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 March 31, 2010





OR





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





For the
transition period from ________ to ________





Commission
file 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 þ No  ̈





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





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





Large
      accelerated filer
                 ̈
                Accelerated
      filer
                þNon-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
þ





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:  8,443,436 shares of common
stock outstanding as of April 30, 2010.





INDEX





PagePart
      I.Financial Information
                        2Item
      1.  Financial Statements
                        2Consolidated
      Balance Sheets -March
      31, 2010 (unaudited) and December 31, 2009
                        2Consolidated
      Statements of Income -For
      the three months ended March 31, 2010 and 2009 (unaudited)
                        3Consolidated
      Statements of Changes in Stockholders’ Equity -For
      the three months ended March 31, 2010 and 2009 (unaudited)
                        4Consolidated
      Statements of Comprehensive Income -For
      the three months ended March 31, 2010 and 2009 (unaudited)
                        5Consolidated
      Statements of Cash Flows -For
      the three months ended March 31, 2010 and 2009 (unaudited)
                        6Notes
      to Consolidated Financial Statements (unaudited)
                        7Item
      2.  Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
                        16Item
      3.  Quantitative and Qualitative Disclosures about Market
      Risk
                        23Item
      4.  Controls and Procedures
                        23Part
      II.  Other Information
                        24Item
      1A.  Risk Factors
                        24Item
      6.  Exhibits
                        24Signatures
                        24Exhibit
      Index
                        25




1


PART
I – FINANCIAL INFORMATION


Item
1.  Financial Statements.


SHORE
BANCSHARES, INC.


CONSOLIDATED
BALANCE SHEETS


(Dollars
in thousands, except per share amounts)





March 31,
                      
                      
                      December 31,2010
                      
                      
                      2009(Unaudited)ASSETSCash
      and due from banks
                      
                      $
                      14,351
                      
                      
                      $
                      14,411Interest
      bearing deposits with other banks
                      
                      
                      11,648
                      
                      
                      
                      598Federal
      funds sold
                      
                      
                      46,121
                      
                      
                      
                      60,637Investment
      securities:Available
      for sale, at fair value
                      
                      
                      104,109
                      
                      
                      
                      97,595Held
      to maturity, at amortized cost – fair value of $8,920 (2010) and $9,012
      (2009)
                      
                      
                      8,820
                      
                      
                      
                      8,940Loans
                      
                      
                      905,194
                      
                      
                      
                      916,557Less:  allowance
      for credit losses
                      
                      
                      (12,791
                      )
                      
                      
                      (10,876
                      )Loans,
      net
                      
                      
                      892,403
                      
                      
                      
                      905,681Premises
      and equipment, net
                      
                      
                      14,682
                      
                      
                      
                      14,307Goodwill
                      
                      
                      15,954
                      
                      
                      
                      15,954Other
      intangible assets, net
                      
                      
                      5,277
                      
                      
                      
                      5,406Other
      real estate and other assets owned, net
                      
                      
                      2,403
                      
                      
                      
                      2,572Other
      assets
                      
                      
                      30,566
                      
                      
                      
                      30,415TOTAL
      ASSETS
                      
                      $
                      1,146,334
                      
                      
                      $
                      1,156,516LIABILITIESDeposits:Noninterest
      bearing demand
                      
                      $
                      119,271
                      
                      
                      $
                      122,492Interest
      bearing demand
                      
                      
                      134,381
                      
                      
                      
                      133,946Money
      market and savings
                      
                      
                      258,423
                      
                      
                      
                      249,793Certificates
      of deposit $100,000 or more
                      
                      
                      259,970
                      
                      
                      
                      262,663Other
      time
                      
                      
                      218,705
                      
                      
                      
                      222,043Total
      deposits
                      
                      
                      990,750
                      
                      
                      
                      990,937Short-term
      borrowings
                      
                      
                      14,001
                      
                      
                      
                      20,404Other
      liabilities
                      
                      
                      15,046
                      
                      
                      
                      15,936Long-term
      debt
                      
                      
                      1,429
                      
                      
                      
                      1,429TOTAL
      LIABILITIES
                      
                      
                      1,021,226
                      
                      
                      
                      1,028,706STOCKHOLDERS’
      EQUITYCommon
      stock, par value $.01 per share; shares authorized – 35,000,000; shares
      issued and outstanding – 8,443,436 (2010) and 8,418,963
    (2009)
                      
                      
                      84
                      
                      
                      
                      84Warrant
                      
                      
                      1,543
                      
                      
                      
                      1,543Additional
      paid in capital
                      
                      
                      29,988
                      
                      
                      
                      29,872Retained
      earnings
                      
                      
                      94,083
                      
                      
                      
                      96,151Accumulated
      other comprehensive (loss) income
                      
                      
                      (590
                      )
                      
                      
                      160TOTAL
      STOCKHOLDERS’ EQUITY
                      
                      
                      125,108
                      
                      
                      
                      127,810TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
                      
                      $
                      1,146,334
                      
                      
                      $
                      1,156,516





See
accompanying notes to Consolidated Financial Statements.


2


SHORE
BANCSHARES, INC.


