ENDED		HIGH		LOW		DIVIDEND
March 31	$	14.22	$	9.93	$	0.10		March 31	$	15.15	$	9.65	$	0.10
June 30		14.00		12.50		0.10		June 30		11.75		9.70		0.10
September 30		13.50		11.02		0.10		September 30		11.00		9.00		0.10
December 31		14.02		12.40		0.10		December 31		10.18		9.05		0.10

Holders

As of March 22, 2013 there were 793 holders of the Company’s common stock.

Dividends

The Company intends to continue its historical practice of paying quarterly cash dividends although there is no assurance that such dividends will continue to be paid in the future. The payment of dividends in the future is dependent on future income, financial position, capital requirements, the discretion and judgment of the Board of Directors, and other considerations. In addition, the payment of dividends is subject to the regulatory restrictions described in Note 13 to the Company's consolidated financial statements.

Securities Authorized for Issuance under Equity Compensation Plans

The following table sets forth certain information regarding Company compensation plans under which equity securities of the Company are authorized for issuance.

	Number of  Securities to be  Issued Upon Exercise of Outstanding Options, Warrants and Rights		Weighted-Average  Exercise Price Of  Outstanding Options,  Warrants and Rights		Number of Securities Remaining Available for Future Issuance under equity compensation plans (excluding securities reflected in column 1)
Equity compensation plans approved by security holders		157,800	$	22.63		455,342	(1)
Equity compensation plans not approved by security holders		-		-		-
Total		157,800	$	22.63		455,342	(1)

(1) Of the shares reflected, 187,817 shares are available to be awarded under the Company’s Stock Award Plan and 267,525 shares are available to be awarded under the Company’s Performance Units Plan.

22

Performance Graph

The following performance graph and included data shall not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that section, nor shall it be deemed soliciting material or subject to Regulation 14A of the Exchange Act or incorporated by reference in any filing under the Exchange Act or the Securities Act of 1933, except as shall be expressly set forth by specific reference in such filing.

The graph compares the performance of Community Bank Shares of Indiana, Inc. common stock to the Russell 2000 index and the SNL Bank $500 MM - $1 B Bank index for the Company’s last five fiscal years. The graph assumes the value of the investment in Company common stock and in each index was $100 at December 31, 2007 and that all dividends were reinvested.

	Period Ending
Index	12/31/07		12/31/08		12/31/09		12/31/10		12/31/11		12/31/12
Community Bank Shares of Indiana, Inc.		100.00		69.02		40.81		63.16		63.97		91.29
Russell 2000		100.00		66.21		84.20		106.82		102.36		119.09
SNL Bank $500M-$1B		100.00		64.08		61.03		66.62		58.61		75.14

23

Item 6. Selected Financial Data

The following table sets forth the Company’s selected historical consolidated financial information from 2008 through 2012. This information should be read in conjunction with the Consolidated Financial Statements and the related Notes. Factors affecting the comparability of certain indicated periods are discussed in "Management’s Discussion And Analysis Of Financial Condition And Results Of Operations." For analytical purposes, net interest margin is 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.

	Years Ended December 31,
(Dollars in thousands, except per share data)	2012			2011			2010			2009			2008
Income Statement Data:
Interest income	$	32,826		$	34,241		$	35,894		$	39,262		$	44,907
Interest expense		4,030			5,968			8,180			15,318			21,453
Net interest income		28,796			28,273			27,714			23,944			23,454
Provision for loan losses		4,101			4,390			3,833			15,925			6,857
Non-interest income		8,423			8,481			7,414			6,326			6,087
Non-interest expense		23,748			22,863			22,461			41,168			22,554
Income (loss) before taxes		9,370			9,501			8,834			(26,823	)		130
Net income (loss)		7,685			7,410			6,988			(21,969	)		821
Net income (loss) available (attributable) to common shareholders		6,921			6,031			5,923			(22,587	)		821
Balance Sheet Data:
Total assets	$	819,500		$	797,354		$	801,466		$	819,159		$	877,363
Total securities		251,205			198,746			204,188			172,723			121,659
Total loans, net		456,827			489,740			502,223			528,183			623,103
Allowance for loan losses		8,762			10,234			10,864			15,236			9,478
Total deposits		624,667			581,358			618,821			592,423			603,185
Other borrowings		45,500			50,879			49,426			76,996			78,983
FHLB advances		40,000			55,000			50,000			68,482			111,943
Subordinated debenture		17,000			17,000			17,000			17,000			17,000
Total shareholders’ equity		86,442			79,485			63,165			59,950			62,599
Per Share Data:
Basic earnings (loss) per common share	$	2.06		$	1.82		$	1.80		$	(6.93	)	$	0.25
Diluted earnings (loss) per common share		2.06			1.79			1.77			(6.93	)		0.25
Book value per common share		17.15			15.47			13.36			12.49			19.31
Cash dividends per common share		0.40			0.40			0.40			0.55			0.70
Performance Ratios:
Return on average assets		0.95	%		0.94	%		0.85	%		(2.60	)%		0.10	%
Return on average equity		9.13			10.58			10.95			(35.02	)		1.29
Net interest margin		4.07			4.07			3.90			3.19			3.09
Efficiency ratio		63.81			62.21			63.94			136.00			76.35
Asset Quality Ratios:
Non-performing assets to total loans		3.30	%		4.17	%		3.63	%		5.12	%		3.47	%
Net loan charge-offs to average loans		1.14			0.99			1.54			1.73			0.58
Allowance for loan losses to total loans		1.92			2.05			2.11			2.80			1.50
Allowance for loan losses to non-performing loans		100.50			64.89			58.26			67.26			45.78
Capital Ratios:
Leverage ratio		12.2	%		11.7	%		9.1	%		8.6	%		7.6	%
Average stockholders’ equity to average total assets		10.4			8.9			7.8			7.4			7.6
Tier 1 risk-based capital ratio		17.9			16.3			13.5			11.9			9.5
Total risk-based capital ratio		19.1			17.5			14.7			13.1			10.7
Dividend payout ratio		17.5			17.9			18.8			NM*			277.2
Other Key Data:
End-of-period full-time equivalent employees		197			196			199			199			238
Number of bank offices		21			21			21			22			23

* Number is not meaningful

24

Item 7. Management’s Discussion And Analysis Of Financial Condition And Results of Operations

Overview

This section presents an analysis of the consolidated financial condition of the Company and its wholly-owned subsidiaries, the Banks, at December 31, 2012 and 2011, and the consolidated results of operations for each of the years in the three year period ended December 31, 2012. The information contained in this section should be read in conjunction with the consolidated financial statements, notes to consolidated financial statements and other financial data presented elsewhere in this annual report on Form 10-K.

The Company conducts its primary business through the Banks, which are community-oriented financial institutions offering a variety of financial services to its local communities. The Banks are engaged primarily in the business of attracting deposits from the general public and using such funds for the origination of: 1) commercial business and real estate loans and 2) secured consumer loans such as home equity lines of credit, automobile loans, and recreational vehicle loans. Additionally, the Banks originate and sell into the secondary market mortgage loans for the purchase of single-family homes in Floyd, Clark, and Scott counties, Indiana, and Jefferson and Nelson counties, Kentucky, including surrounding communities. The Banks invest excess liquidity balances in mortgage-backed, U.S. agency, state and municipal and corporate securities.

The operating results of the Company depend primarily upon the Banks’ net interest income, which is the difference between interest earned on interest-earning assets and interest incurred on interest-bearing liabilities. Interest-earning assets principally consist of loans, taxable and tax-exempt securities, and FHLB stock. Interest-bearing liabilities principally include deposits, retail repurchase agreements, federal funds purchased, advances from the FHLB Indianapolis, and subordinated debentures. The earnings of the Banks are also affected by 1) provision for loan losses, 2) non-interest income (including mortgage banking income, net gains on sales of securities, deposit account service charges, earnings on company owned life insurance, interchange income, and commission-based income on non-deposit investment products), 3) non-interest expenses (including compensation and benefits, occupancy, equipment, data processing expenses, marketing and advertising, legal and professional fees, FDIC insurance premiums, net foreclosed and repossessed asset expense, and other expenses, such as postage, printing, and telephone expenses), and 4) income tax expense.

Forward Looking Information

Statements contained within this report that are not statements of historical fact constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. When used in this discussion the words "anticipate," "project," "expect," "believe," and similar expressions are intended to identify forward-looking statements. The Company cautions that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, all of which may change over time. Actual results could differ materially from forward-looking statements.

25

In addition to factors disclosed by the Company elsewhere in this annual report on Form 10-K, the following factors, among others, could cause actual results to differ materially from such forward-looking statements: 1) adverse changes in economic conditions affecting the banking industry in general and, more specifically, the market areas in which the Company and its subsidiary Banks operate, 2) adverse changes in the legislative and regulatory environment affecting the Company and its subsidiary Banks, 3) increased competition from other financial and non-financial institutions, 4) the impact of technological advances on the banking industry, and 5) other risks detailed at times in the Company’s filings with the Securities and Exchange Commission (see Item 1A of this annual report on Form 10-K for more risk factors). The Company does not assume an obligation to update or revise any forward-looking statements subsequent to the date on which they are made.

Application of Critical Accounting Policies

The Company's consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles and follow general practices within the financial services industry. The most significant accounting policies followed by the Company are presented in Note 1 to the Consolidated Financial Statements. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses, fair value of investment securities and deferred tax assets to be the accounting areas that require the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.

Allowance for Loan Losses

The allowance for loan losses represents management's estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated fair value of collateral securing the loans, estimated losses on loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet. Note 1 to the Consolidated Financial Statements describes the methodology used to determine the allowance for loan losses, and a discussion of the factors driving changes in the amount of the allowance for loan losses is included under "Asset Quality" below.

Loans that exhibit probable or observed credit weaknesses are subject to individual review. Where appropriate, amounts of allowances are allocated to individual loans based on management's estimate of the borrower's ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to the Company. Included in the review of individual loans are those that are impaired. The Company evaluates the collectability of both principal and interest when assessing the need for a loss accrual. Historical loss rates are applied to other loans not subject to allowance allocations. These historical loss rates may be adjusted for significant factors that, in management's judgment, reflect the impact of any current conditions on loss recognition. Factors which management considers in the analysis include the effects of the national and local economies, trends in the nature and volume of loans (delinquencies, charge-offs and nonaccrual loans), changes in mix, asset quality trends, risk management and loan administration, changes in internal lending policies and credit standards, and examination results from bank regulatory agencies and the Company's internal credit examiners.

The Company has not substantively changed any aspect to its overall approach in the determination of the allowance for loan losses. There have been no material changes in assumptions or estimation techniques as compared to prior periods that impacted the determination of the current period allowance.

Based on the procedures discussed above, management is of the opinion that the allowance of $8.8 million was adequate to address probable incurred credit losses associated with the loan portfolio at December 31, 2012.

26

Fair Value of Trust Preferred Securities

The Company had six trust preferred securities in its investment portfolio as of December 31, 2012 with a combined amortized cost of $4.0 million and a fair value of $1.2 million as of the same date. Beginning in 2008, the market for these types of securities effectively froze as market participants were unwilling to conduct transactions unless forced to do so. As a result, the fair value of these securities began deteriorating significantly in 2008 and remained depressed through 2012. In 2009 and 2010, the Company recorded aggregate other-than-temporary impairment (“OTTI”) charges to earnings of $1.5 million related to five of the six securities in its portfolio due to continued weakening of the underlying issuers. Management evaluates these investments for OTTI by estimating the anticipated discounted cash flows from each security. The determination of the anticipated cash flows and the discount rate are both significant estimates requiring management’s judgment. Also, the estimated fair value of these securities is more difficult to determine due to the current market volatility and illiquidity. The valuation model to determine fair value utilizes discounted cash flow models with significant unobservable inputs. In management’s estimation, the valuation method provided a more relevant and accurate representation of the fair value of these securities as of December 31, 2012.

Carrying Value of Foreclosed and Repossessed Assets

Foreclosed and repossessed assets are acquired through or instead of loan foreclosure and are initially measured at fair value less estimated costs to sell. The Company obtains appraisals to determine the initial fair value and then makes any adjustments deemed necessary based on prevailing market conditions and length the asset remains in the Company’s inventory. Determining the carrying value requires significant management judgment as foreclosed and repossessed assets are typically acquired in distressed situations which may materially impact the valuation compared to similar assets in non-distressed sales transactions. Also, if foreclosed and repossessed assets are not sold in a timely manner, they can deteriorate in value significantly as there may be volatility in the market. At December 31, 2012, the Company had foreclosed and repossessed assets of $6.3 million which, in management’s estimation, were reported at the appropriate carrying value.

Deferred Tax Assets

The Company has a net deferred tax asset of approximately $2.4 million. The Company evaluates this asset on a quarterly basis. To the extent the Company believes it is more likely than not that it will not be utilized, the Company will establish a valuation allowance to reduce its carrying amount to the amount it expects to be realized. At December 31, 2012, a valuation allowance of $1.6 million has been established against the outstanding deferred tax asset due to incurred net operating losses for state income taxes. The net operating loss is partially due to YCB’s Nevada subsidiaries that hold and manage YCB’s investments and for the results of 2009 including elevated provision for loan losses. There is uncertainty the Company will be able to utilize this benefit, thus a valuation allowance has been established against the state net operating loss. Note 11 to the Consolidated Financial Statements describes the net deferred tax asset. The Company was profitable in 2010, 2011, and 2012 and has a positive earnings outlook for 2013. The net loss for 2009 was primarily attributable to a goodwill and other intangible asset impairment of $16.2 million and an elevated provision for loan losses of $15.9 million which were not repeated in 2010, 2011, and 2012 and are not expected to be repeated in 2013. As of December 31, 2012, the Company has $638,000 of remaining other intangible assets subject to impairment and has an allowance for loan losses to total loans ratio of 1.92% which management believes is sufficient to cover probable incurred losses as of that date. The estimate of the realizable amount of this asset is a critical accounting policy.

Highlights

The Company had net income available to common shareholders of $6.9 million for the year ended December 31, 2012 compared to $6.0 million for 2011. The increase in earnings in 2012 was attributable to an increase in net interest income of $523,000 and decreases in income tax expense of $406,000 and preferred dividends of $615,000. Earnings per basic and diluted common shares increased to $2.06 for the year ended December 31, 2012 compared to basic and diluted earnings per common share of $1.82 and $1.79 in 2011. The Company’s book value per common share increased to $17.15 per share at December 31, 2012 from $15.47 at December 31, 2011.

27

The following table summarizes selected financial information regarding the Company's financial performance:

Table 1 – Summary

	For the Year Ended December 31,
(Dollars in thousands, except per share amounts)	2012			2011			2010
Net income available to common shareholders	$	6,921		$	6,031		$	5,923
Basic earnings per common share		2.06			1.82			1.80
Diluted earnings per common share		2.06			1.79			1.77
Return on average assets		0.95	%		0.94	%		0.85	%
Return on average equity		9.16			10.58			10.95

The Company’s total assets increased to $819.5 million at December 31, 2012 from $797.4 million at December 31, 2011 primarily due to an increase in securities available for sale of $52.5 million, offset by decreases in net loans and settlement receivable for security sales of $32.9 million and $3.4 million, respectively. Total deposits increased by $43.3 million to $624.7 million at December 31, 2012, primarily attributed to non-interest deposits increasing by $41.5 million from 2011. Other borrowings and FHLB advances decreased by $5.4 million and $15.0 million, respectively, to $45.5 million and $40.0 million, and settlement liability for security purchases decreased by $6.9 million, as of December 31, 2012. Total shareholders’ equity increased by $7.0 million to $86.4 million at December 31, 2012 as the Company achieved net income available to common shareholders of $6.9 million, and declared and paid dividends on common shares of $1.3 million.

Results of Operations

Net Interest Income

The Company’s principal revenue source is net interest income. Net interest income is the difference between interest income on interest-earning assets, such as loans and securities, and the interest expense on the liabilities used to fund those assets, such as interest-bearing deposits and borrowings. Net interest income is impacted by both changes in the amount and composition of interest-earning assets and interest-bearing liabilities as well as changes in market interest rates.

For the year ended December 31, 2012, net interest income increased to $28.8 million from $28.3 million in 2011 while the net interest margin on a taxable equivalent basis was 4.07% for both 2012 and 2011. The increase in net interest income from 2011 to 2012 can be attributed mostly to a decrease in the Company’s cost of interest bearing liabilities of 31 basis points, primarily time deposits and savings and other. The decrease in the cost of interest bearing liabilities was partially offset by a decrease in the yield on interest earning assets of 27 basis points which was mostly attributable to the decline in the yield on the Company’s investment securities portfolio during 2012. Also, the Company’s average non-interest bearing deposits increased during 2012 to $141.3 million from $119.9 million in 2011 which partially offset the decrease in the yield on interest earning assets.

Average interest earning assets increased from $726.6 million for 2011 to $741.3 million in 2012, mostly due to increases in average taxable securities. The average balance of taxable securities has increased to $152.4 million in 2012 from $139.7 million in 2011, while the yield has declined to 1.94% from 2011 as the Company sold a significant portion of the portfolio during 2012 which, along with proceeds from maturities and prepayments, were reinvested at lower yields. The Company’s average balance in tax-exempt securities increased to $72.0 million from $58.3 million in 2011, while the yield on a fully taxable equivalent basis declined from 6.48% in 2011 to 6.09% in 2012. The decrease in the yield on tax-exempt securities was due to additional purchases of municipal securities during 2012. The Company’s yield on loans remained relatively flat at 5.43% on an average balance of $490.0 million for 2012. The decrease in the average balance was due to net loan payments of $19.3 million, transfers to foreclosed and repossessed assets of $12.1 million, and charge-offs during 2012 of $6.0 million. The decline in yield was due to new loans and renewals being originated at lower rates as the result of competition from other lending institutions and a historically low rate environment. The markets in which the Company operates continue to be extremely competitive for loans to qualified borrowers which adds downward pressure on the yield on loans.

28

Average interest bearing liabilities decreased to $574.8 million for 2012 as compared to $591.7 million in 2011 with average costs of 0.70% and 1.01%, respectively. The decrease in average balance and cost in 2012 was the result of a decline in time deposits. The Company has a strong liquidity position which has allowed management to lower its offering rates on deposits. In doing so, the average balance and cost of time deposits decreased to $191.7 million and 0.74% for 2012 from $208.6 million and 1.31% in 2011. Other contributions to the decrease in cost of funds in 2012 were lower average cost of savings and other deposits, which decreased to 0.27%, other borrowings of 1.15%, and FHLB advances which declined to 1.69%. During 2012, the Company was able to continue to lower interest rates which resulted in interest expense declines in savings and other of $434,000 and other borrowings of $139,000. In addition, the Company lowered its interest expense associated with FHLB advances by $72,000 due to the renewal of a $10.0 million advance at a lower rate and repayment of $15.0 million in advances.

For the year ended December 31, 2011, net interest income increased to $28.3 million from $27.7 million in 2010 while the net interest margin on a taxable equivalent basis increased to 4.07% in 2011 as compared to 3.90% in 2010. The increase in net interest income and margin from 2010 to 2011 was achieved mostly through a decrease in the Company’s cost of interest bearing liabilities of 32 basis points, primarily time deposits and FHLB advances. The decrease in the cost of interest bearing liabilities was partially offset by a decrease in the yield on interest earning assets of 12 basis points which was mostly attributable to the decline in the yield on the Company’s loan portfolio during 2011. Also, the Company’s average non-interest bearing deposits decreased during 2011 to $119.9 million from $135.8 million in 2010 which also offset the decline in the cost of interest bearing liabilities.

Average interest earning assets decreased from $739.8 million for 2010 to $726.6 million in 2011, mostly due to decreases in average loans and interest-bearing deposits in other financial institutions while the yield decreased from 5.01% in 2010 to 4.89% in 2011. The Company’s yield on loans declined to 5.46% on an average balance of $505.1 million for 2011. The decrease in the average balance was due to net loan payments of $4.7 million and charge-offs during 2011 of $5.6 million while the reduction in yield was attributable to new loans and renewals being originated at lower rates due to the current rate environment and competition from other lending institutions. The markets in which the Company operates are extremely competitive for qualified loan customers which results in downward pressure on the loan portfolio yield. Also impacting the yield on loans are non-accrual loans of $15.8 million and troubled debt restructurings of $13.5 million, which are at below market rates for the associated risk, as of December 31, 2011. The average balance of taxable securities has increased to $139.7 million for 2011 while the yield as declined to 2.81% from 2010 as the Company sold a significant portion of the portfolio during 2011 which, along with proceeds from maturities and prepayments, were reinvested at lower yields. The Company’s average balance in tax-exempt securities increased to $58.3 million in 2011 from $47.1 million in 2010 while the yield on a fully taxable equivalent basis declined to 6.48% from 6.74% over the respective periods. The decrease in the yield on tax-exempt securities was due to additional purchases of municipal securities during 2011.

