**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**









**FORM
      10-Q**





**x**
            **QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**





For
      the
      Quarterly Period Ended June 30, 2008





**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 x  No  ̈





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





Large
                accelerated filer ̈
            Accelerated
                filerxNon-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 x





**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: 8,404,609 shares of common stock
      outstanding as of August 1, 2008.





**INDEX**





**Page**Part
                I.Financial Information
            2Item
                1. Financial Statements
            2Consolidated
                Balance Sheets - June 30, 2008 (unaudited) and December 31,
                2007
            2Consolidated
                Statements of Income - For the three and six months ended June 30,
                2008
                and 2007 (unaudited)
            3Consolidated
                Statements of Changes in Stockholders’ Equity - For the six months ended
                June 30, 2008 and 2007 (unaudited)
            4Consolidated
                Statements of Cash Flows - For the six months ended June 30, 2008
                and 2007
                (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
            19Item
                4. Controls and Procedures
            20Part
                II. Other Information
            20Item
                1A. Risk Factors
            20Item
                4. Submission of Matters to Vote of Security Holders
            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)





**June 30,**
            
            December 31,**2008**
            
            2007(Unaudited)**ASSETS**Cash
                and due from banks
            
            **$**
            **19,532**
            
            $
            17,198Interest
                bearing deposits with other banks
            
            
            **343**
            
            
            3,036Federal
                funds sold
            
            
            **23,111**
            
            
            6,646Investment
                securities:Available
                for sale, at fair value
            
            
            **80,721**
            
            
            97,137Held-to-maturity,
                at amortized cost (fair value of $11,100 and $12,924,
                respectively)
            
            
            **11,121**
            
            
            12,896Loans
            
            
            **841,600**
            
            
            776,350Less:
                allowance for credit losses
            
            
            **(8,282**
            **)**
            
            (7,551
            )Loans,
                net
            
            
            **833,318**
            
            
            768,799Insurance
                premiums receivable
            
            
            **1,603**
            
            
            1,083Premises
                and equipment, net
            
            
            **14,465**
            
            
            15,617Accrued
                interest receivable
            
            
            **4,843**
            
            
            5,008Investment
                in unconsolidated subsidiary
            
            
            **937**
            
            
            937Goodwill
            
            
            **15,954**
            
            
            15,954Other
                intangible assets, net
            
            
            **6,179**
            
            
            6,436Deferred
                income taxes
            
            
            **2,639**
            
            
            1,847Other
                real estate owned
            
            
            **-**
            
            
            176Other
                assets
            
            
            **4,697**
            
            
            4,141TOTAL
                ASSETS
            
            **$**
            **1,019,463**
            
            $
            956,911**LIABILITIES**Deposits:Noninterest
                bearing demand
            
            **$**
            **109,718**
            
            $
            104,081Interest
                bearing demand
            
            
            **108,549**
            
            
            115,623Money
                market and savings
            
            
            **190,355**
            
            
            169,896Certificates
                of deposit $100,000 or more
            
            
            **186,926**
            
            
            161,568Other
                time
            
            
            **223,108**
            
            
            214,727Total
                deposits
            
            
            **818,656**
            
            
            765,895Accrued
                interest payable
            
            
            **1,873**
            
            
            2,793Short-term
                borrowings
            
            
            **58,263**
            
            
            47,694Long-term
                debt
            
            
            **8,485**
            
            
            12,485Other
                liabilities
            
            
            **9,148**
            
            
            7,809TOTAL
                LIABILITIES
            
            
            **896,425**
            
            
            836,676**STOCKHOLDERS’
                EQUITY**Common
                stock, par value $.01; shares authorized - 35,000,000; shares issued
                and
                outstanding - 8,400,109 and 8,380,530, respectively
            
            
            **84**
            
            
            84Additional
                paid in capital
            
            
            **29,663**
            
            
            29,539Retained
                earnings
            
            
            **93,498**
            
            
            90,365Accumulated
                other comprehensive (loss) income
            
            
            **(207**
            **)**
            
            247TOTAL
                STOCKHOLDERS’ EQUITY
            
            
            **123,038**
            
            
            120,235TOTAL
                LIABILITIES AND STOCKHOLDERS’ EQUITY
            
            **$**
            **1,019,463**
            
            $
            956,911





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 Ended June 30,
            
            For the Six Months Ended June 30,**2008**
            
            2007
            
            **2008**
            
            2007**INTEREST INCOME**Interest
                and fees on loans
            
            **$**
            **13,961**
            
            $
            14,210
            
            **$**
            **28,521**
            
            $
            27,834Interest
                and dividends on investment securities:Taxable
            
            
            **945**
            
            
            1,291
            
            
            **2,025**
            
            
            2,575Tax-exempt
            
            
            **109**
            
            
            135
            
            
            **232**
            
            
            259Interest
                on federal funds sold
            
            
            **83**
            
            
            290
            
            
            **205**
            
            
            810Interest
                on deposits with other banks
            
            
            **29**
            
            
            329
            
            
            **67**
            
            
            667Total
                interest income
            
            
            **15,127**
            
            
            16,255
            
            
            **31,050**
            
            
            32,145**INTEREST
                EXPENSE**Interest
                on deposits
            
            
            **4,997**
            
            
            5,402
            
            
            **10,340**
            
            
            10,770Interest
                on short-term borrowings
            
            
            **316**
            
            
            276
            
            
            **682**
            
            
            559Interest
                on long-term debt
            
            
            **182**
            
            
            335
            
            
            **366**
            
            
            669Total
                interest expense
            
            
            **5,495**
            
            
            6,013
            
            
            **11,388**
            
            
            11,998**NET
                INTEREST INCOME**
            
            
            **9,632**
            
            
            10,242
            
            
            **19,662**
            
            
            20,147Provision
                for credit losses
            
            
            **615**
            
            
            413
            
            
            **1,077**
            
            
            655**NET
                INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES**
            
            
            **9,017**
            
            
            9,829
            
            
            **18,585**
            
            
            19,492**NONINTEREST
                INCOME**Service
                charges on deposit accounts
            
            
            **917**
            
            
            782
            
            
            **1,788**
            
            
            1,471Other
                service charges and fees
            
            
            **765**
            
            
            517
            
            
            **1,501**
            
            
            988Gain
                on sale of investment securities
            
            
            **-**
            
            
            1
            
            
            **-**
            
            
            1Insurance
                agency commissions
            
            
            **3,111**
            
            
            1,562
            
            
            **6,578**
            
            
            3,601Other
                noninterest income
            
            
            **401**
            
            
            399
            
            
            **829**
            
            
            848Total
                noninterest income
            
            
            **5,194**
            
            
            3,261
            
            
            **10,696**
            
            
            6,909**NONINTEREST
                EXPENSE**Salaries
                and wages
            
            
            **4,568**
            
            
            3,816
            
            
            **9,175**
            
            
            7,633Employee
                benefits
            
            
            **1,191**
            
            
            899
            
            
            **2,568**
            
            
            2,015Occupancy
                expense
            
            
            **537**
            
            
            474
            
            
            **1,036**
            
            
            984Furniture
                and equipment expense
            
            
            **298**
            
            
            348
            
            
            **584**
            
            
            670Data
                processing
            
            
            **440**
            
            
            467
            
            
            **910**
            
            
            899Directors’
                fees
            
            
            **130**
            
            
            128
            
            
            **295**
            
            
            291Amortization
                of other intangible assets
            
            
            **129**
            
            
            64
            
            
            **258**
            
            
            147Agency
                commissions
            
            
            **712**
            
            
            -
            
            
            **1,323**
            
            
            -Other
                noninterest expenses
            
            
            **1,724**
            
            
            1,551
            
            
            **3,171**
            
            
            2,999Total
                noninterest expense
            
            
            **9,729**
            
            
            7,747
            
            
            **19,320**
            
            
            15,638**INCOME
                BEFORE INCOME TAXES**
            
            
            **4,482**
            
            
            5,343
            
            
            **9,961**
            
            
            10,763Income
                tax expense
            
            
            **1,716**
            
            
            1,987
            
            
            **3,823**
            
            
            4,004**NET
                INCOME**
            
            **$**
            **2,766**
            
            $
            3,356
            
            **$**
            **6,138**
            
            $
            6,759Basic
                earnings per common share
            
            **$**
            **0.33**
            
            $
            0.40
            
            **$**
            **0.73**
            
            $
            0.81Diluted
                earnings per common share
            
            **$**
            **0.33**
            
            $
            0.40
            
            **$**
            **0.73**
            
            $
            0.81Dividends
                paid per common share
            
            **$**
            **0.16**
            
            $
            0.16
            
            **$**
            **0.32**
            
            $
            0.32





See
      accompanying notes to Consolidated Financial Statements.