CONSOLIDATED
STATEMENTS OF INCOME (Unaudited)


(Dollars
in thousands, except per share amounts)





For the Three Months EndedMarch 31,2010
                
                
                2009INTEREST
      INCOMEInterest
      and fees on loans
                
                $
                12,874
                
                
                $
                13,617Interest
      and dividends on investment securities:Taxable
                
                
                882
                
                
                
                756Tax-exempt
                
                
                59
                
                
                
                85Interest
      on federal funds sold
                
                
                12
                
                
                
                7Interest
      on deposits with other banks
                
                
                1
                
                
                
                1Total
      interest income
                
                
                13,828
                
                
                
                14,466INTEREST
      EXPENSEInterest
      on deposits
                
                
                3,385
                
                
                
                4,285Interest
      on short-term borrowings
                
                
                32
                
                
                
                49Interest
      on long-term debt
                
                
                16
                
                
                
                74Total
      interest expense
                
                
                3,433
                
                
                
                4,408NET
      INTEREST INCOME
                
                
                10,395
                
                
                
                10,058Provision
      for credit losses
                
                
                7,617
                
                
                
                1,935NET
      INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES
                
                
                2,778
                
                
                
                8,123NONINTEREST
      INCOMEService
      charges on deposit accounts
                
                
                786
                
                
                
                809Other
      service charges and fees
                
                
                929
                
                
                
                738Investment
      securities gains
                
                
                -
                
                
                
                49Insurance
      agency commissions
                
                
                2,889
                
                
                
                3,335Other
      noninterest income
                
                
                278
                
                
                
                419Total
      noninterest income
                
                
                4,882
                
                
                
                5,350NONINTEREST
      EXPENSESalaries
      and wages
                
                
                4,490
                
                
                
                4,540Employee
      benefits
                
                
                1,281
                
                
                
                1,380Occupancy
      expense
                
                
                622
                
                
                
                549Furniture
      and equipment expense
                
                
                300
                
                
                
                314Data
      processing
                
                
                631
                
                
                
                610Directors’
      fees
                
                
                121
                
                
                
                168Amortization
      of other intangible assets
                
                
                129
                
                
                
                129Insurance
      agency commissions expense
                
                
                428
                
                
                
                550FDIC
      insurance premium expense
                
                
                481
                
                
                
                244Other
      noninterest expenses
                
                
                1,838
                
                
                
                1,399Total
      noninterest expense
                
                
                10,321
                
                
                
                9,883(LOSS)
      INCOME BEFORE INCOME TAXES
                
                
                (2,661
                )
                
                
                3,590Income
      tax (benefit) expense
                
                
                (1,099
                )
                
                
                1,377NET
      (LOSS) INCOME
                
                
                (1,562
                )
                
                
                2,213Preferred
      stock dividends and discount accretion
                
                
                -
                
                
                
                337Net
      (loss) income available to common shareholders
                
                $
                (1,562
                )
                
                $
                1,876Basic
      net (loss) earnings per common share
                
                $
                (0.19
                )
                
                $
                0.22Diluted
      net (loss) earnings per common share
                
                $
                (0.19
                )
                
                $
                0.22Dividends
      paid per common share
                
                $
                0.06
                
                
                $
                0.16





See
accompanying notes to Consolidated Financial Statements.


3





SHORE
BANCSHARES, INC.


CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)


For the
Three Months Ended March 31, 2010 and 2009


(Dollars
in thousands, except per share amounts)





AccumulatedAdditional
                    
                    
                    
                    
                    
                    Other
                    
                    
                    TotalPreferred
                    
                    
                    Common
                    
                    
                    
                    
                    
                    Paid in
                    
                    
                    Retained
                    
                    
                    Comprehensive
                    
                    
                    Stockholders’Stock
                    
                    
                    Stock
                    
                    
                    Warrant
                    
                    
                    Capital
                    
                    
                    Earnings
                    
                    
                    Income (Loss)
                    
                    
                    EquityBalances,
      January 1, 2010
                    
                    $
                    -
                    
                    
                    $
                    84
                    
                    
                    $
                    1,543
                    
                    
                    $
                    29,872
                    
                    
                    $
                    96,151
                    
                    
                    $
                    160
                    
                    
                    $
                    127,810Comprehensive
      income:Net
      loss
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (1,562
                    )
                    
                    
                    -
                    
                    
                    
                    (1,562
                    )Unrealized
      gains on available-for-sale securities, net of taxes
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    44
                    
                    
                    
                    44Unrealized
      losses on cash flow hedging activities, net of taxes
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (794
                    )
                    
                    
                    (794
                    )Total
      comprehensive income
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (2,312
                    )Stock-based
      compensation expense
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    116
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    116Cash
      dividends paid ($0.06 per share)
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (506
                    )
                    
                    
                    -
                    
                    
                    
                    (506
                    )Balances,
      March 31, 2010
                    
                    $
                    -
                    
                    
                    $
                    84
                    
                    
                    $
                    1,543
                    
                    
                    $
                    29,988
                    
                    
                    $
                    94,083
                    
                    
                    $
                    (590
                    )
                    
                    $
                    125,108Balances,
      January 1, 2009
                    
                    $
                    -
                    
                    
                    $
                    84
                    
                    
                    $
                    -
                    
                    
                    $
                    29,768
                    
                    
                    $
                    96,140
                    
                    
                    $
                    1,393
                    
                    
                    $
                    127,385Comprehensive
      income:Net
      income
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    2,213
                    
                    
                    
                    -
                    
                    
                    
                    2,213Unrealized
      losses on available-for-sale securities, net of taxes
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (370
                    )
                    
                    
                    (370
                    )Total
      comprehensive income
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,843Warrant
      issued
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,543
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,543Preferred
      shares issued pursuant to TARP
                    
                    
                    25,000
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    25,000Discount
      from issuance of preferred stock
                    
                    
                    (1,543
                    )
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (1,543
                    )Discount
      accretion
                    
                    
                    57
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (57
                    )
                    
                    
                    -
                    
                    
                    
                    -Common
      shares issued for employee stock-based awards
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1Stock-based
      compensation expense
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    21
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    21Preferred
      stock dividends ($5.00 per share)
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (125
                    )
                    
                    
                    -
                    
                    
                    
                    (125
                    )Cash
      dividends paid ($0.16 per share)
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (1,344
                    )
                    
                    
                    -
                    
                    
                    
                    (1,344
                    )Balances,
      March 31, 2009
                    
                    $
                    23,514
                    
                    
                    $
                    84
                    
                    
                    $
                    1,543
                    
                    
                    $
                    29,790
                    
                    
                    $
                    96,827
                    
                    
                    $
                    1,023
                    
                    
                    $
                    152,781





See
accompanying notes to Consolidated Financial Statements.


