UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549


_______________________________





FORM
10-Q





Q          QUARTERLY REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE SECURITIES


EXCHANGE ACT OF 1934





For the
Quarterly Period Ended March 31, 2009





OR





£           TRANSITION REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE SECURITIES


EXCHANGE ACT OF 1934





For the
transition period from ________ to ________





Commission
file number 0-22345





SHORE BANCSHARES,
INC.


(Exact
name of registrant as specified in its charter)





Maryland
            
            52-1974638(State or Other Jurisdiction of
            
            (I.R.S. EmployerIncorporation or Organization)
            
            Identification No.)





18 East Dover Street, Easton, Maryland
              
              21601(Address of Principal Executive Offices)
              
              (Zip Code)





(410)
822-1400


Registrant’s
Telephone Number, Including Area Code





N/A


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





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





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).  Yes £ No £ (Not
Applicable)





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





Large accelerated filer
                  £
                  Accelerated filer
                  RNon-accelerated filer
                  £
                  Smaller reporting company
                  £(Do not check if a smaller reporting company)





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





APPLICABLE
ONLY TO CORPORATE ISSUERS





Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date:  8,404,709 shares of common
stock outstanding as of April 30, 2009.







INDEX





PagePart
      I. Financial Information
                                                      2Item
      1.  Financial Statements
                                                      2Consolidated
      Balance Sheets - March 31, 2009 (unaudited) and December 31,
      2008
                                                      2Consolidated
      Statements of Income - For the three months ended March 31, 2009 and 2008
      (unaudited)
                                                      3Consolidated
      Statements of Changes in Stockholders’ Equity -
                                                        For
      the three months ended March 31, 2009 and 2008 (unaudited)
                                                      4Consolidated
      Statements of Cash Flows - For the three months ended March 31, 2009 and
      2008 (unaudited)
                                                      5Notes
      to Consolidated Financial Statements (unaudited)
                                                      6Item
      2.  Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
                                                      12Item
      3.  Quantitative and Qualitative Disclosures about Market
      Risk
                                                      20Item
      4.  Controls and Procedures
                                                      20Part
      II.  Other Information
                                                      20Item
      1A.  Risk Factors
                                                      20Item
      6.  Exhibits
                                                      20Signatures
                                                      21Exhibit
      Index
                                                      22




1




PART
I – FINANCIAL INFORMATION


Item
1.  Financial Statements.


SHORE
BANCSHARES, INC.


CONSOLIDATED
BALANCE SHEETS


(Dollars
in thousands, except per share amounts)





March
      31,
                    
                    
                    December
      31,2009
                    
                    
                    2008(Unaudited)ASSETSCash
      and due from banks
                    
                    $
                    17,765
                    
                    
                    $
                    16,803Interest
      bearing deposits with other banks
                    
                    
                    6,838
                    
                    
                    
                    481Federal
      funds sold
                    
                    
                    24,496
                    
                    
                    
                    10,010Investment
      securities:Available
      for sale, at fair value
                    
                    
                    70,137
                    
                    
                    
                    79,204Held-to-maturity,
      at amortized cost – fair value of $8,951 (2009) and $10,390
      (2008)
                    
                    
                    8,816
                    
                    
                    
                    10,252Loans
                    
                    
                    908,118
                    
                    
                    
                    888,528Less:  allowance
      for credit losses
                    
                    
                    (9,686
                    )
                    
                    
                    (9,320
                    )Loans,
      net
                    
                    
                    898,432
                    
                    
                    
                    879,208Insurance
      premiums receivable
                    
                    
                    1,332
                    
                    
                    
                    1,348Premises
      and equipment, net
                    
                    
                    13,941
                    
                    
                    
                    13,855Accrued
      interest receivable
                    
                    
                    4,672
                    
                    
                    
                    4,606Goodwill
                    
                    
                    15,954
                    
                    
                    
                    15,954Other
      intangible assets, net
                    
                    
                    5,792
                    
                    
                    
                    5,921Deferred
      income taxes
                    
                    
                    1,982
                    
                    
                    
                    1,579Other
      real estate owned
                    
                    
                    1,463
                    
                    
                    
                    148Other
      assets
                    
                    
                    4,979
                    
                    
                    
                    5,272TOTAL
      ASSETS
                    
                    $
                    1,076,599
                    
                    
                    $
                    1,044,641LIABILITIESDeposits:Noninterest
      bearing demand
                    
                    $
                    108,017
                    
                    
                    $
                    102,584Interest
      bearing demand
                    
                    
                    125,136
                    
                    
                    
                    125,370Money
      market and savings
                    
                    
                    157,086
                    
                    
                    
                    150,958Certificates
      of deposit $100,000 or more
                    
                    
                    245,553
                    
                    
                    
                    235,235Other
      time
                    
                    
                    237,297
                    
                    
                    
                    231,224Total
      deposits
                    
                    
                    873,089
                    
                    
                    
                    845,371Accrued
      interest payable
                    
                    
                    2,304
                    
                    
                    
                    2,350Short-term
      borrowings
                    
                    
                    31,057
                    
                    
                    
                    52,969Long-term
      debt
                    
                    
                    7,947
                    
                    
                    
                    7,947Other
      liabilities
                    
                    
                    8,756
                    
                    
                    
                    8,619TOTAL
      LIABILITIES
                    
                    
                    923,153
                    
                    
                    
                    917,256STOCKHOLDERS’
      EQUITYPreferred
      stock, par value $0.01 (liquidation preference of $1,000 per share);
      shares authorized - 25,000 (2009) and 0 (2008); shares issued and
      outstanding – 25,000 (2009) and 0 (2008); net of discount - $1,486 (2009)
      and $0 (2008)
                    
                    
                    23,514
                    
                    
                    
                    -Common
      stock, par value $.01; shares authorized – 35,000,000; shares issued and
      outstanding – 8,404,709 (2009) and 8,404,684 (2008)
                    
                    
                    84
                    
                    
                    
                    84Warrants
                    
                    
                    1,543
                    
                    
                    
                    -Additional
      paid in capital
                    
                    
                    29,790
                    
                    
                    
                    29,768Retained
      earnings
                    
                    
                    97,492
                    
                    
                    
                    96,140Accumulated
      other comprehensive income
                    
                    
                    1,023
                    
                    
                    
                    1,393TOTAL
      STOCKHOLDERS’ EQUITY
                    
                    
                    153,446
                    
                    
                    
                    127,385TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
                    
                    $
                    1,076,599
                    
                    
                    $
                    1,044,641





See
accompanying notes to Consolidated Financial Statements.





2




SHORE
BANCSHARES, INC.


CONSOLIDATED
STATEMENTS OF INCOME (Unaudited)


(Dollars
in thousands, except per share amounts)





For
      the Three Months EndedMarch
      31,2009
                
                
                2008INTEREST
      INCOMEInterest
      and fees on loans
                
                $
                13,617
                
                
                $
                14,560Interest
      and dividends on investment securities:Taxable
                
                
                756
                
                
                
                1,080Tax-exempt
                
                
                85
                
                
                
                123Interest
      on federal funds sold
                
                
                7
                
                
                
                122Interest
      on deposits with other banks
                
                
                1
                
                
                
                38Total
      interest income
                
                
                14,466
                
                
                
                15,923INTEREST
      EXPENSEInterest
      on deposits
                
                
                4,285
                
                
                
                5,343Interest
      on short-term borrowings
                
                
                49
                
                
                
                366Interest
      on long-term debt
                
                
                74
                
                
                
                184Total
      interest expense
                
                
                4,408
                
                
                
                5,893NET
      INTEREST INCOME
                
                
                10,058
                
                
                
                10,030Provision
      for credit losses
                
                
                912
                
                
                
                462NET
      INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES
                
                
                9,146
                
                
                
                9,568NONINTEREST
      INCOMEService
      charges on deposit accounts
                
                
                809
                
                
                
                871Other
      service charges and fees
                
                
                738
                
                
                
                736Investment
      securities gains
                
                
                49
                
                
                
                -Insurance
      agency commissions
                
                
                3,335
                
                
                
                3,531Other
      noninterest income
                
                
                419
                
                
                
                364Total
      noninterest income
                
                
                5,350
                
                
                
                5,502NONINTEREST
      EXPENSESalaries
      and wages
                
                
                4,540
                
                
                
                4,607Employee
      benefits
                
                
                1,380
                
                
                
                1,377Occupancy
      expense
                
                
                549
                
                
                
                499Furniture
      and equipment expense
                
                
                314
                
                
                
                286Data
      processing
                
                
                438
                
                
                
                470Directors’
      fees
                
                
                168
                
                
                
                165Amortization
      of other intangible assets
                
                
                129
                
                
                
                129Insurance
      agency commissions expense
                
                
                550
                
                
                
                611FDIC
      insurance premium expense
                
                
                244
                
                
                
                14Other
      noninterest expenses
                
                
                1,571
                
                
                
                1,433Total
      noninterest expense
                
                
                9,883
                
                
                
                9,591INCOME
      BEFORE INCOME TAXES
                
                
                4,613
                
                
                
                5,479Income
      tax expense
                
                
                1,735
                
                
                
                2,107NET
      INCOME
                
                $
                2,878
                
                
                $
                3,372Preferred
      stock dividends and discount accretion
                
                
                337
                
                
                
                -Net
      income available to common shareholders
                
                $
                2,541
                
                
                $
                3,372Basic
      earnings per common share
                
                $
                0.30
                
                
                $
                0.40Diluted
      earnings per common share
                
                $
                0.30
                
                
                $
                0.40Dividends
      paid per common share
                
                $
                0.16
                
                
                $
                0.16





See
accompanying notes to Consolidated Financial Statements.