3





SHORE
      BANCSHARES, INC.


CONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)


For
      the
      Six Months Ended June 30, 2008 and 2007


(Dollars
      in thousands, except per share amounts)





AccumulatedAdditional
            
            Other
            
            TotalCommon
            
            Paid in
            
            Retained
            
            Comprehensive
            
            Stockholders’Stock
            
            Capital
            
            Earnings
            
            Income (Loss)
            
            EquityBalances, January 1, 2008
            
            $
            84
            
            $
            29,539
            
            $
            90,365
            
            $
            247
            
            $
            120,235Adjustment
                to initially apply EITF Issue 06-4
            
            
            -
            
            
            -
            
            
            (318
            )
            
            -
            
            
            (318
            )Comprehensive
                income:Net
                income
            
            
            -
            
            
            -
            
            
            6,138
            
            
            -
            
            
            6,138Unrealized
                losses on available-for-sale securities, net of taxes
            
            
            -
            
            
            -
            
            
            -
            
            
            (454
            )
            
            (454
            )Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            5,684Shares
                issued for employee stock-based awards
            
            
            -
            
            
            77
            
            
            -
            
            
            -
            
            
            77Stock-based
                compensation expense
            
            
            -
            
            
            47
            
            
            -
            
            
            -
            
            
            47Cash
                dividends paid ($0.32 per share)
            
            
            -
            
            
            -
            
            
            (2,687
            )
            
            -
            
            
            (2,687
            )Balances,
                June 30, 2008
            
            **$**
            **84**
            
            **$**
            **29,663**
            
            **$**
            **93,498**
            
            **$**
            **(207**
            **)**
            **$**
            **123,038**Balances,
                January 1, 2007
            
            $
            84
            
            $
            29,687
            
            $
            82,279
            
            $
            (723
            )
            $
            111,327Comprehensive
                income:Net
                income
            
            
            -
            
            
            -
            
            
            6,759
            
            
            -
            
            
            6,759Unrealized
                losses on available-for-sale securities, net of taxes
            
            
            -
            
            
            -
            
            
            -
            
            
            (274
            )
            
            (274
            )Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            6,485Shares
                issued for employee stock-based awards
            
            
            -
            
            
            37
            
            
            -
            
            
            -
            
            
            37Stock-based
                compensation expense
            
            
            -
            
            
            29
            
            
            -
            
            
            -
            
            
            29Repurchase
                and retirement of 10,234 shares
            
            
            -
            
            
            (266
            )
            
            -
            
            
            -
            
            
            (266
            )Cash
                dividends paid ($0.32 per share)
            
            
            -
            
            
            -
            
            
            (2,682
            )
            
            -
            
            
            (2,682
            )Balances,
                June 30, 2007
            
            **$**
            **84**
            
            **$**
            **29,487**
            
            **$**
            **86,356**
            
            **$**
            **(997**
            **)**
            **$**
            **114,930**




See
      accompanying notes to Consolidated Financial Statements.


4


SHORE
      BANCSHARES, INC .


CONSOLIDATED
      STATEMENTS OF CASH FLOWS (Unaudited)


(Dollars
      in thousands)





For the Six Months Ended June 30,**2008**
            
            2007**CASH FLOWS FROM OPERATING ACTIVITIES:**Net
                income
            
            **$**
            **6,138**
            
            $
            6,759Adjustments
                to reconcile net income to net cash provided by operating
                activities:Depreciation
                and amortization
            
            
            **889**
            
            
            743Stock-based
                compensation expense
            
            
            **47**
            
            
            29Discount
                accretion on debt securities
            
            
            **(116**
            **)**
            
            (62
            )Provision
                for credit losses
            
            
            **1,077**
            
            
            655Loss
                on disposals of premises and equipment
            
            
            **9**
            
            
            -Loss
                on sale of other real estate owned
            
            
            **50**
            
            
            -Net
                changes in:Insurance
                premiums receivable
            
            
            **(520**
            **)**
            
            86Accrued
                interest receivable
            
            
            **165**
            
            
            (173
            )Other
                assets
            
            
            **(1,598**
            **)**
            
            (271
            )Accrued
                interest payable
            
            
            **(920**
            **)**
            
            (172
            )Other
                liabilities
            
            
            **1,021**
            
            
            102Net
                cash provided by operating activities
            
            
            **6,242**
            
            
            7,696**CASH
                FLOWS FROM INVESTING ACTIVITIES:**Proceeds
                      from maturities and principal payments of securities available
                      for
                      sale
            
            
            **39,193**
            
            
            15,343Purchases
                of securities available for sale
            
            
            **(23,477**
            **)**
            
            (11,824
            )Proceeds
                  from maturities and principal payments of securitiesheld to
                  maturity
            
            
            **2,785**
            
            
            9Purchases
                of securities held to maturity
            
            
            **(1,012**
            **)**
            
            -Net
                increase in loans
            
            
            **(65,734**
            **)**
            
            (31,561
            )Purchases
                of premises and equipment
            
            
            **(193**
            **)**
            
            (569
            )Proceeds
                from sale of premises
            
            
            **1,318**
            
            
            -Proceeds
                from sales of other real estate owned
            
            
            **264**
            
            
            85Net
                cash used in investing activities
            
            
            **(46,856**
            **)**
            
            (28,517
            )**CASH
                FLOWS FROM FINANCING ACTIVITIES:**Net
                increase (decrease) in demand, money market and savings
                deposits
            
            
            **19,022**
            
            
            (16,701
            )Net
                increase in certificates of deposit
            
            
            **33,739**
            
            
            7,247Net
                increase (decrease) in short-term borrowings
            
            
            **10,569**
            
            
            (965
            )Proceeds
                from issuance of long-term debt
            
            
            **3,000**
            
            
            2,000Repayment
                of long-term debt
            
            
            **(7,000**
            **)**
            
            -Proceeds
                from issuance of common stock
            
            
            **77**
            
            
            37Stock
                repurchased and retired
            
            
            **-**
            
            
            (266
            )Dividends
                paid
            
            
            **(2,687**
            **)**
            
            (2,682
            )Net
                cash provided by (used in) financing activities
            
            
            **56,720**
            
            
            (11,330
            )Net
                increase (decrease) in cash and cash equivalents
            
            
            **16,106**
            
            
            (32,151
            )Cash
                and cash equivalents at beginning of period
            
            
            **26,880**
            
            
            79,673Cash
                and cash equivalents at end of period
            
            **$**
            **42,986**
            
            $
            47,522Supplemental
                cash flows information:Interest
                paid
            
            **$**
            **12,309**
            
            $
            12,170Income
                taxes paid
            
            **$**
            **4,979**
            
            $
            4,130Transfers
                from loans to other real estate owned
            
            **$**
            **138**
            
            $
            -





See
      accompanying notes to Consolidated Financial Statements.


5


Shore
      Bancshares, Inc.