4


SHORE
BANCSHARES, INC.


CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)


(Dollars
in thousands)





For the Three Months
                        Ended March 31,2010
                      
                      
                      2009Net
      (loss) income
                      
                      $
                      (1,562
                      )
                      
                      $
                      2,213Other
      comprehensive (loss) income:Securities
      available for sale:Unrealized
      holding gains (losses) on available-for-sale securities
                      
                      
                      74
                      
                      
                      
                      (567
                      )Tax
      effect
                      
                      
                      (30
                      )
                      
                      
                      226Reclassification
      of gains recognized in net income
                      
                      
                      -
                      
                      
                      
                      (49
                      )Tax
      effect
                      
                      
                      -
                      
                      
                      
                      20Net
      of tax amount
                      
                      
                      44
                      
                      
                      
                      (370
                      )Cash
      flow hedging activities:Unrealized
      holding losses on cash flow hedging activities
                      
                      
                      (1,331
                      )
                      
                      
                      -Tax
      effect
                      
                      
                      537
                      
                      
                      
                      -Net
      of tax amount
                      
                      
                      (794
                      )
                      
                      
                      -Total
      other comprehensive loss
                      
                      
                      (750
                      )
                      
                      
                      (370
                      )Comprehensive
      (loss) income
                      
                      $
                      (2,312
                      )
                      
                      $
                      1,843





See
accompanying notes to Consolidated Financial Statements.


5


SHORE
BANCSHARES, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS (Unaudited)


(Dollars
in thousands)





For the Three Months Ended March 31,2010
                
                
                2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      (loss) income
                
                $
                (1,562
                )
                
                $
                2,213Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for credit losses
                
                
                7,617
                
                
                
                1,935Depreciation
      and amortization
                
                
                564
                
                
                
                426Discount
      accretion on debt securities
                
                
                (27
                )
                
                
                (46
                )Stock-based
      compensation expense
                
                
                116
                
                
                
                21Gains
      on sales of securities
                
                
                -
                
                
                
                (49
                )Write-downs
      of other real estate owned
                
                
                247
                
                
                
                -Net
      changes in:Insurance
      premiums receivable
                
                
                (355
                )
                
                
                16Accrued
      interest receivable
                
                
                24
                
                
                
                (66
                )Other
      assets
                
                
                (645
                )
                
                
                (219
                )Accrued
      interest payable
                
                
                (165
                )
                
                
                (46
                )Other
      liabilities
                
                
                (725
                )
                
                
                136Net
      cash provided by operating activities
                
                
                5,089
                
                
                
                4,321CASH
      FLOWS FROM INVESTING ACTIVITIES:Proceeds
      from maturities and principal payments of securities available for
      sale
                
                
                11,742
                
                
                
                19,528Proceeds
      from sales of investment securities available for sale
                
                
                -
                
                
                
                2,048Purchases
      of securities available for sale
                
                
                (18,299
                )
                
                
                (13,075
                )Proceeds
      from maturities and principal payments of securities held to
      maturity
                
                
                115
                
                
                
                1,434Net
      decrease (increase) in loans
                
                
                5,520
                
                
                
                (21,451
                )Purchases
      of premises and equipment
                
                
                (660
                )
                
                
                (339
                )Proceeds
      from sales of other real estate owned
                
                
                63
                
                
                
                -Net
      cash used in investing activities
                
                
                (1,519
                )
                
                
                (11,855
                )CASH
      FLOWS FROM FINANCING ACTIVITIES:Net
      increase in demand, money market and savings deposits
                
                
                5,844
                
                
                
                11,327Net
      (decrease) increase in certificates of deposit
                
                
                (6,031
                )
                
                
                16,392Net
      decrease in short-term borrowings
                
                
                (6,403
                )
                
                
                (21,912
                )Proceeds
      from issuance of preferred stock and warrant
                
                
                -
                
                
                
                25,000Proceeds
      from issuance of common stock
                
                
                -
                
                
                
                1Preferred
      stock dividends paid
                
                
                -
                
                
                
                (125
                )Common
      stock dividends paid
                
                
                (506
                )
                
                
                (1,344
                )Net
      cash (used in) provided by financing activities
                
                
                (7,096
                )
                
                
                29,339Net
      (decrease) increase in cash and cash equivalents
                
                
                (3,526
                )
                
                
                21,805Cash
      and cash equivalents at beginning of period
                
                
                75,646
                
                
                
                27,294Cash
      and cash equivalents at end of period
                
                $
                72,120
                
                
                $
                49,099Supplemental
      cash flows information:Interest
      paid
                
                $
                3,598
                
                
                $
                4,454Income
      taxes paid
                
                $
                91
                
                
                $
                19Transfers
      from loans to other real estate owned
                
                $
                141
                
                
                $
                1,315





See
accompanying notes to Consolidated Financial Statements.


