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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, 2015

OR

o 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

Your Community Bankshares, Inc.

(Exact Name of Registrant as Specified in its Charter)

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:

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 o  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 o  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 o

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 o

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. x

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.

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

As of June 30, 2015, the aggregate market value of the Registrant’s common stock held by non-affiliates of the Registrant was $134,747,190 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 8, 2016, there were issued and outstanding 5,453,021 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 17, 2016 are incorporated by reference into Items 10, 11, 12, 13 and 14 of Part III.

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Form 10-K

Index

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Part I

Item 1.  Business

General

Your Community Bankshares, Inc. (the “Company”) is a bank holding company headquartered in New Albany, Indiana. The Company’s wholly-owned banking subsidiary is Your Community Bank (“YCB”) (YCB is at times referred to as the “Bank”).  The Bank is a state-chartered commercial bank headquartered in New Albany, Indiana regulated by the Indiana Department of Financial Institutions, Federal Deposit Insurance Corporation (“FDIC”), and the Kentucky Department of Financial Institutions (with respect to its Kentucky branches).  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.

The Company has subordinated debentures issued through four trusts, Community Bank Shares (IN) Statutory Trust I and Trust II and First Federal Statutory Trust II and Trust III (“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 $1.6 billion, total deposits of $1.3 billion, and shareholders’ equity of $127.1 million as of December 31, 2015. 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 a well-capitalized, profitable and independent community bank that has a significant presence in its 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 and services 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.

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.

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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 the interest rate adjustment of two percentage points per year and six percentage points of 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 the margin.  The Company’s policy is to qualify borrowers for one-year ARM loans based on the maximum interest rate that may apply during the first five years after the date on which the first regular periodic payment will be due.

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.

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.

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The Company occasionally originates real estate loans with loan-to-value ratios in excess of 80%. For loans sold in 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 of more than 80%, the Company may require the loan to be covered by private mortgage insurance to cover the loan down to 80% loan-to-value. For example, a loan with a 90% loan-to-value ratio may be required to have private mortgage insurance for the amount greater than 80% loan-to-value, which in this case is 10%. The Company requires fire and casualty insurance and flood insurance, if applicable under Federal law, 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 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.

Portfolio mortgage loans, as well as 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 mortgage loans is to make certain the loan complies with the Ability to Repay rules under the Truth in Lending Act as amended under the Dodd Frank Act.  These loans require credit reports, appraisals, and proof of a borrower’s ability to repay the loan before they are approved or denied.

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.

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.

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Employees

As of December 31, 2015, the Company employed 350 employees, 339 full-time and 11 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 Fayette, Jefferson, Hardin, Bullitt, Meade and Nelson counties in Kentucky.  Floyd, Clark, Jefferson and Nelson counties are four of the thirteen counties comprising the Louisville, Kentucky Standard Metropolitan Statistical Area, which has a population in excess of 1.2 million.

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. 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, if the activities are so closely related to banking or managing or controlling banks as to be a proper incident thereto as determined by the Federal Reserve Board.  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 and its subsidiaries.

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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 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;

·                  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.

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 that are financial in nature, incidental to financial activity, or complementary to financial activity that does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally.  These activities include underwriting securities, 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 a state-chartered commercial bank, the Company’s subsidiary bank is subject to examination, supervision and extensive regulation by the FDIC, the Indiana Department of Financial Institutions (“DFI”), and, with respect to YCB’s branch offices located in Kentucky, the Kentucky Department of Financial institutions (“KDFI).  The Bank is a member of and owns stock in the Federal Home Loan Bank (“FHLB”) of Indianapolis. The FHLB institutions located in Indianapolis and Cincinnati are two of the twelve regional banks in the FHLB system. The Bank is 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 Bank is subject is intended primarily for the protection of the Company’s customers and depositors, and not its shareholders.

The FDIC and DFI regularly examine the Bank and prepare reports for the consideration of the Bank’s Board of Directors on any deficiencies that they may find in the Bank’s operations. The relationship of the Bank with its 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 Bank’s mortgage documents and communication of loan and deposit rates to both existing and prospective customers.