3




SHORE
BANCSHARES, INC.


CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)


For the
Three Months Ended March 31, 2009 and 2008


(Dollars
in thousands, except per share amounts)




AccumulatedAdditional
                    
                    
                    
                    
                    
                    Other
                    
                    
                    TotalPreferred
                    
                    
                    Common
                    
                    
                    
                    
                    
                    Paid
      in
                    
                    
                    Retained
                    
                    
                    Comprehensive
                    
                    
                    Stockholders’Stock
                    
                    
                    Stock
                    
                    
                    Warrants
                    
                    
                    Capital
                    
                    
                    Earnings
                    
                    
                    Income
      (Loss)
                    
                    
                    EquityBalances,
      January 1, 2009
                    
                    $
                    -
                    
                    
                    $
                    84
                    
                    
                    $
                    -
                    
                    
                    $
                    29,768
                    
                    
                    $
                    96,140
                    
                    
                    $
                    1,393
                    
                    
                    $
                    127,385Comprehensive
      income:Net
      income
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    2,878
                    
                    
                    
                    -
                    
                    
                    
                    2,878Unrealized
      losses on available-for- sale securities, net of taxes
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (370
                    )
                    
                    
                    (370
                    )Total
      comprehensive income
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2,508Warrants
      issued
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,543
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,543Preferred
      shares issued pursuant to TARP
                    
                    
                    25,000
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    25,000Discount
      from issuance of preferred stock
                    
                    
                    (1,543
                    )
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (1,543
                    )Discount
      accretion
                    
                    
                    57
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (57
                    )
                    
                    
                    -
                    
                    
                    
                    -Common
      shares issued for employee stock-based awards
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1Stock-based
      compensation expense
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    21
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    21Preferred
      stock dividends ($5.00 per share)
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (125
                    )
                    
                    
                    -
                    
                    
                    
                    (125
                    )Cash
      dividends paid ($0.16 per share)
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (1,344
                    )
                    
                    
                    -
                    
                    
                    
                    (1,344
                    )Balances,
      March 31, 2009
                    
                    $
                    23,514
                    
                    
                    $
                    84
                    
                    
                    $
                    1,543
                    
                    
                    $
                    29,790
                    
                    
                    $
                    97,492
                    
                    
                    $
                    1,023
                    
                    
                    $
                    153,446Balances,
      January 1, 2008
                    
                    $
                    -
                    
                    
                    $
                    84
                    
                    
                    $
                    -
                    
                    
                    $
                    29,539
                    
                    
                    $
                    90,365
                    
                    
                    $
                    247
                    
                    
                    $
                    120,235Adjustment
      to initially apply EITF Issue 06-4
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (318
                    )
                    
                    
                    -
                    
                    
                    
                    (318
                    )Comprehensive
      income:Net
      income
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    3,372
                    
                    
                    
                    -
                    
                    
                    
                    3,372Unrealized
      gains on available-for-sale securities, net of taxes
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    714
                    
                    
                    
                    714Total
      comprehensive income
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    4,086Shares
      issued for employee stock-based awards
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    16
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    16Stock-based
      compensation expense
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    23
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    23Cash
      dividends paid ($0.16 per share)
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (1,343
                    )
                    
                    
                    -
                    
                    
                    
                    (1,343
                    )Balances,
      March 31, 2008
                    
                    $
                    -
                    
                    
                    $
                    84
                    
                    
                    $
                    -
                    
                    
                    $
                    29,578
                    
                    
                    $
                    92,076
                    
                    
                    $
                    961
                    
                    
                    $
                    122,699





See
accompanying notes to Consolidated Financial Statements.




4




SHORE
BANCSHARES, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS (Unaudited)


(Dollars
in thousands)





For the Three Months Ended March
      31,2009
                
                
                2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                
                $
                2,878
                
                
                $
                3,372Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      and amortization
                
                
                426
                
                
                
                433Stock-based
      compensation expense
                
                
                21
                
                
                
                23Discount
      accretion on debt securities
                
                
                (46
                )
                
                
                (80
                )Provision
      for credit losses
                
                
                912
                
                
                
                462Gain
      on sales of securities
                
                
                (49
                )
                
                
                -Loss
      on sale of other real estate owned
                
                
                -
                
                
                
                50Net
      changes in:Insurance
      premiums receivable
                
                
                16
                
                
                
                (771
                )Accrued
      interest receivable
                
                
                (66
                )
                
                
                (40
                )Other
      assets
                
                
                139
                
                
                
                (619
                )Accrued
      interest payable
                
                
                (46
                )
                
                
                (214
                )Other
      liabilities
                
                
                136
                
                
                
                3,317Net
      cash provided by operating activities
                
                
                4,321
                
                
                
                5,933CASH
      FLOWS FROM INVESTING ACTIVITIES:Proceeds
      from maturities and principal payments of securities available for
      sale
                
                
                19,528
                
                
                
                26,253Proceeds
      from sales of investment securities available for sale
                
                
                2,048
                
                
                
                -Purchases
      of securities available for sale
                
                
                (13,075
                )
                
                
                (13,923
                )Proceeds
      from maturities and principal payments of securities held to
      maturity
                
                
                1,434
                
                
                
                690Purchases
      of securities held to maturity
                
                
                -
                
                
                
                (802
                )Net
      increase in loans
                
                
                (21,451
                )
                
                
                (32,458
                )Purchases
      of premises and equipment
                
                
                (339
                )
                
                
                (73
                )Proceeds
      from sales of other real estate owned
                
                
                -
                
                
                
                264Net
      cash used in investing activities
                
                
                (11,855
                )
                
                
                (20,049
                )CASH
      FLOWS FROM FINANCING ACTIVITIES:Net
      increase in demand, money market and savings deposits
                
                
                11,327
                
                
                
                12,530Net
      increase in certificates of deposit
                
                
                16,392
                
                
                
                30,492Net
      decrease in short-term borrowings
                
                
                (21,912
                )
                
                
                (4,982
                )Proceeds
      from issuance of long-term debt
                
                
                -
                
                
                
                3,000Proceeds
      from issuance of preferred stock and warrants
                
                
                25,000
                
                
                
                -Proceeds
      from issuance of common stock
                
                
                1
                
                
                
                16Preferred
      stock dividends paid
                
                
                (125
                )
                
                
                -Common
      stock dividends paid
                
                
                (1,344
                )
                
                
                (1,343
                )Net
      cash provided by financing activities
                
                
                29,339
                
                
                
                39,713Net
      increase in cash and cash equivalents
                
                
                21,805
                
                
                
                25,597Cash
      and cash equivalents at beginning of period
                
                
                27,294
                
                
                
                26,880Cash
      and cash equivalents at end of period
                
                $
                49,099
                
                
                $
                52,477Supplemental
      cash flows information:Interest
      paid
                
                $
                4,454
                
                
                $
                6,107Income
      taxes paid
                
                $
                19
                
                
                $
                125Transfers
      from loans to other real estate owned
                
                $
                1,315
                
                
                $
                138





See
accompanying notes to Consolidated Financial Statements.





5





Shore
Bancshares, Inc.


Notes to
Consolidated Financial Statements


For the
Three Months Ended March 31, 2009 and 2008


(Unaudited)





Note 1 - Basis of
Presentation





The
consolidated financial statements include the accounts of Shore Bancshares, Inc.
(the “Company”) and its subsidiaries with all significant intercompany
transactions eliminated.The consolidated financial statements conform to
accounting principles generally accepted in the United States of America
(“GAAP”) and to prevailing practices within the banking industry.  The
accompanying interim financial statements are unaudited; however, in the opinion
of management all adjustments necessary to present fairly the consolidated
financial position at March 31, 2009, the consolidated results of operations for
the three months ended March 31, 2009 and 2008, changes in stockholders’ equity
for the three months ended March 31, 2009 and 2008, and cash flows for the three
months ended March 31, 2009 and 2008, have been included.  All such
adjustments are of a normal recurring nature.  The amounts as of
December 31, 2008 were derived from the 2008 audited financial
statements.  The results of operations for the three months ended
March 31, 2009 are not necessarily indicative of the results to be expected for
any other interim period or for the full year.  This Quarterly Report
on Form 10-Q should be read in conjunction with the Company’s Annual Report on
Form 10-K for the year ended December 31, 2008.





Note 2 - Earnings Per
Share





Basic
earnings per common share are calculated by dividing net income available to
common stockholders by the weighted average number of common shares outstanding
during the period.  Diluted earnings per common share are calculated
by dividing net income available to common stockholders by the weighted average
number of common shares outstanding during the period, adjusted for the dilutive
effect of stock-based awards.  The following table provides
information relating to the calculation of earnings per common
share:





For the Three Months EndedMarch 31,(In thousands, except per share data)
                  
                  2009
                  
                  
                  2008Net
      income available to common shareholders
                  
                  $
                  2,541
                  
                  
                  $
                  3,372Weighted
      average shares outstanding - Basic
                  
                  
                  8,405
                  
                  
                  
                  8,391Dilutive
      effect of stock-based awards
                  
                  
                  3
                  
                  
                  
                  9Weighted
      average shares outstanding - Diluted
                  
                  
                  8,408
                  
                  
                  
                  8,400Earnings
      per common share – Basic
                  
                  $
                  0.30
                  
                  
                  $
                  0.40Earnings
      per common share - Diluted
                  
                  $
                  0.30
                  
                  
                  $
                  0.40





There
were 157 thousand antidilutive weighted average warrants and two thousand
antidilutive weighted average stock-based awards excluded from the diluted
earnings per share calculation for the three months ended March 31,
2009.  There were no antidilutive weighted average common share
equivalents excluded from the diluted earnings per share calculation for the
three months ended March 31, 2008.