6





Shore
Bancshares, Inc.


Notes to
Consolidated Financial Statements


For the
Three Months Ended March 31, 2010 and 2009


(Unaudited)





Note 1 - Basis of
Presentation





The
consolidated financial statements include the accounts of Shore Bancshares, Inc.
and its subsidiaries with all significant intercompany transactions
eliminated.  The consolidated financial statements conform to accounting
principles generally accepted in the United States of America (“GAAP”) and to
prevailing practices within the banking industry.  The accompanying
interim financial statements are unaudited; however, in the opinion of
management all adjustments necessary to present fairly the consolidated
financial position at March 31, 2010, the consolidated results of operations for
the three months ended March 31, 2010 and 2009, changes in stockholders’ equity
for the three months ended March 31, 2010 and 2009, and cash flows for the three
months ended March 31, 2010 and 2009, have been included.  All such
adjustments are of a normal recurring nature.  The amounts as of
December 31, 2009 were derived from the 2009 audited financial
statements.  The results of operations for the three months ended
March 31, 2010 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 Annual Report of Shore
Bancshares, Inc. on Form 10-K for the year ended December 31,
2009.  For purposes of comparability, certain reclassifications have
been made to amounts previously reported to conform with the current period
presentation.





Shore
Bancshares, Inc. has evaluated events and transactions occurring subsequent to
the balance sheet date of March 31, 2010 for items that should potentially be
recognized or disclosed in these financial statements as prescribed by Topic
855, “Subsequent
Events”, of the Financial Accounting Standards Board’s Accounting
Standards Codification (“ASC”).





When used
in these notes, the term “the Company” refers to Shore Bancshares, Inc. and,
unless the context requires otherwise, its consolidated
subsidiaries.





Note 2 – Earnings Per
Share





Basic
earnings/(loss) per common share are calculated by dividing net income/(loss)
available to common stockholders by the weighted average number of common shares
outstanding during the period.  Diluted earnings/(loss) per common
share are calculated by dividing net income/(loss) available to common
stockholders by the weighted average number of common shares outstanding during
the period, adjusted for the dilutive effect of stock-based
awards.  There is no dilutive effect on the earnings/(loss) per share
during loss periods.  The following table provides information
relating to the calculation of earnings/(loss) per common share:





For the Three Months Ended
                    March 31,(In thousands, except per share data)
                  
                  2010
                  
                  
                  2009Net
      (loss) income available to common shareholders
                  
                  $
                  (1,562
                  )
                  
                  $
                  1,876Weighted
      average shares outstanding - Basic
                  
                  
                  8,436
                  
                  
                  
                  8,405Dilutive
      effect of stock-based awards
                  
                  
                  -
                  
                  
                  
                  3Weighted
      average shares outstanding - Diluted
                  
                  
                  8,436
                  
                  
                  
                  8,408(Loss)
      earnings per common share - Basic
                  
                  $
                  (0.19
                  )
                  
                  $
                  0.22(Loss)
      earnings per common share - Diluted
                  
                  $
                  (0.19
                  )
                  
                  $
                  0.22





There
were nine thousand weighted average stock-based awards and that portion of a
warrant to purchase 173 thousand weighted average shares of common stock
excluded from the diluted earnings per share calculation for the three months
ended March 31, 2010 because the effect would have been
antidilutive.  The calculation of diluted earnings per share for the
three months ended March 31, 2009 excluded two thousand weighted average
stock-based awards and that portion of a warrant to purchase 157 thousand
weighted average shares of common stock because their effect would have been
antidilutive.


7


Note 3 – Investment
Securities





The
amortized cost and estimated fair values of investment securities are as
follows:





Gross
                
                
                Gross
                
                
                EstimatedAmortized
                
                
                Unrealized
                
                
                Unrealized
                
                
                Fair(Dollars in thousands)
                
                Cost
                
                
                Gains
                
                
                Losses
                
                
                ValueAvailable-for-sale
      securities:March
      31, 2010:Obligations
      of U.S. Treasury
                
                $
                2,999
                
                
                $
                -
                
                
                $
                -
                
                
                $
                2,999Obligations
      of U.S. Government agencies and corporations
                
                
                66,049
                
                
                
                707
                
                
                
                276
                
                
                
                66,480Mortgage-backed
      securities
                
                
                33,220
                
                
                
                916
                
                
                
                66
                
                
                
                34,070Other
      equity securities
                
                
                551
                
                
                
                9
                
                
                
                -
                
                
                
                560Total
                
                $
                102,819
                
                
                $
                1,632
                
                
                $
                342
                
                
                $
                104,109December
      31, 2009:Obligations
      of U.S. Treasury
                
                $
                2,998
                
                
                $
                -
                
                
                $
                -
                
                
                $
                2,998Obligations
      of U.S. Government agencies and corporations
                
                
                57,258
                
                
                
                879
                
                
                
                397
                
                
                
                57,740Mortgage-backed
      securities
                
                
                35,579
                
                
                
                818
                
                
                
                90
                
                
                
                36,307Other
      equity securities
                
                
                546
                
                
                
                4
                
                
                
                -
                
                
                
                550Total
                
                $
                96,381
                
                
                $
                1,701
                
                
                $
                487
                
                
                $
                97,595Held-to
      maturity securities:March
      31, 2010:Obligations
      of states and political subdivisions
                
                $
                8,820
                
                
                $
                166
                
                
                $
                66
                
                
                $
                8,920December
      31, 2009:Obligations
      of states and political subdivisions
                