Notes
      to
      Consolidated Financial Statements


For
      the
      Three and Six Months Ended June 30, 2008 and 2007


(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 financial position at June 30, 2008, the results of
      operations for the three and six months ended June 30, 2008 and 2007, changes
      in
      stockholders’ equity for the six months ended June 30, 2008 and 2007, and cash
      flows for the six months ended June 30, 2008 and 2007, have been included.
      All
      such adjustments are of a normal recurring nature. The amounts as of December
      31, 2007 were derived from audited financial statements. The results of
      operations for the three and six months ended June 30, 2008 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,
      2007.





Note
      2
      - Earnings Per Share





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





For the Three Months Ended June 30,
            
            For the Six Months Ended June 30,(In thousands, except per share data)
            
            2008
            
            2007
            
            2008
            
            2007Net
                Income
            
            **$**
            **2,766**
            
            $
            3,356
            
            **$**
            **6,138**
            
            $
            6,759Weighted
                Average Shares Outstanding – Basic
            
            
            **8,381**
            
            
            8,378
            
            
            **8,379**
            
            
            8,380Dilutive
                effect of stock-based awards
            
            
            **7**
            
            
            15
            
            
            **8**
            
            
            15Weighted
                Average Shares Outstanding – Diluted
            
            
            **8,388**
            
            
            8,393
            
            
            **8,387**
            
            
            8,395Earnings
                per common share – Basic
            
            **$**
            **0.33**
            
            $
            0.40
            
            **$**
            **0.73**
            
            $
            0.81Earnings
                per common share – Diluted
            
            **$**
            **0.33**
            
            $
            0.40
            
            **$**
            **0.73**
            
            $
            0.81




There
      were 22 thousand and 20 thousand antidilutive stock-based awards excluded from
      the earnings per share calculation for the three and six months ended June
      30,
      2008, respectively. There were no antidilutive stock-based awards excluded
      from
      the earnings per share calculation for the three and six months ended June
      30,
      2007.





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:





June 30,
            
            December 31,
            
            June 30,(Dollars in thousands)
            
            2008
            
            2007
            
            2007Impaired
                loans with a valuation allowance
            
            **$**
            **4,520**
            
            $
            3,413
            
            $
            1,781Impaired
                loans with no valuation allowance
            
            
            **277**
            
            
            127
            
            
            144Total
                impaired loans
            
            **$**
            **4,797**
            
            $
            3,540
            
            $
            1,925Allowance
                for credit losses applicable to impaired loans
            
            **$**
            **991**
            
            $
            819
            
            $
            869Allowance
                for credit losses applicable to other than impaired loans
            
            
            **7,291**
            
            
            6,732
            
            
            6,016Total
                allowance for credit losses
            
            **$**
            **8,282**
            
            $
            7,551
            
            $
            6,885Average
                recorded investment in impaired loans
            
            **$**
            **3,924**
            
            $
            3,958
            
            $
            4,519





Gross
      interest income of $187 thousand for the first half of 2008, $404 thousand
      for
      fiscal year 2007 and $264 thousand for the first half of 2007 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 $190 thousand
      for the first half of 2008, $142 thousand for fiscal year 2007 and $133 thousand
      for the first half of 2007.





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 June 30, 2008, total commitments
      to extend credit were approximately $235.4 million. The comparable amount was
      $246.3 million at December 31, 2007. Outstanding letters of credit were
      approximately $20.5 million at June 30, 2008 and $18.3 million at December
      31,
      2007.





Note
      5
      - Stock-Based Compensation





At
      June
      30, 2008, the Company had two equity compensation plans: (i) the Shore
      Bancshares, Inc. Employee Stock Purchase Plan (“ESPP”); and (ii) the Shore
      Bancshares, Inc. 2006 Stock and Incentive Compensation Plan (“2006 Equity
      Plan”). In addition, at June 30, 2008, stock options remained outstanding under
      the Shore Bancshares, Inc. 1998 Stock Option Plan, which plan expired on March
      3, 2008. 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, 2007. 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 and six months ended June 30, 2008, the Company recognized pre-tax
      stock-based compensation expense of $24 thousand and $47 thousand, respectively,
      compared to $17 thousand and $29 thousand for the same periods last year.
      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 $346 thousand as of June 30, 2008. The
      weighted-average period over which this unrecognized expense was expected to
      be
      recognized was 4.0 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 in the first six months
      of
      2008 and 2007 reflected forfeitures as they occurred.





No
      options were granted during the first half of 2008 and
      2007.


7


The
      following table summarizes stock option activity for the Company under all
      plans
      for the six months ended June 30, 2008:





Weighted
            
            AggregateNumber
            
            Average
            
            Intrinsicof Shares
            
            Exercise Price
            
            ValueOutstanding at beginning of year
            
            
            33,797
            
            $
            15.67Granted
            
            
            -
            
            
            -Exercised
            
            
            (8,606
            )
            
            16.60Expired/Cancelled
            
            
            (2,066
            )
            
            18.47Outstanding
                at end of period
            
            
            23,125
            
            
            15.08
            
            $
            84,230Exercisable
                at end of period
            
            
            23,125
            
            $
            15.08
            
            $
            84,230




The
      following summarizes information about options outstanding at June 30,
      2008:





Options Outstanding and ExercisableOptions Outstanding
            
            
            
            Weighted AverageRemainingExercise Price
            
            Number
            
            Number
            
            Contract Life (in years)$
            21.33
            
            
            5,075
            
            
            5,075
            
            
            0.614.00
            
            
            3,255
            
            
            3,255
            
            
            1.613.17
            
            
            14,795
            
            
            14,795
            
            
            3.823,125
            
            
            23,125





The
      total
      intrinsic value of stock options exercised during the six months ended June
      30,
      2008 and 2007 was approximately $58 thousand and $24 thousand, respectively.
      Cash received upon exercise of options during the first six months of 2008
      and
      2007 was approximately $77 thousand and $37 thousand, respectively.





The
      following table summarizes restricted stock award activity for the Company
      under
      the 2006 Equity Plan for the six months ended June 30, 2008:





Number
            
            Weighted Average Grantof Shares
            
            Date Fair ValueNonvested
                at January 1, 2008
            
            
            3,845
            
            $
            25.31Granted
            
            
            13,783
            
            
            21.93Vested
            
            
            (769
            )
            
            25.31Cancelled
            
            
            -
            
            
            -Nonvested
                at June 30, 2008
            
            
            16,859
            
            $
            22.55





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 six months ended June 30,
      2008
      and 2007 is included in the following table:





Community
            
            Insurance products
            
            Parent(Dollars in thousands)
            
            banking
            
            and services
            
            Company
            
            Total2008Interest
                income
            
            **$**
            **31,018**
            
            **$**
            **32**
            
            **$**
            **-**
            
            **$**
            **31,050**Interest
                expense
            
            
            **(11,320**
            **)**
            
            **-**
            
            
            **(68**
            **)**
            
            **(11,388**
            **)**Provision
                for credit losses
            
            
            **(1,077**
            **)**
            
            **-**
            
            
            **-**
            
            
            **(1,077**
            **)**Noninterest
                income
            
            
            **3,607**
            
            
            **7,089**
            
            
            **-**
            
            
            **10,696**Noninterest
                expense
            
            
            **(10,306**
            **)**
            
            **(6,189**
            **)**
            
            **(2,825**
            **)**
            
            **(19,320**
            **)**Net
                intersegment income (expense)
            
            
            **(2,431**
            **)**
            
            **(194**
            **)**
            
            **2,625**
            
            
            **-**Income
                before taxes
            
            
            **9,491**
            
            
            **738**
            
            
            **(268**
            **)**
            
            **9,961**Income
                tax (expense) benefit
            
            
            **(3,643**
            **)**
            
            **(283**
            **)**
            
            **103**
            
            
            **(3,823**
            **)**Net
                income
            
            **$**
            **5,848**
            
            **$**
            **455**
            
            **$**
            **(165**
            **)**
            **$**
            **6,138**Total
                assets
            
            **$**
            **995,389**
            
            **$**
            **20,719**
            
            **$**
            **3,355**
            
            **$**
            **1,019,463**2007Interest
                income
            
            $
            32,145
            
            $
            -
            
            $
            -
            
            $
            32,145Interest
                expense
            
            
            (11,998
            )
            