Note 3 - Significant
Accounting Policy





Under the
provisions of Statements of Financial Accounting Standards (“SFAS”) Nos. 114 and
118, "Accounting by Creditors for Impairment of a Loan," a loan is considered
impaired if it is probable that the Company will not collect all principal and
interest payments according to the loan’s contracted terms.  The
impairment of a loan is measured at the present value of expected future cash
flows using the loan’s effective interest rate, or at the loan’s observable
market price or the fair value of the collateral if the loan is collateral
dependent.  Interest income generally is not recognized on specific
impaired loans unless the likelihood of further loss is
remote.  Interest payments received on such loans are applied as a
reduction of the loan’s principal balance.  Interest income on other
nonaccrual loans is recognized only to the extent of interest payments
received.





6




Information
with respect to impaired loans and the related valuation allowance is shown
below:





March 31,
                  
                  
                  December 31,
                  
                  
                  March 31,(Dollars in thousands)
                  
                  2009
                  
                  
                  2008
                  
                  
                  2008Impaired
      loans with a valuation allowance
                  
                  $
                  970
                  
                  
                  $
                  2,550
                  
                  
                  $
                  3,387Impaired
      loans with no valuation allowance
                  
                  
                  6,701
                  
                  
                  
                  5,565
                  
                  
                  
                  51Total
      impaired loans
                  
                  $
                  7,671
                  
                  
                  $
                  8,115
                  
                  
                  $
                  3,438Allowance
      for credit losses applicable to impaired loans
                  
                  $
                  133
                  
                  
                  $
                  341
                  
                  
                  $
                  999Allowance
      for credit losses applicable to other than impaired loans
                  
                  
                  9,553
                  
                  
                  
                  8,979
                  
                  
                  
                  6,927Total
      allowance for credit losses
                  
                  $
                  9,686
                  
                  
                  $
                  9,320
                  
                  
                  $
                  7,926Average
      recorded investment in impaired loans
                  
                  $
                  7,242
                  
                  
                  $
                  5,477
                  
                  
                  $
                  3,489





Gross
interest income of $143 thousand for the first three months of 2009, $476
thousand for fiscal year 2008 and $68 thousand for the first three months of
2008 would have been recorded if nonaccrual loans had been current and
performing in accordance with their original terms.  Interest actually
recorded on such loans was $4 thousand for the first three months of 2009, $193
thousand for fiscal year 2008 and $1 thousand for the first three months of
2008.





Impaired
loans do not include groups of smaller balance homogenous loans such as
residential mortgage and consumer installment loans that are evaluated
collectively for impairment.  Reserves for probable credit losses
related to these loans are based upon historical loss ratios and are included in
the allowance for credit losses.





Note 4 -
Commitments





In the
normal course of business, to meet the financial needs of its customers, the
Company’s bank subsidiaries are parties to financial instruments with
off-balance sheet risk.  These financial instruments include
commitments to extend credit and standby letters of credit.  At March
31, 2009, total commitments to extend credit were approximately $207.5
million.  The comparable amount was $211.4 million at December 31,
2008.  Outstanding letters of credit were approximately $11.9 million
at March 31, 2009 and $12.5 million at December 31, 2008.





Note 5 - Stock-Based
Compensation





At March
31, 2009, the Company had three equity compensation plans:  (i) the
Shore Bancshares, Inc. Employee Stock Purchase Plan (“ESPP”); (ii) the Shore
Bancshares, Inc. 2006 Stock and Incentive Compensation Plan (“2006 Equity
Plan”); and (iii) the Shore Bancshares, Inc. 1998 Stock Option Plan (the “1998
Option Plan”).  The plans are described in detail in Note 13 to the
audited financial statements contained in the Company’s Annual Report on Form
10-K for the year ended December 31, 2008.  The ability of the Company
to grant options under the 1998 Option Plan terminated by its terms on March 3,
2008, but stock options granted under the 1998 Option Plan were outstanding at
March 31, 2009.





Stock-based
awards granted to date are generally time-based, vesting on each anniversary of
the grant date over a three to five year period of time and, in the case of
stock options, expiring 10 years from the grant date.  ESPP awards
allow employees to purchase shares of the Company’s common stock at 85% of the
fair market value on the date of grant.  ESPP grants are 100% vested
at date of grant and have a 27-month term.





During
the three months ended March 31, 2009 and 2008, the Company recognized pre-tax
stock-based compensation expense of $21 thousand and $23 thousand,
respectively.  Stock-based compensation expense is recognized ratably
over the requisite service period for all awards and is based on the grant-date
fair value.  Unrecognized stock-based compensation expense related to
nonvested share-based compensation arrangements was $278 thousand as of March
31, 2009.  The weighted-average period over which this unrecognized
expense was expected to be recognized was 3.3 years.





The
Company estimates the fair value of stock options using the Black-Scholes
valuation model with weighted average assumptions for dividend yield, expected
volatility, risk-free interest rate and expected lives (in
years).  The expected dividend yield is calculated by dividing the
total expected annual dividend payout by the average stock price.  The
expected volatility is based on historical volatility of the underlying
securities.  The risk-free interest rate is based on the Federal
Reserve Bank’s constant maturities daily interest rate in effect at grant
date.  The expected life of the options represents the period of time
that the Company expects the awards to be outstanding based on historical
experience with similar awards.  Stock-based compensation expense
recognized in the consolidated statements of income for the three months ended
March 31, 2009 and 2008 reflected forfeitures as they occurred.





7




No
options were granted during the first three months of 2009 and
2008.





The
following table summarizes stock option activity for the Company under all plans
for the three months ended March 31, 2009:





Weighted
                  
                  
                  AggregateNumber
                  
                  
                  Average
                  
                  
                  Intrinsicof Shares
                  
                  
                  Exercise Price
                  
                  
                  ValueOutstanding
      at beginning of year
                  
                  
                  18,550
                  
                  
                  $
                  15.52Granted
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  (25
                  )
                  
                  
                  21.33Expired/Cancelled
                  
                  
                  (4,975
                  )
                  
                  
                  21.33Outstanding
      at end of period
                  
                  
                  13,550
                  
                  
                  
                  13.37
                  
                  
                  $
                  45,807Exercisable
      at end of period
                  
                  
                  13,550
                  
                  
                  $
                  13.37
                  
                  
                  $
                  45,807





The
following summarizes information about stock options outstanding at March 31,
2009:





Options Outstanding and ExercisableOptions Outstanding
                          
                          
                          
                          
                          
                          Weighted AverageRemainingExercise
      Price
                          
                          
                          Number
                          
                          
                          Number
                          
                          
                          Contract
      Life (in years)$
                          14.00
                          
                          
                          
                          3,255
                          
                          
                          
                          3,255
                          
                          
                          
                          1.013.17
                          
                          
                          
                          10,295
                          
                          
                          
                          10,295
                          
                          
                          
                          3.213,550
                          
                          
                          
                          13,550





The total
intrinsic value of stock options exercised during the three months ended March
31, 2009 was less than $1 thousand. The comparable amount for the three months
ended March 31, 2008 was approximately $9 thousand.  Cash received
upon exercise of options during the first three months of 2009 and 2008 was
approximately $1 thousand and $16 thousand, respectively.





The
following table summarizes restricted stock award activity for the Company under
the 2006 Equity Plan for the three months ended March 31, 2009:





Number
                  
                  
                  Weighted Average Grantof Shares
                  
                  
                  Date Fair ValueNonvested
      at January 1, 2009
                  
                  
                  16,859
                  
                  
                  $
                  22.55Granted
                  
                  
                  -
                  
                  
                  
                  -Vested
                  
                  
                  (2,939
                  )
                  
                  
                  21.93Cancelled
                  
                  
                  -
                  
                  
                  
                  -Nonvested
      at March 31, 2009
                  
                  
                  13,920
                  
                  
                  $
                  22.68





Note 6 - Segment
Reporting





The
Company operates two primary business segments:  Community Banking and
Insurance Products and Services.  Through the Community Banking
business, the Company provides services to consumers and small businesses on the
Eastern Shore of Maryland and Delaware through its 18-branch
network.  Community banking activities include small business
services, retail brokerage, and consumer banking products and
services.  Loan products available to consumers include mortgage, home
equity, automobile, marine, and installment loans, credit cards and other
secured and unsecured personal lines of credit.  Small business
lending includes commercial mortgages, real estate development loans, equipment
and operating loans, as well as secured and unsecured lines of credit, credit
cards, accounts receivable financing arrangements, and merchant card
services.





Through
the Insurance Products and Services business, the Company provides a full range
of insurance products and services to businesses and consumers in the Company’s
market areas.  Products include property and casualty, life, marine,
individual health and long-term care insurance.  Pension and profit
sharing plans and retirement plans for executives and employees are available to
suit the needs of individual businesses.