                $
                8,940
                
                
                $
                163
                
                
                $
                91
                
                
                $
                9,012





Gross
unrealized losses and fair value by length of time that the individual
available-for-sale securities have been in a continuous unrealized loss position
at March 31, 2010, are as follows:





Less than
                  12 Months
                
                
                More than
                  12 Months
                
                
                Total(Dollars in thousands)
                
                Fair
                  Value
                
                
                Unrealized
                  Losses
                
                
                Fair
                  Value
                
                
                Unrealized
                  Losses
                
                
                Fair
                  Value
                
                
                Unrealized
                  LossesAvailable-for-sale
      securities:U.S.
      Gov’t. agencies and corporations
                
                $
                33,611
                
                
                $
                276
                
                
                $
                -
                
                
                $
                -
                
                
                $
                33,611
                
                
                $
                276Mortgage-backed
      securities
                
                
                8,031
                
                
                
                66
                
                
                
                -
                
                
                
                -
                
                
                
                8,031
                
                
                
                66Total
                
                $
                41,642
                
                
                $
                342
                
                
                $
                -
                
                
                $
                -
                
                
                $
                41,642
                
                
                $
                342





The
available-for-sale securities have a fair value of approximately $104.1
million.  Of these securities, approximately $41.6 million have
unrealized losses when compared to their amortized cost.  The
securities with the unrealized losses in the available-for-sale portfolio all
have modest duration risk, low credit risk, and minimal losses (approximately
0.33%) when compared to amortized cost.  The unrealized losses that
exist are the result of market changes in interest rates since original
purchase.  Because the Company does not intend to sell these
securities and it is not more likely than not that the Company will be required
to sell these securities before recovery of their amortized cost bases, which
may be at maturity, the Company considers the unrealized losses in the
available-for-sale portfolio to be temporary.




8




Gross
unrealized losses and fair value by length of time that the individual
held-to-maturity securities have been in a continuous unrealized loss position
at March 31, 2010, are as follows:




Less than
                  12 Months
                
                
                More than
                  12 Months
                
                
                Total(Dollars in thousands)
                
                Fair
                  Value
                
                
                Unrealized
                  Losses
                
                
                Fair
                  Value
                
                
                Unrealized
                  Losses
                
                
                Fair
                  Value
                
                
                Unrealized
                  LossesHeld-to-maturity
      securities:Obligations
      of states and political subdivisions
                
                $
                2,088
                
                
                $
                62
                
                
                $
                185
                
                
                $
                4
                
                
                $
                2,273
                
                
                $
                66





The
held-to-maturity securities have a fair value of approximately $8.9
million.  Approximately $2.3 million of these securities have
unrealized losses when compared to their amortized cost.  All of the
securities with unrealized losses are municipal securities with modest duration
risk, low credit risk, and minimal losses (approximately 0.75%) when compared to
amortized cost.  The unrealized losses that exist are the result of
market changes in interest rates since the original purchase.  Because
the Company does not intend to sell these securities and it is not more likely
than not that the Company will be required to sell these securities before
recovery of their amortized cost bases, which may be at maturity, the Company
considers that the unrealized losses in the held-to-maturity portfolio are
temporary.





Note 4 – Impaired
Loans





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.





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





March 31,
                
                
                December 31,
                
                
                March 31,(Dollars in thousands)
                
                2010
                
                
                2009
                
                
                2009Impaired
      loans with a valuation allowance
                
                $
                662
                
                
                $
                2,028
                
                
                $
                2,952Impaired
      loans with no valuation allowance
                
                
                29,793
                
                
                
                14,274
                
                
                
                6,701Total
      impaired loans
                
                $
                30,455
                
                
                $
                16,302
                
                
                $
                9,653Allowance
      for credit losses applicable to impaired loans
                
                $
                422
                
                
                $
                468
                
                
                $
                1,460Allowance
      for credit losses applicable to other than impaired loans
                
                
                12,369
                
                
                
                10,408
                
                
                
                9,249Total
      allowance for credit losses
                
                $
                12,791
                
                
                $
                10,876
                
                
                $
                10,709Average
      recorded investment in impaired loans
                
                $
                23,379
                
                
                $
                12,646
                
                
                $
                7,242





Gross
interest income of $467 thousand for the first three months of 2010, $859
thousand for fiscal year 2009 and $143 thousand for the first three months of
2009 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 $0 for the first three months of 2010 and $4 thousand
for both fiscal year 2009 and the first three months of 2009.





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.


9


Note 5 – Other Assets and
Liabilities





The
Company had the following other assets at March 31, 2010 and December 31,
2009.





(Dollars in thousands)
                
                March 31, 2010
                
                
                December 31, 2009Nonmarketable
      investment securities
                
                $
                3,149
                
                
                $
                3,149Insurance
      premiums receivable
                
                
                1,338
                
                
                
                983Accrued
      interest receivable
                
                
                4,780
                
                
                
                4,804Deferred
      income taxes
                
                
                4,977
                
                
                
                3,337Interest
      rate caps (1)
                
                
                4,807
                
                
                
                6,168Prepaid
      FDIC premium expense
                
                
                5,112
                
                
                
                5,449Other
      assets
                
                
                6,403
                
                
                
                6,525Total
                
                $
                30,566
                
                
                $
                30,415





The
Company had the following other liabilities at March 31, 2010 and December 31,
2009.





(Dollars in thousands)
                
                March 31, 2010
                
                
                December 31, 2009Accrued
      interest payable
                
                $
                1,616
                
                
                $
                1,781Counterparty
      collateral - interest rate caps (1)
                
                
                4,781
                
                
                
                4,847Other
      liabilities
                
                
                8,649
                
                
                
                9,308Total
                
                $
                15,046
                
                
                $
                15,936





(1)  See
Note 8 for further discussion.