            -
            
            
            -
            
            
            (11,998
            )Provision
                for credit losses
            
            
            (655
            )
            
            -
            
            
            -
            
            
            (655
            )Noninterest
                income
            
            
            3,275
            
            
            3,634
            
            
            -
            
            
            6,909Noninterest
                expense
            
            
            (10,260
            )
            
            (2,792
            )
            
            (2,586
            )
            
            (15,638
            )Net
                intersegment income (expense)
            
            
            (2,319
            )
            
            (181
            )
            
            2,500
            
            
            -Income
                before taxes
            
            
            10,188
            
            
            661
            
            
            (86
            )
            
            10,763Income
                tax (expense) benefit
            
            
            (3,790
            )
            
            (246
            )
            
            32
            
            
            (4,004
            )Net
                income
            
            $
            6,398
            
            $
            415
            
            $
            (54
            )
            $
            6,759Total
                assets
            
            $
            928,213
            
            $
            9,556
            
            $
            2,994
            
            $
            940,763





Note
      7 – Fair Value Measurements




Effective
      January 1, 2008, the Company adopted Statement of Financial Accounting
      Standards (“SFAS”) No. 157, “ *Fair
      Value Measurements”* which
      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 in periods subsequent to initial recognition,
      whether the measurements are made on a recurring basis (for example, available
      for sale investment securities) or on a nonrecurring basis (for example,
      impaired loans).




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 sale, loans held for investment
      and
      certain other assets. These nonrecurring fair value adjustments typically
      involve application of lower of cost or market accounting or write-downs of
      individual assets.




Under
      SFAS 157, the company groups assets and liabilities 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.





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.


9




The
      following is a description of valuation methodologies used for assets and
      liabilities 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 June 30, 2008, 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.





Assets
      and Liabilities Recorded at Fair Value on a Recurring Basis


The
      table
      below presents the recorded amount of assets and liabilities measured at fair
      value on a recurring basis at June 30, 2008.





SignificantOther
            
            SignificantQuoted
            
            Observable
            
            UnobservablePrices
            
            Inputs
            
            Inputs(Dollars
                in thousands)
            
            Fair
                Value
            
            (Level
                1)
            
            (Level
                2)
            
            (Level
                3)Securities
                available for sale
            
            $
            80,721
            
            
            -
            
            $
            80,721
            
            
            -




Assets
      and Liabilities Recorded at Fair Value on a Nonrecurring Basis


The
      Company may be required from time to time, to measure certain assets at fair
      value on a nonrecurring basis in accordance with GAAP. These include assets
      that
      are measured at the lower of cost or market that were recognized at fair value
      below cost at the end of the period. The table below presents the recorded
      amount of assets and liabilities measured at fair value on a nonrecurring basis
      at June 30, 2008.





SignificantOther
            
            SignificantQuoted
            
            Observable
            
            UnobservablePrices
            
            Inputs
            
            Inputs(Dollars
                in thousands)
            
            Fair
                Value
            
            (Level
                1)
            
            (Level
                2)
            
            (Level
                3)Impaired
                loans
            
            $
            3,806
            
            
            -
            
            
            -
            
            $
            3,806





Impaired
      loans had a carrying amount of $4.8 million with a valuation allowance of $1.0
      at June 30, 2008.





Note
      8 – Sale-leaseback





On
      April
      17, 2008, the Company entered into a sale-leaseback agreement with Milford
      Plaza
      Enterprises, LLC (“Purchaser”). Under the agreement, the Company terminated its
      ground lease with the Purchaser and conveyed to the Purchaser title to the
      Company’s improvements to the property, generally consisting of the Company’s
      branch banking facility in Milford, Delaware. The Company received $1.3 million
      for this sale and an immaterial loss was recorded on the transaction. The
      Company has leased back the facility for an initial period of 12 years. Monthly
      rental expense under the agreement is approximately $11
      thousand.


10




Note 9 – New Accounting Pronouncements




**Pronouncements
      adopted**


*SFAS No. 158,
      “Employers’ Accounting for Defined Benefit Pension and Other Postretirement
      Plans, an amendment of FASB Statements No. 87, 88 106, and 132(R).”* SFAS 158
      requires an employer to recognize the overfunded or underfunded status of
      post-retirement defined benefit plans as an asset or a liability in its
      statement of financial position. The funded status is measured as the difference
      between plan assets at fair value and the benefit obligation (the projected
      benefit obligation for pension plans or the accumulated benefit obligation
      for
      other post-retirement benefit plans). An employer is also required to measure
      the funded status of a plan as of the date of its year-end statement of
      financial position with changes in the funded status recognized through
      comprehensive income. SFAS 158 also requires certain disclosures regarding
      the effects on net periodic benefit cost for the next fiscal year that arise
      from delayed recognition of gains or losses, prior service costs or credits,
      and
      the transition asset or obligation. The adoption of SFAS 158’s requirement to
      recognize the funded status in the financial statements for fiscal years ending
      after December 15, 2006 did not have a significant impact on the Company’s
      consolidated financial statements. SFAS 158’s requirement to use the fiscal
      year-end date as the measurement date is effective for fiscal years ending
      after
      December 15, 2008, and did not have a significant impact on the Company’s
      consolidated financial statements.





*SFAS
      No. 159, "The Fair Value Option for Financial Assets and Financial
      Liabilities-Including an amendment of FASB Statement No. 115."* SFAS
      159
      permits entities to choose to measure eligible items at fair value at specified
      election dates. Unrealized gains and losses on items for which the fair value
      option has been elected are reported in earnings at each subsequent reporting
      date. The fair value option (i) may be applied instrument by instrument, with
      certain exceptions, (ii) is irrevocable (unless a new election date occurs)
      and
      (iii) is applied only to entire instruments and not to portions of instruments.
      The objective is to improve financial reporting by providing entities with
      the
      opportunity to mitigate volatility in reported earnings caused by measuring
      related assets and liabilities differently without having to apply complex
      hedge
      accounting provisions. This Statement is expected to expand the use of fair
      value measurement, which is consistent with the FASB’s long-term measurement
      objectives for accounting for financial instruments. The Company adopted SFAS
      159 on January 1, 2008 and has not elected the fair value option for any
      financial assets or liabilities at June 30, 2008.




The
      Emerging Issues Task Force (“EITF”) of the FASB issued EITF Issue 06-4,
“Accounting for Deferred Compensation and Postretirement Benefit Aspects of
      Endorsement Split-Dollar Life Insurance Arrangements,” which was effective
      January 1, 2008. EITF 06-4 requires the recognition of a liability and related
      compensation costs for endorsement split-dollar life insurance policies that
      provide a benefit to an employee that extends to postretirement periods as
      defined in SFAS No. 106, " Employers' Accounting for Postretirement Benefits
      Other Than Pensions." The EITF reached a consensus that Bank Owned Life
      Insurance policies purchased for this purpose do not effectively settle the
      entity's obligation to the employee in this regard and thus the entity must
      record compensation cost and a related liability. Entities should recognize
      the
      effects of applying this Issue through either, (a) a change in accounting
      principle through a cumulative-effect adjustment to retained earnings or to
      other components of equity or net assets in the balance sheet as of the
      beginning of the year of adoption, or (b) a change in accounting principle
      through retrospective application to all prior periods. This Issue is effective
      for fiscal years beginning after December 15, 2007. The effects of the guidance
      have been applied as a change in accounting principle through a
      cumulative-effect adjustment to retained earnings of $318,000.