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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 Bank 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 Bank’s unimpaired capital and surplus. 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 holder of greater than ten percent of a bank’s stock, and certain of their affiliated interests, 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. As of December 31, 2015, the Bank was in compliance with these 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 internal control, 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.

Capital and Liquidity Requirements. Bank holding companies are required to comply with the Federal Reserve’s risk-based capital guidelines. The Federal Deposit Insurance Corporation (“FDIC”) has adopted risk-based capital ratio guidelines to which depository institutions under their supervision, including YCB, are subject. The guidelines establish a systematic analytical framework that makes regulatory capital requirements more sensitive to differences in risk profiles among banking organizations. Risk-based capital ratios are determined by allocating assets and specified off-balance sheet commitments to four risk-weighted categories, with higher levels of capital being required for the categories perceived as representing greater risk. YCB exceeded all risk-based minimum capital requirements of the FDIC as of December 31, 2015. For YCB’s regulatory capital ratios and regulatory requirements as of December 31, 2015 and 2014, see Note 14 to the consolidated financial statements.

The federal regulatory authorities’ current risk-based capital guidelines are supervisory policies issued by the Basel Committee on Banking Supervision. The Basel Committee is a committee of central banks and bank regulators from the major industrialized countries that develops broad policy guidelines for use by a country’s regulators in determining appropriate supervisory policies. In December 2010 and January 2011, the Basel Committee published the final texts of reforms on capital and liquidity supervisory policies generally referred to as “Basel III.”

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On July 2, 2013, the Federal Reserve approved final rules known as the “Basel III Capital Rules” substantially revising the risk-based capital and leverage capital requirements applicable to bank holding companies and depository institutions, including the Company and YCB.  The Basel III Capital Rules address the components of capital and other issues affecting the numerator in banking institutions’ regulatory capital ratios. Basel III Capital Rules also implemented the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal banking agencies’ rules.  Certain of the Basel III Capital Rules came into effect for the Company and YCB on January 1, 2015; these rules are subject to a phase-in period which began on January 1, 2015.

The Basel III Capital Rules introduced a new capital measure “Common Equity Tier 1” (“CET1”). The rules specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements. CET1 capital consists of common stock instruments that meet the eligibility criteria in the final rules, retained earnings, accumulated other comprehensive income and common equity Tier 1 minority interest.  The rules also define CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1, and not to the other components of capital. They also expand the scope of the adjustments as compared to existing regulations.

When fully phased-in on January 1, 2019, the Basel III Capital Rules will require banking organizations to maintain:

The Basel III Capital Rules also provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and is not expected to have any current applicability to the Company or YCB.

The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer will face limitations on the payment of dividends, common stock repurchases and discretionary cash payments to executive officers based on the amount of the shortfall.

The Basel III Capital Rules provides for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1.  Under the Basel III Capital Rules, the Company and YCB were given a one-time election (“Opt-out Election”) to filter certain accumulated other comprehensive income (“AOCI”) components, comparable to the treatment under the current general risk-based capital rule. The Company and YCB elected to choose the AOCI Opt-out Election.

Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and will be phased-in over a five-year period (20% per year). The implementation of the capital conservation buffer will begin on January 1, 2016 at the 0.625% level and be phased-in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).

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In addition, the Basel III Capital Rules revise the rules for calculating risk-weighted assets to enhance their risk sensitivity. They establish a new framework under which mortgage-backed securities and other securitization exposures will be subject to risk-weights ranging from 20% to 1,250%. The rules also establish adjusted risk-weights for credit exposures, including multi-family and commercial real estate exposures that are 90 days or more past due or on non-accrual, which will be subject to a 150% risk-weight, except in situations where qualifying collateral and/or guarantees are in place. The existing treatment of residential mortgage exposures will remain subject to either a 50% risk-weight (for prudently underwritten owner-occupied first liens that are current or less than 90 days past due) or a 100% risk-weight (for all other residential mortgage exposures including 90 days or more past due exposures).

Management believes that, as of December 31, 2015, the Company and YCB would meet all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis if such requirements were currently effective. Requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely impact the Company’s net income.