8




Selected
financial information by line of business for the first three months of 2009 and
2008 is included in the following table:





Community
                  
                  
                  Insurance Products
                  
                  
                  Parent(Dollars in thousands)
                  
                  Banking
                  
                  
                  and Services
                  
                  
                  Company
                  
                  
                  Total2009Interest
      income
                  
                  $
                  14,451
                  
                  
                  $
                  15
                  
                  
                  $
                  -
                  
                  
                  $
                  14,466Interest
      expense
                  
                  
                  (4,388
                  )
                  
                  
                  -
                  
                  
                  
                  (20
                  )
                  
                  
                  (4,408
                  )Provision
      for credit losses
                  
                  
                  (912
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (912
                  )Noninterest
      income
                  
                  
                  1,856
                  
                  
                  
                  3,494
                  
                  
                  
                  -
                  
                  
                  
                  5,350Noninterest
      expense
                  
                  
                  (5,539
                  )
                  
                  
                  (2,786
                  )
                  
                  
                  (1,558
                  )
                  
                  
                  (9,883
                  )Net
      intersegment income (expense)
                  
                  
                  (1,446
                  )
                  
                  
                  (113
                  )
                  
                  
                  1,559
                  
                  
                  
                  -Income
      before taxes
                  
                  
                  4,022
                  
                  
                  
                  610
                  
                  
                  
                  (19
                  )
                  
                  
                  4,613Income
      tax (expense) benefit
                  
                  
                  (1,513
                  )
                  
                  
                  (229
                  )
                  
                  
                  7
                  
                  
                  
                  (1,735
                  )Net
      income
                  
                  $
                  2,509
                  
                  
                  $
                  381
                  
                  
                  $
                  (12
                  )
                  
                  $
                  2,878Total
      assets
                  
                  $
                  1,053,525
                  
                  
                  $
                  19,723
                  
                  
                  $
                  3,351
                  
                  
                  $
                  1,076,5992008Interest
      income
                  
                  $
                  15,906
                  
                  
                  $
                  17
                  
                  
                  $
                  -
                  
                  
                  $
                  15,923Interest
      expense
                  
                  
                  (5,859
                  )
                  
                  
                  -
                  
                  
                  
                  (34
                  )
                  
                  
                  (5,893
                  )Provision
      for credit losses
                  
                  
                  (462
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (462
                  )Noninterest
      income
                  
                  
                  1,802
                  
                  
                  
                  3,700
                  
                  
                  
                  -
                  
                  
                  
                  5,502Noninterest
      expense
                  
                  
                  (5,141
                  )
                  
                  
                  (3,044
                  )
                  
                  
                  (1,406
                  )
                  
                  
                  (9,591
                  )Net
      intersegment income (expense)
                  
                  
                  (1,263
                  )
                  
                  
                  (90
                  )
                  
                  
                  1,353
                  
                  
                  
                  -Income
      before taxes
                  
                  
                  4,983
                  
                  
                  
                  583
                  
                  
                  
                  (87
                  )
                  
                  
                  5,479Income
      tax (expense) benefit
                  
                  
                  (1,916
                  )
                  
                  
                  (224
                  )
                  
                  
                  33
                  
                  
                  
                  (2,107
                  )Net
      income
                  
                  $
                  3,067
                  
                  
                  $
                  359
                  
                  
                  $
                  (54
                  )
                  
                  $
                  3,372Total
      assets
                  
                  $
                  980,506
                  
                  
                  $
                  20,818
                  
                  
                  $
                  2,512
                  
                  
                  $
                  1,003,836





Note 7 - Fair Value
Measurements




SFAS No.
157, “Fair Value
Measurements” provides a framework for measuring and disclosing fair
value under GAAP.  SFAS 157 requires disclosures about the fair value
of assets and liabilities recognized in the balance sheet, whether the
measurements are made on a recurring basis or on a nonrecurring
basis.




SFAS 157
defines fair value as the exchange price that would be received for an asset or
paid to transfer a liability (an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date.  SFAS 157 also
establishes a fair value hierarchy, which requires an entity to maximize the use
of observable inputs and minimize the use of unobservable inputs when measuring
fair value.




The
Company utilizes fair value measurements to record fair value adjustments to
certain assets and to determine fair value disclosures. Securities available for
sale are recorded at fair value on a recurring basis. Additionally, from time to
time, the Company may be required to record at fair value other assets on a
nonrecurring basis, such as loans held for investment (impaired loans) and
foreclosed assets(other real estate owned).  These nonrecurring fair
value adjustments typically involve application of lower of cost or market
accounting or write-downs of individual assets.




Under
SFAS 157, assets and liabilities are grouped at fair value in three levels,
based on the markets in which the assets and liabilities are traded and the
reliability of the assumptions used to determine the fair value. These hierarchy
levels are:





Level 1
inputs – Unadjusted quoted prices in active markets for identical assets or
liabilities that the entity has the ability to access at the measurement
date.





Level 2
inputs – Inputs other than quoted prices included in Level 1 that are observable
for the asset or liability, either directly or indirectly.  These
might include quoted prices for similar assets or liabilities in active markets,
and inputs other than quoted prices that are observable for the asset or
liability, such as interest rates and yield curves that are observable at
commonly quoted intervals.


9


Level 3
inputs – Unobservable inputs for determining the fair values of assets or
liabilities that reflect an entity’s own assumptions about the assumptions that
market participants would use in pricing the assets or
liabilities.




The
following is a description of valuation methodologies used for the Company’s
assets recorded at fair value.





Investment Securities
Available for Sale


Investment
securities available for sale are recorded at fair value on a recurring
basis.  Fair value measurement is based upon quoted prices, if
available.  If quoted prices are not available, fair values are
measured using independent pricing models or other model-based valuation
techniques such as the present value of future cash flows, adjusted for the
security’s credit rating, prepayment assumptions and other factors such as
credit loss assumptions.  Level 1 securities include those traded on
an active exchange such as the New York Stock Exchange, Treasury securities that
are traded by dealers or brokers in active over-the-counter markets and money
market funds.  Level 2 securities include mortgage-backed securities
issued by government sponsored entities, municipal bonds and corporate debt
securities. Securities classified as Level 3 include asset-backed securities in
less liquid markets.





Loans


The
Company does not record loans at fair value on a recurring basis; however, from
time to time, a loan is considered impaired and an allowance for loan loss is
established.  Loans for which it is probable that payment of interest
and principle will not be made in accordance with the contractual terms of the
loan are considered impaired.  Once a loan is identified as
individually impaired, management measures impairment in accordance with SFAS
114, “Accounting by Creditors for Impairment of a Loan.”  The fair
value of impaired loans is estimated using one of several methods, including the
collateral value, market value of similar debt, enterprise value, liquidation
value and discounted cash flows.  Those impaired loans not requiring a
specific allowance represent loans for which the fair value of expected
repayments or collateral exceed the recorded investment in such
loans.  At March 31, 2009, substantially all of the impaired loans
were evaluated based upon the fair value of the collateral.  In
accordance with SFAS 157, impaired loans that have an allowance established
based on the fair value of collateral require classification in the fair value
hierarchy.  When the fair value of the collateral is based on an
observable market price or a current appraised value, the Company records the
loan as nonrecurring Level 2.  When an appraised value is not
available or management determines the fair value of the collateral is further
impaired below the appraised value and there is no observable market price, the
Company records the loan as nonrecurring Level 3.





Foreclosed
Assets


Foreclosed
assets are adjusted for fair value upon transfer of loans to foreclosed
assets.  Subsequently, foreclosed assets are carried at the lower of
carrying value and fair value.  Fair value is based upon independent
market prices, appraised value of the collateral or management’s estimation of
the value of the collateral.  When the fair value of the collateral is
based on an observable market price or a current appraised value, the Company
records the foreclosed asset as nonrecurring Level 2.  When an
appraised value is not available or management determines the fair value of the
collateral is further impaired below the appraised value and there is no
observable market price, the Company records the foreclosed asset as
nonrecurring Level 3.





Assets Recorded at Fair
Value on a Recurring Basis


The table
below presents the recorded amount of assets measured at fair value on a
recurring basis at March 31, 2009.




SignificantOther
                                      
                                      SignificantQuoted
                                      
                                      Observable
                                      
                                      UnobservablePrices
                                      
                                      Inputs
                                      
                                      Inputs(Dollars
      in thousands)
                                      
                                      Fair
      Value
                                      
                                      (Level
      1)
                                      
                                      (Level
      2)
                                      
                                      (Level
      3)Securities
      available for sale
                                      
                                      $ 70,137
                                      
                                      -
                                      
                                      $ 70,137
                                      
                                      -




10




Assets Recorded at Fair
Value on a Nonrecurring Basis


The table
below presents the recorded amount of assets and liabilities measured at fair
value on a nonrecurring basis at March 31, 2009.





SignificantOther
                  
                  
                  SignificantQuoted
                  
                  
                  Observable
                  
                  
                  UnobservablePrices
                  
                  
                  Inputs
                  
                  
                  Inputs(Dollars
      in thousands)
                  
                  Fair
      Value
                  
                  
                  (Level
      1)
                  
                  
                  (Level
      2)
                  
                  
                  (Level
      3)Impaired
      loans
                  
                  $
                  7,538
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  $
                  7,538Other
      real estate owned
                  
                  
                  1,463
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,463





Impaired
loans had a carrying amount of $7.7 million with a valuation allowance of $133
thousand at March 31, 2009.





Note 8 - Restricted
Investment in Bank Stock





Restricted
stock, which represents required investments in the common stock of two
correspondent banks, is carried at cost and, as of March 31, 2009 and December
31, 2008, consists of the common stock of the Federal Home Loan Bank (“FHLB”) of
Atlanta and the FHLB of Pittsburgh.





Management
evaluates the restricted stock for impairment in accordance with FASB Statement
of Position (“SOP”) 01-6, “Accounting by Certain Entities (Including Entities
With Trade Receivables) That Lend to or Finance the Activities of
Others.”  Management’s determination of whether these investments are
impaired is based on their assessment of the ultimate recoverability of their
cost rather than by recognizing temporary declines in value.  The
determination of whether a decline affects the ultimate recoverability of the
cost of an investment is influenced by criteria such as (1) the significance of
the decline in net assets of the issuing bank as compared to the capital stock
amount for that bank and the length of time this situation has persisted, (2)
commitments by the issuing bank to make payments required by law or regulation
and the level of such payments in relation to the operating performance of that
bank, and (3) the impact of legislative and regulatory changes on institutions
and, accordingly, on the customer base of the issuing bank.