EITF
      Issue 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based
      Payment Awards.” EITF 06-11 requires that tax benefits generated by dividends
      paid during the vesting period on certain equity-classified share-based
      compensation awards be classified as additional paid-in capital and included
      in
      a pool of excess tax benefits available to absorb tax deficiencies from
      share-based payment awards. EITF 06-11 is effective for years beginning after
      December 15, 2007. The adoption of EITF 06-11 did not have a significant impact
      on the Company’s consolidated financial position or results of
      operations.




**Pronouncements
      issued but not yet effective**


*SFAS
      No. 141R, “Business Combinations.”* SFAS
      141R’s objective is to improve the relevance, representational faithfulness, and
      comparability of the information that a reporting entity provides in its
      financial reports about a business combination and its effects. SFAS 141R
      applies prospectively to business combinations for which the acquisition date
      is
      on or after December 31, 2008. This statement will change the Company’s
      accounting treatment for business combinations on a prospective
      basis.




*SFAS
      No. 160, “Noncontrolling Interests in Consolidated Financial
      Statements.”* SFAS
      160’s objective is to improve the relevance, comparability, and transparency of
      the financial information that a reporting entity provides in its consolidated
      financial statements by establishing accounting and reporting standards for
      the
      noncontrolling interest in a subsidiary and for the deconsolidation of a
      subsidiary. SFAS 160 shall be effective for fiscal years and interim periods
      within those fiscal years, beginning on or after December 15, 2008. The Company
      does not expect the implementation of SFAS 160 to have a material impact on
      its
      consolidated financial statements.





*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,
      with early application encouraged. The Company does not expect the
      implementation of SFAS 161 to have a material impact on its consolidated
      financial statements.


11


*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. This Statement is effective
      60
      days following the Security and Exchange Commission’s approval of the Public
      Company Accounting Oversight Board amendments to AU Section 411, *The
      Meaning of Present Fairly in Conformity with Generally Accepted Accounting
      Principles.* The
      Company does not expect the implementation of SFAS 162 to have a material impact
      on its consolidated financial statements.





*SFAS
      No. 163, “Accounting for Financial Guarantee Insurance Contracts - an
      interpretation of FASB Statement No. 60.”* SFAS
      163
      requires that an insurance enterprise recognize a claim liability prior to
      an
      event of default (insured event) when there is evidence that credit
      deterioration has occurred in an insured financial obligation. This Statement
      also clarifies how Statement 60 applies to financial guarantee insurance
      contracts, including the recognition and measurement to be used to account
      for
      premium revenue and claim liabilities. The accounting and expanded disclosure
      requirements of SFAS 163 will improve the quality and comparability of financial
      information that will be provided to users of financial statements. This
      Statement is effective for financial statements issued for fiscal years
      beginning after December 15, 2008, and all interim periods within those fiscal
      years. This Statement also requires that disclosures about the risk-management
      activities of the insurance enterprise be effective for the first period
      (including interim periods) beginning after issuance of this Statement. The
      Company does not expect the implementation of SFAS 163 to have a material impact
      on its consolidated financial statements.





**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 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.





**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, 2007.





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,
      Queen Anne’s, Talbot, Caroline and Dorchester Counties 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.


12


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





The
      Company 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 Securities and Exchange
      Commission.





**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. 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.





**OVERVIEW**





Net
      income for the second quarter of 2008 was $2.766 million, or diluted earnings
      per share of $0.33, compared to $3.356 million, or diluted earnings per share
      of
      $0.40, for the second quarter of 2007. For the first quarter of 2008, net income
      was $3.372 million or $0.40 per diluted share. Annualized return on average
      assets was 1.12% for the three months ended June 30, 2008, compared to 1.43%
      for
      the same period in 2007. Annualized return on average stockholders’ equity was
      8.98% for the second quarter of 2008, compared to 11.69% for the second quarter
      of 2007. For the first quarter of 2008, annualized return on average assets
      was
      1.38% and return on average equity was 10.96%.


13


Net
      income for the first half of 2008 was $6.1 million, or diluted earnings per
      share of $0.73, compared to $6.8 million, or diluted earnings per share of
      $0.81, for the first half of 2007. Annualized return on average assets was
      1.25%
      for the six months ended June 30, 2008, compared to 1.43% for the same period
      in
      2007. Annualized return on average stockholder’s equity was 10.02% for the first
      half of 2008, compared to 11.89% for the first half of 2007.





**RESULTS
      OF OPERATIONS**





**Net
      Interest Income**


Net
      interest income for the three months ended June 30, 2008 was $9.6 million,
      a
      decrease of 6.0% when compared to the same period last year. Lower yields on
      earning assets were the primary reason for the decrease. The net interest margin
      was 4.17% for the second quarter of 2008, a decrease of 49 basis points when
      compared to the second quarter of 2007. Net interest income decreased 4.0%
      from
      the first quarter of 2008 mainly due to lower yields on earning assets. The
      net
      interest margin decreased 25 basis points from 4.42% for the first quarter
      of
      2008. The 225 basis-point reduction in interest rates by the Federal Reserve
      during the first half of 2008 had a significant impact on the overall yield
      on
      earning assets.





Interest
      income was $15.1 million for the second quarter of 2008, a decrease of 6.9%
      from
      the second quarter of 2007. Average earning assets increased 5.8% during the
      second quarter of 2008 when compared to the same period in 2007, while yields
      earned decreased 84 basis points to 6.53%. Average loans increased 15.6% while
      the yield earned on loans decreased 115 basis points. Loans


comprised
      87.7% and 80.2% of total average earning assets for the quarters ended June
      30,
      2008 and 2007, respectively. Interest income decreased 5.0% when compared to
      the
      first quarter of 2008. Average earning assets increased 1.9% during the second
      quarter of 2008 when compared to the first quarter of 2008, while yields earned
      decreased 47 basis points.





Interest
      expense decreased 8.6% for the three months ended June 30, 2008 when compared
      to
      the same period last year. Average interest bearing liabilities increased 6.3%,
      while rates paid decreased 46 basis points to 2.92%. Average balances increased
      in all categories of interest bearing liabilities except for interest bearing
      demand deposits and long-term debt. However, rates declined enough to reduce
      interest expense in all categories of interest bearing liabilities except for
      certificates of deposit $100,000 or more and short-term borrowings. The average
      balance of interest bearing deposits increased 5.7% for the quarter ended June
      30, 2008 when compared to the same period in 2007. The overall rate paid for
      interest bearing deposits decreased 39 basis points to 2.89%. For the three
      months ended June 30, 2008, the average balance of certificates of deposits
      $100,000 or more increased 16.3% when compared to the same period last year,
      and
      the average rate paid for those certificates of deposit decreased 63 basis
      points to 4.26%. Interest expense decreased 6.8% when compared to the first
      quarter of 2008. Average interest bearing liabilities increased 1.2% during
      the
      quarter ended June 30, 2008 while rates paid decreased 25 basis points when
      compared to the same quarter of last year.





Net
      interest income for the six months ended June 30, 2008 was $19.7 million, a
      decrease of 2.4% when compared to the same period last year. The decrease was
      primarily the result of lower yields on earning assets. The net interest margin
      was 4.30% for the first half of 2008, a decrease of 26 basis points when
      compared to the first half of 2007.





Interest
      income was $31.0 million for the first half of 2008, a decrease of 3.4% from
      the
      first half of 2007. Average earning assets increased 4.4% during the first
      six
      months of 2008 when compared to the same period in 2007, while yields earned
      decreased 49 basis points to 6.76%. Average loans increased 14.8% during the
      first half of 2008 while the yield earned on loans decreased 80 basis points
      when compared to the first half of 2007. Loans comprised 87.1% and 79.2% of
      total average earning assets for the first half of 2008 and 2007, respectively.