Note 6 - Stock-Based
Compensation





At March
31, 2010, the Company maintained two equity compensation plans under which it
may issue shares of common stock or grant other equity-based
awards:  (i) the Shore Bancshares, Inc. 2006 Stock and Incentive
Compensation Plan (“2006 Equity Plan”); and (ii) the Shore Bancshares, Inc. 1998
Stock Option Plan (the “1998 Option Plan”).  The Company's ability to
grant options under the 1998 Option Plan expired on March 3, 2008 pursuant to
the terms of that plan, but stock options granted thereunder were outstanding as
of March 31, 2010.





Stock-based
awards granted to date generally are time-based, vest in equal installments on
each anniversary of the grant date over a three- to five-year period of time,
and, in the case of stock options, expire 10 years from the grant
date.





During
the three months ended March 31, 2010, the Company recognized pre-tax
stock-based compensation expense of $116 thousand, compared to $21 thousand for
the same period 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 $645
thousand as of March 31, 2010.  The weighted-average period over which
this unrecognized expense was expected to be recognized was 2.3
years.





The
following table summarizes restricted stock award activity for the Company under
the 2006 Equity Plan for the three months ended March 31, 2010:





Number
                        
                        
                        Weighted Average Grantof Shares
                        
                        
                        Date Fair ValueNonvested
      at beginning of period
                        
                        
                        27,405
                        
                        
                        $
                        20.23Granted
                        
                        
                        24,473
                        
                        
                        
                        13.41Vested
                        
                        
                        (5,908
                        )
                        
                        
                        17.65Cancelled
                        
                        
                        -
                        
                        
                        
                        -Nonvested
      at end of period
                        
                        
                        45,970
                        
                        
                        $
                        16.93





The
Company estimates the fair value of stock options using the Black-Scholes
valuation model with weighted average assumptions for dividend yield, expected
volatility, risk-free interest rate and expected lives (in
years).  The expected dividend yield is calculated by dividing the
total expected annual dividend payout by the average stock price.  The
expected volatility is based on historical volatility of the underlying
securities.  The risk-free interest rate is based on the Federal
Reserve Bank’s constant maturities daily interest rate in effect at grant
date.  The expected life of the options represents the period of time
that the Company expects the awards to be outstanding based on historical
experience with similar awards.  Stock-based compensation expense
recognized in the consolidated statements of income for the three months ended
March 31, 2010 and 2009 reflected forfeitures as they occurred.


10





The
following table summarizes stock option activity for the Company for the three
months ended March 31, 2010:





Weighted
                  
                  
                  AggregateNumber
                  
                  
                  Average
                  
                  
                  Intrinsicof Shares
                  
                  
                  Exercise Price
                  
                  
                  ValueOutstanding
      at beginning of year
                  
                  
                  10,850
                  
                  
                  $
                  13.36Granted
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  -
                  
                  
                  
                  -Expired/Cancelled
                  
                  
                  (2,430
                  )
                  
                  
                  14.00Outstanding
      at end of period
                  
                  
                  8,420
                  
                  
                  
                  13.17
                  
                  
                  $
                  9,094Exercisable
      at end of period
                  
                  
                  8,420
                  
                  
                  $
                  13.17
                  
                  
                  $
                  9,094





At March
31, 2010, all 8,420 outstanding options were exercisable, had a weighted average
exercise price of $13.17, and had a remaining contract life of 2.1
years.





The total
intrinsic value of stock options exercised during the three months ended March
31, 2010 and 2009 was $0 and less than $1 thousand,
respectively.  Cash received upon exercise of options during the first
three months of 2010 and 2009 was $0 and approximately $1 thousand,
respectively.





Note 7 – Fair Value
Measurements




ASC 820,
“Fair Value Measurements and
Disclosures”, provides a framework for measuring and disclosing fair
value under GAAP. This accounting guidance requires disclosures about the fair
values of assets and liabilities recognized in the balance sheet, whether the
measurements are made on a recurring basis or on a nonrecurring
basis.




ASC 820
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.  ASC 820 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 liabilities and to determine fair value disclosures.
Securities available for sale and derivative assets and liabilities are recorded
at fair value on a recurring basis. Additionally, from time to time, the Company
may be required to record at fair value other assets on a nonrecurring basis,
such as loans held for investment (impaired loans) and foreclosed assets (other
real estate owned). These nonrecurring fair value adjustments typically involve
application of lower of cost or market accounting or write-downs of individual
assets.




Under ASC
820, assets and liabilities are grouped at fair value in three levels, based on
the markets in which the assets and liabilities are traded and the reliability
of the assumptions used to determine their fair values. 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.




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


11





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.  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.  At March 31, 2010, substantially all impaired loans were
evaluated based on the fair value of the collateral.  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.   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.





Other Real Estate and Other
Assets Owned (Foreclosed Assets)


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





Derivative Assets and
Liabilities


Derivative
instruments held or issued by the Company for risk management purposes are
traded in over-the-counter markets where quoted market prices are not readily
available.  For those derivatives, the Company measures fair value
using models that use primarily market observable inputs, such as yield curves
and option volatilities, and include the value associated with counterparty
credit risk.  The Company classifies derivative instruments held or
issued for risk management purposes as recurring Level 2.  As of March
31, 2010, the Company’s derivative instruments consisted solely of interest rate
caps.  Derivative assets and liabilities are included in other assets
and liabilities, respectively, in the accompanying consolidated balance
sheet.