The FHLB
of Atlanta announced that it would not pay dividends for the fourth quarter of
2008 and would no longer provide dividend guidance prior to the end of each
quarter but after the end of each quarter when quarterly results are
known.  Also, the FHLB of Atlanta would no longer conduct repurchases
of excess activity-based stock on a daily basis, but would make such
determinations quarterly.  Similarly, the FHLB of Pittsburgh announced
in December 2008 that it voluntarily suspended the payment of dividends and the
repurchase of excess capital stock from member banks, citing a significant
reduction in the level of core earnings resulting from lower short-term interest
rates, the increased cost of maintaining liquidity and constrained access to the
debt markets at attractive rates and maturities as the main reasons for the
decision to suspend dividends and the repurchase of excess capital stock. The
FHLB of Pittsburgh last paid a dividend in the third quarter of
2008.





Management
believes that no impairment charge in respect of the restricted stock is
necessary as of March 31, 2009.





Note 9 - Subsequent
Event





On April
15, 2009, the Company completed the repurchase of all 25,000 shares of its Fixed
Rate Cumulative Perpetual Preferred Stock, Series A, with a liquidation value of
$1,000 per share, that were sold to the U.S. Department of Treasury (“Treasury”)
on January 9, 2009 pursuant to the Troubled Asset Relief Program (“TARP”)
Capital Purchase Program (“CPP”). The repurchase price was $25 million, plus
accrued dividends of $208,333.33.  The repurchase was approved by the
Treasury following consultation with and approval from the Federal Reserve Bank
of Richmond and the Federal Deposit Insurance Corporation.





Note 10 - New Accounting
Pronouncements





Pronouncements
adopted


SFAS No. 141(R), “Business
Combinations.”  During December 2007, the FASB issued SFAS
141(R). SFAS 141(R) recognizes and measures the goodwill acquired in a business
combination and defines a bargain purchase, and requires the acquirer to
recognize that excess as a gain attributable to the acquirer. In contrast,
Statement 141 required the “negative goodwill” amount to be allocated as a pro
rata reduction of the amounts assigned to assets acquired. SFAS 141(R) applies
prospectively to business combinations for which the acquisition date is on or
after December 15, 2008. The Company adopted SFAS No. 141R effective March 31,
2009.  This statement will change the Company’s accounting treatment
for business combinations on a prospective basis.





11




SFAS No. 160, “Noncontrolling
Interests in Consolidated Financial Statements.” During December 2007, the
FASB issued SFAS 160 to establish accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. It clarifies that a noncontrolling interest in a subsidiary is an
ownership interest in the consolidated entity that should be reported as equity
in the consolidated financial statement, but separate from the parent’s
equity.  SFAS 160 is effective for fiscal years, and interim periods
within those fiscal years, beginning on or after December 15, 2008. Management
adopted this Statement effective March 31, 2009, and adoption did not have a
material impact on the Company’s consolidated financial condition or results of
operations.





SFAS No. 161, “Disclosures about
Derivative Instruments and Hedging Activities – an amendment of FASB Statement
No. 133”.  SFAS 161 is intended to enhance the disclosures
previously required for derivative instruments and hedging activities under SFAS
No. 133, “Accounting for Derivative Instruments and Hedging Activities”, to
include how and why an entity uses derivative instruments, how derivative
instruments and related hedge items are accounted for and their impact on an
entity’s financial positions, results of operations and cash
flows.  SFAS 161 is effective for financial statements issued for
fiscal years and interim periods beginning after November 15,
2008.  Adoption of SFAS 161 did not have a material impact on the
consolidated financial statements.





SFAS No. 162, “The Hierarchy of
Generally Accepted Accounting Principles.”SFAS 162 identifies
the sources of accounting principles and the framework for selecting the
principles to be used in the preparation of financial statements of
nongovernmental entities that are presented in conformity with GAAP in the
United States (the “GAAP hierarchy”).  The FASB concluded that the
GAAP hierarchy should reside in the accounting literature established by the
FASB and is issuing this Statement to achieve that result.  Adoption
of SFAS 162 was not a change in the Company’s current accounting practices;
therefore, it did not have a material impact on the Company’s consolidated
financial condition or results of operations.





Financial Accounting Standards Board
Staff Position (“FSP”)  No. EITF 03-6-1, “Determining Whether
Instruments Granted in Share-Based Payment Transactions Are Participating
Securities”.This FSP clarifies that instruments granted in
share-based payment transactions can be participating securities prior to the
requisite service having been rendered. A basic principle of the FSP is that
unvested share-based payment awards that contain nonforfeitable rights to
dividends or dividend equivalents (whether paid or unpaid) are participating
securities and are to be included in the computation of EPS pursuant to the
two-class method. The provisions of this FSP are effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those years. All prior-period EPS data presented are
required to be adjusted retrospectively to conform with the provisions of the
FSP. The Company adopted this FSP effective March 31, 2009, and adoption did not
have a material effect on the Company’s consolidated results of operations or
earnings per share.





Pronouncements
issued but not yet effective


FSP Nos. FAS 107-1 and APB 28-1, FAS
157-4, FAS 115-2 and FAS 124-2, Other Than Temporary Impairment. FASB has
issued FSPs to address concerns regarding (1) determining whether a market is
not active and a transaction is not orderly, (2) recognition and presentation of
other-than-temporary impairments and (3) interim disclosures of fair values of
financial instruments. The FSPs will be effective for interim and annual periods
ending after June 15, 2009, with early adoption permitted for periods ending
after March 15, 2009. The Company will adopt the FSPs effective for the period
ending June 30, 2009, but does not anticipate that adoption will result in a
material effect on consolidated results of operations.





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





Unless
the context clearly suggests otherwise, references to “the Company”, “we”,
“our”, and “us” in this report are to Shore Bancshares, Inc. and its
consolidated subsidiaries.





Forward-Looking
Information


Portions
of this Quarterly Report on Form 10-Q contain forward-looking statements within
the meaning of The Private Securities Litigation Reform Act of
1995.  Statements that are not historical in nature, including
statements that include the words “anticipate”, “estimate”, “should”, “expect”,
“believe”, “intend”, and similar expressions, are expressions about our
confidence, policies, and strategies, the adequacy of capital levels, and
liquidity and are not guarantees of future performance.  Such
forward-looking statements involve certain risks and uncertainties, including
economic conditions, competition in the geographic and business areas in which
we operate, inflation, fluctuations in interest rates, legislation, and
governmental regulation.  These risks and uncertainties are described
in detail in the section of the periodic reports that Shore Bancshares, Inc.
files with the Securities and Exchange Commission (the “SEC”) entitled “Risk
Factors” (see Item 1A of Part II of this report).  Actual results may
differ materially from such forward-looking statements, and we assume no
obligation to update forward-looking statements at any time except as required
by law.





12




Introduction


The
following discussion and analysis is intended as a review of significant factors
affecting the financial condition and results of operations of Shore Bancshares,
Inc. and its consolidated subsidiaries for the periods
indicated.  This discussion and analysis should be read in conjunction
with the unaudited consolidated financial statements and related notes presented
in this report, as well as the audited consolidated financial statements and
related notes included in the Annual Report of Shore Bancshares, Inc. on Form
10-K for the year ended December 31, 2008.





Shore
Bancshares, Inc. is the largest independent financial holding company located on
the Eastern Shore of Maryland.  It is the parent company of The Talbot
Bank of Easton, Maryland located in Easton, Maryland (“Talbot Bank”), The
Centreville National Bank of Maryland located in Centreville, Maryland
(“Centreville National Bank”) and The Felton Bank, located in Felton, Delaware
(“Felton Bank”) (collectively, the “Banks”).  The Banks operate 18
full service branches in Kent County, Queen Anne’s County, Talbot County,
Caroline County and Dorchester County in Maryland and Kent County,
Delaware.  The Company engages in the insurance business through three
insurance producer firms, The Avon-Dixon Agency, LLC, Elliott Wilson Insurance,
LLC and Jack Martin Associates, Inc.; a wholesale insurance company, TSGIA,
Inc.; and two insurance premium finance companies, Mubell Finance, LLC and ESFS,
Inc. (all of the foregoing are collectively referred to as the “Insurance
Subsidiary”) and the mortgage broker business through Wye Mortgage Group, LLC,
all of which are wholly-owned subsidiaries of Shore Bancshares,
Inc.





The
shares of common stock of Shore Bancshares, Inc. are listed on the NASDAQ Global
Select Market under the symbol “SHBI”.





Shore
Bancshares, Inc. maintains an Internet site at www.shbi.net on which
it makes available free of charge its Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the
foregoing as soon as reasonably practicable after these reports are
electronically filed with, or furnished to, the SEC.





Critical
Accounting Policies


Our
financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America (“GAAP”).  The
financial information contained within the financial statements is, to a
significant extent, financial information contained that is based on measures of
the financial effects of transactions and events that have already
occurred.  A variety of factors could affect the ultimate value that
is obtained either when earning income, recognizing an expense, recovering an
asset or relieving a liability.





We
believe that our most critical accounting policy relates to the allowance for
credit losses.  The allowance for credit losses is an estimate of the
losses that may be sustained in the loan portfolio.  The allowance is
based on two basic principles of accounting: (i) SFAS No. 5, Accounting for
Contingencies, which requires that losses be accrued when they are probable of
occurring and estimable, and (ii) SFAS No. 114, Accounting by Creditors for
Impairment of a Loan, which requires that losses be accrued based on the
differences between the loan balance and the value of collateral, present value
of future cash flows or values that are observable in the secondary
market.  Management uses many factors, including economic conditions
and trends, the value and adequacy of collateral, the volume and mix of the loan
portfolio, and our internal loan processes in determining the inherent loss that
may be present in our loan portfolio.  Actual losses could differ
significantly from management’s estimates.  In addition, GAAP itself
may change from one previously acceptable method to another.  Although
the economics of transactions would be the same, the timing of events that would
impact the transactions could change.