Average interest bearing liabilities decreased to $591.7 million for 2011 as compared to $614.5 million in 2010 with average costs of 1.01% and 1.33%, respectively. The decrease in average balance and cost in 2011 was mostly attributable to a decline in time deposits. Due to the Company’s liquidity position, management was able to lower its offering rates on deposits. As a result, the average balance and cost of time deposits decreased to $208.6 million and 1.31% for 2011 from $242.9 million and 1.76% in 2010. Also contributing to the decrease in cost of funds, were lower average balances and average cost of FHLB advances which declined to $45.6 million and 2.03% in 2011. During 2011, the Company was able to renew maturing advances at lower rates which resulted in interest expense on FHLB advances declining by $527,000.

29

Table 2 provides detailed information as to average balances, interest income/expense, and rates by major balance sheet category for 2010 through 2012.

Table 2 - Average Balance Sheets and Rates for Years Ended 2012, 2011 and 2010

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.

	2012									2011									2010
	Average						Average			Average						Average			Average						Average
(Dollars in thousands)	Balance			Interest			Rate			Balance			Interest			Rate			Balance			Interest			Rate
ASSETS
Earning assets:
Interest-bearing deposits in other financial institutions	$	20,908		$	71			0.34	%	$	17,253		$	44			0.25	%	$	40,879		$	84			0.21	%
Taxable securities		152,409			2,965			1.94			139,695			3,930			2.81			120,390			3,971			3.31
Tax-exempt securities		72,004			4,394			6.09			58,274			3,778			6.48			47,068			3,164			6.74
Total loans and fees (1)(2)		489,956			26,688			5.43			505,067			27,591			5.46			523,982			29,589			5.66
FHLB and Federal Reserve stock		5,992			202			3.36			6,327			182			2.87			7,489			162			2.17
Total earning assets		741,269			34,320			4.62			726,616			35,525			4.89			739,808			36,970			5.01
Non-interest earning assets:
Less: Allowance for loan losses		(10,181	)								(10,321	)								(13,794	)
Non-earning assets:
Cash and due from banks		15,041									15,805									36,081
Bank premises and equipment, net		13,795									13,667									14,093
Other assets		46,064									39,572									44,255
Total assets	$	805,988								$	785,340								$	820,443
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest bearing liabilities:
Savings and other	$	263,355		$	710			0.27	%	$	268,647		$	1,144			0.43	%	$	245,431		$	1,213			0.50	%
Time deposits		191,723			1,421			0.74			208,595			2,741			1.31			242,907			4,269			1.76
Other borrowings		52,600			606			1.15			51,855			745			1.44			54,567			828			1.52
FHLB advances		50,164			852			1.69			45,595			924			2.03			54,626			1,451			2.66
Subordinated debenture		17,000			441			2.59			17,000			414			2.44			17,000			419			2.47
Total interest bearing liabilities		574,842			4,030			0.70			591,691			5,968			1.01			614,531			8,180			1.33
Non-interest bearing liabilities:
Non-interest bearing deposits		141,320									119,854									135,843
Other liabilities		5,898									3,775									6,261
Shareholders’ equity		83,928									70,020									63,808
Total liabilities and shareholders’ equity	$	805,988								$	785,340								$	820,443
Net interest income (taxable equivalent basis)					30,290									29,557									28,790
Less: taxable equivalent adjustment					(1,494	)								(1,284	)								(1,076	)
Net interest income				$	28,796								$	28,273								$	27,714
Net interest spread								3.92	%								3.88	%								3.68	%
Net interest margin								4.07	%								4.07	%								3.90	%

(1) The amount of direct loan origination cost included in interest on loans was $308, $658, and $591 for the years ended December 31, 2012, 2011, and 2010, respectively.

(2) Includes loans held for sale and non-accruing loans in the average loan amounts outstanding.

30

Table 3 illustrates the extent to which changes in interest rates on a fully taxable equivalent basis and changes in the volume of interest-earning assets and interest-bearing liabilities affected the Company's interest income and interest expense 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. A tax rate of 34% was used in adjusting interest on tax-exempt assets to a fully taxable equivalent (“FTE”) basis.

Table 3 - Volume/Rate Variance Analysis

	Year Ended December 31,2012 compared to Year Ended December 31, 2011									Year Ended December 31,2011 compared to Year Ended December 31, 2010
	Increase/(Decrease) Due to									Increase/(Decrease) Due to
	Total Net Change			Volume			Rate			Total Net Change			Volume			Rate
Interest income:
Interest-bearing deposits with other financial institutions	$	27		$	11		$	16		$	(40	)	$	(57	)	$	17
Taxable securities		(965	)		333			(1,298	)		(41	)		628			(669	)
Tax-exempt securities		616			848			(232	)		614			730			(116	)
Total loans and fees		(903	)		(823	)		(80	)		(1,998	)		(1,050	)		(948	)
FHLB and Federal Reserve stock		20			(10	)		30			20			(28	)		48
Total increase (decrease) in interest income		(1,205	)		359			(1,564	)		(1,445	)		223			(1,668	)
Interest expense:
Savings and other		(434	)		(22	)		(412	)		(69	)		108			(177	)
Time deposits		(1,320	)		(207	)		(1,113	)		(1,528	)		(548	)		(980	)
Other borrowings		(139	)		11			(150	)		(83	)		(40	)		(43	)
FHLB advances		(72	)		87			(159	)		(527	)		(217	)		(310	)
Subordinated debenture		27			-			27			(5	)		-			(5	)
Total increase (decrease) in interest expense		(1,938	)		(131	)		(1,807	)		(2,212	)		(697	)		(1,515	)
Increase (decrease) in net interest income	$	733		$	490		$	243		$	767		$	920		$	(153	)

Non-interest Income

Non-interest income was $8.4 million for 2012, $8.5 million for 2011, and $7.4 million for 2010. For the year ended December 31, 2012, non-interest income decreased by 0.7% as compared to 2011 due primarily to decreases in net gains on sales of available for sale securities of $317,000, offset by an increase in mortgage banking income of $151,000 and interchange income of $72,000. In 2011, non-interest income increased by 14.4%, due primarily to increases in net gains on sales of available for sale securities of $748,000 and the non-recurrence of other-than-temporary impairment loss of $360,000 in 2010, offset by a decrease in mortgage banking income of $95,000.

31

Table 4 provides a breakdown of the Company’s non-interest income during the past three years.

Table 4 - Analysis of Non-interest Income

	Year Ended December 31,							Percent Increase/(Decrease)
(Dollars in thousands)	2012		2011		2010			2012/2011			2011/2010
Service charges on deposit accounts	$	3,408	$	3,417	$	3,433			(0.3	)%		(0.5	)%
Commission income		166		156		130			6.4			20.0
Net gain on sale of available for sale securities		2,182		2,499		1,751			(12.7	)		42.7
Mortgage banking income		421		270		365			55.9			(26.0	)
Earnings on company owned life insurance		697		686		720			1.6			(4.7	)
Interchange income		1,038		966		907			7.5			6.5
Net impairment loss recognized in earnings		-		-		(360	)		-			(100.0	)
Other		511		487		468			4.9			4.1
Total	$	8,423	$	8,481	$	7,414			(0.7	)%		14.4	%

Service charges on deposit accounts decreased slightly by $9,000 to $3.4 million for the year ended December 31, 2012. Of the $3.4 million of service charge income recognized in 2012, approximately $2.0 million was earned from non-sufficient funds and overdraft fees charged to customers. Non-sufficient funds and overdraft fees decreased by $396,000 from 2011 to 2012 due to regulatory changes made in 2010. The decrease in non-sufficient funds and overdraft fees in 2012 was partially offset by an increase in service fees on deposit accounts of approximately $234,000, service fees on savings accounts of $53,000, and ATM surcharges of $88,000. Service charges on deposit accounts decreased slightly for the year ended December 31, 2011 to $3.4 million. On July 1, 2010 regulatory changes required customers to opt in or affirmatively consent to overdraft services and provides them with an ongoing right to revoke consent. Also, we must provide customers who do not opt in with the same account terms, conditions and features, including price, as provided to customers who do opt in. As a result, fee income from non-sufficient funds (“NSF fees”) decreased by $242,000. To offset the reduction in NSF fees, the Company implemented several new fees for deposit accounts during the year including, but not limited to: paper statement fees, dormant account fee, and minimum balance fees. As a result of the new fees, other service charge income on deposit accounts (excluding NSF fees) increased by $204,000.

In 2012, the Company received net proceeds of $88.4 million on sales of available for sale securities for net gains of $2.2 million compared to proceeds of $107.4 million and net gains of $2.5 million in 2011. The proceeds from sales are reinvested in the security portfolio as management continues to selectively sell securities when it is determined a change in the prepayment risk may reduce the unrealized gain in an investment.

Mortgage banking income increased by $151,000 to $421,000 for the year ended December 31, 2012 compared to $270,000 in 2011. In 2012, the Company originated $20.5 million of loans for sale into the secondary market as compared to $15.3 million in 2011. In 2011, mortgage banking income decreased by $95,000 to $270,000 compared to $365,000 in 2010. In 2011, the Company originated $15.3 million of loans for sale into the secondary market as compared to $20.2 million in 2010.

Earnings on company owned life insurance increased slightly to $697,000 for the year ended December 31, 2012 from $686,000 for the equivalent period in 2011 as the crediting rate remained relatively consistent with 2011. During 2011, earnings on company owned life insurance decreased to $686,000 compared to $720,000 in 2010. The income decreased in 2011 due to a decrease in the crediting rate by the companies that issued the policies.

32

The Company recorded a net other-than-temporary impairment (“OTTI”) charge in earnings of $360,000 for the year ended December 31, 2010. In 2010 and 2009, the Company recorded OTTI charges on five of its six pooled trust preferred securities (“CDO”), which consisted of bank issuers (the one CDO for which the Company did not record an OTTI charge is comprised of insurance companies). The Company did not record an OTTI charge during 2011 or 2012. Beginning in 2008 and continuing into 2012 we noted a continuing decline in the fair value of our CDO portfolio due to market illiquidity and a lack of transactions involving these types of securities. Additionally, as the economic downturn continued, we noted further deterioration in the financial condition of the underlying issuers, particularly those pools with issuer banks. Also, we noted an increase in the number of issuers deferring and defaulting on the underlying notes in the CDO’s consistent with the increase in bank closures. Our analysis to determine OTTI is based on estimating the expected cash flows to be received from the underlying issuers and determining the present value of cash flows expected to us utilizing an appropriate discount rate (see footnote 2 to the Consolidated Financial Statements for further information). At December 31, 2012, the fair value of our CDO’s has yet to recover. Although an appropriate amount of OTTI has been recorded in 2009 and 2010, further deterioration in the issuers in the CDO’s could lead to future OTTI charges should they be significant.

Interchange income increased to $1.0 million in 2012 from $966,000 in 2011. The Company has focused on increasing interchange income through various initiatives including offering incentives to current and new customers. In addition, the Company has added new deposit accounts during 2012 which also factored into the increase in interchange income.

Non-interest Expense

Non-interest expense increased to $23.7 million for the year ended December 31, 2012 from $22.9 million in 2011. The increase was attributable mostly to salaries and employee benefits, foreclosed and repossessed assets, and legal and professional expense, offset by decreases in occupancy, data processing and FDIC insurance premiums. In 2011, non-interest expense increased to $22.9 million from $22.5 million for the same period in 2010. The increase was attributable mostly to salaries and employee benefits, but also occupancy, legal and professional, and foreclosed and repossessed assets expense, offset by decreases in equipment, marketing and advertising, FDIC insurance premiums, prepayment penalties on extinguishment of debt, and other expenses.

Table 5 provides a breakdown of the Company’s non-interest expense for the past three years.

Table 5 - Analysis of Non-interest Expense

	Year Ended in December 31,						Percent Increase/(Decrease)
(Dollars in thousands)	2012		2011		2010		2012/2011			2011/2010
Salaries and employee benefits	$	12,181	$	11,556	$	10,492		5.4	%		10.1	%
Occupancy		2,184		2,314		2,053		(5.6	)		12.7
Equipment		1,060		1,075		1,215		(1.4	)		(11.5	)
Data processing		2,266		2,512		2,508		(9.8	)		0.2
Marketing and advertising		299		219		241		36.5			(9.1	)
Legal and professional		1,715		1,570		1,379		9.2			13.9
FDIC insurance premiums		653		743		1,370		(12.1	)		(45.8	)
Prepayment penalties on extinguishment of debt		-		-		335		-			(100.0	)
Foreclosed and repossessed assets, net		1,135		735		548		54.4			34.1
Other		2,255		2,139		2,320		5.4			(7.8	)
Total	$	23,748	$	22,863	$	22,461		3.9	%		1.8	%

33

Salaries and employee benefits increased to $12.2 million for the year ended December 31, 2012 from $11.6 million in 2011 with a slight increase in the number of full time equivalent employees (“FTE”) to 197 at the end of 2012 from 196 at December 31, 2011. The average expense per FTE increased to $62,000 for 2012 from $59,000 in 2011 which was due to increases in base salaries to employees, bonus and incentive pay, payroll tax and insurance benefits expense. Due to the performance of the Company in 2012, incentive and stock based compensation also increased as the majority of the Company’s incentive plans are primarily based on achievement of budgeted net income. In 2011, salaries and benefits increased to $11.6 million compared to $10.5 million in 2010 while the number of FTE decreased to 196 from 199 at the end of 2010, or $59,000 expense per FTE in 2011 versus $53,000 in 2010. The increase in expense was due to increases in base salaries to employees, bonus and incentive pay, stock based compensation, and unemployment assessments. Due to the Company’s performance in 2011, expense associated with net income increased which included the bonus and incentive pay and certain stock based compensation plans. Unemployment insurance assessments rose during the year due to staff reductions in 2009 which increased the Company’s claims history.

Occupancy decreased by $130,000 to $2.2 million for the year ended December 31, 2012 from $2.3 million for the same period in 2011. The decrease was primarily due to a decrease in property taxes of $188,000 resulting from a successful challenge of the assessed value of YCB’s main office location with the local government authority, offset by small increases in rent and depreciation expense. Occupancy increased from $2.1 million for 2010 to $2.3 million in 2011 due to higher expense for property tax on owned branch locations. During 2011, the Company increased its accrual for property taxes for its Scott County locations.

Equipment expense remained consistent at $1.1 million for the year ended December 31, 2012, compared to 2011, which was attributable to a decrease in depreciation expense for furniture and fixtures, repairs and maintenance of furniture and fixtures, and automobile expense, offset by increases in depreciation expense for computer equipment and personal property tax expense. The Company has been focused on efficient use of its capital expenditures throughout 2011 and 2012 which has allowed us to reduce our expenditures in certain areas and/or use older equipment for longer periods. Equipment expense decreased to $1.1 million for 2011 from $1.2 million in 2010 as the result of a decrease in depreciation expense for furniture and fixtures and computer equipment.

Data processing expense decreased in 2012 by $246,000 to $2.3 million, compared to $2.5 million in 2011, due to a decrease in expense for the Company’s third party core data processor. Those decreases were offset by increases in communication lines and software and hardware maintenance expense. Data processing expense was $2.5 million in 2011 and 2010 as increases in expenditures for core data processing were fully offset by a decrease in expenditures for software maintenance.

Marketing and advertising expense was $299,000 for 2012, up from $219,000 in 2011 as the Company increased its spending on event advertising and sponsorships. Marketing and advertising expense was $219,000 for 2011, down from $241,000 in 2010 as the Company decreased its spending on print and billboard advertising and increased expenditures on sponsorships

Legal and professional service fees increased by $145,000 to $1.7 million in 2012 compared to $1.6 million in 2011. The increase was due to professional services expense of $306,000, offset by a decrease in legal fees of $161,000. The increase in professional service expense was due to fees incurred with the implementation of a captive insurance subsidiary during the fourth quarter of 2012. The Company anticipates a reduction in its effective tax rate beginning in 2013 as a result of the formation of the captive insurance company (see further discussion in “Income Tax Expense”). While legal fees decreased for 2012, they remain elevated due to higher levels of non-performing assets and past due credits and are anticipated to be higher than historical averages (pre-2009) in 2013. Legal and professional service fees increased to $1.6 million in 2011 from $1.4 million in 2010. The increase was due to expense associated with collection of past due credits in 2011 as the Company’s level of non-performing loans and classified loan credits remained consistent with 2010.

FDIC insurance premiums decreased to $653,000 in 2012 from $743,000 in 2011. The decrease is attributable to the change in the assessment base in 2011 described below resulting in a full 12 months of the new methodology in 2012 versus 9 months in 2011 and an increase in the subsidiary bank’s Tier 1 capital. FDIC insurance premiums decreased to $743,000 in 2011 from $1.4 million in 2010. In the second quarter of 2011, the FDIC changed the assessment base the premiums were calculated from the amount of deposits to average assets less average Tier 1 capital which further reduced the Company’s premiums.

34

During the twelve months ended December 31, 2010 the Company incurred $335,000 in prepayment penalties on extinguishment of debt for the prepayment of $10.5 million of FHLB advances which carried a rate 6.05%. Management determined the penalties incurred for prepaying the advances would be more than offset by a reduction in interest expense over the remaining scheduled maturities for each advance. The prepaid advances were not replaced with other borrowings, therefore, the penalties were entirely expensed in 2010.

Foreclosed and repossessed assets expense, net, increased to $1.1 million for the twelve months ended December 31, 2012 from $735,000 in 2011 due primarily to net losses on sales of $485,000 and increased expense of other real estate owned. The increase in net losses on sales of foreclosed and repossessed assets was due to an increase in sales (both cash and financed) to $10.4 million in 2012 from $2.2 million in 2011. It is anticipated expenditures for foreclosed and repossessed assets will remain elevated in 2013. Foreclosed and repossessed assets expense, net, increased to $735,000 for 2011 as compared to $548,000 in 2010 due primarily to net losses realized on sales in 2011 of $140,000 versus net gains on sales of $11,000 in 2010.

Other expenses increased to $2.3 million in 2012 compared to $2.1 million in 2011. The increase was primarily due to a reduction in the amount of the deferral of direct loan origination costs 2012 as compared to 2011 and increased expense for conferences and training, offset by a decrease in telephone expense as the Company installed a new telephone system that eliminated costs associated with the older system. Other expenses decreased to $2.1 million in 2011 from $2.3 million in 2010. The decrease in 2011 was attributable to lower expenditures on postage as the result of fees implemented for paper statements to customers, which increased enrollment for electronic statements. Also contributing to the decline was a reduction in printing expenditures in 2011 as the Company focused on reducing printing by using dual monitors and issuing tablets to members of management.

Income Tax Expense

Income tax expense for the year ended December 31, 2012 was $1.7 million compared to $2.1 million in 2011 while the effective tax rate decreased to 18.0% from 22.0% over the same period. The decrease in income tax expense and effective tax rate was due to an increase in tax exempt income of $140,000 and low income tax housing credit of $110,000. During the fourth quarter of 2012, the Company formed a captive insurance subsidiary in Nevada, CBIN Insurance Inc. CBIN Insurance, Inc. issued insurance policies to the Company’s subsidiaries effective beginning in 2013 for certain gaps in coverage and insurable risks that may not be cost effectively obtained through third parties. From an income tax perspective, CBIN Insurance, Inc.’s revenue is exempt from income taxes up to $1.2 million while the expense at the subsidiaries is tax deductible. As a result, the Company anticipates a reduction in income tax expense of approximately $300,000 in 2013 and an increase in net income of approximately the same amount. Income tax expense for 2011 increased to $2.1 million as compared to $1.8 million in 2010 while the Company’s effective tax rate increased to 22.0% from 20.9% over the respective periods. The increase in provision for taxes was directly attributable to an increase in income before taxes of $667,000 from 2010 to 2011. Additionally, the effective tax rate and provision was impacted by the end of the Company’s participation in the New Markets Tax Credit program at the end of 2010 which provided tax credits of $180,000 annually.

Financial Condition

Loan Portfolio

The Company’s loan portfolio decreased to $465.6 million as of December 31, 2012 from $500.0 million at December 31, 2011. All categories of loans declined from the previous year with the largest decrease occurring in the Company’s residential real estate loan portfolios. The decreases were due to loan charge-offs during the year of $6.0 million, transferring $12.1 million into other real estate owned, as well as soft loan demand which resulted in net loan repayments during the year of $19.3 million. The Company’s loan portfolio mix remained relatively consistent with 2011.