Assets Recorded at Fair
Value on a Recurring Basis


The table
below presents the recorded amount of assets measured at fair value on a
recurring basis at March 31, 2010. There
were no transfers between Levels 1 and 2 during the first quarter of
2010.





SignificantOther
                  
                  
                  SignificantQuoted
                  
                  
                  Observable
                  
                  
                  UnobservablePrices
                  
                  
                  Inputs
                  
                  
                  Inputs(Dollars in thousands)
                  
                  Fair Value
                  
                  
                  (Level 1)
                  
                  
                  (Level 2)
                  
                  
                  (Level 3)Securities
      available for sale:U.S.
      Treasury
                  
                  $
                  2,999
                  
                  
                  $
                  2,999
                  
                  
                  $
                  -
                  
                  
                  $
                  -U.S.
      Government agencies
                  
                  
                  66,480
                  
                  
                  
                  -
                  
                  
                  
                  66,480
                  
                  
                  
                  -Mortgage-backed
      securities
                  
                  
                  34,070
                  
                  
                  
                  -
                  
                  
                  
                  34,070
                  
                  
                  
                  -Other
      equity securities
                  
                  
                  560
                  
                  
                  
                  -
                  
                  
                  
                  560
                  
                  
                  
                  -Total
                  
                  $
                  104,109
                  
                  
                  $
                  2,999
                  
                  
                  $
                  101,110
                  
                  
                  $
                  -Interest
      rate caps
                  
                  $
                  4,807
                  
                  
                  $
                  -
                  
                  
                  $
                  4,807
                  
                  
                  $
                  -




12





Assets Recorded at Fair
Value on a Nonrecurring Basis


The table
below presents the recorded amount of assets measured at fair value on a
nonrecurring basis at March 31, 2010.





SignificantOther
                  
                  
                  SignificantQuoted
                  
                  
                  Observable
                  
                  
                  UnobservablePrices
                  
                  
                  Inputs
                  
                  
                  Inputs(Dollars in thousands)
                  
                  Fair Value
                  
                  
                  (Level 1)
                  
                  
                  (Level 2)
                  
                  
                  (Level 3)Impaired
      loansReal
      estate - construction
                  
                  $
                  20,962
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  20,962Real
      estate - residential
                  
                  
                  5,083
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  5,083Real
      estate - commercial
                  
                  
                  2,854
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,854Commercial
                  
                  
                  1,099
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,099Consumer
                  
                  
                  35
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  35Total
                  
                  $
                  30,033
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  30,033Other
      real estate and other assets owned
                  
                  $
                  2,403
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  2,403





Impaired
loans had a carrying amount of $30.4 million at March 31, 2010 with a valuation
allowance of $422 thousand.





The
following disclosures relate to the fair value of the Company’s financial
instruments and include the methods and assumptions used to estimate the fair
value of each class of financial instruments for which it is practicable to
estimate that value:





Cash and Cash
Equivalents


For
short-term instruments, the carrying amount is a reasonable estimate of fair
value.





Investment
Securities


For all
investments in debt securities, fair values are based on quoted market
prices.  If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.





Loans


The fair
values of categories of fixed rate loans, such as commercial loans, residential
mortgage, and other consumer loans, are estimated by discounting the future cash
flows using the current rates at which similar loans would be made to borrowers
with similar credit ratings and for the same remaining
maturities.  Other loans, including variable rate loans, are adjusted
for differences in loan characteristics.





Financial
Liabilities


The fair
value of demand deposits, savings accounts, and certain money market deposits is
the amount payable on demand at the reporting date.  The fair value of
fixed-maturity certificates of deposit is estimated using the rates currently
offered for deposits of similar remaining maturities.  These estimates
do not take into consideration the value of core deposit
intangibles.  The fair values of securities sold under agreements to
repurchase (included in short-term borrowings) and long-term debt are estimated
using the rates offered for similar borrowings.





Commitments to Extend Credit
and Standby Letters of Credit


The
majority of the Company’s commitments to grant loans and standby letters of
credit are written to carry current market interest rates if converted to
loans.  Because commitments to extend credit and letters of credit are
generally unassignable by the Company or the borrower, they only have value to
the Company and the borrower and, therefore, it is impractical to assign any
value to these commitments.


13


The
estimated fair values of the Company’s financial instruments as of March 31,
2010 and December 31, 2009 are as follows:





March 31, 2010
                
                
                December 31, 2009Estimated
                
                
                
                
                
                EstimatedCarrying
                
                
                Fair
                
                
                Carrying
                
                
                Fair(Dollars in thousands)
                
                Amount
                
                
                Value
                
                
                Amount
                
                
                ValueFinancial
      assets:Cash
      and cash equivalents
                
                $
                72,120
                
                
                $
                72,120
                
                
                $
                75,646
                
                
                $
                75,646Investment
      securities
                
                
                112,929
                
                
                
                113,029
                
                
                
                106,535
                
                
                
                106,607Loans
                
                
                905,194
                
                
                
                918,287
                
                
                
                916,557
                
                
                
                934,362Less:  allowance
      for loan  losses
                
                
                (12,791
                )
                
                _ -
                
                
                
                (10,876
                )
                
                
                -Total
                
                $
                1,077,452
                
                
                $
                1,103,436
                
                
                $
                1,087,862
                
                
                $
                1,116,615Financial
      liabilities:Deposits
                
                $
                990,750
                
                
                $
                994,923
                
                
                $
                990,937
                
                
                $
                999,016Short-term
      borrowings
                
                
                14,001
                
                
                