Management
has significant discretion in making the adjustments inherent in the
determination of the provision and allowance for credit losses, including in
connection with the valuation of collateral, the borrower’s prospects of
repayment, and in establishing allowance factors on the formula allowance and
unallocated allowance components of the allowance.  The establishment
of allowance factors is a continuing exercise, based on management’s continuing
assessment of the totality of all factors, including, but not limited to,
delinquencies, loss history, trends in volume and terms of loans, effects of
changes in lending policy, the experience and depth of management, national and
local economic trends, concentrations of credit, the quality of the loan review
system and the effect of external factors such as competition and regulatory
requirements, and their impact on the portfolio, and allowance factors may
change from period to period, resulting in an increase or decrease in the amount
of the provision or allowance, based upon the same volume and classification of
loans.  Changes in allowance factors will have a direct impact on the
amount of the provision, and a corresponding effect on net
income.  Errors in management’s perception and assessment of these
factors and their impact on the portfolio could result in the allowance not
being adequate to cover losses in the portfolio, and may result in additional
provisions or charge-offs.





13




Three
basic components comprise our allowance for credit losses:  (i) a
specific allowance; (ii) a formula allowance; and (iii) a nonspecific
allowance.  Each component is determined based on estimates that can
and do change when the actual events occur.  The specific allowance is
used to individually allocate an allowance to loans identified as
impaired.  An impaired loan may show deficiencies in the borrower’s
overall financial condition, payment history, support available from financial
guarantors and/or the fair market value of collateral.  When a loan is
identified as impaired, a specific allowance is established based on our
assessment of the loss that may be associated with the individual
loan.  The formula allowance is used to estimate the loss on
internally risk rated loans, exclusive of those identified as impaired. Loans
identified as special mention, substandard, doubtful and loss, as well as
impaired, are segregated from performing loans.  Remaining loans are
then grouped by type (commercial, commercial real estate and construction,
residential real estate or consumer).  Each loan type is assigned an
allowance factor based on management’s estimate of the risk, complexity and size
of individual loans within a particular category.  Classified loans
are assigned higher allowance factors than non-rated loans due to management’s
concerns regarding collectibility or management’s knowledge of particular
elements regarding the borrower.  Allowance factors grow with the
worsening of the internal risk rating.  The nonspecific formula is
used to estimate the loss of non-classified loans stemming from more global
factors such as delinquencies, loss history, trends in volume and terms of
loans, effects of changes in lending policy, the experience and depth of
management, national and local economic trends, concentrations of credit, the
quality of the loan review system and the effect of external factors such as
competition and regulatory requirements.  The nonspecific allowance
captures losses that have impacted the portfolio but have yet to be recognized
in either the formula or specific allowance.





RECENT
DEVELOPMENTS





On
January 9, 2009, Shore Bancshares, Inc. participated in the United States
Department of the Treasury (“Treasury”) Troubled Asset Relief Program (“TARP”)
Capital Purchase Program by issuing 25,000 shares of Fixed Rate Cumulative
Perpetual Preferred, Series A (the “Preferred Stock”) and a common stock
purchase warrant covering 172,970 shares of common stock to the Treasury for a
total sales price of $25 million.  On April 15, 2009, Shore
Bancshares, Inc. repurchased all 25,000 shares of the Preferred Stock from
Treasury for $25 million, plus accrued dividends of
$208,333.33.  Shore Bancshares, Inc. has the right to repurchase the
warrant at its fair market value, but has not yet decided to do
so.  The Treasury must liquidate any portion of the warrant not
repurchased by Shore Bancshares, Inc.  The warrant may be exercised at
any time until January 9, 2019 at an exercise price of $21.68 per share, or an
aggregate exercise price of approximately $3.75 million. The warrant counts as
tangible common equity.





On
February 27, 2009, the FDIC announced a proposed rule outlining its plan to
implement an emergency special assessment of 20 basis points on all insured
depository institutions in order to restore the Deposit Insurance Fund to an
acceptable level.  The assessment, which would be payable on September
30, 2009, would be in addition to a planned increase in premiums and a change in
the way regular premiums are assessed which the FDIC also approved on February
27, 2009.  In addition, the proposed rule provides that, after June
30, 2009, if the reserve ratio of the Deposit Insurance Fund is estimated to
fall to a level that the FDIC believes would adversely affect public confidence
or to a level which is close to or less than zero at the end of a calendar
quarter, then an additional emergency special assessment of up to 10 basis
points may be imposed on all insured depository institutions.  This
rule will significantly increase the Banks’ FDIC premiums in 2009.





OVERVIEW





Net
income for the first quarter of 2009 was $2.5 million, or diluted earnings per
common share of $0.30, compared to $3.4 million, or diluted earnings per common
share of $0.40, for the first quarter of 2008.  For the fourth quarter
of 2008, net income was $2.3 million or $0.27 per common diluted
share.  Annualized return on average assets was 0.97% for the three
months ended March 31, 2009, compared to 1.38% for the same period in
2008.  Annualized return on average stockholders’ equity was 6.84% for
the first quarter of 2009, compared to 10.96% for the first quarter of
2008.  For the fourth quarter of 2008, annualized return on average
assets was 0.87% and return on average equity was 7.11%.  Generally,
these first quarter 2009 results improved over fourth quarter 2008 results
except for return on average equity.  Excluding the $25 million impact
of TARP funds, the return on average equity for the first quarter of 2009 would
have been higher than the return on average equity for the fourth quarter of
2008.





14




RESULTS
OF OPERATIONS





Net
Interest Income


Net
interest income for the three months ended March 31, 2009 was $10.1 million, an
increase of 0.3% when compared  to the same period last
year.  An increase in average loan volume and reduction in cost of
funds was sufficient to offset the decline in loan yields.  The net
interest margin was 4.09% for the first quarter of 2009, a decrease of 33 basis
points when compared to the first quarter of 2008.  The 400
basis-point reduction in interest rates by the Federal Reserve during 2008 had a
significant impact on the overall yield on earning assets.  Net
interest income decreased 2.8% from the fourth quarter of 2008, mainly due to
lower yields on loans despite a $22 million increase in average loan volume and
a lower cost of funds.  The net interest margin decreased 15 basis
points from 4.24% for the fourth quarter of 2008.





Interest
income was $14.5 million for the first quarter of 2009, a decrease of 9.2% from
the first quarter of 2008.  Average earning assets increased 9.2%
during the first quarter of 2009 when compared to the same period in 2008, while
yields earned decreased 113 basis points to 5.87%.  Average loans
increased 12.8% while the yield earned on loans decreased 120 basis points.
Loans comprised 89.3% and 86.5% of total average earning assets for the quarters
ended March 31, 2009 and 2008, respectively.  Interest income
decreased 4.4% when compared to the fourth quarter of 2008.  Average
earning assets increased 2.8% during the first quarter of 2009 when compared to
the fourth quarter of 2008, while yields earned decreased 31 basis
points.





Interest
expense was $4.4 million for the three months ended March 31, 2009, a decrease
of $1.5 million, or 25.2%,  when compared to the same period last
year.  Average interest bearing liabilities increased 6.2%, while
rates paid decreased 92 basis points to 2.25%.  The Company incurs the
largest amount of interest expense from time
deposits.    For the three months ended March 31, 2009, the
average balance of certificates of deposits $100,000 or more increased 32.0%
when compared to the same period last year, while the average rate paid for
those certificates of deposit decreased 118 basis points to
3.42%.  Average other time deposits increased 7.2%, while the average
rate paid on average other time deposits decreased 91 basis points to 3.53% when
compared to the first quarter of 2008.  Interest expense decreased
7.7% when compared to the fourth quarter of 2008.  Average interest
bearing liabilities increased slightly during the quarter ended March 31, 2009
when compared to the fourth quarter of 2008, while rates paid on these
liabilities decreased 16 basis points.





The
following table presents the distribution of the average consolidated balance
sheets, interest income/expense, and annualized yields earned and rates paid for
the three months ended March 31, 2009 and 2008.





15





For the Three Months Ended
                  
                  
                  For the Three Months EndedMarch 31, 2009
                  
                  
                  March 31, 2008Average
                  
                  
                  Income(1)/
                  
                  
                  Yield/
                  
                  
                  Average
                  
                  
                  Income(1)/
                  
                  
                  Yield/(Dollars in thousands)
                  
                  Balance
                  
                  
                  Expense
                  
                  
                  Rate
                  
                  
                  Balance
                  
                  
                  Expense
                  
                  
                  RateEarning
      assetsLoans
      (2), (3)
                  
                  $
                  898,494
                  
                  
                  $
                  13,660
                  
                  
                  
                  6.17
                  %
                  
                  $
                  796,849
                  
                  
                  $
                  14,601
                  
                  
                  
                  7.37
                  %Investment
      securities:Taxable
                  
                  
                  74,852
                  
                  
                  
                  756
                  
                  
                  
                  4.10
                  
                  
                  
                  91,556
                  
                  
                  
                  1,080
                  
                  
                  
                  4.74Tax-exempt
                  
                  
                  9,105
                  
                  
                  
                  131
                  
                  
                  
                  5.84
                  
                  
                  
                  12,676
                  
                  
                  
                  190
                  
                  
                  
                  6.01Federal
      funds sold
                  
                  
                  21,585
                  
                  
                  
                  7
                  
                  
                  
                  0.14
                  
                  
                  
                  16,237
                  
                  
                  
                  122
                  
                  
                  
                  3.03Interest
      bearing deposits
                  
                  
                  2,250
                  
                  
                  