35

Commercial loans, which consist of loans to business customers secured by business assets such as accounts receivable, inventory, and equipment, decreased to $96.3 million as of December 31, 2012 from $100.9 million at December 31, 2011. The decrease in the commercial portfolio was mostly due to charge-offs during 2012 of $1.0 million as new originations were offset by repayments. Commercial loans have certain inherent risks which require loan officers to carefully monitor the borrower’s financial condition and receive periodic updates on the aging and balance of accounts receivable and inventory, if secured by these types of assets. Should the Company be forced to pursue foreclosure, there can often be significant erosion in the value of the collateral securing these types of loans. The value of equipment securing commercial borrowings generally tends to depreciate in value rapidly and/or may be industry specific with a limited market for resale. Accounts receivable are most likely have significant past due issues if the borrower is having financial difficulty and also may be worth a fraction of the balance while inventory may be stale.

Construction loans decreased to $39.2 million at December 31, 2012 from $44.7 million as of December 31, 2011. The decline in construction loans was attributable to charge-offs totaling $938,000 for 2012 as compared to $1.1 million in 2011. Also, there is very soft demand for construction loans in the Company’s market area for qualified borrowers which further contributed to the decline. Construction loans consist of both individual and business borrowings for the development and construction of 1-4 family residences and subdivisions. Beginning in 2008, the Company has experienced a high rate of delinquency and charge-offs in this portfolio, mostly to developers of multiple properties, as the market for new homes in our market area slowed. The repayment of commercial construction loans is dependent on the resale to third parties in a timely fashion. Should there be a significant delay in selling the finished properties or a downturn in the market, the developer may not receive cash sufficient to service their borrowings. In addition, if the Company forecloses on a partially or fully developed property, there can be significant erosion in value as the improvements may have deteriorated resulting in losses to the Company. Management has continued to work with our construction borrowers who are having difficulty to minimize our loss exposure and prevent foreclosure including restructuring where appropriate.

Commercial real estate loans decreased by $2.2 million to $168.5 million at December 31, 2012 from $170.7 million as of December 31, 2011. New originations of commercial real estate loans were offset by charge offs of $3.0 million and the transfer of two large loans, totaling $6.2 million, into other real estate owned in 2012. Given the current economic conditions, loan demand for new commercial real estate loans has been minimal with most new loans during the year coming from refinancing of existing debt with other financial institutions. Also, we have had strong competition from other financial institutions in our market for new commercial real estate loans to qualified customers and, in some cases, we have declined to match offering rates that we believed were not commensurate with the associated risk.

Residential real estate loans accounted for the largest decline in balance for 2012, declining from $175.9 million as of December 31, 2011 to $155.3 million at December 31, 2012, a decrease of $20.5 million. Residential loans included borrowings secured by first and second liens on 1-4 family residential properties, including home equity lines of credit. The decrease in the portfolio was attributed to payoffs of current loans to refinance to historically low interest rates. New originations of residential real estate are typically sold on the secondary market, with the Company originating $20.5 million for sale and not offsetting payoffs of current loans.

The Company’s lending activities remain primarily concentrated within its existing markets, and are principally comprised of loans secured by single-family residential housing developments, owner occupied manufacturing and retail facilities, general business assets, and single-family residential real estate. The Company emphasizes the acquisition of deposit relationships from new and existing commercial business and real estate loan clients.

36

Table 6 provides a breakdown of the Company’s loans by type during the past five years.

Table 6 - Loans by Type

	As of December 31,
(Dollars in thousands)	2012		2011		2010		2009		2008
Commercial	$	96,306	$	100,884	$	103,295	$	94,168	$	95,365
Construction		39,217		44,722		48,872		51,592		73,936
Commercial Real Estate		168,488		170,723		171,931		193,577		206,973
Residential Real Estate		155,374		175,886		177,411		189,403		237,769
Consumer		6,204		7,759		11,578		14,679		18,538
Total loans	$	465,589	$	499,974	$	513,087	$	543,419	$	632,581

Table 7 illustrates the Company’s fixed rate maturities and repricing frequency for the loan portfolio.

Table 7 - Selected Loan Distribution

As of December 31, 2012 (Dollars in thousands)	Total		One Year or Less		Over One Through Five Years		Over Five Years
Fixed rate maturities:
Commercial	$	53,916	$	10,865	$	26,514	$	16,537
Construction		26,522		8,256		16,540		1,726
Commercial Real Estate		102,742		20,956		47,882		33,904
Residential Real Estate		98,565		11,732		46,771		40,062
Consumer		6,033		1,328		4,498		207
Total fixed rate maturities	$	287,778	$	53,137	$	142,205	$	92,436
Variable rate maturities:
Commercial	$	42,390	$	35,042	$	5,328	$	2,020
Construction		12,695		11,074		1,355		266
Commercial Real Estate		65,746		6,321		5,331		54,094
Residential Real Estate		56,809		11,131		14,772		30,906
Consumer		171		171		-		-
Total variable rate maturities	$	177,811	$	63,739	$	26,786	$	87,286

Allowance and Provision for Loan Losses

Federal regulations require insured institutions to classify their assets on a regular basis. The regulations provide for three categories of classified loans: substandard, doubtful and loss. The regulations also contain a special mention and a specific allowance category. Special mention is defined as loans that do not currently expose an insured institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving management’s close attention. Assets classified as substandard or doubtful require the institution to establish general allowances for loan losses. If an asset or portion thereof is classified as loss, the insured institution must either establish specified allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge off such amount.

37

The Company maintains the allowance for loan losses at a level that is sufficient to absorb probable credit losses incurred in its loan portfolio. The allowance is determined based on the application of loss estimates to graded loans by categories. Management determines the level of the allowance for loan losses based on its evaluation of the collectability of the loan portfolio, including the composition of the portfolio, historical loan loss experience, specific impaired loans, and general economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated future cash flows. The allowance for loan losses is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs of specific loans, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited directly to the provision for loan losses. As of December 31, 2012, the Company’s allowance for loan losses totaled $8.8 million, a decrease of $1.5 million from December 31, 2011 which lowered the allowance for loan losses to total loans ratio to 1.92% from 2.05% for the same periods, respectively. The Company’s net charge-offs totaled $5.6 million in 2012, an increase from $5.0 million for the 2011 fiscal year. Of the $6.0 million in charge-offs in 2012, $3.0 million were commercial real estate loans as compared to $547,000 of commercial real estate charge-offs in 2011. The increase in commercial real estate charge-offs was mostly due to the write-off of one large credit relationship totaling $2.5 million. The remaining $6.2 million of the loan balance after the charge-off was placed in other real estate owned and subsequently sold in 2012 for a net loss of $69,000. Beginning in late 2007 the Company has experienced an elevated level of non-performing loans coupled with a significant decline in the collateral values securing certain types of loans in its portfolio, specifically construction real estate. The Company’s loan portfolio has had increases in past due loans, impaired loans, and classified loans beginning in 2007 through 2012 which has led to an increase in charge-offs for those credits management has determined to be uncollectible. Management has allocated amounts for probable incurred losses in the Company’s loan portfolio based on the best estimate available as of December 31, 2012.

Provisions for loan losses are charged against earnings to bring the total allowance for loan losses to a level considered adequate by management based on historical experience, the volume and type of lending conducted by the Company, the status of past due principal and interest payments, general economic conditions, and inherent credit risk related to the collectability of the Company’s loan portfolio. The provision for loan losses decreased to $4.1 million for the twelve months ended December 31, 2012 from $4.4 million for the same period in 2011, or $289,000 and 6.6%. During 2012, the volume of problem credits decreased as compared to 2011 which resulted in lower non-performing loans of $8.7 million at December 31, 2012 as compared to $15.8 million at December 31, 2011. Over the same period, classified loans (includes loans classified as watch, special mention, substandard, and doubtful) decreased to $50.8 million, which included TDRs of $13.5 million, as compared to $69.5 million at December 31, 2011, which included TDRs of $24.0 million (see Footnote 3 to the Company’s Consolidated Financial Statements for further information on classified loans and TDRs). During 2012, the number of new identified classified credits slowed while the Company was able to resolve previously identified classified credits through foreclosure or improvement by the borrower. The provision for 2012 remained elevated due to adjustments to the fair value of collateral dependent loans and previously classified loans being downgraded. In addition, the economy in which the Company operates has gradually improved but still has yet to recover to pre-2008 levels. As of December 31, 2012, the Company had a total of $8.6 million in loans classified as doubtful and $19.4 million classified as substandard. Of the total balance of substandard and doubtful loans, $9.3 million were construction loans while $11.8 million were commercial real estate loans. Beginning in 2008, the Company has had significant collection issues in its construction portfolio which has led to aggregate charge-offs of $11.8 million of the total $30.6 million total charge-offs for the four year period ended December 31, 2012 despite representing only approximately 9% of the Company entire loan portfolio over the same period. In addition, $9.3 million of the $39.2 million construction loans outstanding as of December 31, 2012, were classified with an allocated allowance for loan losses of $1.1 million as of the same date. In an effort to properly identify and resolve problem credits in the construction portfolio, management has undertaken several initiatives including loan reviews of unclassified construction credits and weekly meetings with loan officers. While management believes all construction loans have been properly classified as of December 31, 2012 with the appropriate allocation of allowance for loan losses, there can be no assurance that provision for loan losses in the future will decrease for this portfolio segment.

Statements made in this section regarding the adequacy of the allowance for loan losses are forward-looking statements that may or may not be accurate due to the impossibility of predicting future events. Because of uncertainties inherent in the estimation process, management’s estimate of credit losses in the loan portfolio and the related allowance may differ from actual results.

38

Table 8 provides the Company’s loan charge-off and recovery activity during the past five years.

Table 8 - Summary of Loan Loss Experience

	Year Ended in December 31,
(Dollars in thousands)	2012			2011			2010			2009			2008
Allowance for loan losses at beginning of year	$	10,234		$	10,864		$	15,236		$	9,478		$	6,316
Charge-offs:
Commercial		(1,008	)		(2,827	)		(843	)		(2,122	)		(1,080	)
Construction		(938	)		(1,065	)		(4,063	)		(5,742	)		(780	)
Commercial real estate		(3,043	)		(547	)		(1,885	)		(411	)		(720	)
Residential real estate		(769	)		(785	)		(1,557	)		(1,449	)		(730	)
Consumer		(204	)		(337	)		(340	)		(661	)		(503	)
Total		(5,962	)		(5,561	)		(8,688	)		(10,385	)		(3,813	)
Recoveries:
Commercial		107			109			212			52			7
Construction		53			2			22			-			2
Commercial real estate		54			232			102			14			4
Residential real estate		57			40			68			40			5
Consumer		118			158			79			112			100
Total		389			541			483			218			118
Net loan charge-offs		(5,573	)		(5,020	)		(8,205	)		(10,167	)		(3,695	)
Provision for loan losses		4,101			4,390			3,833			15,925			6,857
Allowance for loan losses at end of year	$	8,762		$	10,234		$	10,864		$	15,236		$	9,478
Ratios:
Allowance for loan losses to total loans		1.88	%		2.05	%		2.11	%		2.80	%		1.50	%
Net loan charge-offs to average loans		1.14			0.99			1.57			1.73			0.58
Allowance for loan losses to non-performing loans		100.50			64.88			72.36			67.26			45.78

The following table depicts management’s allocation of the allowance for loan losses by loan type during the last five years. Allowance funding and allocation is based on management’s assessment of economic conditions, past loss experience, loan volume, past-due history and other factors. Since these factors and management's assumptions are subject to change, the allocation is not necessarily indicative of future loan portfolio performance. Allocations of the allowance may be made for specific loans or loan categories, but the entire allowance is available for any loan that may be charged off. Loan losses are charged against the allowance when a loss has been confirmed by management.

Table 9 - Management's Allocation of the Allowance for Loan Losses

	As of December 31,
	2012					2011					2010					2009					2008
(Dollars in thousands)	Allowance		Percent of Loans to Total Loans			Allowance		Percent of Loans to Total Loans			Allowance		Percent of Loans to Total Loans			Allowance		Percent of Loans to Total Loans			Allowance		Percent of Loans to Total Loans
Commercial	$	2,007		20.7	%	$	2,999		20.2	%	$	3,245		20.1	%	$	3,032		17.3	%	$	1,119		15.1	%
Construction		1,399		8.4			1,112		8.9			1,893		9.5			6,633		9.5			3,492		11.7
Commercial Real Estate		2,836		36.2			3,207		34.1			2,499		33.5			1,828		35.6			3,244		32.7
Residential Real Estate		2,389		33.4			2,681		35.2			2,803		34.6			3,243		34.9			1,154		37.6
Consumer		131		1.3			235		1.6			424		2.3			500		2.7			469		2.9
Total	$	8,762		100.0	%	$	10,234		100.0	%	$	10,864		100.0	%	$	15,236		100.0	%	$	9,478		100.0	%

39

Asset Quality

Loans, including impaired loans, are placed on non-accrual status when they become past due 90 days or more as to principal or interest. When loans are placed on non-accrual status, all unpaid accrued interest is reversed. These loans remain on non-accrual status until the loan becomes current or the loan is deemed uncollectible and is charged off. The Company defines impaired loans to be those loans that management has determined it is probable, based on current information and events, the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans individually classified as impaired decreased to $28.6 million at December 31, 2012 from $40.3 million at December 31, 2011. Impaired loans at December 31, 2012 and 2011 included $13.8 million and $26.6 million, respectively, of troubled debt restructurings (“TDR’s”). TDRs included one large commercial real estate credit relationship totaling $8.1 million at the end of 2012. Subsequent to December 31, 2012, the Company transferred this relationship to non-accrual status and charged-off the allocated allowance for loan losses of $1.2 million. The Company did not record additional provision for loan losses in the first quarter of 2013 related to this credit. For further information on non-performing loans and their impact on the Company’s earnings, see discussion above under “Allowance and Provision for Loan Losses”.

Total non-performing loans decreased to $8.7 million at December 31, 2012 from $15.8 million at December 31, 2011 with total non-performing assets decreasing to $15.1 million from $20.8 million as of the same dates, respectively. Non-performing assets also include foreclosed real estate and other repossessed assets that have been acquired through foreclosure or acceptance of a deed in lieu of foreclosure. Foreclosed real estate and repossessed assets are carried at fair value less estimated selling costs, and are actively marketed for sale.

Table 10 provides the Company’s non-performing loan experience during the past five years.

Table 10 - Non-Performing Assets

	As of December 31,
(Dollars in thousands)	2012			2011			2010			2009			2008
Loans on non-accrual status (1)	$	8,718		$	15,772		$	15,013		$	22,653		$	20,702
Loans past due 90 days or more and still accruing		-			-			-			-			-
Total non-performing loans		8,718			15,772			15,013			22,653			20,702
Other foreclosed and repossessed assets		6,345			5,076			3,633			5,190			1,241
Total non-performing assets	$	15,063		$	20,848		$	18,646		$	27,843		$	21,943
Percentage of non-performing loans to total loans		1.87	%		3.15	%		2.93	%		4.17	%		3.27	%
Percentage of non-performing assets to total loans		3.24			4.17			3.63			5.12			3.47

(1) Impaired loans on non-accrual status are included in loans. See Note 3 to the Consolidated Financial Statements for additional discussion on impaired loans.

40

Investment Securities

Table 11 sets forth the breakdown of the Company’s securities portfolio for the past five years.

Table 11 - Securities Portfolio

	As of December 31,
(Dollars in thousands)	2012		2011		2010		2009		2008
Securities Available for Sale:
State and municipal	$	84,437	$	76,527	$	56,498	$	49,809	$	20,542
Residential mortgage-backed agencies issued by U.S. Government sponsored entities		154,980		121,027		146,083		120,084		97,588
U.S. Government and federal agency		10,355		-		-		-		-
Collateralized debt obligations, including trust preferred securities		1,176		937		1,359		2,585		3,285
Mutual Funds		257		255		248		245		244
Total securities available for sale	$	251,205	$	198,746	$	204,188	$	172,723	$	121,659

Table 12 sets forth the breakdown of the Company’s investment securities available for sale by type and maturity as of December 31, 2012. For analytical purposes, the weighted average yield on state and municipal securities is adjusted to a taxable equivalent adjustment basis to recognize the income tax savings on tax-exempt securities. A tax rate of 34% was used in adjusting interest on tax-exempt securities to a fully taxable equivalent (“FTE”) basis.

Table 12 - Investment Securities Available for Sale

	As of December 31, 2012
(Dollars in thousands)	Amortized Cost		Fair Value		Weighted Average Yield
State and municipal
Within one year	$	59	$	59		7.77	%
Over one through five years		1,091		1,222		5.95
Over five through ten years		22,675		24,403		5.39
Over ten years		53,672		58,753		5.99
Total state and municipal		77,497		84,437		5.82
Collateralized debt obligations, including trust preferred securities
Over ten years		3,997		1,176		2.25
Total mutual funds		250		257		3.16
Residential mortgage-backed agencies issued by U.S. Government sponsored entities
Within one year		127		128		4.53
Over one through five years		76,685		77,688		5.91
Over five through ten years		54,993		55,323		1.96
Over ten years		21,170		21,841		1.98
Total mortgage-backed securities		152,975		154,980		1.98
U.S. Government sponsored entities and agencies
Over one through five years		1,376		1,407		1.47
Over five through ten years		9,024		8,948		1.48
Total US government agency securities		10,400		10,355		1.55
Total available for sale securities	$	245,119	$	251,205		3.17	%

41

Securities available for sale increased to $251.2 million at December 31, 2012 from $198.7 million at December 31, 2011. The increase in available for sale securities was due primarily to purchases of $177.9 million, offset by sales of $88.4 million and maturities, prepayments and calls of $35.4 million during 2012. The current strategy for the securities portfolio is to maintain an intermediate average life that remains relatively stable in a changing interest rate environment, thus minimizing exposure to sustained increases in interest rates. The investment portfolio primarily consists of mortgage-backed securities, securities issued by the United States government and its agencies, securities issued by states and municipalities, and trust preferred securities. Mortgage-backed securities consist primarily of obligations insured or guaranteed by Federal Home Loan Mortgage Corporation, Federal National Mortgage Association, or Government National Mortgage Association.

A significant portion of the Company’s unrealized losses at December 31, 2012 were related to six trust preferred securities comprised of debt of banks and insurance companies. In 2010 and 2009, the Company recorded other-than-temporary impairment charges through earnings on five of the six securities. See footnote 2 to the Company’s consolidated financial statements for further discussion of the fair value of these securities and management’s evaluation of other-than-temporary impairment.

Deposits

The Company attracts deposits from the market areas it serves by offering a wide range of deposit accounts with a variety of rate structures and terms. The Company uses interest rate risk simulations to assist management in monitoring the Company’s deposit pricing, and periodically may offer special rates on certificates of deposits and money market accounts to maintain sufficient liquidity levels. The Company relies primarily on its retail and commercial sales staff and current customer relationships to attract and retain deposits. Market interest rates and competitive pressures can significantly affect the Company’s ability to attract and retain deposits. The Company’s strategic plan includes continuing to grow non-interest bearing accounts which contribute to higher levels of non-interest income and net interest margin.

Total deposits increased by $43.3 million to $624.7 million at December 31, 2012 due to an increase in non-interest bearing deposits of $41.5 million. Total interest bearing deposits remained consistent from 2011 to 2012 with increases in demand accounts of $18.3 million, money markets of $2.6 million, and savings of $3.4 million, offset by decreases in certificates of deposits of $19.5 million and individual retirement accounts of $3.0 million. In 2012, management continued its focus on repricing maturing certificates of deposits and lowering the current offering rates for other interest bearing deposit accounts given the current rate environment. Because the Company continued to have soft loan demand and excess liquidity, management was able to reprice deposits rates at or below rates offered in its markets. As a result of the reduction in rates, the Company saw a decrease in its certificate of deposit accounts. The Company’s non-interest bearing deposits increased in 2012 due to an emphasis on growing these types of accounts through allocating a significant portion of incentive based compensation for business service and retail employees on growth of non-interest deposits.

42

Table 13 provides a profile of the Company’s deposits during the past five years.