Prompt Corrective Action Regulations. The Basel III Capital Rules revised the “prompt corrective action” regulations pursuant to Section 38 of The Federal Deposit Insurance Act (the “FDIA”), by:

The FDIA generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be “undercapitalized.” “Undercapitalized” institutions are subject to growth limitations and are required to submit a capital restoration plan. The agencies may not accept such a plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. In addition, for a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with such capital restoration plan. The bank holding company must also provide appropriate assurances of performance. The aggregate liability of the parent holding company is limited to the lesser of (i) an amount equal to 5.0% of the depository institution’s total assets at the time it became undercapitalized and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.”

Significantly undercapitalized” depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator.

Management believes that, as of December 31, 2015, YCB was “well capitalized” based on the aforementioned existing ratios and the ratios as modified by the Basel III Capital Rules.

Federal Home Loan Bank System. The Bank is a member 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 a member of the FHLB system, the Bank is 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, 2015, $3.9 million of FHLB stock was outstanding for the Bank, which complied with this requirement. In past years, the Bank has received dividends on its FHLB stock.

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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

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.

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 Temporary Liquidity Guarantee Program) 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, non-personal time deposits, and Eurocurrency liabilities.  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.

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 7.0 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.

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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.

Volcker Rule.  The final rules adopted on December 10, 2013, to implement a part of the Dodd-Frank Act commonly referred to as the “Volcker Rule”, would prohibit insured depository institutions and companies affiliated with insured depository institutions (“banking entities”) from engaging in short-term proprietary trading of certain securities, derivatives, commodity futures and options on these instruments, for their own account.  The final rules also impose limits on banking entities’ investments in, and other relationships with, hedge funds or private equity funds.  These rules will become effective on April 1, 2014.  Certain collateralized debt obligations (“CDOs”), securities backed by trust preferred securities which were initially defined as covered funds subject to the investment prohibitions, have been exempted to address the concern that many community banks holding such CDOs securities may have been required to recognize significant losses on those securities.

Like the Dodd-Frank Act, the final rules provide exemptions for certain activities, including market making, underwriting, risk mitigating hedging, trading in government obligations, certain insurance company activities, and organizing and offering hedge funds or private equity funds.  The final rules also clarify that certain activities are not prohibited, including acting as agent, broker, or custodian.

The compliance requirements under the final rules vary based on the size of the banking entity and the scope of activities conducted.  Banking entities with significant trading operations will be required to establish a detailed compliance program and their CEOs will be required to attest that the program is reasonably designed to achieve compliance with the final rule.  Independent testing and analysis of an institution’s compliance program are also required.  The final rules reduce the burden on smaller, less-complex institutions by limiting their compliance and reporting requirements.  A banking entity that does not engage in covered trading activities will not need to establish a compliance program.  As the Company and the Bank held no investment positions at December 31, 2015 that were subject to the final rule these new rules may require us to conduct certain internal analysis and reporting, we believe that they will not require any material changes in our operations or business.

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 its SEC reports available through its website, www.yourcommunitybank.com.

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, the terms “we”, “us” and “our” refer to Your Community Bankshares, Inc., an Indiana corporation and its subsidiaries (unless the context clearly implies otherwise).

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Industry Risk Factors

Economic Conditions.  The Company’s success depends, to a certain extent, upon economic or political conditions, local and national, as well as governmental monetary policies. Conditions such as recession, unemployment, changes in interest rates, inflation, money supply and other factors beyond the Company’s control may adversely affect its asset quality, deposit levels and loan demand and, therefore, our earnings. Because the Company has a significant amount of commercial real estate loans, decreases in real estate values could adversely affect the value of property used as collateral. Adverse changes in the economy may also have a negative effect on the ability of the Company’s borrowers to make timely repayments of their loans, which would have an adverse impact on the Company’s earnings. In addition, substantially all of the Company’s loans are to individuals and businesses in our market area. Consequently, any economic decline in the Company’s primary market areas, which include southern Indiana and Elizabethtown, Louisville and Lexington, Kentucky, could have an adverse impact on the Company’s earnings.

Enactment of Dodd-Frank and the promulgation of regulations thereunder could significantly increase our compliance and operating costs or otherwise have a material and adverse effect on our 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 affecting our business 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) enhanced financial institution safety and soundness regulations, including increases in assessment fees and deposit insurance coverage; and (iii) the establishment of new regulatory bodies, such as the Consumer Financial Protection Bureau.  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.