Interest
      expense decreased 5.1% for the six months ended June 30, 2008 when compared
      to
      the same period last year. Average interest bearing liabilities increased 4.6%,
      while rates paid decreased 29 basis points to 3.05%. Average balances increased
      in all categories of interest bearing liabilities except for long-term debt.
      However, rates declined enough to reduce interest expense in all categories
      of
      interest bearing liabilities except for certificates of deposit $100,000 or
      more
      and short-term borrowings. The average balance of interest bearing deposits
      increased 4.2% for the first half of 2008 when compared to the same period
      in
      2007. The overall rate paid for interest bearing deposits decreased 24 basis
      points to 3.00%. For the six months ended June 30, 2008, the average balance
      of
      certificates of deposits $100,000 or more increased 6.5% when compared to the
      same period last year, and the average rate paid for those certificates of
      deposit decreased 7 basis points to 4.44%.


14







**Analysis
      of Interest Rates and Interest Differentials**


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 June 30, 2008 and 2007.





**For the Three Months Ended June 30, 2008**
            
            For the Three Months Ended June 30, 2007**Average**
            
            **Income(1)/**
            
            **Yield/**
            
            Average
            
            Income(1)/
            
            Yield/(Dollars in thousands)
            
            **Balance**
            
            **Expense**
            
            **Rate**
            
            Balance
            
            Expense
            
            RateEarning
                assetsInvestment
                securitiesTaxable
            
            **$**
            **83,654**
            
            **$**
            **945**
            
            
            **4.54**
            **%**
            $
            115,181
            
            $
            1,291
            
            
            4.48
            %Nontaxable
            
            
            **11,200**
            
            
            **167**
            
            
            **6.01**
            
            
            13,663
            
            
            207
            
            
            6.06Loans
                (2), (3)
            
            
            **822,781**
            
            
            **14,003**
            
            
            **6.85**
            
            
            711,866
            
            
            14,232
            
            
            8.00Federal
                funds sold
            
            
            **15,194**
            
            
            **83**
            
            
            **2.21**
            
            
            22,085
            
            
            290
            
            
            5.26Interest
                bearing deposits
            
            
            **5,812**
            
            
            **29**
            
            
            **2.01**
            
            
            24,594
            
            
            329
            
            
            5.34Total
                earning assets
            
            
            **938,641**
            
            
            **15,227**
            
            
            **6.53**
            **%**
            
            887,389
            
            
            16,349
            
            
            7.37
            %Cash
                and due from banks
            
            
            **16,618**
            
            
            
            
            
            
            
            
            16,730Other
                assets
            
            
            **50,315**
            
            
            
            
            
            
            
            
            43,314Allowance
                for credit losses
            
            
            **(8,102**
            **)**
            
            
            
            
            
            
            
            (6,688
            )Total
                assets
            
            **$**
            **997,472**
            
            
            
            
            
            
            
            $
            940,745Interest
                bearing liabilitiesDemand
                deposits
            
            **$**
            **109,716**
            
            
            **95**
            
            
            **0.35**
            **%**
            $
            111,251
            
            
            270
            
            
            0.97
            %Money
                market and savings deposits
            
            
            **183,392**
            
            
            **659**
            
            
            **1.45**
            
            
            173,006
            
            
            751
            
            
            1.74Certificates
                of deposit $100,000 or more
            
            
            **183,108**
            
            
            **1,940**
            
            
            **4.26**
            
            
            157,463
            
            
            1,923
            
            
            4.89Other
                time deposits
            
            
            **219,250**
            
            
            **2,303**
            
            
            **4.23**
            
            
            215,936
            
            
            2,458
            
            
            4.55Interest
                bearing deposits
            
            
            **695,466**
            
            
            **4,997**
            
            
            **2.89**
            
            
            657,656
            
            
            5,402
            
            
            3.28Short-term
                borrowings
            
            
            **45,354**
            
            
            **316**
            
            
            **2.80**
            
            
            26,488
            
            
            276
            
            
            4.17Long-term
                debt
            
            
            **15,101**
            
            
            **182**
            
            
            **4.85**
            
            
            27,000
            
            
            335
            
            
            4.96Total
                interest bearing liabilities
            
            
            **755,921**
            
            
            **5,495**
            
            
            **2.92**
            **%**
            
            711,144
            
            
            6,013
            
            
            3.38
            %Noninterest
                bearing deposits
            
            
            **106,035**
            
            
            
            
            
            
            
            
            105,987Other
                liabilities
            
            
            **11,686**
            
            
            
            
            
            
            
            
            8,776Stockholders’
                equity
            
            
            **123,830**
            
            
            
            
            
            
            
            
            114,838Total
                liabilities and stockholders’ equity
            
            **$**
            **997,472**
            
            
            
            
            
            
            
            $
            940,745Net
                interest spread
            
            
            
            
            **$**
            **9,732**
            
            
            **3.61**
            **%**
            
            
            
            $
            10,336
            
            
            3.99
            %Net
                interest margin
            
            
            
            
            
            
            
            
            **4.17**
            **%**
            
            
            
            
            
            
            
            4.66
            %




15





The
      following table presents the distribution of the average consolidated balance
      sheets, interest income/expense, and annualized yields earned and rates paid
      for
      the six months ended June 30, 2008 and 2007.


**For the Six Months Ended June 30, 2008**
              
              **For the Six Months Ended June 30, 2007****Average**
              
              **Income(1)/**
              
              **Yield/**
              
              Average
              
              Income(1)/
              
              Yield/(Dollars in thousands)
              
              **Balance**
              
              **Expense**
              
              **Rate**
              
              Balance
              
              Expense
              
              RateEarning assetsInvestment
                  securitiesTaxable
              
              **$**
              **87,638**
              
              **$**
              **2,025**
              
              
              **4.65**
              **%**
              $
              115,755
              
              $
              2,575
              
              
              4.45
              %Nontaxable
              
              
              **11,938**
              
              
              **357**
              
              
              **6.01**
              
              
              13,667
              
              
              399
              
              
              5.84Loans
                  (2), (3)
              
              
              **809,815**
              
              
              **28,604**
              
              
              **7.10**
              
              
              705,465
              
              
              27,873
              
              
              7.90Federal
                  funds sold
              
              
              **15,856**
              
              
              **205**
              
              
              **2.61**
              
              
              30,743
              
              
              810
              
              
              5.27Interest
                  bearing deposits
              
              
              **5,013**
              
              
              **67**
              
              
              **2.69**
              
              
              25,630
              
              
              667
              
              
              5.20Total
                  earning assets
              
              
              **930,260**
              
              
              **31,258**
              
              
              **6.76**
              **%**
              
              891,260
              
              
              32,324
              
              
              7.25
              %Cash
                  and due from banks
              
              
              **16,482**
              
              
              
              
              
              
              
              
              16,640Other
                  assets
              
              
              **50,855**
              
              
              
              
              
              
              
              
              43,425Allowance
                  for credit losses
              
              
              **(7,909**
              **)**
              
              
              
              
              
              
              
              (6,567
              )Total
                  assets
              
              **$**
              **989,688**
              
              
              
              
              
              
              
              $
              944,758Interest
                  bearing liabilitiesDemand
                  deposits
              
              **$**
              **112,465**
              
              
              **266**
              
              
              **0.48**
              **%**
              $
              111,249
              
              
              506
              
              
              0.91
              %Money
                  market and savings deposits
              
              
              **179,378**
              
              
              **1,364**
              
              
              **1.53**
              
              
              179,161
              
              
              1,575
              
              
              1.76Certificates
                  of deposit $100,000 or more
              
              
              **181,831**
              
              
              **4,010**
              
              
              **4.44**
              
              
              170,741
              
              
              3,849
              
              
              4.51Other
                  time deposits
              
              
              **218,323**
              
              
              **4,700**
              
              
              **4.33**
              
              
              203,057
              
              
              4,840
              
              
              4.77Interest
                  bearing deposits
              
              
              **691,997**
              
              
              **10,340**
              
              
              **3.00**
              
              
              664,208
              
              
              10,770
              
              
              3.24Short-term
                  borrowings
              
              
              **44,354**
              
              
              **682**
              
              
              **3.09**
              
              
              26,832
              
              
              559
              
              
              4.17Long-term
                  debt
              
              
              **15,013**
              
              
              **366**
              
              
              **4.90**
              
              
              27,000
              
              
              669
              
              
              4.96Total
                  interest bearing liabilities
              
              
              **751,364**
              
              
              **11,388**
              
              
              **3.05**
              **%**
              
              718,040
              
              
              11,998
              
              
              3.34
              %Noninterest
                  bearing deposits
              
              
              **103,508**
              
              
              