Table 13 – Deposits

	December 31,
(Dollars in thousands)	2012		2011		2010		2009		2008
Demand (NOW)	$	110,986	$	92,683	$	85,520	$	83,748	$	91,641
Money market accounts		137,385		134,818		149,777		119,991		101,032
Savings		39,397		36,010		35,127		31,721		29,302
Individual retirement accounts-certificates of deposit		25,395		28,375		31,760		32,583		28,981
Certificates of deposit, $100,000 and over		64,854		69,873		83,918		90,380		97,440
Other certificates of deposit		77,239		91,722		117,705		123,753		162,322
Total interest bearing deposits		455,256		453,481		503,807		482,176		510,718
Total non-interest bearing deposits		169,411		127,877		115,014		110,247		92,467
Total	$	624,667	$	581,358	$	618,821	$	592,423	$	603,185

Table 14 – Average Deposits

						December 31,
	2012					2011					2010
(Dollars in thousands)	Average Balance		Average Rate			Average Balance		Average Rate			Average Balance		Average Rate
Demand (NOW)	$	92,644		0.29	%	$	85,133		0.34	%	$	79,644		0.35	%
Money market accounts		132,321		0.32			146,664		0.57			132,219		0.69
Savings		38,390		0.05			36,850		0.05			33,568		0.05
Individual retirement accounts-certificates of deposit		27,513		0.88			30,415		1.44			32,754		2.01
Certificates of deposit, $100,000 and over		73,624		0.69			71,407		1.19			87,450		1.56
Other certificates of deposit		90,586		0.74			106,773		1.36			122,703		1.83
Total interest bearing deposits		455,078		0.47	%		477,242		0.81	%		488,338		1.12	%
Total non-interest bearing deposits		141,320		-			119,854		-			135,843		-
Total	$	596,398				$	597,096				$	624,181

Other Borrowings

The Company’s other borrowings consist of repurchase agreements, line of credit with another financial institution, federal funds purchased, which represent overnight liabilities to non-affiliated financial institutions, and a structured repurchase agreement. While repurchase agreements are effectively deposit equivalents, these arrangements consist of securities that are sold to commercial customers under agreements to repurchase. Other borrowings decreased to $45.5 million at December 31, 2012 from $50.9 million at December 31, 2011 as decreases in the structured repurchase agreement of $9.8 million and the line of credit with another financial institution of $2.1 million were offset partially by an increase of $6.8 million in repurchase agreements.

43

Federal Home Loan Bank Advances

FHLB advances decreased to $40.0 million at December 31, 2012 from $55.0 million at December 31, 2011. Due to soft loan demand and an increase in total deposits, the Company has maintained a high level of liquidity which it used to repay outstanding FHLB advances during the year. Management evaluates its use of wholesale funding in relation to its other funding options (deposits, federal funds purchased, sales of securities, etc.) based on the cost and the Company’s immediate and long-term liquidity needs (see the “Liquidity” section for further information on FHLB advance availability).

Liquidity

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. The Bank’s primary sources of funds are deposits; repayment of loans and mortgage-backed securities; Federal Home Loan Bank advances; maturities of investment securities and other short-term investments; and income from operations. While scheduled loan and mortgage-backed security repayments are a relatively predictable source of funds, deposit flows and loan and mortgage-backed security prepayments are greatly influenced by general interest rates, economic conditions and competition. Liquidity management is both a daily and long term function of business management. If the Banks require funds beyond those generated internally, then as of December 31, 2012 the Banks had $70.0 million in additional capacity under its borrowing agreements with the FHLB based on the Banks’ current FHLB stock holdings and approximately $31.5 million in federal funds purchased with other financial institutions. The holding company’s primary source of liquidity is dividends from its subsidiaries, YCB and SCSB which are limited by banking regulations. Currently, YCB can declare and pay dividends of $7.8 million while SCSB can declare dividends of $684,000 without prior regulatory approval. The Company anticipates it will have sufficient funds available to meet current loan commitments and other credit commitments.

Capital

Total capital of the Company increased to $86.4 million at December 31, 2012 from $79.5 million as of December 31, 2011, an increase of $7.0 million or 8.8%. The increase in capital was primarily due to net income available to common shareholders of $6.9 million offset by dividends on common shares of $1.3 million. We are prohibited from paying dividends on our common stock unless we have fully paid all required dividends on the senior preferred stock. To date we have met all our required dividend payments on the senior preferred stock and thus are not prohibited from paying dividends on our common stock.

The Company has been repurchasing shares of its common stock since May 21, 1999. A net total of 492,806 shares at an aggregate cost of $8.5 million have been repurchased since that time under both the current and prior repurchase plans. The Company’s Board of Directors authorized a share repurchase plan in June 2007 under which a maximum of $5.0 million of the Company’s common stock could be purchased. Through December 31, 2012, a total of $1.6 million had been expended to purchase 85,098 shares under this plan. The Company’s ability to repurchase shares is restricted should we not pay dividends on preferred shares issued under the SBLF program.

Regulatory agencies measure capital adequacy within a framework that makes capital requirements, in part, dependent on the risk inherent in the balance sheets of individual financial institutions. The Company and the Banks continue to exceed the regulatory requirements for Tier I, Tier I leverage and total risk-based capital ratios (see Note 13 to the Consolidated Financial Statements).

44

Off Balance Sheet Arrangements

The Company uses off balance sheet financial instruments, such as commitments to make loans, credit lines and letters of credit to meet customer financing needs. These agreements provide credit or support the credit of others and usually have expiration dates but may expire without being used. In addition to credit risk, the Company also has liquidity risk associated with these commitments as funding for these obligations could be required immediately. The contractual amount of these financial instruments with off balance sheet risk was as follows at December 31, 2012:

	(In thousands)
Commitments to make loans	$	14,101
Unused lines of credit		126,268
Standby letters of credit		2,375
Total	$	142,744

Aggregate Contractual Obligations

As of December 31, 2012:	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
(Dollars in thousands)
Time deposits	$	167,488	$	140,826	$	23,025	$	3,270	$	367
Repurchase agreements		45,438		45,438		-		-		-
FHLB borrowings		40,000		20,000		20,000		-		-
Subordinated debentures		17,000		-		-		-		17,000
Line of credit		-		-		-		-		-
Note payable		62		62		-		-		-
Defined benefit plan		856		41		354		86		375
Lease commitments		2,601		581		999		750		271
Total	$	273,445	$	206,948	$	44,378	$	4,106	$	18,013

Time deposits represent certificates of deposit held by the Company.

FHLB advances represent the amounts that are due the FHLB and consist of $40.0 million in fixed rate advances.

Subordinated debentures represent the scheduled maturities of subordinated debentures issued to trusts formed by the Company in connection with the issuance of trust preferred securities.

Line of credit represents borrowings on the Company’s revolving line of credit with another bank.

Note payable represents amounts due for the participation in construction of a low income housing development project and are payable on demand.

Defined benefit plan represent expected benefit payments to be paid to participants.

Lease commitments represent the total minimum lease payments under noncancelable operating leases, before considering renewal options that generally are present.

45

Item 7A. 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 one of the Company’s most significant ongoing business risk considerations.

The Company currently contracts with an independent third party consulting firm to measure its 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 and 200 basis points down within the model to estimate their combined effects on net interest income over a one-year horizon. In 2008, the Federal Open Market Committee lowered its target for the federal funds rate to 0-25 bps. A majority of our loans are indexed to prime, 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. Interest rate movements are spread equally over the forecast period of one year. The Company feels that using gradual interest rate movements within the model is more representative of future rate changes than instantaneous interest rate shocks. The Company does not project growth in amounts 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. The Company believes that the changes made to its interest rate risk measurement process have improved the accuracy of results of the process. Consequently, the Company believes that it has better information on which to base asset and liability allocation decisions going forward.

Assumptions based on the historical behavior of the Company’s 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. The Company continually monitors and updates 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”), it is estimated that as of December 31, 2012 the Company’s net interest income would decrease by an estimated $117,000, or 0.4%, over the one year forecast horizon. As of December 31, 2011, in the Up 200 Scenario the Company estimated that net interest income would decrease $55,000 over a one year forecast horizon ending December 31, 2012.

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

The interest sensitivity profile of the Company 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. Such profile is also influenced by market interest rates, deposit growth, loan growth, and other factors.

46

The following tables, which are representative only and are not precise measurements of the effect of changing interest rates on the Company’s net interest income in the future, illustrate the Company’s estimated one year net interest income sensitivity profile based on the above referenced asset/liability model as of December 31, 2012 and 2011, respectively:

Interest Rate Sensitivity For 2012

(Dollars in thousands)	Base		Gradual Increase In Interest Rates of 200 Basis Points
Projected interest income:
Loans	$	24,531	$	25,408
Investments		5,829		6,056
FHLB and FRB stock		184		184
Interest-bearing deposits in other financial institutions		1		3
Federal funds sold		92		335
Total interest income		30,637		31,986
Projected interest expense:
Deposits		1,133		1,929
Federal funds purchased and Repurchase agreements		169		696
FHLB advances		443		443
Subordinated debentures		410		553
Total interest expense		2,155		3,621
Net interest income	$	28,482	$	28,365
Change from base			$	(117	)
% Change from base				(0.4	)%

47

Interest Rate Sensitivity For 2011

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

48

COMMUNITY BANK SHARES OF INDIANA, INC.

New Albany, Indiana

FINANCIAL STATEMENTS

December 31, 2012, 2011, and 2010

CONTENTS

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	50
FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS	51
CONSOLIDATED STATEMENTS OF INCOME	52
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME	54
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY	55
CONSOLIDATED STATEMENTS OF CASH FLOWS	57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS	59

49

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders

Community Bank Shares of Indiana, Inc.

New Albany, Indiana

We have audited the accompanying consolidated balance sheets of Community Bank Shares of Indiana, Inc. as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Community Bank Shares of Indiana, Inc. as of December 31, 2012 and 2011, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2012 in conformity with U.S. generally accepted accounting principles.

Crowe Horwath LLP

Louisville, Kentucky

March 28, 2013

See accompanying notes.

50

COMMUNITY BANK SHARES OF INDIANA, INC.

CONSOLIDATED BALANCE SHEETS

December 31

(In thousands, except per share amounts)

	2012			2011
ASSETS
Cash and due from financial institutions	$	19,039		$	15,166
Interest-bearing deposits in other financial institutions		32,305			30,297
Securities available for sale		251,205			198,746
Loans held for sale		1,225			1,154
Loans, net of allowance for loan losses of $8,762 and $10,234		456,827			489,740
Federal Home Loan Bank and Federal Reserve stock		5,998			5,952
Accrued interest receivable		3,014			3,196
Premises and equipment, net		14,094			13,780
Company owned life insurance		20,709			20,012
Other intangible assets		638			865
Foreclosed and repossessed assets		6,345			5,076
Prepaid FDIC insurance premium		2,392			2,999
Settlement receivable for security sales		-			3,371
Other assets		5,709			7,000
	$	819,500		$	797,354
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Non interest-bearing	$	169,411		$	127,877
Interest-bearing		455,256			453,481
Total deposits		624,667			581,358
Other borrowings		45,500			50,879
Federal Home Loan Bank advances		40,000			55,000
Subordinated debentures		17,000			17,000
Accrued interest payable		177			329
Settlement liability for security purchases		-			6,914
Other liabilities		5,714			6,389
Total liabilities		733,058			717,869
Commitments and contingent liabilities (Note 14)		-			-
Shareholders’ equity
Preferred stock, without par value; 5,000,000 authorized; 28,000 shares issued and outstanding in 2012 and 2011; aggregate liquidation preference of $28,000		28,000			28,000
Common stock, $.10 par value per share; 10,000,000 shares authorized;     3,863,937 shares issued; 3,371,131 and 3,327,484 outstanding in 2012 and       2011, respectively		386			386
Additional paid-in capital		44,306			44,488
Retained earnings		18,778			13,201
Accumulated other comprehensive income		3,473			2,666
Treasury stock, at cost (2012- 492,806 shares, 2011- 536,453 shares)		(8,501	)		(9,256	)
Total shareholders’ equity		86,442			79,485
	$	819,500		$	797,354

See accompanying notes.

51

COMMUNITY BANK SHARES OF INDIANA, INC.

CONSOLIDATED STATEMENTS OF INCOME

Years ended December 31

(In thousands, except per share amounts)

	2012		2011		2010
Interest and dividend income
Loans, including fees	$	26,688	$	27,591	$	29,589
Taxable securities		2,965		3,930		3,971
Tax-exempt securities		2,900		2,494		2,088
Federal Home Loan Bank and Federal Reserve dividends		202		182		162
Interest-bearing deposits in other financial institutions		71		44		84
		32,826		34,241		35,894
Interest expense
Deposits		2,131		3,885		5,482
Other borrowings		606		745		828
Federal Home Loan Bank advances		852		924		1,451
Subordinated debentures		441		414		419
		4,030		5,968		8,180
Net interest income		28,796		28,273		27,714
Provision for loan losses		4,101		4,390		3,833
Net interest income after provision for loan losses		24,695		23,883		23,881
Non-interest income
Service charges on deposit accounts		3,408		3,417		3,433
Commission income		166		156		130
Net gain on sales of available for sale securities		2,182		2,499		1,751
Mortgage banking income		421		270		365
Earnings on company owned life insurance		697		686		720
Interchange income		1,038		966		907
Other-than-temporary impairment loss
Total impairment loss		-		-		(784	)
Loss recognized in other comprehensive income		-		-		424
Net impairment loss recognized in earnings		-		-		(360	)
Other income		511		487		468
		8,423		8,481		7,414
Non-interest expense
Salaries and employee benefits		12,181		11,556		10,492
Occupancy		2,184		2,314		2,053
Equipment		1,060		1,075		1,215
Data processing		2,266		2,512		2,508
Marketing and advertising		299		219		241
Legal and professional service fees		1,715		1,570		1,379
FDIC insurance premiums		653		743		1,370
Prepayment penalties on extinguishment of debt		-		-		335
Foreclosed and repossessed assets, net		1,135		735		548
Other expense		2,255		2,139		2,320
		23,748		22,863		22,461

(Continued) 

52

COMMUNITY BANK SHARES OF INDIANA, INC.

CONSOLIDATED STATEMENTS OF INCOME

Years ended December 31

(In thousands, except per share amounts)

	2012			2011			2010
Income before income taxes	$	9,370		$	9,501		$	8,834
Income tax expense		1,685			2,091			1,846
Net income		7,685			7,410			6,988
Preferred stock dividends and discount accretion		(764	)		(1,379	)		(1,065	)
Net income available to common shareholders	$	6,921		$	6,031		$	5,923
Earnings per common share:
Basic	$	2.06		$	1.82		$	1.80
Diluted	$	2.06		$	1.79		$	1.77

See accompanying notes.

53

COMMUNITY BANK SHARES OF INDIANA, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Years ended December 31

(In thousands, except per share amounts)

	2012			2011			2010
Net Income	$	7,685		$	7,410		$	6,988
Other comprehensive income (loss), net of tax:
Unrealized gain on securities:
Unrealized holding gains (losses) on available for sale securities for which a portion of an other-than-temporary impairment has been recognized in earnings (net of tax of $0, $0, and $(106) for the years ended 2012, 2011, and 2010, respectively)		-			-			(207	)
Unrealized gain (losses) arising during the period (net of tax of $1,171, $2,634 and $(375) for the years ended 2012, 2011, and 2010, respectively)		2,274			5,085			(727	)
Reclassification adjustment for gains included in net income (net of tax of $(742), $(850) and $(595) for the years ended 2012, 2011 and 2010, respectively)		(1,440	)		(1,649	)		(1,156	)
Reclassification adjustment for other-than-temporary impairment related to credit losses (net of tax of $0, $0, and $122 for the years ended 2012, 2011, and 2010, respectively)		-			-			238
Net unrealized gain (loss) on securities		834			3,436			(1,852	)
Defined benefit pension plans:
Net loss arising during the period (net tax of $(13), $(89) and $(3) for the years ended 2012, 2011 and 2010, respectively)		(27	)		(172	)		(9	)
Total other comprehensive income (loss)		807			3,264			(1,861	)
Comprehensive income	$	8,492		$	10,674		$	5,127

See accompanying notes.

54

COMMUNITY BANK SHARES OF INDIANA, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Years ended December 31

(In thousands except per share data)

						Additional						Accumulated Other						Total
	Preferred Stock			Common Stock		Paid-In Capital			Retained Earnings			Comprehensive Income (Loss)			Treasury Stock			Shareholders’ Equity
Balance at January 1, 2010	$	19,034		$	386	$	45,550		$	3,891		$	1,263		$	(10,174	)	$	59,950
Net income		-			-		-			6,988			-			-			6,988
Other comprehensive loss													(1,861	)					(1,861	)
Cash dividends declared on common stock ($0.40 per share)		-			-		-			(1,314	)		-			-			(1,314	)
Dividends on preferred stock		-			-		-			(976	)		-			-			(976	)
Issuance of treasury stock under dividend reinvestment plan		-			-		(203	)		-			-			407			204
Amortization of preferred stock discount		89			-		-			(89	)		-			-			-
Stock award expense		-			-		174			-			-			-			174
Balance at December 31, 2010	$	19,123		$	386	$	45,521		$	8,500		$	(598	)	$	(9,767	)	$	63,165
Net income		-			-		-			7,410			-			-			7,410
Other comprehensive income													3,264						3,264
Cash dividends declared on common stock ($0.40 per share)		-			-		-			(1,330	)		-			-			(1,330	)
Dividends on preferred stock		-			-		-			(1,034	)		-			-			(1,034	)
Issuance of treasury stock under dividend reinvestment plan		-			-		(115	)		-			-			323			208
Amortization of preferred stock discount		345			-		-			(345	)		-			-			-
Repurchase of series A preferred stock		(19,468	)		-		-			-			-			-			(19,468	)
Warrant repurchased		-			-		(1,101	)		-			-			-			(1,101	)
Issuance of series B preferred stock		28,000			-		-			-			-			-			28,000
Issuance of stock award shares		-			-		(188	)		-			-			188			-
Stock award expense		-			-		371			-			-			-			371
Balance at December 31, 2011	$	28,000		$	386	$	44,488		$	13,201		$	2,666		$	(9,256	)	$	79,485

See accompanying notes.

55

COMMUNITY BANK SHARES OF INDIANA, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Years ended December 31

(In thousands except per share data)

	Preferred Stock		Common Stock		Additional Paid-In Capital			Retained Earnings			Accumulated Other Comprehensive Income		Treasury Stock			Total Shareholders’ Equity
Balance at January 1, 2012	$	28,000	$	386	$	44,488		$	13,201		$	2,666	$	(9,256	)	$	79,485
Net income		-		-		-			7,685					-			7,685
Other comprehensive income												807					807
Cash dividends declared on common stock ($0.40 per share)		-		-		-			(1,344	)		-		-			(1,344	)
Dividends on preferred stock		-		-		-			(764	)		-		-			(764	)
Issuance of treasury stock under dividend reinvestment plan		-		-		(40	)		-			-		251			211
Issuance of stock award shares		-		-		(504	)		-			-		504			-
Stock award expense		-		-		362			-			-		-			362
Balance at December 31, 2012	$	28,000	$	386	$	44,306		$	18,778		$	3,473	$	(8,501	)	$	86,442

See accompanying notes. 

56

COMMUNITY BANK SHARES OF INDIANA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31

(In thousands)

	2012			2011			2010
Cash flows from operating activities
Net income	$	7,685		$	7,410		$	6,988
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses		4,101			4,390			3,833
Depreciation and amortization		1,538			1,509			1,541
Net amortization of securities		1,449			917			784
Net gain on sales of available for sale securities		(2,182	)		(2,499	)		(1,751	)
Other-than-temporary impairment loss		-			-			360
Prepayment penalties on extinguishment of debt		-			-			335
Mortgage loans originated for sale		(20,464	)		(15,253	)		(20,167	)
Proceeds from mortgage loan sales		20,808			15,433			20,421
Net gain on sales of mortgage loans		(415	)		(254	)		(355	)
Earnings on company owned life insurance		(697	)		(686	)		(720	)
Deferred income tax expense		926			457			1,170
Share based compensation expense		362			371			174
Net (gain) loss on sale of foreclosed assets		485			112			(12	)
Net gain on disposition of premises and equipment		(37	)		(15	)		(3	)
Net change in
Accrued interest receivable		182			(107	)		127
Accrued interest payable		(152	)		(286	)		(203	)
Other assets		1,082			1,645			528
Other liabilities		(938	)		566			(327	)
Net cash from operating activities		13,733			13,710			12,723
Cash flows from investing activities
Net change in interest-bearing deposits		(2,008	)		(6,479	)		6,123
Available for sale securities:
Sales		88,351			107,443			117,818
Purchases		(177,871	)		(116,090	)		(173,404	)
Maturities, prepayments and calls		35,418			24,530			21,922
Loan originations and payments, net		19,256			4,722			21,769
Purchase of premises and equipment, net		(1,649	)		(1,410	)		(586	)
Proceeds from the sale of premises and equipment		43			15			3
Proceeds from the sale of foreclosed assets		7,827			1,837			2,045
Purchase of FHLB and Federal Reserve stock		(58	)		(27	)		(42	)
Redemption of FHLB and Federal Reserve stock		12			883			904
Investment in company owned life insurance		-			(117	)		-
Net cash from investing activities		(30,679	)		15,307			(3,448	)

(Continued)

57

COMMUNITY BANK SHARES OF INDIANA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31

(In thousands)

	2012			2011			2010
Cash flows from financing activities
Net change in deposits	$	43,309		$	(37,463	)	$	26,398
Net change in other borrowings		(5,379	)		1,453			(27,570	)
Proceeds from Federal Home Loan Bank advances		10,000			62,000			75,000
Repayment of Federal Home Loan Bank advances		(25,000	)		(57,000	)		(93,835	)
Repurchase of series A preferred stock		-			(19,468	)		-
Proceeds from issuance of series B preferred stock		-			28,000			-
Repurchase of warrant		-			(1,101	)		-
Cash dividends paid on preferred shares		(978	)		(812	)		(974	)
Cash dividends paid on common shares		(1,133	)		(1,118	)		(1,110	)
Net cash from financing activities		20,819			(25,509	)		(22,091	)
Net change in cash and due from banks		3,873			3,508			(12,816	)
Cash and due from banks at beginning of year		15,166			11,658			24,474
Cash and due from banks at end of year	$	19,039		$	15,166		$	11,658
Supplemental cash flow information:
Interest paid	$	4,182		$	6,254		$	8,383
Income taxes paid, net of refunds		1,600			84			1,520
Supplemental noncash disclosures:
Transfers from loans to foreclosed assets		12,129			3,779			4,698
Sale and financing of foreclosed assets		2,555			387			4,302
Issuance of treasury shares under dividend reinvestment plan		211			208			204
Security transactions in suspense, net payable		-			3,543			-

See accompanying notes.