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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 and can access loans through lending groups and other non-regulated entities. This “disintermediation” could result in the loss of fee and interest 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 the Louisville, Kentucky metropolitan statistical area. 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.

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 Dodd-Frank, 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 higher FDIC premiums.  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.

Company Risk Factors

Our allowance for loan losses may not be adequate to cover actual losses.  We maintain an allowance for loan losses which is established through a provision for loan losses based on management’s evaluation of the risks inherent in our loan portfolio and the general economy. The allowance is based upon a number of factors, including the size of the loan portfolio, asset classifications, economic trends, industry experience and trends, industry and geographic concentrations, estimated collateral values, management’s assessment of the credit risk inherent in the portfolio, historical loan loss experience and loan underwriting policies. In addition, we evaluate all loans identified as problem loans and augment the allowance based upon our estimation of the loss associated with those problem loans.  Additions to our allowance for loan losses decrease our net income.

Our estimates are subjective, and their accuracy depends on the outcome of future events. Changes in economic, operating, and other conditions that are generally beyond our control could cause actual loan losses to increase significantly. In addition, bank regulatory agencies, as an integral part of their supervisory functions, periodically review the adequacy of our allowance for loan losses. Regulatory agencies may from time to time require us to increase our provision for loan losses or to recognize additional loan charge-offs when their judgment has differed from ours.  Any of these events could have a material negative impact on our operating results.

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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 shareholders 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.

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 Elizabethtown, Lexington, Louisville and Bardstown, Kentucky. If real estate values, including values of land held for development, 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 often depend on the successful operation or management of the properties, as well as the business and financial condition of the borrower, adverse conditions in the real estate market, adverse economic conditions or changes in applicable government regulations all could adversely affect repayment of our commercial real estate loans.

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. Construction loans generally carry a higher degree of risk than long-term financing of existing properties because repayment depends on the ultimate completion of the project and often on the sale of the property. If we are forced to foreclose on a project prior to its completion, we may not be able to recover the entire unpaid portion of the loan or we may be required to fund additional money to complete the project, or hold the property for an indeterminate period of time.  During an economic downturn, declines in real estate values coupled with 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.

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.

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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 fraudulent electronic 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.

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.

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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.

The required accounting treatment of purchased credit-impaired (PCI) loans we acquired through business combinations and FDIC-assisted transactions could result in higher net interest margins and interest income in current periods and lower net interest margins and interest income in future periods.  Under U.S. GAAP, we record loans acquired at a discount (that is due, in part, to credit,) at fair value which may underestimate the actual performance of such loans.  As a result, if these loans outperform our original fair value estimates, the difference between our original estimate and the actual performance of the loan (the “discount”) is accreted into net interest income. Thus, our net interest margins may initially appear higher.  We expect the yields on our loans to decline as our acquired loan portfolio pays down or matures and we expect downward pressure on our interest income to the extent that the runoff on our acquired loan portfolio is not replaced with comparable high-yielding loans. This could result in higher net interest margins and interest income in current periods and lower net interest rate margin and lower interest income in future periods.

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 for talent in most activities in which we engage can be intense. We may not be able to hire the best people or to keep them.

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, corporate bonds, mutual funds, and U.S. Government sponsored entities and agencies.  We must evaluate these securities for other-than-temporary impairment loss (“OTTI”) on a periodic basis.  We may need to record OTTI charges in our investments in the future should the issuers of those securities experience financial difficulties.  Any future OTTI charges could significantly impact our earnings.

Significant legal actions could subject us to substantial uninsured liabilities.  From time to time we are 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.

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 shares are listed on the Nasdaq Capital Market under the symbol “YCB”, trading activity in our shares 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.

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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 and CBIN Insurance, Inc.  We do not have any significant assets other than cash and the stock of YCB 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, 2015, our subsidiaries did not have the ability to pay us dividends without prior regulatory approval.

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 2015 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 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:

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.

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.

Item 1B.  Unresolved Staff Comments

Not applicable.