              
              
              
              
              
              104,459Other
                  liabilities
              
              
              **11,642**
              
              
              
              
              
              
              
              
              8,539Stockholders’
                  equity
              
              
              **123,174**
              
              
              
              
              
              
              
              
              113,720Total
                  liabilities and stockholders’ equity
              
              **$**
              **989,688**
              
              
              
              
              
              
              
              $
              944,758Net
                  interest spread
              
              
              
              
              **$**
              **19,870**
              
              
              **3.71**
              **%**
              
              
              
              $
              20,326
              
              
              3.91
              %Net
                  interest margin
              
              
              
              
              
              
              
              
              **4.30**
              **%**
              
              
              
              
              
              
              
              4.56
              %




(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 include all.





**Noninterest
      Income**


Noninterest
      income for the second quarter of 2008 increased $1.9 million when compared
      to
      the second quarter of 2007. The increase was primarily the result of the
      acquisition of two insurance agencies during the fourth quarter of 2007. Service
      charges on deposit accounts increased $135 thousand, other service charges
      and
      fees increased $248 thousand and insurance agency commissions increased $1.5
      million for the second quarter of 2008 when compared to the second quarter
      of
      2007. Noninterest income decreased $308 thousand from the first quarter of
      2008
      primarily due to a decrease in insurance agency commissions of $356 thousand
      offset by an increase in service charge income of $46 thousand and an increase
      in other service charges and fees of $29 thousand.





Noninterest
      income for the first half of 2008 increased $3.8 million when compared to the
      first half of 2007. The increase was primarily the result of the acquisition
      of
      the two insurance agencies during the fourth quarter of 2007. Service charges
      on
      deposit accounts increased $317 thousand, other service charges and fees
      increased $513 thousand and insurance agency commissions increased $3.0 million
      for the first six months of 2008 when compared to the same period in 2007.





**Noninterest
      Expense**


Noninterest
      expense for the second quarter of 2008 increased $2.0 million when compared
      to
      the second quarter of 2007. The increase was primarily attributable to the
      operating expenses of the two insurance agencies acquired during the fourth
      quarter of 2007. Salaries and benefits increased $1.0 million, agency
      commissions increased $712 thousand and other noninterest expenses increased
      $173 thousand for the second quarter of 2008 when compared to the second quarter
      of 2007. Noninterest expense increased $138 thousand from the first quarter
      of
      2008 primarily due to an increase in agency commissions and other noninterest
      expenses partially offset by a decrease in salaries and benefits.




16




Noninterest
      expense for the first half of 2008 increased $3.7 million when compared to
      the
      first half of 2007. The increase was primarily attributable to the operating
      expenses of the two insurance agencies acquired during the fourth quarter of
      2007. Salaries and benefits increased $2.1 million, agency commissions increased
      $1.3 million and other noninterest expenses increased $172 thousand for the
      first six months of 2008 when compared to the same period last year.





**Income
      Taxes**


The
      effective tax rate was 38.3% for the three months ended June 30, 2008 compared
      to 37.2% for the same period last year. For the six months ended June 30, 2008
      and 2007, the effective tax rate was 38.4% and 37.2%, respectively. The increase
      in the effective tax rate for both the quarter-to-date and year-to-date
      comparisons was due to a 1.25% increase in the Maryland corporate income tax
      rate at the beginning of 2008. Management believes that 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.





**ANALYSIS
      OF FINANCIAL CONDITION**





**Loans**


Loans,
      net of unearned income, totaled $841.6 million at June 30, 2008, an increase
      of
      $65.2 million, or 8.4%, since December 31, 2007. Average loans, net of unearned
      income, were $822.8 million for the three months ended June 30, 2008, an
      increase of $110.9 million, or 15.6%, when compared to the same period last
      year. Average loans, net of unearned income, were $809.8 million for the six
      months ended June 30, 2008, an increase of $104.3 million, or 14.8%, when
      compared to the same period in 2007.





**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 June 30, 2008 and 2007
      was $615 thousand and $413 thousand, respectively. The provision for credit
      losses for the first quarter of 2008 was $462 thousand. The increased provision
      for the second quarter of 2008 when compared to the second quarter of 2007
      and
      the first quarter of 2008 reflected current economic conditions and the
      continued growth in the loan portfolio. The provision for credit losses for
      the
      six months ended June 30, 2008 and 2007 was $1.1 million and $655 thousand,
      respectively. Generally, the credit quality of the portfolio remained strong
      as
      evidenced by charge-off data for the second quarter and first half of 2008
      and
      loan delinquency at June 30, 2008. Management believes that we continue to
      maintain strong underwriting guidelines.





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 $259 thousand
      for the three months ended June 30, 2008, compared to $34 thousand for the
      same
      period last year and $87 thousand for the first quarter of 2008. The allowance
      for credit losses as a percentage of average loans was 1.01% for the second
      quarter of 2008, 0.97% for the second quarter of 2007 and 0.99% for the first
      quarter of 2008. Net charge-offs were $346 thousand for the first half of 2008,
      compared to $70 thousand for the same period in 2007. The allowance for credit
      losses as a percentage of average loans was 1.02% for the first half of 2008
      and
      0.98% for the first half of 2007. Nonperforming assets were $4.8 million at
      June
      30, 2008, compared to $3.7 million at December 31, 2007. Loans past due 90
      days
      and still accruing at June 30, 2008 decreased to $537 thousand from $1.6 million
      at December 31, 2007. 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 June 30,
      2008.


17


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


For the Three Months Ended June 30,
              
              For the Six Months Ended June 30,(Dollars in thousands)
              
              **2008**
              
              2007
              
              **2008**
              
              2007Allowance
                  balance - beginning of period
              
              **$**
              **7,926**
              
              $
              6,506
              
              **$**
              **7,551**
              
              $
              6,300Charge-offs:Real
                  estate
              
              
              **(59**
              **)**
              
              -
              
              
              **(71**
              **)**
              
              -Consumer
              
              
              **(72**
              **)**
              
              (43
              )
              
              **(135**
              **)**
              
              (122
              )Commercial
                  and other
              
              
              **(154**
              **)**
              
              (19
              )
              
              **(196**
              **)**
              
              (35
              )Totals
              
              
              **(285**
              **)**
              
              (62
              )
              
              **(402**
              **)**
              
              (157
              )Recoveries:Real
                  estate
              
              
              **-**
              
              
              -
              
              
              **8**
              
              
              -Consumer
              
              
              **22**
              
              
              18
              
              
              **41**
              
              
              45Commercial
                  and other
              
              
              **4**
              
              
              10
              
              
              **7**
              
              
              42Totals
              
              
              **26**
              
              
              28
              
              
              **56**
              
              
              87Net
                  charge-offs
              
              
              **(259**
              **)**
              
              (34
              )
              
              **(346**
              **)**
              
              (70
              )Provision
                  for credit losses
              
              
              **615**
              
              
              413
              
              
              **1,077**
              
              
              655Allowance
                  balance - end of period
              
              **$**
              **8,282**
              
              $
              6,885
              
              **$**
              **8,282**
              
              $
              6,885Average
                  loans outstanding during the period
              
              **$**
              **822,781**
              
              $
              711,866
              
              **$**
              **809,815**
              
              $
              705,465Net
                  charge-offs (annualized) as a percentage ofaverage
                  loans outstanding during the period
              
              
              **0.13**
              **%**
              
              0.02
              %
              
              **0.09**
              **%**
              
              0.02
              %Allowance
                  for credit losses at period end as apercentage
                  of average loans
              
              
              **1.01**
              **%**
              
              0.97
              %
              
              **1.02**
              **%**
              
              0.98
              %





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. Despite
      the
      weaknesses in the national economy and real estate market, management believes
      that the local economy and real estate market remain relatively stable. ****





We
      have a
      concentration of commercial real estate loans. Commercial real estate loans,
      excluding construction and land development loans, at June 30, 2008 were
      approximately $288.8 million, or 34.3% of total loans, compared to $249.5
      million, or 32.1% of total loans at December 31, 2007. Construction and land
      development loans at June 30, 2008 were $174.3 million, or 20.7% of total loans,
      compared to $155.5 million, or 20.0% of total loans, at December 31, 2007.
      We do
      not engage in foreign or subprime lending activities.