58

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations and Principles of Consolidation: The consolidated financial statements include Community Bank Shares of Indiana, Inc. (CBIN) and its wholly owned subsidiaries, Your Community Bank (YCB), The Scott County State Bank (SCSB), and CBIN Insurance, Inc. collectively referred to as “the Company”. YCB utilizes 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 the Bank’s investment securities. CBIN Insurance, Inc. is a captive insurance company formed by CBIN in 2012 which issues policies to its subsidiaries to cover gaps in coverage and other risks not insured by its third-party provider. During June 2004 and June 2006, the Company completed placements of floating rate subordinated debentures through Community Bank Shares (IN) Statutory Trust I and Trust II (Trusts), trusts formed by the Company. Because the Trusts are not consolidated with the Company, the financial statements reflect the subordinated debt issued by the Company to the Trusts. Intercompany balances and transactions are eliminated in consolidation.

The Company provides financial services through its offices in Floyd, Clark and Scott counties in Indiana, and Jefferson and Nelson counties in Kentucky. Its primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are residential mortgage, commercial, and installment loans. Substantially all loans are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. There are no significant concentrations of loans to any one industry or customer. However, the customers’ ability to repay their loans is dependent on the real estate and general economic conditions in the area.

Use of Estimates: 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, fair value and impairment of securities, carrying value of foreclosed and repossessed assets, status of contingencies, and deferred tax assets are particularly subject to change.

Cash Flows: Cash and cash equivalents include cash and non-interest bearing deposits with other financial institutions with maturities less than 90 days. Net cash flows are reported for interest-bearing deposits in other financial institutions, loans, deposits, and other borrowings.

Interest-bearing Deposits in Other Financial Institutions: Interest-bearing deposits in other financial institutions mature within one year, are carried at cost.

Securities: Securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.

59

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments except for mortgage backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.  For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings.  For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) other-than-temporary impairment (OTTI) related to other factors, which is recognized in other comprehensive income.  The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.

In order to determine OTTI for purchased beneficial interests that, on the purchase date, were not highly rated, 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. OTTI is deemed to have occurred if there has been an adverse change in the remaining expected future cash flows.

Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments.

Interest income on commercial, mortgage and consumer loans is discontinued at the time the loan is 90 days delinquent. Consumer loans are typically charged-off no later than 120 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not received for loans placed on non-accrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.

60

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as special mention, substandard, or doubtful.

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.

Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length and reasons for the delay, the borrower’s prior payment record, and the amount of shortfall in relation to the principal and interest owed.

Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Smaller balance homogeneous loans, such as consumer and residential real estate, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosure. Trouble debt restructurings (“TDRs”) are renewals or restructuring of loans to borrowers experiencing financial difficulty where the Banks grant a concession. Typically, the banks’ concessions are interest rate reductions, interest only payments, extension of the maturity date, or a combination of concessions. TDRs are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a TDR is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the average actual loss history experienced by the Company over the most recent 3 years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified: Commercial, Construction, Commercial Real Estate, Residential Real Estate, and Consumer.

61

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Commercial loans consist of borrowings for commercial purposes to individuals, corporations, partnerships, sole proprietorships, and other business enterprises. Commercial loans are generally secured by business assets such as equipment, accounts receivable, inventory, or any other asset excluding real estate and generally made to finance capital expenditures or operations. The Company’s risk exposure is related to deterioration in the value of collateral securing the loan should foreclosure become necessary. Generally, business assets used or produced in operations do not maintain their value upon foreclosure which may require the Company to write-down the value significantly to sell.

Construction loans primarily consist of borrowings to purchase and develop raw land into 1-4 family residential properties. Construction loans are extended to individuals as well as corporations for the construction of an individual or multiple properties and are secured by raw land and the subsequent improvements. Repayment of the loans to real estate developers is dependent upon the sale of properties to third parties in a timely fashion upon completion. Should there be delays in construction or a downturn in the market for those properties, there may be significant erosion in value which may be absorbed by the Company. In recent fiscal years, a significant portion of the Company’s loan charge-offs have been on 1-4 family development properties. Consequently, the Company has allocated the highest percentage of allowance for loan losses as a percentage of loans to construction loans compared to the other identified loan portfolio segments.

Commercial real estate consists of borrowings secured by owner-occupied and non-owner-occupied commercial real estate. Repayment of these loans is dependent upon rental income or the subsequent sale of the property for loans secured by non-owner-occupied commercial real estate and by cash flows from business operations for owner-occupied commercial real estate. Loans for which the source of repayment is rental income are primarily impacted by local economic conditions which dictate occupancy rates and the amount of rent charged. Commercial real estate loans that are dependent on cash flows from operations can also be adversely affected by current market conditions for their product or service.

Residential real estate loans consist of loans to individuals for the purchase of primary residences and open and closed-end home equity loans with repayment primarily through wage or other income sources of the individual borrower. The Company’s loss exposure to these loans is dependent on local market conditions for residential properties as loan amounts are determined, in part, by the fair value of the property at origination.

Consumer loans are comprised of loans to individuals both unsecured and secured by automobiles. These loans typically have maturities of 5 years or less with repayment dependent on individual wages and income. The risk of loss on consumer loans is elevated as the collateral securing these loans, if any, rapidly depreciate in value or may be worthless and/or difficult to locate if repossession is necessary. Losses in this portfolio are generally relatively low, however, due to the small individual loan size and the balance outstanding as a percentage of the Company’s entire portfolio.

Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 7 to 40 years. Furniture, fixtures, and equipment are depreciated using the straight-line method with useful lives ranging from 2 to 10 years. Leasehold improvements are amortized over the shorter of their economic lives or the term of the lease with lives ranging from 5 to 15 years.

62

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Federal Home Loan Bank (FHLB) and Federal Reserve Stock: FHLB and Federal Reserve stock are required investments for institutions that are members of the Federal Reserve and FHLB systems. The required investment in the common stock is based on a predetermined formula. Federal Reserve and FHLB stock are carried at cost, classified as restricted securities, and are periodically evaluated for impairment. Because the stocks are viewed as long term investments, impairment is based on ultimate recovery of par value. Both cash and stock dividends are reported as income.

Company Owned Life Insurance: The Company has purchased life insurance policies on certain key executives. Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

Other Intangible Assets: Other intangible assets consist of core deposit and acquired customer relationship intangible assets arising from whole bank acquisitions are amortized on an accelerated method over their estimated useful lives, which the Company has determined to be 10 years.

Foreclosed and Repossessed Assets: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed.

Repurchase Agreements: Repurchase agreement liabilities, included in other borrowings, represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance.

Equity: Treasury stock is carried at cost.

Retirement Plans: Pension expense is the net of service and interest cost, return on plan assets, and amortization of gains and losses not immediately recognized. Profit sharing and 401k plan expense is the amount of matching contributions. Deferred compensation expense allocated the benefits over years of service.

Stock-Based Compensation: Compensation cost is recognized for stock options, restricted stock awards, and deferred stock units issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used for restricted stock and deferred stock unit awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.

Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

63

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

A tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded.

The Company recognizes interest and/or penalties related to income tax matters in income tax expense.

Loan Commitments and Related Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer-financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.

Earnings (Loss) Per Common Share: Basic earnings (loss) per common share is net income (loss) available (attributable) to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options and stock warrants. Earnings and dividends per share are restated for stock splits and dividends through the date of issuance of the financial statements.

Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income, recognized as separate components of equity, includes changes in the following items: unrealized gains and losses on securities available for sale and changes in the funded status of the pension plan.

Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are such matters that will have a material effect on the consolidated financial statements.

Restrictions on Cash: Cash on hand or on deposit with the Federal Reserve Bank was required to meet regulatory reserve and clearing requirements.

Dividend Restriction: Banking regulations require maintaining certain capital levels and may limit the dividends paid by the bank subsidiaries to the holding company or by the holding company to shareholders, as more fully described in a separate note.

Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

Operating Segments: While the chief decision-makers monitor the revenue streams of the various products and services, the identifiable segments are not material and operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.

64

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Adoption of New Accounting Standards:

In June 2011, the FASB amended existing guidance and eliminated the option to present the components of other comprehensive income as part of the statement of changes in shareholder’s equity. The amendment requires that comprehensive income be presented in either a single continuous statement or in two separate consecutive statements. The amendments in this guidance are effective as of the beginning of a fiscal reporting year, and interim periods within that year, that begins after December 15, 2011. Early adoption is permitted. The adoption of this amendment changed the presentation of the components of comprehensive income for the Company as part of the consolidated statement of shareholder’s equity.

NOTE 2 – SECURITIES

The following table summarizes the amortized cost and fair value of the available-for-sale securities portfolio at December 31, 2012 and 2011 and the corresponding amounts of gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
2012	(In thousands)
State and municipal	$	77,497	$	7,050	$	(110	)	$	84,437
Residential mortgage-backed agencies issued by U.S. Government sponsored entities		152,975		2,101		(96	)		154,980
U.S. Government sponsored entities and agencies		10,400		31		(76	)		10,355
Collateralized debt obligations, including trust preferred securities		3,997		-		(2,821	)		1,176
Mutual funds		250		7		-			257
Total	$	245,119	$	9,189	$	(3,103	)	$	251,205

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
2011	(In thousands)
State and municipal	$	70,728	$	5,803	$	(4	)	$	76,527
Residential mortgage-backed agencies issued by U.S. Government sponsored entities		118,876		2,190		(39	)		121,027
Collateralized debt obligations, including trust preferred securities		4,069		-		(3,132	)		937
Mutual funds		250		5		-			255
Total	$	193,923	$	7,998	$	(3,175	)	$	198,746

Total other-than-temporary impairment recognized in accumulated other comprehensive income (loss) for securities available for sale was $1.5 million and $1.6 million at December 31, 2012 and 2011, respectively.

65

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 2 – SECURITIES (Continued)

Sales of available for sale securities were as follows:

	2012		2011		2010
	(In thousands)
Proceeds	$	88,351	$	107,443	$	117,818
Gross gains		2,182		2,499		1,760
Gross losses		-		-		(9	)

The tax provision applicable to these net realized gains amounted to $742,000, $850,000 and $595,000, respectively.

The amortized cost and fair value of the contractual maturities of available for sale securities at year-end 2012 were as follows. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed agency securities and mutual funds which do not have a single maturity date are shown separately.

	Amortized Cost		Fair Value
2012	(In thousands)
Due in one year or less	$	59	$	59
Due from one to five years		2,467		2,629
Due from five to ten years		31,699		33,350
Due after ten years		57,669		59,929
Residential mortgage-backed agencies issued by U.S. Government sponsored entities		152,975		154,980
Mutual Funds		250		257
Total	$	245,119	$	251,205

Securities pledged at year-end 2012 and 2011 had a carrying amount of $63.6 million and $77.2 million to secure public deposits, repurchase agreements and Federal Home Loan Bank advances.

At year end 2012 and 2011, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of shareholders’ equity.

66

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 2 – SECURITIES (Continued)

Securities with unrealized losses at year end 2012 and 2011, aggregated by investment category and length of time that individual securities have been in a continuous loss position are as follows (in thousands):

	Less than 12 Months					12 Months or More					Total
	(In thousands)
2012	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
State and municipal	$	5,204	$	(110	)	$	-	$	-		$	5,204	$	(110	)
Residential mortgage-backed agencies issued by U.S. Government sponsored entities		32,911		(96	)		-		-			32,911		(96	)
U.S. Government sponsored entities and agencies		8,948		(76	)		-		-			8,948		(76	)
Collateralized debt obligations, including trust preferred securities		-		-			1,176		(2,821	)		1,176		(2,821	)
Total temporarily impaired	$	47,063	$	(282	)	$	1,176	$	(2,821	)	$	48,239	$	(3,103	)

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

67

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 2 – SECURITIES (Continued)

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

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

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

As of December 31, 2012, the Company’s security portfolio consisted of 301 securities, 29 of which were in an unrealized loss position. The majority of unrealized losses are related to the Company’s collateralized debt obligations, while smaller unrealized losses were present in the Company’s state and municipal, residential mortgage-backed securities issued by U.S. Government sponsored entities, and U.S. Government sponsored entities and agencies, as discussed below:

State and Municipal

As of December 31, 2012, the Company had approximately $5.2 million of state and municipal securities with an unrealized loss of $110,000. Of the 195 state and municipal securities in the Company’s portfolio, 190 had an investment grade rating as of December 31, 2012 while 5 were not rated. The decline in value in these securities is attributable to interest rate and liquidity, and not credit quality. All of the state and municipal securities in the Company’s portfolio have a fair value as a percentage of amortized cost greater than 90%. The Company does not have the intent to sell its state and municipal securities and it is unlikely that it will be required to sell the securities before the anticipated recovery. The Company does not consider these securities to be other-than-temporarily impaired as of December 31, 2012.

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

At December 31, 2012, all of the mortgage-backed securities held by the Company were issued by U.S. government-sponsored entities, primarily Fannie Mae and Freddie Mac, institutions which the government has affirmed its commitment to support. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2012.

68

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 2 – SECURITIES (Continued)

U.S. Government sponsored entities and agencies

At December 31, 2012, the unrealized losses in the U.S. Government sponsored entities and agencies securities portfolio were attributable to changes in interest rates and liquidity, and not credit quality. Because the Company does not have the intent to sell these securities and it is not likely the it will be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2012.

Collateralized Debt Obligations

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

Our analysis of these six investments falls within the scope of FASB ASC 325-40 and includes $4.0 million amortized cost of pooled trust preferred securities (CDOs). See the table below for a detail of the CDOs at December 31, 2012 (in thousands):

	Current Moody Rating	Par   Value		Amortized Cost		Estimated Fair Value		Previously Recognized OTTI Related to Credit Loss, Pre-Tax		OTTI Related to Credit Loss Recognized in 2012, Pre-Tax
Security 1	CCC- (S&P)	$	2,000	$	2,000	$	684	$	-	$	-
Security 2	C		153		-		-		146		-
Security 3	Caa2		49		43		21		5		-
Security 4	Caa2		317		282		141		35		-
Security 5	Ca		1,549		836		165		637		-
Security 6	Ca		1,549		836		165		637		-
		$	5,617	$	3,997	$	1,176	$	1,460	$	-

69

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 2 – SECURITIES (Continued)

The issuers in five of the six securities are banks and bank holding companies while one is comprised of insurance companies. The Company uses the OTTI evaluation model to evaluate the present value of expected cash flows (see Footnote 15 for further information about the Company’s valuation methodology for these securities). 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. Additionally, we assumed that all bank and bank holding company issuers with total assets of greater than $15 billion would prepay their obligations before January 1, 2016. Upon completion of the analysis, our model indicated we did not have additional other-than-temporary impairment. At December 31, 2012 the six securities subject to FASB ASC 325-40 accounted for the $2.8 million of unrealized loss in the collateralized debt obligations category.

There were no credit losses recognized in earnings related to these securities for the years ended December 31, 2012 and 2011. Prior to 2011, the Company had recognized credit losses of $1.5 million.

NOTE 3 – LOANS

Loans at year-end were as follows:

	2012			2011
	(In thousands)
Commercial	$	96,306		$	100,884
Construction		39,217			44,722
Commercial Real Estate:
Owner occupied nonfarm/residential		91,819			92,848
Other nonfarm/residential		76,669			77,875
Residential Real Estate:
Secured by first liens		115,280			131,054
Home equity		40,094			44,832
Consumer		6,204			7,759
Subtotal		465,589			499,974
Less:  Allowance for loan losses		(8,762	)		(10,234	)
Loans, net	$	456,827		$	489,740

During 2012 and 2011, substantially all of the Company’s residential and commercial real estate loans were pledged as collateral to the Federal Home Loan Bank to secure advances.

70

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 3 – LOANS (Continued)

The following table presents the activity in the allowance for loan losses by portfolio segment for the years ended December 31, 2012 and 2011 (in thousands):

2012:

	Commercial			Construction			Commercial Real Estate			Residential Real Estate			Consumer			Total
Beginning balance	$	2,999		$	1,112		$	3,207		$	2,681		$	235		$	10,234
Provision for loan losses		(91	)		1,172			2,618			420			(18	)		4,101
Loans charged-off		(1,008	)		(938	)		(3,043	)		(769	)		(204	)		(5,962	)
Recoveries		107			53			54			57			118			389
Ending balance	$	2,007		$	1,399		$	2,836		$	2,389		$	131		$	8,762

2011:

	Commercial			Construction			Commercial Real Estate			Residential Real Estate			Consumer			Total
Beginning balance	$	3,245		$	1,893		$	2,499		$	2,803		$	424		$	10,864
Provision for loan losses		2,472			282			1,023			623			(10	)		4,390
Loans charged-off		(2,827	)		(1,065	)		(547	)		(785	)		(337	)		(5,561	)
Recoveries		109			2			232			40			158			541
Ending balance	$	2,999		$	1,112		$	3,207		$	2,681		$	235		$	10,234

Activity in the allowance for loan losses for the years ended December 31, 2010 was as follows:

	2010
	(in thousands)
Beginning balance	$	15,236
Provision for loan losses		3,833
Loans charged-off		(8,688	)
Recoveries		483
Ending balance	$	10,864

71

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 3 – LOANS (Continued)

The following table presents the balance in the allowance for loan losses and the recorded investment in loans, which includes the unpaid principal balance, net of partial charge-offs of $2.8 million and $6.5 million as of December 31, 2012 and 2011, by portfolio segment and based on impairment method as of December 31, 2012 and 2011 (in thousands):

2012:

	Commercial		Construction		Commercial Real Estate		Residential  Real Estate		Consumer		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	90	$	1,066	$	1,495	$	1,028	$	-	$	3,679
Collectively evaluated for impairment		1,917		333		1,341		1,361		131		5,083
Total ending allowance balance	$	2,007	$	1,399	$	2,836	$	2,389	$	131	$	8,762
Loans:
Loans individually evaluated for impairment	$	916	$	9,280	$	11,780	$	6,624	$	23	$	28,623
Loans collectively evaluated for impairment		95,390		29,937		156,708		148,750		6,181		436,966
Total ending loans balance	$	96,306	$	39,217	$	168,488	$	155,374	$	6,204	$	465,589

2011:

	Commercial		Construction		Commercial Real Estate		Residential  Real Estate		Consumer		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	517	$	815	$	1,749	$	563	$	17	$	3,661
Collectively evaluated for impairment		2,482		297		1,458		2,118		218		6,573
Total ending allowance balance	$	2,999	$	1,112	$	3,207	$	2,681	$	235	$	10,234
Loans:
Loans individually evaluated for impairment	$	1,548	$	13,902	$	20,899	$	3,811	$	146	$	40,306
Loans collectively evaluated for impairment		99,336		30,820		149,824		172,075		7,613		459,668
Total ending loans balance	$	100,884	$	44,722	$	170,723	$	175,886	$	7,759	$	499,974

72

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 3 – LOANS (Continued)

The following table presents information related to loans individually evaluated for impairment by class of loans as of and for the years ending December 31, 2012 and 2011:

2012:

	Unpaid Principal Balance		Recorded Investment		Allowance for  Loan Losses  Allocated		Average  Recorded Investment		Interest Income Recognized and Received
	(In thousands)
With no related allowance recorded:
Commercial	$	746	$	746	$	-	$	330	$	7
Construction		6,398		3,828		-		2,200		6
Commercial real estate:
Owner occupied nonfarm/nonresidential		672		672		-		420		6
Other nonfarm/nonresidential		512		512		-		410		4
Residential real estate:
Secured by first liens		2,390		2,389		-		961		10
Home equity		714		714		-		266		8
Consumer		23		23		-		11		-
Total	$	11,455	$	8,884	$	-	$	4,598	$	41

	Unpaid Principal Balance		Recorded Investment		Allowance for  Loan Losses  Allocated		Average  Recorded Investment		Interest Income Recognized and Received
	(In thousands)
With an allowance recorded:
Commercial	$	170	$	170	$	90	$	865	$	10
Construction		5,662		5,452		1,066		10,101		175
Commercial real estate:
Owner occupied nonfarm/nonresidential		936		936		102		6,138		278
Other nonfarm/nonresidential		9,660		9,660		1,393		10,508		230
Residential real estate:
Secured by first liens		2,491		2,491		518		2,931		48
Home equity		1,030		1,030		510		603		14
Consumer		-		-		-		100		-
Total	$	19,949	$	19,739	$	3,679	$	31,246	$	755

73

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 3 – LOANS (Continued)

2011:

	Unpaid Principal Balance		Recorded Investment		Allowance for  Loan Losses  Allocated		Average Recorded Investment		Interest Income Recognized and Received
	(In thousands)
Commercial	$	3,064	$	1,548	$	517	$	627	$	9
Construction		17,709		13,902		815		10,633		3
Commercial real estate:
Owner occupied nonfarm/nonresidential		9,719		9,719		924		2,516		1
Other nonfarm/nonresidential		12,299		11,180		825		11,187		293
Residential real estate:
Secured by first liens		3,491		3,416		297		3,923		73
Home equity		395		395		266		187		-
Consumer		146		146		17		188		-
Total	$	46,823	$	40,306	$	3,661	$	29,261	$	379

At December 31, 2011all impaired loans had an allocated allowance for loan losses. The recorded investment in loans excludes accrued interest receivable and loan origination fees, net due to immateriality.