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Item 2.  Properties

The Company conducts its business through its corporate headquarters located in New Albany, Indiana.  The Bank operates a main office and 13 branch offices in Clark, Floyd, Scott Counties, Indiana, and 22 branch offices in Bullitt, Fayette, Hardin, Hart, Jefferson, Meade, and Nelson Counties, Kentucky.  The following table sets forth certain information concerning the main offices and each branch office at December 31, 2015. The Company’s aggregate net book value of premises and equipment was $33.3 million at December 31, 2015.

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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.

Item 4.  Mine Safety Disclosures

Not applicable.

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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 “YCB”.  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.

Holders

As of March 8, 2016 there were 1,087 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 it will continue to pay dividends in the future.  The future payment of dividends depends on future income, financial position, capital requirements, the discretion and judgment of the Board of Directors, and other considerations.  In addition, our ability to pay dividends is subject to the regulatory restrictions described in Note 14 to the Company’s consolidated financial statements.

EQUITY PLAN INFORMATION

The following table provides information about our equity compensation plans as of December 31, 2015.

(1) Of the shares reflected, 239,759 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.

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Performance Graph

The graph compares the performance of Your Community Bank Shares, Inc. common stock to the Russell 2000 index and the SNL Bank $1B - $5B 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, 2010 and that all dividends were reinvested.

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Item 6.  Selected Financial Data

The following table sets forth the Company’s selected historical consolidated financial information from 2011 through 2015.  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 35% was used in adjusting interest on tax-exempt assets to a fully taxable equivalent basis.

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(1)         Applicable under Basel III for 2015 only

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 subsidiary at December 31, 2015 and 2014, and the consolidated results of operations for each of the years in the three year period ended December 31, 2015.  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 Bank, which is a community-oriented financial institution offering a variety of financial services to its local communities.  The Bank is 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 Bank originates and sells into the secondary market mortgage loans for the purchase of single-family homes in Floyd, Clark, and Scott Counties, Indiana, and Bullitt, Fayette, Hardin, Hart, Jefferson, Meade, and Nelson Counties, Kentucky, including surrounding communities.  The Bank invests 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 Bank’s net interest income, which is the difference between interest earned on interest-earning assets and interest paid 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 of Indianapolis and Cincinnati, holding company debt from another financial institution, and subordinated debentures.  The Bank’s earnings 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.

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In addition to risks identified by the Company under “Risk Factors” and elsewhere in this Annual Report on Form 10-K, the following factors, among other things, 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 Bank operate, 2) adverse changes in the legislative and regulatory environment affecting the Company and its subsidiary Bank, 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.  The Company does not assume any obligation to update or revise any forward-looking statements after the date on which they are made unless required by law.

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, carrying value of foreclosed and repossessed assets 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 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 individual 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.

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 from those used in prior periods that have impacted the determination of the current period allowance.

Based on the procedures discussed above, management is of the opinion that the allowance of $6.9 million was adequate to address probable incurred credit losses associated with the loan portfolio at December 31, 2015.

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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, 2015, the Company had foreclosed and repossessed assets of $10.0 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 $14.4 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 must establish a valuation allowance to reduce its carrying amount to the amount it expects to be realized.  At December 31, 2015, a valuation allowance of $927,000 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.  The Company is uncertain if it will be able to utilize this benefit, thus a valuation allowance has been established against the state net operating loss.  Additionally, the Company acquired net operating losses for federal taxes as part of its acquisition of First Financial Service Corporation (“First Financial”) that were incurred from 2011 through 2015 and generated a net operating loss for federal income taxes of $6.0 million during 2015.  Note 13 to the Consolidated Financial Statements describes the net deferred tax asset.  The Company has been profitable from 2010 through 2015 and has a positive earnings outlook for 2016.  The net loss for 2015 was primarily attributable to elevated expenses associated with the acquisition of First Financial that will not be repeated in 2016.

Highlights

The Company had net income available to common shareholders of $10.0 million for the year ended December 31, 2015 compared to $8.6 million for 2014.  The increase in earnings in 2015 was attributable to increases in net interest income and non-interest income of $22.4 million and $4.9 million, respectively, and a decrease in income tax expense of $476,000 offset by an increase in provision for loans losses of $1.3 million and in non-interest expense of $26.4 million.  Earnings per basic and diluted common shares decreased to $1.85 and $1.82, respectively, for the year ended December 31, 2015 compared to basic and diluted earnings per common share of $2.49 and $2.46, respectively, in 2014.  The Company’s book value per common share increased to $23.41 per share at December 31, 2015 from $20.75 at December 31, 2014.