**Nonperforming
      Assets**


The
      following table summarizes our nonperforming and past due
      assets:


**June
                  30,**
              
              December
                  31,(Dollars
                  in thousands)
              
              **2008**
              
              2007Nonperforming
                  assetsNonaccrual
                  loans
              
              **$**
              **4,797**
              
              $
              3,540Other
                  real estate owned
              
              
              **-**
              
              
              176Total
                  nonperforming assets
              
              
              **4,797**
              
              
              3,716Loans
                  90 days past due and still accruing
              
              
              **537**
              
              
              1,606Total
                  nonperforming assets and past due loans
              
              **$**
              **5,334**
              
              $
              5,322





**Investment
      Securities**


Investment
      securities totaled $91.8 million at June 30, 2008, compared to $110.0 million
      at
      December 31, 2007. The decreased balance was due to the use of proceeds from
      maturing securities to fund loan growth. The average balance of investment
      securities was $94.9 million for the three months ended June 30, 2008, compared
      to $128.8 million for the same period in 2007. The tax equivalent yields on
      investment securities were 4.72% and 4.65% for the three months ended June
      30,
      2008 and 2007, respectively. The
      average balance of investment securities was $99.6 million for the six months
      ended June 30, 2008, compared to $129.4 million for the same period in 2007.
      The
      tax equivalent yields on investment securities were 4.81% and 4.60% for the
      six
      months ended June 30, 2008 and 2007, respectively.





**Deposits**


Total
      deposits at June 30, 2008 were $818.7 million, compared to $765.9 million at
      December 31, 2007. Certificates of deposit of $100,000 or more increased $25.4
      million, or 15.7%, due primarily to increased deposits of a large municipal
      customer, and money market and savings deposits increased $20.5 million, or
      12.0%, since the end of 2007. Growth in other time and demand deposits has
      remained relatively flat since December 31, 2007.


18


**Short-term
      borrowings**


Short-term
      borrowings at June 30, 2008 and December 31, 2007 were $58.3 million and $47.7
      million, respectively. 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. Short-term advances are defined as those with original
      maturities of one year or less.





**Long-Term
      Debt**


At
      June
      30, 2008 and December 31, 2007, the Company had the following long-term
      debt:


**June 30,**
              
              December 31,(Dollars
                  in thousands)
              
              **2008**
              
              2007Federal
                  Home Loan Bank (FHLB) 5.69% Advance due June 2008
              
              **$**
              **-**
              
              $
              7,000FHLB
                  4.17% Advance due November 2009
              
              
              **3,000**
              
              
              3,000FHLB
                  3.09% Advance due January 2010
              
              
              **3,000**
              
              
              -Acquisition
                  related debt, 4.08% interest, equal annual installments for five
                  years
              
              
              **2,485**
              
              
              2,485**$**
              **8,485**
              
              $
              12,485




**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 also members of the Federal
      Home Loan Bank of Atlanta and Felton Bank is a member of the Federal Home Loan
      Bank of Pittsburgh to which they have pledged collateral sufficient to permit
      additional borrowings of up to approximately $62.5 million in the aggregate
      at
      June 30, 2008. 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 $123.0 million at June 30, 2008, an increase of 2.3%
      since December 31, 2007. Accumulated other comprehensive income, which consists
      solely of net unrealized gains or losses on investment securities available
      for
      sale, decreased $454 thousand since the end of 2007, resulting in accumulated
      other comprehensive loss of $207 thousand at June 30, 2008.





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.





A
      comparison of our capital ratios as of June 30, 2008 and December 31, 2007
      to
      the minimum regulatory requirements is presented below:





Minimum**June 30,**
              
              December 31,
              
              Regulatory**2008**
              
              2007
              
              RequirementsTier 1
                  risk-based capital
              
              
              **11.73**
              **%**
              
              12.15
              %
              
              4.00
              %Total
                  risk-based capital
              
              
              **12.74**
              **%**
              
              13.14
              %
              
              8.00
              %Leverage
                  ratio
              
              
              **10.36**
              **%**
              
              10.50
              %
              
              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, 2007 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, 2007.


19


**Item
      4. Controls and Procedures.**





We
      maintain disclosure controls and procedures that are designed to ensure that
      information required to be disclosed in our reports filed 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 the 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 June 30,
      2008
      was carried out under the supervision and with the participation of management,
      including the CEO and the PAO. Based on that evaluation, the Company’s
      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 second quarter of 2008, 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, 2007. Management
      does not believe that any material changes in our risk factors have occurred
      since they were last disclosed.





**Item
      4. Submission of Matters to Vote of Security Holders.**





At
      the
      Annual Meeting of Stockholders held on April 23, 2008, the stockholders of
      Shore
      Bancshares, Inc. voted on the election of directors and the ratification of
      the
      appointment of the Company’s auditors for fiscal year 2008. The Board of
      Directors submitted these matters to a vote through the solicitation of proxies.
      The results of the votes are set forth below:





(1)
            To
                elect five individuals to serve as Class II Directors until the 2011
                Annual Meeting of Stockholders and until their successors are duly
                elected
                and qualify. The results of the vote were as
                follows:





For
            
            Withheld
            
            Abstain
            
            Broker Non-VotesHerbert
                L. Andrew, III
            
            
            6,476,597
            
            
            84,096
            
            
            -
            
            
            -Blenda
                W. Armistead
            
            
            6,461,431
            
            
            99,262
            
            
            -
            
            
            -Mark
                M. Freestate
            
            
            6,436,649
            
            
            124,044
            
            
            -
            
            
            -Neil
                R. LeCompte
            
            
            6,466,387
            
            
            94,306
            
            
            -
            
            
            -F.
                Winfield Trice, Jr.
            
            
            6,470,168
            
            
            90,525
            
            
            -
            
            
            -





(2)
            To
                ratify the appointment of Stegman & Company as the Company’s
                independent registered public accounting firm for fiscal year 2008.
                The
                results of the vote were as
                follows:





For
              
              Against
              
              Abstain
              
              Broker Non-Votes6,547,178
              
              
              4,368
              
              
              9,147
              
              
              -





**Item
      6.**  **Exhibits.**





The
      exhibits filed or furnished with this quarterly report are shown on the Exhibit
      List that follows the signatures to this report, which list 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:
                August 8, 2008
            By:
            /s/
                W. Moorhead VermilyeW.
                Moorhead VermilyePresident/Chief
                Executive Officer




Date:
                August 8, 2008
            By:
            /s/
                Susan E. LeavertonSusan
                E. Leaverton, CPATreasurer/Principal
                Accounting Officer


21


**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).32.1
            
            Certification
                of the CEO pursuant to Section 906 of the Sarbanes-Oxley Act (furnished
                herewith).32.2
            
            Certification
                of the PAO pursuant to Section 906 of the Sarbanes-Oxley Act (furnished
                herewith).


.


22