Further information about impaired loans is presented below:

	2010
	(in thousands)
Average of individually impaired loans during the year	$	25,624
Interest income recognized and received during impairment		294

74

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 3 – LOANS (Continued)

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

	2012				2011
	Nonaccrual		Loans Past Due Over 90 Days Still Accruing		Nonaccrual		Loans Past  Due Over 90  Days Still  Accruing
	(In thousands)
Commercial	$	416	$	-	$	1,040	$	-
Construction		3,708		-		7,457		-
Commercial real estate:
Owner occupied nonfarm/residential		627		-		1,036		-
Other nonfarm/residential		1,846		-		2,290		-
Residential real estate:
Secured by first liens		1,930		-		3,427		-
Home equity		5		-		372		-
Consumer		186		-		150		-
Total	$	8,718	$	-	$	15,772	$	-

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

2012:

	30 – 59 Days  Past Due		60 – 89 Days Past Due		Greater than 89 Days Past  Due		Total Past  Due		Loans Not Past Due		Loans Past Due Over 90 Days Still Accruing
	(In thousands)
Commercial	$	166	$	-	$	435	$	601	$	95,705	$	-
Construction		1,264		1		3,014		4,279		34,938		-
Commercial real estate:
Owner occupied nonfarm/residential		325		-		57		382		91,437		-
Other nonfarm/residential		119		-		1,846		1,965		74,704		-
Residential real estate:
Secured by first liens		3,593		566		1,960		6,119		109,161		-
Home equity		1,221		313		55		1,589		38,505		-
Consumer		186		46		70		302		5,902		-
Total	$	6,874	$	926	$	7,437	$	15,237	$	450,352	$	-

75

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 3 – LOANS (Continued)

2011:

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

76

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 3 – LOANS (Continued)

Troubled Debt Restructurings:

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

	2012				2011
	Recorded Investment		Allowance for Loan Losses Allocated		Recorded Investment		Allowance for Loan Losses Allocated
Commercial:
Interest only payments	$	-	$	-	$	500	$	24
Extended maturity		5		5		489		281
Multiple modifications		160		4		332		12
Construction:
Interest rate reduction		1,355		173		-		-
Extended maturity		474		89		926		320
Multiple modifications		2,655		374		5,333		80
Commercial real estate:
Owner occupied nonfarm/nonresidential
Interest only		195		81		8,710		887
Other nonfarm/nonresidential
Interest rate reduction		8,070		1,200		8,070		616
Interest only payments		202		-		206		4
Multiple modifications		-		-		1,127		87
Residential real estate:
Secured by first liens
Interest rate reduction		65		7		100		7
Interest only payments		-		-		124		8
Extended maturity		306		36		307		4
Multiple modifications		315		50		373		29
Home equity
Interest rate reduction		-		-		30		1
Consumer
Interest rate reduction		-		-		8		-
Total	$	13,802	$	2,019	$	26,635	$	2,360

Subsequent to December 31, 2012, the Company transferred one credit relationship classified as a TDR in 2012 and 2011 with a recorded investment of $8.1 million to non-accrual status. In addition, the Company charged-off the allocated allowance of $1.2 million at that time. The relationship was included in the Company’s impaired loans as of December 31, 2012.

77

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 3 – LOANS (Continued)

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

2012:

	TDRs Greater than 30 Days Past Due and          Still Accruing		TDRs on Nonaccrual		Total TDRs Not Performing  to  Modified Terms		Total TDRs Defaulted  Within 12  Months of Modification
Commercial:
Multiple modifications	$	-	$	93	$	93	$	-
Construction:
Extended maturity		-		61		61		61
Commercial real estate:
Owner occupied nonfarm/nonresidential
Interest only		195				195
Other nonfarm/nonresidential		-		-		-		-
Residential:
Secured by first liens
Multiple modifications		39		165		204		-
Home equity		-		-		-		-
Consumer		-		-		-		-
Total	$	234	$	319	$	553	$	61

78

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 3 – LOANS (Continued)

2011:

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

During the years ending December 31, 2012 and 2011, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or adjustment of scheduled loan payments from principal and interest to interest only.

Modifications involving a reduction of the stated interest rate of the loan were for periods ranging from 5 to 324 months. Modifications involving an extension of the maturity date were for periods ranging from 2 to 180 months. Modifications involving an adjustment from principal and interest payments to interest only were for periods ranging from 4 to 60 months.

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

79

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 3 – LOANS (Continued)

The following tables present loans by class modified as TDRs that occurred during the years ending December 31, 2012 and 2011 and their performance, by modification type (in thousands):

2012:

	Number of Loans		TDRs Performing to Modified Terms		TDRs Not Performing to Modified Terms
Construction:
Interest rate reduction		1		1,355		-
Commercial real estate:
Owner occupied nonfarm/nonresidential:
Interest only payments		1		-		195
Total		2	$	1,355	$	195

2011:

	Number of Loans		TDRs Performing to Modified Terms		TDRs Not Performing to Modified Terms
Commercial:
Interest only payments		1	$	-	$	500
Extended maturity		5		239		250
Multiple modifications		2		-		262
Construction:
Extended maturity		1		416		-
Multiple modifications		4		5,333		-
Commercial real estate:
Owner occupied nonfarm/nonresidential:
Interest only payments		2		8,710		-
Other nonfarm/nonresidential:
Interest only payments		1		206		-
Residential:
Secured by first liens:
Interest rate reduction		1		32		-
Interest only payments		3		124		-
Extended maturity		1		306		-
Multiple modifications		1		55		-
Home equity:
Interest rate reduction		1		30		-
Consumer:
Interest rate reduction		1		8		-
Total		24	$	15,459	$	1,012

80

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 3 – LOANS (Continued)

The troubled debt restructurings described above increased the allowance for loan losses by $949,000 and $1.8 million during the years ending December 31, 2012 and 2011. There were $3.4 million and $2.0 million of charge-offs of TDRs during 2012 and 2011, respectively. For modifications occurring during the years ended December 31, 2012 and 2011, the post-modification balances equaled the pre-modification balances.

The Company did not have any commitments to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructurings as of December 31, 2012 and 2011.

Credit Quality Indicators:

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

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

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

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

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

81

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 3 – LOANS (Continued)

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

2012:

	Watch		Special Mention		Substandard		Doubtful		Pass		Total
	(In thousands)
Commercial	$	5,372	$	642	$	467	$	408	$	89,417	$	96,306
Construction		7,017		-		4,982		4,298		22,920		39,217
Commercial real estate:
Owner occupied nonfarm/residential		4,317		195		1,355		57		85,895		91,819
Other nonfarm/residential		2,808		-		8,539		1,846		63,476		76,669
Residential real estate:
Secured by first liens		1,574		331		2,566		1,725		109,084		115,280
Home equity		482		56		1,425		209		37,922		40,094
Consumer		70		-		86		11		6,037		6,204
Total	$	21,640	$	1,224	$	19,420	$	8,554	$	414,751	$	465,589

2011

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

Related Party Loans: Loans to principal officers, directors, and their affiliates were as follows.

	2012
	(In thousands)
Beginning loans	$	13,905
New loans		9,722
Change in related parties		1,528
Repayments		(7,926	)
Ending loans	$	17,229

Off-balance-sheet commitments (including commitments to make loans, unused lines of credit, and letters of credit) to principal officers, directors, and their affiliates as of December 31, 2012 and 2011 were $15.1 million and $17.3 million.

82

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 4- PREMISES AND EQUIPMENT

Year-end premises and equipment were as follows:

	2012			2011
	(In thousands)
Land and land improvements	$	2,768		$	2,766
Buildings		13,988			13,642
Furniture, fixtures and equipment		13,463			12,854
Leasehold improvements		1,216			1,384
		31,435			30,646
Less:  Accumulated depreciation		(17,341	)		(16,866	)
	$	14,094		$	13,780

Depreciation expense was $1.3 million, $1.2 million, and $1.3 million for 2012, 2011, and 2010.

Branch location rent expense was $651,000, $620,000 and $640,000 for 2012, 2011, and 2010, respectively. Rent commitments under noncancelable operating leases (in thousands) were as follows, before considering renewal options that generally are present.

2013	$	581
2014		513
2015		486
2016		420
2017		330
Thereafter		271
Total	$	2,601

NOTE 5 – DEPOSITS

Time deposits of $100,000 or more were $71.8 million and $77.7 million at year-end 2012 and 2011.

Scheduled maturities of time deposits for the next five years (in thousands) were as follows:

2013	$	140,826
2014		18,874
2015		4,151
2016		2,729
2017		541
Thereafter		367

Deposits from principal officers, directors and their affiliates at year-end 2012 and 2011 were approximately $24.2 million and $28.8 million.

83

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 6 – OTHER BORROWINGS

Other borrowings consist of retail repurchase agreements representing overnight borrowings from deposit customers, federal funds purchased representing overnight borrowings from other financial institutions, lines of credit with other financial institutions, a structured repurchase agreement, and a note payable.

One of the Company’s subsidiary banks is a limited partner in an investment partnership which constructs low income housing. The Company currently has a 14.8% ownership interest, although that is expected to be reduced to 5% - 7% once all partnership units have been sold. In exchange for an investment of $1.0 million, the Company issued a note payable for $1.0 million to the partnership. The note payable had a balance of $62,000 and $377,000 at December 31, 2012 and 2011. Payments are due on demand in the amount requested from the partnership. The note does not bear interest unless payments are not paid within 15 days of the request. In accordance with accounting guidance, the Company did not consolidate the investment in the partnership into its financial statements because it owns less than 50% of the partnership and does not control the operations.

84

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 6 – OTHER BORROWINGS (Continued)

Information concerning 2012, 2011, and 2010 other borrowings is summarized as follows.

	2012			2011			2010
	(Dollars in thousands)
Repurchase agreements at year-end
Balance	$	45,438		$	38,602		$	35,096
Weighted average interest rate		0.27	%		0.29	%		0.38	%
Repurchase agreements during the year
Average daily balance	$	42,477		$	36,680		$	38,987
Maximum month-end balance		45,438			40,263			41,263
Weighted average interest rate		0.28	%		0.33	%		0.37	%
Federal funds purchased and lines of credit at year-end
Balance		-		$	2,100		$	3,800
Weighted average interest rate		-			4.35	%		4.30	%
Federal funds purchased and lines of credit during the year
Average daily balance	$	1,480		$	5,374		$	5,780
Maximum month-end balance		3,951			13,800			12,535
Weighted average interest rate		3.62	%		2.56	%		3.39	%
Structured repurchase agreement at year-end
Balance		-		$	9,800		$	9,800
Weighted average interest rate		-			4.97	%		4.97	%
Structured repurchase agreement during the year
Average daily balance	$	8,649		$	9,800		$	9,800
Maximum month-end balance		9,800			9,800			9,800
Weighted average interest rate		4.97	%		4.97	%		4.97	%
Note payable at year-end
Balance	$	62		$	377		$	730
Weighted average interest rate		0.00	%		0.00	%		0.00	%
Note payable during the year
Average daily balance	$	140		$	588		$	2
Maximum month-end balance		239			730			730
Weighted average interest rate		0.00	%		0.00	%		0.00	%

85

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES

At year-end, advances from the Federal Home Loan Bank (FHLB) were as follows.

	2012					2011
	Weighted Average Rate			Amount		Weighted Average Rate			Amount
	(Dollars in thousands)
Fixed rate		1.98	%	$	40,000		1.64	%	$	55,000

The advances were collateralized by $247.8 million and $277.1 million of first mortgage and commercial real estate loans under a blanket lien arrangement and certain available for sale securities at year-end 2012 and 2011. Based on this collateral and the Company’s holdings of FHLB stock, the Company is eligible to borrow an additional $70.0 million at year-end 2012.

The contractual maturities of advances outstanding as of December 31, 2012 are as follows:

		(In thousands)
2013	$	20,000
2014		10,000
2015		10,000
	$	40,000

There is a substantial penalty if the Company prepays the advances before the contractual maturities. The Company recognized penalties on prepayment of FHLB advances of $0, $0, and $335,000, for the years ended December 31, 2012, 2011, and 2010.

NOTE 8 - SUBORDINATED DEBENTURES

On June 15, 2006, a trust formed by the Company, Community Bank Shares (IN) Statutory Trust II (Trust II), issued $10.0 million of floating rate trust preferred securities as part of a pooled offering of such securities. On June 17, 2004, a trust formed by the Company, Community Bank Shares (IN) Statutory Trust I (Trust I), issued $7.0 million of floating rate trust preferred securities as part of a pooled offering of such securities. The Company issued subordinated debentures to Trusts I and II in exchange for the proceeds of each offering; the debentures and related debt issuance costs represent the sole assets of Trusts I and II. The Company is not considered the primary beneficiary of the Trusts (variable interest entity), therefore the trusts are not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability. Distributions on the trust preferred securities are payable quarterly in arrears at the annual rate (adjusted quarterly) of three-month LIBOR plus 1.70% (2.01% as of the last adjustment) for Trust II and three-month LIBOR plus 2.65% (2.96% as of the last adjustment) for Trust I and are included in interest expense.

86

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 8 - SUBORDINATED DEBENTURES (Continued)

The maturity dates of the subordinated debentures are June 15, 2036 for Trust II and June 17, 2034 for Trust I. The subordinated debentures may be redeemed by the Company, in whole or in part, at any distribution payment date at the redemption price. The subordinated debentures have variable rates, adjusted quarterly, which are identical to the trust preferred securities. In addition, the subordinated debentures are redeemable in whole or in part from time to time, upon the occurrence of specific events defined within the trust debenture. The Company has the option to defer interest payments on the subordinated debt from time to time for a period not to exceed five consecutive years. Should interest payments be deferred, the Company is restricted from paying dividends until all deferred payments have been made.

Subordinated debentures are considered as Tier I capital for the Company under current regulatory guidelines.

NOTE 9 – BENEFIT PLANS

Defined Benefit Plans: The Company sponsors a defined benefit pension plan. The benefits are based on years of service and the employees’ highest average of total compensation for five consecutive years of employment. In 1997, the plan was amended such that there can be no new participants or increases in benefits to the participants.

A reconciliation of the projected benefit obligation and the value of plan assets follow.

	2012			2011
	(In thousands)
Change in projected benefit obligation
Balance, beginning of year	$	1,321		$	1,096
Interest cost		52			57
Actuarial loss		95			201
Benefits paid to participants		(40	)		(33	)
Ending benefit obligation		1,428			1,321
Change in plan assets
Fair value, beginning of year		915			855
Actual return on plan assets		102			(7	)
Employer contributions		63			100
Benefits paid to participants		(40	)		(33	)
Fair value, end of year		1,040			915
Funded status	$	(388	)	$	(406	)

87

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 9 – BENEFIT PLANS (Continued)

Amounts recognized in accumulated other comprehensive loss consisted of a net actuarial loss of $810,000 and $769,000 at year-end 2012 and 2011. The accumulated benefit obligation was $1.4 million and $1.3 million at year-end 2012 and 2011. The funded status of the plan was a liability as of the years ended 2012 and 2011 and is reported in other liabilities in the Company’s consolidated financial statements.

Components of Net Periodic Benefit Cost and Other Amounts Recognized in Other Comprehensive Income

	2012			2011			2010
	(Dollars in thousands)
Interest cost	$	52		$	56		$	57
Expected return on plan assets		(69	)		(65	)		(56	)
Amortization of unrecognized loss		21			13			13
Net periodic benefit cost		4			4			14
Net loss (gain)		41			261			12
Total recognized in other comprehensive loss (income)		41			261			12
Total recognized in net periodic benefit cost and other comprehensive loss (income)	$	45		$	265		$	26

The estimated net loss for the defined benefit pension plan that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost over the next fiscal year is $23,000.

Assumptions

Weighted-average assumptions used to determine pension benefit obligations at year end:

	2012			2011			2010
Discount rate on benefit obligation		3.50	%		4.00	%		5.25	%

Weighted-average assumptions used to determine net periodic pension cost:

	2012			2011			2010
Rate of expected return on plan assets		7.50	%		7.50	%		7.50	%
Discount rate for periodic benefit costs		4.00	%		5.25	%		5.75	%

88

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 9 – BENEFIT PLANS (Continued)

Plan Assets: The Company’s target allocation for 2013, pension plan asset allocation at year-end 2012 and 2011, and expected long-term rate of return by asset category are as follows:

	Target Allocation			Percentage of Plan Assets at Year-end						Weighted-Average Expected Long-Term
	2013			2012			2011			Rate of Return
Asset Category
Mutual funds		85	%		99	%		93	%		9.0	%
Money market		15			1			7			3.5
Total		100	%		100	%		100	%		7.5	%

The investment policy of the pension plan prohibits investments in: fixed income securities not denominated in U.S. Dollars or Eurodollars, venture capital, guaranteed insurance contracts, commodities, precious metals or gems, derivatives, short-selling and other hedging strategies, or any other non-traditional asset.

The expected long-term return is based on a periodic review and modeling of the plan’s asset allocation and liability structure over a long-term horizon. Expectations of returns on each asset class are the most important of the assumptions used in the review and modeling and are based on reviews of historical data. The expected long-term rate of return on assets was selected from within the reasonable range of rates determined by (a) historical real returns, net of inflation, for the asset classes covered by the investment policy, and (b) projections of inflation over the long-term period during which benefit are payable to plan participants.

Fair Value of Plan Assets:

Fair value is the exchange price that would be received for an asset in the principal or most advantageous market for the asset in an orderly transaction between market participants on the measurement date. Also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Equity Mutual Funds: The fair values for equity mutual funds are determined by quoted market prices (Level 1). The Company does not modify or apply assumptions to the quoted market prices.

Money Market Mutual Funds: The fair values for money market mutual funds are determined by quoted market prices (Level 1). The Company does not modify or apply assumptions to the quoted market prices.

89

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 9 – BENEFIT PLANS (Continued)

The fair value of the plan assets by asset category is as follows:

			Fair Value Measurements Using:
	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs  (Level 3)
	(Dollars in Thousands)
Plan Assets (December 31, 2012)
Money Market Mutual Fund	$	10	$	10	$	-	$	-
Equity Mutual Funds		1,030		1,030		-		-
Total Plan Assets	$	1,040	$	1,040	$	-	$	-
Plan Assets (December 31, 2011)
Money Market Mutual Fund	$	64	$	64	$	-	$	-
Equity Mutual Funds		851		851		-		-
Total Plan Assets	$	915	$	915	$	-	$	-

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

Estimated Future Payments: The following benefit payments, which reflect expected future service, are expected (in thousands):

	Pension Benefits
2013	$	41
2014		42
2015		312
2016		39
2017		47
Years 2018-2022		375

The Company expects to contribute approximately $85,000 to its pension plan in 2013.