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

Table 1 — Summary

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The Company’s total assets increased to $1.6 billion at December 31, 2015 from $888.7 million at December 31, 2014 due to the acquisition of First Financial on January 1, 2015.  Most asset categories were impacted by the acquisition, including net loans which increased $412.4 million, securities available for sale which increased $176.8 million, net premises and equipment which increased $15.1 million, other assets which increased $22.2 million, and company owned life insurance which increased $11.1 million, offset by a decrease in deposit for partial redemption of preferred stock and unpaid dividends of $11.3 million.  In connection with the acquisition, the Company recorded goodwill of $4.9 million after determining the fair value of assets acquired and liabilities assumed.  See footnote 2 to the consolidated financial statements for further information on the acquisition of First Financial.

Total liabilities increased to $1.4 billion at December 31, 2015 from $789.2 million at December 31, 2014.  Total deposits increased by $611.1 million to $1.3 billion at December 31, 201, primarily due to the deposits assumed in the First Financial transaction, which had a fair value of $704.8 million.  Excluding the assumption of First Financial’s deposits, total deposits decreased by $93.7 million as the Company repriced the higher yield deposits assumed from First Financial, which lead to deposit run-off.  Also contributing to the increase in total liabilities was an increase in other borrowings to $108.3 million at December 31, 2015 from $67.0 million as of December 31, 2014.  The increase was due to the assumption of subordinated debentures with a fair value of $28.8 million from First Financial as well as the issuance of $25.0 million of subordinated debt during 2015.  Total shareholders’ equity increased by $27.5 million to $127.1 million at December 31, 2015.  The increase was a result of stock issued to the former shareholders of First Financial as well as the proceeds from the sale of stock to support the acquisition of First Financial.  Total shareholders’ equity was also impacted by net income available to common shareholders of $10.0 million, redemption of $28.0 million of preferred stock, and dividends on common shares of $2.6 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.

Net interest income for the year ended December 31, 2015 increased $22.4 million to $54.7 million while the net interest margin on a taxable equivalent basis decreased to 3.98% for 2015 from 4.25% in 2014.  The increase in net interest income was due to average earning assets increasing to $1.4 billion in 2015 from $797.3 million as a result of the First Financial acquisition.  The average balances for most earning assets and interest-bearing liabilities increased from the same period in 2014 due to the aforementioned acquisition.

The average balance of interest-bearing assets increased to $1.4 billion with an average yield of 4.34% in 2015 compared to $797.3 million and 4.49% in 2014.  The decline in yield on earning assets on a fully taxable equivalent basis was due to a shift in the Company’s earning asset mix to interest-bearing deposits in other financial institutions with an average balance of $38.0 million and yield of 0.42% in 2015 compared to $11.7 million and 0.51% in 2014, respectively, and taxable securities with an average balance of $288.1 million and yield of 1.79% in 2015 compared to $115.1 million and 1.79% in 2014.  The acquisition of First Financial  increased the Company’s liquidity while the acquisition of Kentucky municipal deposits required the Company to carry higher levels of securities to pledge.  A decline in the tax equivalent yield on tax-exempt securities to 5.41% in 2015 from 5.57% in 2014 also impacted the yield on interest-earning assets.  The yield continues to be affected by the current interest rate environment as maturities and repayments are replaced with lower yielding investments.  Offsetting the increase in lower-yielding assets was an increase in the Company’s loan yield to 5.10% for the year ended December 31, 2015 from 4.96% in 2014.  Although the Company’s loan portfolio is experiencing the same interest rate pressure, the yield was bolstered by accretion income of $3.2 million on acquired loans in 2015 compared to $1.0 million in 2014.