                  1
                  
                  
                  
                  0.14
                  
                  
                  
                  4,204
                  
                  
                  
                  38
                  
                  
                  
                  3.64Total
      earning assets
                  
                  
                  1,006,286
                  
                  
                  
                  14,555
                  
                  
                  
                  5.87
                  %
                  
                  
                  921,522
                  
                  
                  
                  16,031
                  
                  
                  
                  7.00
                  %Cash
      and due from banks
                  
                  
                  12,857
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  16,648Other
      assets
                  
                  
                  49,232
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  55,013Allowance
      for credit losses
                  
                  
                  (9,654
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (7,716
                  )Total
      assets
                  
                  $
                  1,058,721
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  985,467Interest
      bearing liabilitiesDemand
      deposits
                  
                  $
                  121,109
                  
                  
                  
                  72
                  
                  
                  
                  0.24
                  %
                  
                  $
                  115,215
                  
                  
                  
                  171
                  
                  
                  
                  0.60
                  %Money
      market and savings deposits
                  
                  
                  153,141
                  
                  
                  
                  174
                  
                  
                  
                  0.46
                  
                  
                  
                  175,363
                  
                  
                  
                  705
                  
                  
                  
                  1.62Certificates
      of deposit $100,000 or more
                  
                  
                  238,602
                  
                  
                  
                  2,012
                  
                  
                  
                  3.42
                  
                  
                  
                  180,826
                  
                  
                  
                  2,070
                  
                  
                  
                  4.60Other
      time deposits
                  
                  
                  232,660
                  
                  
                  
                  2,027
                  
                  
                  
                  3.53
                  
                  
                  
                  217,123
                  
                  
                  
                  2,397
                  
                  
                  
                  4.44Interest
      bearing deposits
                  
                  
                  745,512
                  
                  
                  
                  4,285
                  
                  
                  
                  2.33
                  
                  
                  
                  688,527
                  
                  
                  
                  5,343
                  
                  
                  
                  3.12Short-term
      borrowings
                  
                  
                  39,581
                  
                  
                  
                  49
                  
                  
                  
                  .50
                  
                  
                  
                  43,354
                  
                  
                  
                  366
                  
                  
                  
                  3.40Long-term
      debt
                  
                  
                  7,947
                  
                  
                  
                  74
                  
                  
                  
                  3.79
                  
                  
                  
                  14,925
                  
                  
                  
                  184
                  
                  
                  
                  4.95Total
      interest bearing liabilities
                  
                  
                  793,040
                  
                  
                  
                  4,408
                  
                  
                  
                  2.25
                  %
                  
                  
                  746,806
                  
                  
                  
                  5,893
                  
                  
                  
                  3.17
                  %Noninterest
      bearing deposits
                  
                  
                  104,061
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  100,982Other
      liabilities
                  
                  
                  10,972
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  13,940Stockholders’
      equity
                  
                  
                  150,648
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  123,739Total
      liabilities and stockholders’ equity
                  
                  $
                  1,058,721
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  985,467Net
      interest spread
                  
                  
                  
                  
                  
                  $
                  10,147
                  
                  
                  
                  3.62
                  %
                  
                  
                  
                  
                  
                  $
                  10,138
                  
                  
                  
                  3.83
                  %Net
      interest margin
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  4.09
                  %
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  4.42
                  %
 (1)
                    All
      amounts are reported on a tax equivalent basis computed using the
      statutory federal income tax rate of 35% exclusive of the alternative
      minimum tax rate and nondeductible interest
  expense.
 (2)
                    Average
      loan balances include nonaccrual
loans.
 (3)
                    Interest
      income on loans includes amortized loan fees, net of costs, for each loan
      category and yield calculations are stated to included
  all.





Noninterest
Income


Noninterest
income for the first quarter of 2009 decreased $152 thousand, or 2.8%, when
compared to the first quarter of 2008. The decline in noninterest income during
the first quarter of 2009 when compared to the first quarter of 2008 was
primarily due to a decline in insurance agency commissions of $196
thousand.  Noninterest income
increased $942 thousand, or 21.4%, from the fourth quarter of 2008 primarily as
a result of an increase of $840 thousand in insurance agency commissions and
contingency payments.  Insurance agency contingency payments are
typically received in the first quarter of each year and are based on the prior
year’s performance.  The first quarter of 2009 included investment
securities gains of $49 thousand, compared to securities losses of $15 thousand
in the fourth quarter of 2008.





Noninterest
Expense


Noninterest
expense for the first quarter of 2009 increased $292 thousand, or 3.0%, when
compared to the first quarter of 2008 and increased $262 thousand, or 2.7%, when
compared to the fourth quarter of 2008.  A significant portion of the
increase was due to higher FDIC insurance premium expense of $230 thousand when
compared to the first quarter of 2008 and $97 thousand when compared to the
fourth quarter of 2008.  The balance of the increase for both the
first quarter of 2008 and fourth quarter of 2008 comparisons related to higher
general operating costs.





Income
Taxes


The
effective tax rate was 37.6% for the three months ended March 31, 2009, compared
to 38.5% for the same period last year. Management believes that currently there
are no additional changes in tax laws or to our tax structure that are likely to
have a material impact on our future effective tax rate.





16




ANALYSIS
OF FINANCIAL CONDITION





Loans


Loans,
net of unearned income, totaled $908.1 million at March 31, 2009, an increase of
$19.6 million, or 2.2%, since December 31, 2008.  Average loans, net
of unearned income, were $898.5 million for the three months ended March 31,
2009, an increase of $101.6 million, or 12.8%, when compared to the same period
last year.





Allowance
for Credit Losses


We have
established an allowance for credit losses, which is increased by provisions
charged against earnings and recoveries of previously charged-off
debts.  The allowance is decreased by current period charge-offs of
uncollectible debts.  Management evaluates the adequacy of the
allowance for credit losses on a quarterly basis and adjusts the provision for
credit losses based upon this analysis.  The evaluation of the
adequacy of the allowance for credit losses is based on a risk rating system of
individual loans, as well as on a collective evaluation of smaller balance
homogenous loans based on factors such as past credit loss experience, local
economic trends, nonperforming and problem loans, and other factors which may
impact collectibility.  A loan is placed on nonaccrual when it is
specifically determined to be impaired and principal and interest is delinquent
for 90 days or more.  Please refer to the discussion above under the
caption “Critical Accounting Policies” for an overview of the underlying
methodology management employs on a quarterly basis to maintain the
allowance.





The
provision for credit losses for the three months ended March 31, 2009 and 2008
was $912 thousand and $462 thousand, respectively. The provision for credit
losses for the fourth quarter of 2008 was $1.4 million.  The continued
higher level of provision expense was primarily in response to sustained growth
in the loan portfolio, the general increase in nonperforming assets and loan
charge-offs, as well as overall economic conditions.  Management
believes that we continue to maintain strong underwriting guidelines and
emphasize credit quality.





Our
historical charge-off ratios remain lower than those of similarly sized
institutions according to the most recent Bank Holding Company Performance
Report prepared by the Federal Reserve Board.  Net charge-offs were
$546 thousand for the three months ended March 31, 2009, compared to $87
thousand for the same period last year and $683 thousand for the fourth quarter
of 2008.  The allowance for credit losses as a percentage of average
loans was 1.08% for the first quarter of 2009, 0.99% for the first quarter of
2008 and 1.06% for the fourth quarter of 2008.  Nonperforming assets
were $9.1 million at March 31, 2009, compared to $8.3 million at December 31,
2008, with nonaccrual loans decreasing $444 thousand but other real estate owned
increasing $1.3 million.  Loans past due 90 days and still accruing at
March 31, 2009 increased to $7.8 million from $1.4 million at December 31,
2008.  More than half of this increase was attributable to one loan
customer.  Although this real-estate secured loan has matured, the
customer continues to pay interest owed on the loan.  Based on
management’s quarterly evaluation of the adequacy of the allowance for credit
losses, it believes that the allowance for credit losses and the related
provision were adequate at March 31, 2009.





17




The
following table presents a summary of the activity in the allowance for credit
losses:





For the Three Months EndedMarch 31,(Dollars
      in thousands)
                  
                  2009
                  
                  
                  2008Allowance
      balance – beginning of period
                  
                  $
                  9,320
                  
                  
                  $
                  7,551Charge-offs:Real
      estate - construction
                  
                  
                  (87
                  )
                  
                  
                  -Real
      estate - residential
                  
                  
                  (340
                  )
                  
                  
                  (12
                  )Real
      estate - commercial
                  
                  
                  -
                  
                  
                  
                  -Commercial
                  
                  
                  (98
                  )
                  
                  
                  (42
                  )Consumer
                  
                  
                  (111
                  )
                  
                  
                  (63
                  )Totals
                  
                  
                  (636
                  )
                  
                  
                  (117
                  )Recoveries:Real
      estate - construction
                  
                  
                  -
                  
                  
                  
                  -Real
      estate - residential
                  
                  
                  52
                  
                  
                  
                  8Real
      estate - commercial
                  
                  
                  -
                  
                  
                  
                  -Commercial
                  
                  
                  4
                  
                  
                  
                  3Consumer
                  
                  
                  34
                  
                  
                  
                  19Totals
                  
                  
                  90
                  
                  
                  
                  30Net
      charge-offs
                  
                  
                  (546
                  )
                  
                  
                  (87
                  )Provision
      for credit losses
                  
                  
                  912
                  
                  
                  
                  462Allowance
      balance – end of period
                  
                  $
                  9,686
                  
                  
                  $
                  7,926Average
      loans outstanding during the period
                  
                  $
                  898,494
                  
                  
                  $
                  796,849Net
      charge-offs (annualized) as a percentage of average loans outstanding
      during the period
                  
                  
                  0.25
                  %
                  
                  
                  0.04
                  %Allowance
      for credit losses at period end as a percentage of average
      loans
                  
                  
                  1.08
                  %
                  
                  
                  0.99
                  %





Because
most of our loans are secured by real estate, weaknesses in the local real
estate market may have a material adverse effect on the performance of our loan
portfolio and the value of the collateral securing that
portfolio.  Although the local economy does not appear to show to the
same extent of weakness as in other parts of the country, the effects of
continued weakness in the national economy and/or an increasing weakness in the
local economy could result in even higher provisions for credit losses and loan
charge-offs for us in the future.