Your Community Bank is a participant in the Financial Institutions Retirement Fund, a multi-employer defined benefit pension plan covering two of its employees. Employees are fully vested at the completion of five years of participation in the plan. No contributions were required during the three-year period ended December 31, 2012. There have been no new enrollments since 1998.

Deferred Compensation Arrangements: The Company has entered into deferred compensation arrangements with certain directors and officers. The liability for such arrangements is fully accrued during the service period, with benefits paid monthly upon retirement until death, or date specified by the agreement. The liability was $230,000 and $239,000 at December 31, 2012 and 2011, respectively, and was included in other liabilities in the Company’s consolidated financial statements. Expense related to these arrangements for 2012, 2011 and 2010 was $10,000, $10,000 and $12,000

90

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 9 – BENEFIT PLANS (Continued)

Defined Contribution Plans: The 401(k) benefit plan matches employee contributions equal to 100% of the first 3% plus 50% of the next 2% of the compensation contributed. Expense for 2012, 2011 and 2010 was $282,000, $266,000 and $257,000.

NOTE 10 – STOCK-BASED COMPENSATION PLANS

The Company has three share based compensation plans as described below. Total compensation cost that has been charged against income for those plans was $362,000, $371,000, and $174,000 for 2012, 2011, and 2010. The total income tax benefit was $122,000, $126,000, and $36,000 for the respective periods.

Stock Options: The Company’s stock option plan provides for the granting of both incentive and nonqualified stock options and other share based awards, including restricted stock and deferred stock units, for up to 400,000 shares of common stock 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 the Board of Directors at the date of grant and generally vest over periods of three to four years. As of December 31, 2012, the plan allows for additional option and share-based award grants of up to 150,795 shares.

The fair value of each option award is estimated on the date of grant using the Black-Scholes model. Expected volatilities are based on historical volatilities of the Company’s common stock. The Company uses historical data to estimate option exercise and post-vesting termination behavior. The expected term of options granted is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

The Company did not grant options during 2012, 2011, or 2010.

A summary of the activity in the stock option plan for 2012 follows:

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
	(In thousands, except exercise prices)
Outstanding at beginning of year		168		$	22.73
Granted		-			-
Exercised		-			-
Forfeited		(10	)		24.31
Expired		-			-
Outstanding at end of year		158		$	22.63		3.3	$	-
Vested and expected to vest		158		$	22.63		3.3	$	-
Exercisable at end of year		158		$	22.63		3.3	$	-

91

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 10 – STOCK-BASED COMPENSATION PLANS (Continued)

For the years ended December 31, 2012, 2011, and 2010 there were no options exercised or granted.

As of December 31, 2012, all outstanding stock options had vested and there was no remaining compensation cost to be recognized.

Performance Units Awards: The Company 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. The Company estimates the progress toward achieving these objectives when estimating the number of awards expected to vest and correspondingly, periodic compensation expense.

The compensation cost attributable to these restricted performance units awards is based on both the fair market value of the shares at the grant date and the Company’s stock price at the end of a reporting cycle. Thirty-five percent of the total award will be paid in cash and is therefore classified as a liability, with total compensation cost changing as the Company’s stock price changes. The remaining sixty-five percent is classified as an equity award; total compensation cost is based on the fair market value of sixty-five percent of the total award on the date of grant. The compensation expense is recognized over the specified performance period.

As of December 31, 2012, there were no outstanding units granted under the Plan. There were no units outstanding during the years ended December 31, 2012, 2011 and 2010. There were no modifications or cash paid to settle performance unit awards during the three year period ending December 31, 2012.

Restricted Share Awards: Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at issue date. The fair value of the stock was determined using the market value of the Company’s stock on the grant date. The restricted shares have vesting periods ranging from 16 days to three years from the anniversary of the grant date.

A summary of changes in the Company’s nonvested shares for the year follows:

Nonvested Shares	Shares			Weighted-Average Grant-Date Fair Value
	(In thousands)
Nonvested at January 1, 2012		45		$	13.13
Granted		22			13.45
Vested		(8	)		9.50
Forfeited		-			-
Nonvested at December 31, 2012		59		$	13.74

As of December 31, 2012, there was $236,000 of total unrecognized compensation cost related to nonvested shares granted under the Plan. The cost is expected to be recognized over a weighted-average period of 1.0 years. The fair value of shares vested during the years ended December 31, 2012, 2011, and 2010 was $104,000, $160,000, and $0. There were no modifications or cash paid to settle restricted share awards during the three year period ended December 31, 2012.

92

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

 NOTE 11 - INCOME TAXES

Income tax expense (benefit) was as follows.

	2012			2011			2010
	(In thousands)
Current	$	759		$	1,634		$	741
Deferred		1,042			554			1,170
Change in valuation allowance		(116	)		(97	)		(65	)
Total	$	1,685		$	2,091		$	1,846

Effective tax rates differ from federal statutory rates applied to financial statement income due to the following.

	2012					2011					2010
	(Dollars in thousands)
Federal statutory rate times  financial statement income	$	3,186		34.0	%	$	3,230		34.0	%	$	3,004		34.0	%
Effect of:
Tax-exempt income		(1,094	)	(11.7	)		(954	)	(10.0	)		(758	)	(8.6	)
State taxes, net of federal benefit		116		1.2			97		1.0			65		0.7
Change in valuation allowance		(116	)	(1.2	)		(97	)	(1.0	)		(65	)	(0.7	)
Nontaxable earnings from company owned insurance policies		(237	)	(2.5	)		(233	)	(2.5	)		(245	)	(2.8	)
New markets tax credit		-		-			-		-			(180	)	(2.0	)
Low income housing tax credit		(130	)	(1.4	)		(20	)	(0.2	)		-		-
Incentive stock options expense		-		-			-		-			5		0.1
Other, net		(40	)	(0.4	)		68		0.7			20		0.2
Total	$	1,685		18.0	%	$	2,091		22.0	%	$	1,846		20.9	%

93

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 11- INCOME TAXES (Continued)

Year-end deferred tax assets and liabilities were due to the following:

	2012			2011
	(In thousands)
Deferred tax assets:
Allowance for loan losses	$	2,979		$	3,479
Employee benefit plans		122			81
Other-than-temporary impairment		496			496
Minimum pension liability		275			261
State taxes		1,601			1,717
Restricted stock awards		121			71
Deferred stock units		-			70
Section 1602 grant		122			82
Tax credit carryforward		769			842
Other		171			186
		6,656			7,285
Deferred tax liabilities:
Premises and equipment		(805	)		(685	)
FHLB stock		(176	)		(171	)
Deferred loan fees and costs		(159	)		(157	)
Fair value adjustments from acquisitions		(264	)		(219	)
Net unrealized gain on securities available for sale		(2,079	)		(1,649	)
Intangible assets		(162	)		(294	)
Prepaid expenses		(525	)		(76	)
Other		(57	)		(147	)
		(4,227	)		(3,398	)
Valuation allowance on net deferred tax assets		(1,601	)		(1,717	)
Net deferred tax asset	$	828		$	2,170

The Company incurred net operating losses for state income taxes during years 2002 through 2010 which will be carried forward and applied to future state taxable income. Due to the uncertainty of the Company’s ability to use this benefit, a valuation allowance has been recorded. The cumulative state net operating loss is $14.6 million and can be carried forward for 15 years with expiration beginning in 2018.

The Company has general business credit carryforwards of $144,000 and AMT credit carryforwards of $625,000. The general business credits will begin to expire in 2028 and the AMT credit carryforwards have no expiration period.

Retained earnings of Your Community Bank includes approximately $3.7 million for which no deferred income tax liability has been recognized. This amount represents an allocation of income to bad debt deductions as of December 31, 1987 for tax purposes only. Reduction of amounts so allocated for purposes other than tax bad debt losses including redemption of bank stock or excess dividends, or loss of “bank” status would create income for tax purposes only, which would be subject to the then-current corporate income tax rate. The unrecorded deferred income tax liability on the above amount for Your Community Bank at December 31, 2012 was approximately $1.3 million.

94

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 11- INCOME TAXES (Continued)

The Company has no unrecognized tax benefits as of December 31, 2012 and 2011 and there is no expected change for unrecognized tax benefits over the next twelve months.

The Company did not record any amounts of interest and penalties in the income statement for the years ended December 31, 2012, 2011, and 2010 and did not have an amount accrued for interest and penalties at December 31, 2012, 2011, and 2010.

The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of the states of Indiana and Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2009.

NOTE 12 – PREFERRED STOCK AND WARRANTS

On September 15, 2011, the Company entered into a security purchase agreement with the United States Department of the Treasury (“Treasury”) as part of its Small Business Lending Fund program, pursuant to which the Company sold 28,000 of its Senior Non-Cumulative Perpetual Preferred Stock, Series B (“SBLF Preferred Stock”) to the Treasury for a purchase price of $28,000,000.   

Using the proceeds from the sale of the SBLF Preferred Stock, the Company redeemed its 19,468 outstanding shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “TARP Preferred Stock”), which were issued to the United States Department of the Treasury in May 2009 in connection with the Company’s participation in the Troubled Asset Relief Program – Capital Purchase Program, plus the accrued dividends owed on the TARP Preferred Stock.  As a result of the redemption of the TARP Preferred Stock, the Company is no longer subject to the TARP executive compensation requirements. Also, the Company repurchased the warrant issued to the Treasury in conjunction with its participation in TARP for $1.1 million. The warrant granted the holder the right to purchase 386,270 shares of the Company’s common stock at an exercise price of $7.56 per share.

95

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 12 – PREFERRED STOCK AND WARRANTS (Continued)

The SBLF Preferred Stock qualifies as Tier 1 capital and will accrue non-cumulative dividends, payable quarterly, on each January 1, April 1, July 1 and October 1.  The dividend rate, as a percentage of the liquidation amount, can fluctuate on a quarterly basis during the first 10 quarters during which the preferred stock is outstanding, based upon changes in the level of “Qualified Small Business Lending” (“QSBL”), by the Company’s subsidiary banks.  The dividend rate for the fourth quarter of 2012 was 1.87%. The dividend rate for future dividend periods will be set based upon the percentage change in QSBL between each dividend period and the baseline QSBL level, as determined in accordance with the Purchase Agreement.  Such dividend rate may vary from 1% per annum to 5% per annum for the second through tenth dividend periods, and will be fixed at a rate between 1% per annum to 7% per annum and remain unchanged up to four and one-half years following the funding date (the eleventh through the first half of the nineteenth dividend periods).  If the SBLF Preferred Stock remains outstanding for more than four-and-one-half years, the dividend rate will be fixed at 9%.  Prior to that time, in general, the dividend rate will decrease as the level of the Bank’s QSBL increases.  Such dividends are not cumulative, but the Company may only declare and pay dividends on its common stock (or any other equity securities junior to the SBLF Preferred Stock) if it has declared and paid dividends for the current dividend period on the SBLF Preferred Stock, and will be subject to other restrictions on its ability to repurchase or redeem other securities. If the Company’s QSBL with respect to its ninth dividend period is less than or equal to its QSBL baseline, then, beginning on January 1, 2014 and on all dividend payments thereafter ending on April 1, 2015, the Company will pay the holders of its SBLF Preferred Stock a special lending incentive fee equal to 0.5% of the liquidation amount per share of SBLF Preferred Stock.

Holders of the SBLF Preferred Stock have the right to vote as a separate class on certain matters relating to the rights of holders of SBLF Preferred Stock and on certain corporate transactions.  Except with respect to such matters and, if applicable, the election of the additional directors described below, the SBLF Preferred Stock does not have voting rights.  If (i) the Company has not timely declared and paid dividends on the SBLF Preferred Stock for six dividend periods or more, whether or not consecutive, and (ii) shares of SBLF Preferred Stock with an aggregate liquidation preference of at least $25,000,000 are still outstanding, the Treasury (or any successor holder of SBLF Preferred Stock) may elect two additional directors to the Company’s Board of Directors.  In the event that the Company misses five dividend payments, whether or not consecutive, the holder of the SBLF Preferred Stock will have the right, but not the obligation, to appoint a representative as an observer on the Company’s Board of Directors.

The Company may redeem the shares of SBLF Preferred Stock, in whole or in part, at any time at a redemption price equal to the sum of the liquidation amount per share ($1,000 per share) and the per-share amount of any unpaid dividends for the then-current period, subject to any required prior approval by the Company’s primary federal banking regulator. The terms of the SBLF Preferred Stock impose limits on the ability of the Company to pay dividends and repurchase shares of common stock.  Under the terms of the SBLF Preferred Stock, no repurchases may be effected, and no dividends may be declared or paid on preferred shares ranking pari passu with the SBLF Preferred Stock, junior preferred shares, or other junior securities (including the common stock) during the current quarter and for the next three quarters following the failure to declare and pay dividends on the SBLF Preferred Stock, except that, in any such quarter in which the dividend is paid, dividend payments on shares ranking pari passu may be paid to the extent necessary to avoid any resulting material covenant breach.

96

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 12 – PREFERRED STOCK AND WARRANTS (Continued)

Under the terms of the SBLF Preferred Stock, the Company may only declare and pay a dividend on the common stock or other stock junior to the SBLF Preferred Stock, or repurchase shares of any such class or series of stock, if, after payment of such dividend, the dollar amount of the Company’s Tier 1 Capital would be at least 90% of the Tier 1 Capital of the Company as of September 15, 2011, excluding any subsequent net charge-offs and any redemption of the SBLF Preferred Stock (the “Tier 1 Dividend Threshold”).  Beginning on the first day of the eleventh dividend period, the amount of the Tier 1 Dividend Threshold will be reduced by 10% for each one percent increase in QSBL from the baseline level through the ninth dividend period.

NOTE 13 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON DIVIDENDS

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.

Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. As of December 31, 2012 and 2011, the most recent regulatory notifications categorized YCB and SCSB as well capitalized under the regulatory framework for prompt corrective action. There are no considerations or events since December 31, 2012 that management believes have changed the institution’s classification as well capitalized.

97

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 13 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON DIVIDENDS (Continued)

Actual and required capital amounts and ratios are presented below at year-end.

	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in millions)
2012
Total Capital (to Risk Weighted Assets):
Consolidated	$	105.7		19.1	%	$	44.2		8.0	%		N/A		N/A
Your Community Bank		88.1		18.9			37.3		8.0		$	46.6		10.0	%
Scott County State Bank		16.2		18.6			6.9		8.0			8.7		10.0
Tier I Capital (to Risk Weighted Assets):
Consolidated	$	98.8		17.9	%	$	22.1		4.0	%		N/A		N/A
Your Community Bank		82.3		17.7			18.6		4.0		$	27.9		6.0	%
Scott County State Bank		15.1		17.4			3.5		4.0			5.2		6.0
Tier I Capital (to Average Assets):
Consolidated	$	98.8		12.2	%	$	32.3		4.0	%		N/A		N/A
Your Community Bank		82.3		12.3			26.8		4.0		$	33.5		5.0	%
Scott County State Bank		15.1		11.3			5.4		4.0			6.7		5.0
2011
Total Capital (to Risk Weighted Assets):
Consolidated	$	99.6		17.5	%	$	45.4		8.0	%		N/A		N/A
Your Community Bank		83.0		17.1			38.7		8.0		$	48.4		10.0	%
Scott County State Bank		16.6		20.0			6.6		8.0			8.3		10.0
Tier I Capital (to Risk Weighted Assets):
Consolidated	$	92.4		16.3	%	$	22.7		4.0	%		N/A		N/A
Your Community Bank		76.9		15.9			19.4		4.0		$	29.1		6.0	%
Scott County State Bank		15.5		18.8			3.3		4.0			5.0		6.0
Tier I Capital (to Average Assets):
Consolidated	$	92.4		11.7	%	$	31.5		4.0	%		N/A		N/A
Your Community Bank		76.9		11.7			26.2		4.0		$	32.8		5.0	%
Scott County State Bank		15.5		12.2			5.1		4.0			6.4		5.0

98

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 13 - CAPITAL REQUIREMENTS AND RESTRICTIONS ON DIVIDENDS (Continued)

Dividend Restrictions: The Company’s principal source of funds for dividend payments is dividends received from the Banks. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s retained net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. In 2013, YCB could declare dividends of $7.8 million plus 2013 earnings without prior regulatory approval while SCSB could declare dividends of $684,000 without prior approval. In addition, the Company has limitations on dividends it can pay to common shareholders as more fully described in Note 12 – Preferred Stock and Warrants.

NOTE 14 - OFF-BALANCE-SHEET ACTIVITIES

Some financial instruments, such as commitments to make loans for the Company’s portfolio, credit lines and letters of credit, are issued to meet customer-financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Off-balance-sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment.

The contractual amount of financial instruments with off-balance-sheet risk was as follows at year-end.

	2012				2011
	Fixed Rate		Variable Rate		Fixed Rate		Variable Rate
	(In thousands)
Commitments to make loans	$	13,168	$	1,041	$	7,420	$	3,152
Unused lines of credit		11,374		114,894		9,720		114,571
Letters of credit		-		2,375		-		2,745

Commitments to make loans are generally made for periods of 30 days or less and are at market rates. The fixed rate loan commitments have interest rates ranging from 3.50% to 7.25% and maturities ranging from 1 year to 15 years.

NOTE 15 - FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (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 values:

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.

99

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 15 - FAIR VALUE (Continued)

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 the fair value:

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

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

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

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

100

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 15 - FAIR VALUE (Continued)

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

			Fair Value Measurements Using:
	Assets at Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
			(in thousands)
Assets (December 31, 2012):
Available for sale securities:
State and municipal	$	84,437	$	-	$	84,378	$	59
U.S. Government sponsored entities and agencies		10,355		-		10,355		-
Residential mortgage-backed securities issued by U.S. Government sponsored entities		154,980		-		154,980		-
Collateralized debt obligations, including trust preferred securities		1,176		-		-		1,176
Mutual funds		257		-		257		-
Total available for sale securities	$	251,205	$	-	$	249,970	$	1,235
Assets (December 31, 2011):
Available for sale securities:
State and municipal	$	76,527	$	-	$	76,375	$	152
Residential mortgage-backed securities issued by U.S. Government sponsored entities		121,027		-		121,027		-
Collateralized debt obligations, including trust preferred securities		937		-		-		937
Mutual funds		255		-		255		-
Total available for sale securities	$	198,746	$	-	$	197,657	$	1,089

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

101

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 15 - FAIR VALUE (Continued)

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the period ended December 31:

	Collateralized Debt Obligations, Including Trust Preferred Securities						State and Municipal Securities
	2012			2011			2012			2011
	(in thousands)
Balance at January 1	$	937		$	1,359		$	152		$	-
Other-than-temporary impairment recognized in earnings		-			-			-			-
Net unrealized gain (loss) included in other comprehensive income		311			(422	)		-			-
Principal paydowns		(72	)		-			(93	)		-
Transfers into Level 3		-			-			-			152
Balance at December 31	$	1,176		$	937		$	59		$	152

The fair values of our collateralized debt obligations are determined by us utilizing an estimate of the expected cash flows based on our review of the underlying issuers’ financial condition and the anticipated deferral of payments and defaults of issuers. The fair values of our collateralized debt obligations are determined by the Company’s accounting department and reviewed by the Chief Financial Officer. We provide our estimate of default, prepayment, and recovery probability for each issuer 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 for each security. The discount rates were determined utilizing a risk free rate of three month LIBOR plus 300 bps (3.31% at December 31, 2012), plus a premium for market illiquidity, and a credit component based on the quality of the collateral and the deal structure.