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The average balance of interest-bearing liabilities increased to $1.2 billion with an average cost of 0.44% in 2015 compared to $574.6 million and 0.34% in 2014.  The increase in the average balance and cost between the periods was due to the assumption of First Financial’s liabilities, which generally were higher costing compared to the legacy deposits of the Company.  Offsetting the higher contractual rates of liabilities assumed was accretion of $2.2 million recognized in 2015 compared to $0 in 2014 for time deposits and other borrowings.  The increase in the cost of interest-bearing liabilities was primarily driven by the increase in cost of the Company’s other borrowings, which include subordinated debentures, FHLB advances, subordinated debt, and a term loan at the holding company.  The average balance of other borrowings increased to $88.4 million with an average cost of 3.05% in 2015 from an average balance of $63.5 million and 1.29% in 2014 due to the assumption of $18.5 million of subordinated debentures of First Financial and the issuance of $25.0 million of subordinated debt by YCB during 2015.  In the acquisition of First Financial, the Company assumed $18.5 million of subordinated debentures with a weighted average contractual cost of 7.27% while issuing $25.0 million of subordinated debt with a rate of 6.25% in the fourth quarter of 2015.  The proceeds from the subordinated debt placement were utilized to redeem preferred shares issued to the U.S. Department of Treasury under its Small Business Lending Program.

For the year ended December 31, 2014, net interest income increased $1.3 million, to $32.3 million while the net interest margin on a taxable equivalent basis increased to 4.25% for 2014 from 4.24% in 2013.  The increase in net interest income from 2013 to 2014 was primarily due to an increase in the average balance of loans to $584.1 million in 2014 from $524.8 million in 2013.  The increase in net interest margin was due to a decline in average cost of interest bearing liabilities to 0.34% in 2014 from 0.39%.  The decrease in the cost of interest bearing liabilities was partially offset by a decrease in the yield on interest earning assets of 4 basis points attributable to the decline in the yield on the Company’s investment securities and loan portfolio during 2014.

Average interest earning assets increased to $797.3 million in 2014, from $768.5 million in 2013, primarily due to an increase in average total loans while the while the yield declined to 4.96 % from 5.22% over the same period.  The decline in loan yield was due to rate pressure from the maturity and repricing of existing loans in the portfolio.  Additionally, the markets in which the Company competes remain competitive for high quality loans which also places downward pressure on the yield of the loan portfolio.  Loan growth has offset the decline in average yield as the Company has experienced loan growth in its Lexington market through the addition of new lenders.  Also, the yield on loans was positively impacted by an increase in accretion income recognized of $1.0 million in 2014 compared to $623,000 in 2013.  Accretion income was impacted significantly in 2014 by the refinancing of one credit relationship at another financial institution for which the Company had an unamortized discount of $695,000.  The Company’s average balance in tax-exempt securities increased from $79.6 million to $80.5 million in 2014, while the yield on a fully taxable equivalent basis declined from 5.77% in 2013 to 5.57% in 2014.  The average balance in taxable securities decreased by $27.6 million to $115.1 million in 2014 while the yield on taxable securities increased to 1.79% in 2014 from 1.74% in 2013.  The decrease in the yield on tax-exempt and taxable securities was due to additional purchases of municipal securities and sales and maturities of higher-yielding mortgage-backed securities during 2014.

Average interest bearing liabilities increased to $574.6 million for 2014 from $569.3 million in 2013 with average costs decreasing to 0.34% from 0.39% over the same periods. The decrease in average balance and cost in 2014 was the result of a decline all categories, most significantly in time deposits and other borrowings.  The Company has maintained a strong liquidity position, including securities available-for-sale, which has allowed management to reprice deposits at lower rates at maturity.  As a result, time deposits decreased to an average balance of $141.2 million with an average cost of 0.29% in 2013 from $161.9 million with an average cost of 0.38% in 2013.  Also contributing to the decline in the average cost of funds was a decline in the cost of other borrowings from 1.82% in 2013 to 1.29%.  Other borrowings primarily consist of FHLB advances which the Company has continued to reduce due to its liquidity position and also lower the average cost.  In addition, non-interest bearing deposits increased to an average balance of $188.9 million in 2014 from $172.7 million in 2013 which also improved the Company’s net interest margin.

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Table 2 provides detailed information as to average balances, interest income/expense, and rates by major balance sheet category for 2013 through 2015.

Table 2 - Average Balance Sheets and Rates for Years Ended 2015, 2014 and 2013

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 35% was used in adjusting interest on tax-exempt assets to a fully taxable equivalent basis.