We have a
concentration of commercial real estate loans.  Commercial real estate
loans, excluding construction and land development loans, at March 31, 2009 were
approximately $290.2 million, or 32.0% of total loans, compared to $304.4
million, or 34.3% of total loans, at December 31, 2008.  Construction
and land development loans were $183.5 million at March 31, 2009 and $179.8
million at December 31, 2008, both at 20.2% of total loans. We do not engage in
foreign or subprime lending activities.





Nonperforming
Assets


The
following table summarizes our nonperforming and past due assets:





March 31,
                  
                  
                  December 31,(Dollars in thousands)
                  
                  2009
                  
                  
                  2008Nonperforming
      assetsNonaccrual
      loans
                  
                  $
                  7,671
                  
                  
                  $
                  8,115Other
      real estate owned
                  
                  
                  1,463
                  
                  
                  
                  148Total
      nonperforming assets
                  
                  
                  9,134
                  
                  
                  
                  8,263Loans
      90 days past due and still accruing
                  
                  
                  7,846
                  
                  
                  
                  1,381Total
      nonperforming assets and past due loans
                  
                  $
                  16,980
                  
                  
                  $
                  9,644





18




Investment
Securities


Investment
securities totaled $79.0 million at March 31, 2009, compared to $89.5 million at
December 31, 2008.  The decreased balance reflects the use of proceeds
from maturing securities to fund loan growth.  The average balance of
investment securities was $84.0 million for the three months ended March 31,
2009, compared to $104.2 million for the same period in 2008.  The tax
equivalent yields on investment securities were 4.28% and 4.90% for the three
months ended March 31, 2009 and 2008, respectively.





Deposits


Total
deposits at March 31, 2009 were $873.1 million, compared to $845.4 million at
December 31, 2008.  All categories of deposits grew from the
comparable amounts at the end of 2008 except for a slight decline in interest
bearing demand deposits.  The largest growth was in certificates of
deposit of $100,000 or more, which increased $10.3 million, or
4.4%.





Short-Term
Borrowings


Short-term
borrowings at March 31, 2009 and December 31, 2008 were $31.1 million and $53.0
million, respectively.  The decrease reflected less need for
short-term borrowings as a funding source.  Short-term borrowings
consisted of securities sold under agreements to repurchase, overnight
borrowings from correspondent banks and short-term advances from the Federal
Home Loan Bank (the “FHLB”).  Short-term advances are defined as those
with original maturities of one year or less.





Long-Term
Debt


At March
31, 2009 and December 31, 2008, the Company had the following long-term
debt:





March 31,
                  
                  
                  December 31,(Dollars in thousands)
                  
                  2009
                  
                  
                  2008FLHB
      4.17% Advance due November 2009
                  
                  $
                  3,000
                  
                  
                  $
                  3,000FHLB
      3.09% Advance due January 2010
                  
                  
                  3,000
                  
                  
                  
                  3,000Acquisition-related
      debt, 4.08% interest, amortizing over five years
                  
                  
                  1,947
                  
                  
                  
                  1,947$
                  7,947
                  
                  
                  $
                  7,947





Liquidity
and Capital Resources


We derive
liquidity through increased customer deposits, maturities in the investment
portfolio, loan repayments and income from earning assets.  To the
extent that deposits are not adequate to fund customer loan demand, liquidity
needs can be met in the short-term funds markets through arrangements with
correspondent banks.  Talbot Bank and Centreville National Bank are
members of the FHLB of Atlanta and Felton Bank is a member of the FHLB of
Pittsburgh to which they have pledged collateral sufficient to permit additional
borrowings of up to approximately $67.3 million in the aggregate at March 31,
2009. Management is not aware of any trends or demands, commitments, events or
uncertainties that are likely to materially affect our future ability to
maintain liquidity at satisfactory levels.





Total
stockholders’ equity was $153.4 million at March 31, 2009, an increase of 20.5%
since December 31, 2008.  The increase primarily was due to the
receipt of the proceeds of the sale of Preferred Stock to the Treasury in
January 2009.  Accumulated other comprehensive income, which consisted
solely of net unrealized gains or losses on investment securities available for
sale, decreased $370 thousand since the end of 2008, resulting in accumulated
other comprehensive income of $1.0 million at March 31, 2009.





Bank
regulatory agencies have adopted various capital standards for financial
institutions, including risk-based capital standards.  The primary
objectives of the risk-based capital framework are to provide a more consistent
system for comparing capital positions of financial institutions and to take
into account the different risks among financial institutions’ assets and
off-balance sheet items.





Risk-based
capital standards have been supplemented with requirements for a minimum Tier 1
capital to average assets ratio (leverage ratio).  In addition,
regulatory agencies consider the published capital levels as minimum levels and
may require a financial institution to maintain capital at higher
levels.  The Company’s capital ratios continued to be well in excess
of regulatory minimums.





19




A
comparison of our capital ratios as of March 31, 2009 and December 31, 2008 to
the minimum regulatory requirements is presented below. The
ratios are significantly higher at March 31, 2009 when compared to December 31,
2008 primarily due to the sale by Shore Bancshares, Inc. of 25,000 shares
of Preferred Stock to the Treasury in January 2009 pursuant to the TARP
Capital Purchase Program.  It should be noted, however, that Shore
Bancshares, Inc. redeemed all 25,000 shares of the Preferred Stock on April
15, 2009.





MinimumMarch 31,
                  
                  
                  December 31,
                  
                  
                  Regulatory2009
                  
                  
                  2008
                  
                  
                  RequirementsTier
      1 risk-based capital
                  
                  
                  14.33
                  %
                  
                  
                  11.65
                  %
                  
                  
                  4.00
                  %Total
      risk-based capital
                  
                  
                  15.44
                  %
                  
                  
                  12.74
                  %
                  
                  
                  8.00
                  %Leverage
      ratio
                  
                  
                  12.60
                  %
                  
                  
                  10.27
                  %
                  
                  
                  4.00
                  %





Item
3.  Quantitative and Qualitative Disclosures about Market
Risk.





Our
primary market risk is to interest rate fluctuation and management has
procedures in place to evaluate and mitigate this risk.  This risk and
these procedures are discussed in Item 7 of Part II of the Annual Report of
Shore Bancshares, Inc. on Form 10-K for the year ended December 31, 2008 under
the caption “Market Risk Management”.  Management believes that there
have been no material changes in our market risks, the procedures used to
evaluate and mitigate these risks, or our actual and simulated sensitivity
positions since December 31, 2008.





Item
4.  Controls and Procedures.





We
maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in the reports that Shore Bancshares, Inc.
files under the Securities Exchange Act of 1934 with the SEC, such as this
Quarterly Report, is recorded, processed, summarized and reported within the
time periods specified in those rules and forms, and that such information is
accumulated and communicated to management, including Shore Bancshares, Inc.’s
Chief Executive Officer (“CEO”) and the Principal Accounting Officer (“PAO”), as
appropriate, to allow for timely decisions regarding required
disclosure.  A control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Further, the design of a control
system must reflect the fact that there are resource constraints, and the
benefits of controls must be considered relative to their
costs.  These inherent limitations include the realities that
judgments in decision-making can be faulty, and that breakdowns can occur
because of simple error or mistake.  Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control.  The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions;
over time, controls may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may
deteriorate.





An
evaluation of the effectiveness of these disclosure controls as of March 31,
2009 was carried out under the supervision and with the participation of
management, including the CEO and the PAO.  Based on that evaluation,
management, including the CEO and the PAO, has concluded that our disclosure
controls and procedures are, in fact, effective at the reasonable assurance
level.





During
the first quarter of 2009, there was no change in our internal control over
financial reporting that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.





PART
II – OTHER INFORMATION





Item
1A.  Risk Factors.





The risks
and uncertainties to which our financial condition and operations are subject
are discussed in detail in Item 1A of Part I of the Annual Report of Shore
Bancshares, Inc. on Form 10-K for the year ended December 31,
2008.  Management does not believe that any material changes in our
risk factors have occurred since they were last disclosed.





Item 6.  Exhibits.





The
exhibits filed or furnished with this quarterly report are shown on the Exhibit
Index that follows the signatures to this report, which index is incorporated
herein by reference.





20




SIGNATURES





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





SHORE
      BANCSHARES, INC.Date:
      May 8, 2009
                  By:
                  /s/ W. Moorhead VermilyeW.
      Moorhead VermilyePresident/Chief
      Executive OfficerDate:
      May 8, 2009
                  By:
                  /s/ Susan E. LeavertonSusan
      E. Leaverton, CPATreasurer/Principal
      Accounting
Officer




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EXHIBIT
INDEX


ExhibitNumber
                
                Description31.1
                
                Certifications
      of the CEO pursuant to Section 302 of the Sarbanes-Oxley Act (filed
      herewith).31.2
                
                Certifications
      of the PAO pursuant to Section 302 of the Sarbanes-Oxley Act (filed
      herewith).32
                
                Certification
      pursuant to Section 906 of the Sarbanes-Oxley Act (furnished
      herewith).




22