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

102

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 15 - FAIR VALUE (Continued)

The following table presents quantitative information about recurring Level 3 fair value measurements for the Company’s collateralized debt obligations:

	Fair Value		Valuation Technique	Unobservable Input(s)	Range -  (Weighted Average)
	(in thousands)
Collateralized debt obligations	$	1,176	Discounted cash flow	Constant prepayment rate		0.00%-100.00% (19.07%)
				Collateral default rate		0.00%-100.00% (13.43%)
				Discount rate		10.62%-26.06% (20.66%)
				Recovery probability		0.00%–15.00% (13.93%)

The table below summarizes changes in unrealized gains and losses recorded in earnings for the year ended December 31 for level 3 assets that are still held at December 31:

	Changes in Unrealized Gains/Losses Relating to Assets Still Held at Reporting Date for the Year Ended December 31 Collateralized Debt Obligations, Including Trust Preferred Securities				Changes in Unrealized Gains/Losses Relating to Assets Still Held at Reporting Date for the Year Ended December 31 State and Municipal Securities
	2012		2011		2012		2011
	(in thousands)
Interest income on securities	$	111	$	58	$	4	$	9
Other changes in fair value		-		-		-		-
Total	$	111	$	58	$	4	$	9

103

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 15 - FAIR VALUE (Continued)

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

			Fair Value Measurements Using:
	Assets at Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
			(in thousands)
Assets (December 31, 2012):
Impaired loans:
Commercial	$	37	$	—	$	—	$	37
Construction		2,109		—		—		2,109
Commercial real estate:
Owner occupied nonfarm/residential		834		—		—		834
Other nonfarm/residential		7,214		—		—		7,214
Residential real estate:
Secured by first liens		1,914		—		—		1,914
Home equity		49		—		—		49
Foreclosed and repossessed assets:
Construction		2,545		—		—		2,545
Commercial real estate:
Owner occupied nonfarm/residential		383		—		—		383
Other nonfarm/residential		2,276		—		—		2,276
Residential real estate:
Secured by first liens		1,100		—		—		1,100
Consumer		41		—		—		41
Assets (December 31, 2011):
Impaired loans:
Commercial	$	872	$	—	$	—	$	872
Construction		6,248		—		—		6,248
Commercial real estate:
Owner occupied nonfarm/residential		8,096		—		—		8,096
Other nonfarm/residential		9,375		—		—		9,375
Residential real estate:
Secured by first liens		1,336		—		—		1,336
Home equity		23		—		—		23
Consumer		34		—		—		34
Foreclosed and repossessed assets:
Construction		2,118		—		—		2,118
Commercial real estate:
Owner occupied nonfarm/residential		1,865		—		—		1,865
Residential real estate:
Secured by first liens		1,092		—		—		1,092
Consumer		1		—		—		1

104

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 15 - FAIR VALUE (Continued)

The Company measures for impairment using the fair value of the collateral less costs to sell for collateral-dependent loans. The Company’s impaired loans totaled $28.6 million as of December 31, 2012, which included collateral-dependent loans with a carrying value of $15.2 million. As of December 31, 2012, the Company’s collateral dependent loans had a valuation allowance of $3.0 million, resulting in an additional provision for loan losses of $4.3 million during the twelve months ended December 31, 2012. The Company’s impaired loans totaled $37.7 million as of December 31, 2011, which included collateral-dependent loans with a carrying value of $29.4 million. As of December 31, 2011, the Company’s collateral dependent loans had a valuation allowance of $3.5 million, resulting in an additional provision for loan losses of $3.3 million during the twelve months ended December 31, 2011.

The Company evaluates the fair value of foreclosed assets at the time they are transferred from loans and on a quarterly basis thereafter. During the years ended December 31, 2012 and 2011, the Company recognized charges of $57,000 and $0 to write down foreclosed assets to their fair value.

105

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 15 - FAIR VALUE (Continued)

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2012.

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range - (Weighted Average)
	(in thousands)
Impaired Loans:
Commercial	$	37	Sales comparison approach	Adjustments for differences between comparable sales		0%
Construction		2,109	Sales comparison approach	Adjustments for differences between comparable sales		0%-24% (19%)
Commercial real estate		8,048	Income capitalization approach	Capitalization rate		12%-38% (32%)
			Sales comparison approach	Adjustments for differences between comparable sales		26%
Residential real estate		1,964	Sales comparison approach	Adjustments for differences between comparable sales		14%-52% (28%)
Foreclosed and repossessed assets:
Construction	$	2,545	Income capitalization approach	Capitalization rate		9%
			Sales comparison approach	Adjustments for differences between comparable sales		14%-78% (26%)
Commercial real estate		2,660	Sales comparison approach	Adjustments for differences between comparable sales		10%-60% (41%)
Residential real estate		1,100	Sales comparison approach	Adjustments for differences between comparable sales		0%-38% (22%)
Consumer		41	Sales comparison approach	Adjustments for differences between comparable sales		0%-4% (3%)

106

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 15 - FAIR VALUE (Continued)

Fair value of Financial Instruments

Carrying amount and estimated fair values of financial instruments, not previously presented, were as follows at year-end.

			2012
			Fair Value Measurements Using
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets:
Cash and due from financial institutions	$	19,039	$	19,039	$	—	$	—	$	19,039
Interest-bearing deposits in other financial institutions		32,305		32,305		—		—		32,305
Loans held for sale		1,225		—		1,237		—		1,237
Loans, net		456,827		—		—		470,927		470,927
Accrued interest receivable		3,014		—		1,102		1,912		3,014
Federal Home Loan Bank and Federal Reserve Stock		5,998		n/a		n/a		n/a		n/a
Financial liabilities:
Deposits		624,667		—		616,035		—		616,035
Other borrowings		45,500		—		45,495		—		45,495
Federal Home Loan Bank Advances		40,000		—		40,350		—		40,350
Subordinated debentures		17,000		—		—		9,997		9,997
Accrued interest payable		177		—		161		16		177

107

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 15 - FAIR VALUE (Continued)

	2011
	Carrying Amount		Fair Value
	(In thousands)
Financial assets
Cash and due from financial institutions	$	15,166	$	15,166
Interest-bearing deposits in other financial institutions		30,297		30,297
Loans held for sale		1,154		1,166
Loans, net of allowance for loan losses and impaired loans		460,302		472,612
Accrued interest receivable		3,196		3,196
Federal Home Loan Bank and Federal Reserve Stock		5,952		n/a
Financial liabilities
Deposits		581,358		569,892
Other borrowings		50,879		49,165
Federal Home Loan Bank Advances		55,000		55,825
Subordinated debentures		17,000		10,403
Accrued interest payable		329		329

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

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

(a) Cash and Cash Equivalents

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

(b) FHLB and FRB Stock

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

108

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 15 - FAIR VALUE (Continued)

(c) Loans

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

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

(e) Deposits

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

(f) Other Borrowings

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

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

(g) Accrued Interest Receivable/Payable

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

(i) Off-balance Sheet Instruments

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

109

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 16- PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION

Condensed financial information for Community Bank Shares of Indiana, Inc. is as follows:

CONDENSED BALANCE SHEETS

	December 31,
	2012		2011
	(In thousands)
ASSETS
Cash and due from financial institutions	$	292	$	2,944
Investment in subsidiaries		102,299		96,519
Other assets		2,157		1,372
Total assets	$	104,748	$	100,835
LIABILITIES AND SHAREHOLDERS’ EQUITY
Other borrowings	$	-	$	2,100
Subordinated debentures		17,000		17,000
Accrued expenses and other liabilities		1,306		2,250
Total liabilities		18,306		21,350
Total shareholders’ equity		86,442		79,485
	$	104,748	$	100,835

CONDENSED STATEMENTS OF OPERATIONS

	Years ended December 31,
	2012		2011		2010
Income	(In thousands)
Dividends from subsidiaries	$	4,500	$	5,000	$	-
Management fees from subsidiaries		4,816		4,647		4,465
		9,316		9,647		4,465
Expense
Operating expenses		7,097		6,638		6,258
Income before income taxes and equity   in undistributed net income of subsidiaries		2,219		3,009		(1,793	)
Income tax benefit		770		628		603
Income before equity in undistributed net   income of subsidiaries		2,989		3,637		(1,190	)
Equity in undistributed net income of subsidiaries		4,696		3,773		8,178
Net Income	$	7,685	$	7,410	$	6,988

110

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 16 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION (Continued)

CONDENSED STATEMENTS OF CASH FLOWS

	Years ended December 31,
	2012			2011			2010
	(In thousands)
Cash flows from operating activities
Net income (loss)	$	7,685		$	7,410		$	6,988
Adjustments to reconcile net income to net cash    from operating activities
Equity in undistributed net (income) loss of subsidiaries		(4,696	)		(3,773	)		(8,178	)
Share-based compensation expense		362			371			174
Net change in other assets and liabilities		(1,542	)		285			83
Net cash from operating activities		1,809			4,293			(933	)
Cash flows from investing activities
Investment in subsidiary		(250	)		(7,679	)		-
Net cash from investing activities		(250	)		(7,679	)		-
Cash flows from financing activities
Net change in short-term borrowings		(2,100	)		(1,700	)		(2,500	)
Repurchase of series A preferred stock		-			(19,468	)		-
Issuance of series B preferred stock		-			28,000
Repurchase of warrant		-			(1,101	)		-
Cash dividends paid on preferred shares		(978	)		(812	)		(974	)
Cash dividends paid on common shares		(1,133	)		(1,118	)		(1,110	)
Net cash from financing activities		(4,211	)		3,801			(4,584	)
Net change in cash		(2,652	)		415			(5,517	)
Cash at beginning of year		2,944			2,529			8,046
Cash at end of year	$	292		$	2,944		$	2,529

111

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 17 – EARNINGS PER SHARE

The factors used in the earnings per share computation follows.

	2012			2011			2010
	(In thousands, except share and per share amounts)
Basic
Net income	$	7,685		$	7,410		$	6,988
Preferred stock dividends and discount amortization		(764	)		(1,379	)		(1,065	)
Net Income per common share	$	6,921		$	6,031		$	5,923
Average shares:
Common shares outstanding		3,863,937			3,863,937			3,863,942
Less:  Treasury stock		(501,669	)		(548,007	)		(578,363	)
Average shares outstanding		3,362,268			3,315,930			3,285,579
Net income per common share, basic	$	2.06		$	1.82		$	1.80
Diluted
Net income available to common shareholders	$	6,921		$	6,031		$	5,923
Average shares:
Common shares outstanding for basic		3,362,268			3,315,930			3,285,579
Add:  Dilutive effects of outstanding warrant		-			57,802			51,385
Average shares and dilutive potential Common shares		3,362,268			3,373,732			3,336,964
Net income per common share, diluted	$	2.06		$	1.79		$	1.77

Stock options of 158,000, 193,000, and 193,000 common shares were excluded from 2012, 2011, and 2010 diluted earnings per share because they were anti-dilutive.

Deferred stock units of 0, 0, and 25,000 were excluded from 2012, 2011, and 2010 diluted earnings per share because all the conditions required for issuance at those dates had not been met.

Restricted share awards of 59,000, 45,000, and 17,000 common shares were excluded from 2012, 2011, and 2010 diluted earnings per share because all the condition required for issuance at those dates had not been met.

NOTE 18 – OTHER COMPREHENSIVE INCOME

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

	Balance at 12/31/11			Current Period  Change			Balance at 12/31/12
Unrealized gains on securities available for sale	$	3,173		$	834		$	4,007
Unrealized loss on pension benefits		(507	)		(27	)		(534	)
Total	$	2,666		$	807		$	3,473

112

COMMUNITY BANK SHARES OF INDIANA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2012, 2011 and 2010

NOTE 19 – QUARTERLY FINANCIAL DATA (UNAUDITED)

	Interest Income		Net Interest Income		Net Income		Earnings Per Share Basic Diluted
	(In thousands, except per share amounts)
2012
First quarter	$	8,423	$	7,317	$	1,835	$	0.48	$	0.48
Second quarter		8,370		7,267		1,954		0.51		0.51
Third quarter		8,144		7,144		1,941		0.53		0.53
Fourth quarter		7,889		7,068		1,955		0.54		0.54
2011
First quarter	$	8,712	$	6,981	$	1,788	$	0.46	$	0.44
Second quarter		8,617		7,051		1,855		0.48		0.46
Third quarter		8,424		6,988		1,877		0.40		0.38
Fourth quarter		8,488		7,253		1,890		0.48		0.48

113

Part II

Item 9. Changes In And Disagreements With Accountants On Accounting And Financial Disclosures

Not applicable.

Item 9A. Controls And Procedures

Company management, including the 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 the design and operation of our disclosure controls and procedures pursuant to Securities Exchange Act of 1934 Rule 13a-15. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the disclosure controls and procedures are effective in timely alerting them to material information required to be included in this report. There has been no change in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting.

114

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Community Bank Shares of Indiana’s (the Company’s) management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles and includes those policies and procedures that:

¨ Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the Company’s assets;

¨ Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

¨ Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Our management, including our principal executive officer and principal financial officer, assessed the effectiveness of our internal control over financial reporting as of the end of the fiscal year covered by this annual report on Form 10-K. In making this assessment, our management used the criteria set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our management’s assessment, management concluded that, as of December 31, 2012, our Company’s internal control over financial reporting is effective based on the COSO criteria.

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

/s/ James D. Rickard	/s/ Paul A. Chrisco
James D. Rickard	Paul A. Chrisco
President and Chief Executive Officer	Executive Vice President and
	Chief Financial Officer

115

Item 9B. Other Information

Not applicable.

Part III

Item 10. Directors, Executive Officers And Corporate Governance

The information regarding Company directors required by this item is incorporated herein by reference to information under the headings “Corporate Governance and Board Matters”, “Section 16(a) Beneficial Ownership Reporting Compliance” and “Proposal No. 2 – Election of Directors” in our definitive proxy statement, to be filed with the SEC, relating to our 2013 annual meeting of shareholders (“2013 Proxy Statement”) to be held on May 21, 2013. Information regarding the members of the Audit Committee, the Company’s code of business conduct and ethics, the identification of the Audit Committee Financial Expert and stockholder nominations of directors is also incorporated by reference to the information under the aforesaid headings. The information regarding our executive officers required by this item is incorporated by reference to the information under the heading “Executive Officers Who Are Not Directors” and the other headings listed above in the 2013 Proxy Statement.

Item 11. Executive Compensation

Information concerning executive compensation is incorporated herein by reference to the information under the heading “Executive Compensation” in the 2013 Proxy Statement.

Item 12. Security Ownership Of Certain Beneficial Owners And Management And Related Stockholder Matters

See Part II, Item 5, for information about securities authorized for issuance under the Company’s equity compensation plans. Information concerning security ownership of management is incorporated herein by reference to the information under the heading “Stock Ownership by Directors and Executive Officers” in the 2013 Proxy Statement.

Item 13. Certain Relationships And Related Transactions, And Director Independence

Information concerning relationships and related transactions, and director independence is incorporated herein by reference to the information under the headings "Compensation Committee Interlocks And Insider Participation”, “Corporate Governance And Board Matters” and “Certain Relationships and Related Person Transactions” in the 2013 Proxy Statement.

Item 14. Principal Accountant Fees And Services

Information concerning principal accountant fees and services is incorporated herein by reference to the information under the headings “Report of the Audit Committee,” Independent Registered Public Accounting Firm” and “Proposal No. 1 – Ratification of Independent Registered Public Accounting Firm” in the 2013 Proxy Statement.

116

Part IV

Item 15. Exhibits And Financial Statement Schedules

(a)(1) Financial Statements

The following financial statements are included in Item 8 of this Form 10-K:

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets

Consolidated Statements of Income

Consolidated Statements of Comprehensive Income

Consolidated Statements of Changes in Shareholders’ Equity

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

(a)(2) Financial Statement Schedules

All financial statement schedules have been omitted as the required information is inapplicable or the required information has been included in the Consolidated Financial Statements or notes thereto.

(a) (3) Exhibits

Reference is made to the Exhibit Index beginning on Page E-1 hereof.

117

Signatures

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	COMMUNITY BANK SHARES
	OF INDIANA, INC.
March 29, 2013	By:	/s/ James D. Rickard
	James D. Rickard
	President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

/s/ James D. Rickard	President, Chief Executive Officer, and Director	March 29, 2013
James D. Rickard	(Principal Executive Officer)
/s/ Paul A. Chrisco	Executive Vice-President and Chief Financial Officer	March 29, 2013
Paul A. Chrisco	(Principal Financial and Accounting Officer)
/s/ Gary L. Libs	Chairman of the Board of Directors and Director	March 29, 2013
Gary L. Libs
/s/ R. Wayne Estopinal	Director	March 29, 2013
R. Wayne Estopinal
/s/ George M. Ballard	Director	March 29, 2013
George M. Ballard
/s/ Kerry M. Stemler	Director	March 29, 2013
Kerry M. Stemler
/s/ Steven R. Stemler	Director	March 29, 2013
Steven R. Stemler
/s/ Norman E. Pfau Jr.	Director	March 29, 2013
Norman E. Pfau Jr.
/s/ Gerald T. Koetter	Director	March 29, 2013
Gerald T. Koetter

118

Exhibit Index

Exhibit		Filed with this	Incorporated By Reference
Number	Document	Form 10-K	Form	File No.	Date Filed
2.1	Agreement and Plan of Merger between Community Bank Shares of Indiana, Inc., The Bancshares, Inc., and CBIN Subsidiary, Inc.		8-K	000-25766	02/16/2006
3.1	Articles of Amendment to Amended and Restated Articles of Incorporation		8-K	000-25766	09/05/2011
3.1	Amended and Restated Articles of Incorporation		S-8	333-128278	09/13/2005
3.3	Bylaws		8-K	000-25766	07/27/2007
4.0	Warrant to Purchase Shares of Common Stock		8-K	000-25766	06/01/2009
4.1	Securities Purchase Agreement:  SBLF Preferred Shares		8-K	000-25766	09/16/2011
10.1	Employment Agreement James D. Rickard *		10-Q	000-25766	11/14/2000
10.2	Amendment to Employment Agreement with James D. Rickard *		8-K	000-25766	11/06/2006
10.3	Form of Letter Agreement Amendment to Employment Agreement with James D. Rickard, Michael K. Bauer, Kevin J. Cecil, Paul A. Chrisco and Bill D. Wright*		8-K	000-25766	06/01/2009
10.4	Employment Agreement with Michael K. Bauer*	X
10.5	Form of Letter Agreement Amendment to Employment Agreement with James D. Rickard, Michael K. Bauer, Kevin J. Cecil, Paul A. Chrisco and Bill D. Wright*	X
10.6	Employment Agreement with Kevin J. Cecil *		10-K	000-25766	03/31/2004
10.7	Amendment to Employment Agreement with Kevin J. Cecil *		8-K	000-25766	11/06/2006
10.8	Employment Agreement with Paul A. Chrisco *		10-K	000-25766	03/31/2004
10.9	Amendment to Employment Agreement with Paul A. Chrisco *		8-K	000-25766	11/06/2006
10.10	Employment Agreement with Bill D. Wright	X
10.11	Community Bank Shares of Indiana, Inc. 1997 Stock Incentive Plan *		S-8	333- 60089	07/29/1998
10.12	Community Bank Shares of Indiana, Inc. Dividend Reinvestment Plan *		S-3D S-3D	333-40211 333-130721	11/14/1997 12/28/2005
10.13	Community Bank Shares of Indiana, Inc. 2005 Stock Award Plan, as amended *		Exh. B to DEF 14A	000-25766	11/06/2006
10.14	Community Bank Shares of Indiana, Inc. Performance Units Plan, as amended *		8-K	000-25766	10/23/2006
10.15	Letter of agreement between Community Bank Shares of Indiana, Inc. and the United States Department of Treasury		8-K	000-25766	06/01/2009
10.16	Repurchase Letter of Agreement between Community Bank Shares of Indiana, Inc. and the United States Department of Treasury		8-K	000-25766	9/16/2011
10.17	Warrant Repurchase Agreement between Community Bank Shares of Indiana, Inc. and the United States Department of Treasury		8-K	000-25766	10/20/2011
11.1	Computation of Earnings Per Share	X
14.1	Community Bank Shares of Indiana, Inc. and Affiliates Business Ethics Policy		8-K	000-25766	04/30/2007
21.0	Subsidiaries of Registrant	X
23.1	Consent of Crowe Horwath LLP	X
31.1	Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350 (As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002)	X
31.2	Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350 (As Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002)	X
32.1	Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	X
32.2	Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	X

119

99.1	Certification of Principal Executive Officer and Principal Financial Officer pursuant to 31 CFR Part 30	X
101.INS**	XBRL Instance Document
101.SCH**	XBRL Taxonomy Extension Schema
101.CAL**	XBRL Taxonomy Extension Calculation Linkbase
101.DEF**	XBRL Taxonomy Extension Definition Linkbase
101.LAB**	XBRL Taxonomy Extension Label Linkbase
101.PRE**	XBRL Taxonomy Extension Presentation Linkbase

* Management contract or compensatory plan or arrangement.

** Pursuant to Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Annual Report on Form 10-K shall not be deemed to be “filed” for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Exchange Act of 1934, or otherwise subject to the liability of those sections, and shall not be deemed part of a registration statement, prospectus or other document filed under the Securities Act of 1933 or the Exchange Act of 1934, except as shall be expressly set forth by specific reference in such filings.

120