                14,001
                
                
                
                20,404
                
                
                
                20,404Long-term
      debt
                
                
                1,429
                
                
                
                1,515
                
                
                
                1,429
                
                
                
                1,530Total
                
                $
                1,006,180
                
                
                $
                1,010,439
                
                
                $
                1,012,770
                
                
                $
                1,020,950





Note 8 – Derivative
Instruments and Hedging Activities





ASC 815,
“Derivatives and
Hedging”, defines derivatives, requires that derivatives be carried at
fair value on the balance sheet and provides for hedge accounting when certain
conditions are met.  Changes in the fair values of derivative
instruments designated as “cash flow” hedges, to the extent the hedges are
highly effective, are recorded in other comprehensive income, net of
taxes.  Ineffective portions of cash flow hedges, if any, are
recognized in current period earnings.  The net interest settlement on
cash flow hedges is treated as an adjustment of the of the interest income or
interest expense of the hedged assets or liabilities.  The Company
uses derivative instruments to hedge its exposure to changes in interest
rates.  The Company does not use derivatives for any trading or other
speculative purposes.





During
the third quarter of 2009, as part of its overall interest rate risk management
strategy, the Company purchased interest rate caps to effectively fix the
interest rate on $70 million of the Company’s money market deposit accounts at
2.97% for five years. The interest rate caps qualified for hedge
accounting.  The aggregate fair value of these derivatives was an
asset of $4.8 million at March 31, 2010 and $6.2 million at December 31,
2009.   For the first quarter of 2010, interest expense included
a net interest settlement of $30 thousand.





By
entering into derivative instrument contracts, the Company exposes itself, from
time to time, to counterparty credit risk.  Counterparty credit risk
is the failure of the counterparty to perform under the terms of the derivative
contract.  When the fair value of a derivative contract is in an asset
position, the counterparty has a liability to the Company, which creates credit
risk for the Company.  The Company attempts to minimize this risk by
selecting counterparties with investment grade credit ratings, limiting its
exposure to any single counterparty and regularly monitoring its market position
with each counterparty.  Also to minimize risk, the Company obtained
counterparty collateral which was recorded in other liabilities.  The
counterparty collateral was $4.8 million at March 31, 2010 and December 31,
2009.





Note 9 –
Commitments





In the
normal course of business, to meet the financial needs of its customers, the
Company’s bank subsidiaries enter into financial instruments with off-balance
sheet risk.  These financial instruments include commitments to extend
credit and standby letters of credit.  At March 31, 2010, total
commitments to extend credit were approximately $159.0 million. The comparable
amount was $147.3 million at December 31, 2009.  Outstanding letters
of credit were approximately $16.3 million at March 31, 2010 and $19.0 million
at December 31, 2009.





Note 10 – Segment
Reporting





The
Company operates in 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 19-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.


14





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.





Selected
financial information by business segments for the first three months of 2010
and 2009 is included in the following table:





Community
                    
                    
                    Insurance Products
                    
                    
                    Parent
                    
                    
                    Consolidated(Dollars in thousands)
                    
                    Banking
                    
                    
                    and Services
                    
                    
                    Company
                    
                    
                    Total2010Interest
      income
                    
                    $
                    13,784
                    
                    
                    $
                    44
                    
                    
                    $
                    -
                    
                    
                    $
                    13,828Interest
      expense
                    
                    
                    (3,404
                    )
                    
                    
                    -
                    
                    
                    
                    (29
                    )
                    
                    
                    (3,433
                    )Provision
      for credit losses
                    
                    
                    (7,617
                    )
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (7,617
                    )Noninterest
      income
                    
                    
                    1,832
                    
                    
                    
                    3,050
                    
                    
                    
                    -
                    
                    
                    
                    4,882Noninterest
      expense
                    
                    
                    (6,058
                    )
                    
                    
                    (2,470
                    )
                    
                    
                    (1,793
                    )
                    
                    
                    (10,321
                    )Net
      intersegment income (expense)
                    
                    
                    (1,447
                    )
                    
                    
                    (130
                    )
                    
                    
                    1,577
                    
                    
                    
                    -Income
      (loss) before taxes
                    
                    
                    (2,910
                    )
                    
                    
                    494
                    
                    
                    
                    (245
                    )
                    
                    
                    (2,661
                    )Income
      tax (expense) benefit
                    
                    
                    1,202
                    
                    
                    
                    (204
                    )
                    
                    
                    101
                    
                    
                    
                    1,099Net
      income (loss)
                    
                    $
                    (1,708
                    )
                    
                    $
                    290
                    
                    
                    $
                    (144
                    )
                    
                    $
                    (1,562
                    )Total
      assets
                    
                    $
                    1,122,636
                    
                    
                    $
                    20,531
                    
                    
                    $
                    3,177
                    
                    
                    $
                    1,146,3442009Interest
      income
                    
                    $
                    14,451
                    
                    
                    $
                    15
                    
                    
                    $
                    -
                    
                    
                    $
                    14,466Interest
      expense
                    
                    
                    (4,388
                    )
                    
                    
                    -
                    
                    
                    
                    (20
                    )
                    
                    
                    (4,408
                    )Provision
      for credit losses
                    
                    
                    (1,935
                    )
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (1,935
                    )Noninterest
      income
                    
                    
                    1,856
                    
                    
                    
                    3,494
                    
                    
                    
                    -
                    
                    
                    
                    5,350Noninterest
      expense
                    
                    
                    (5,539
                    )
                    
                    
                    (2,786
                    )
                    
                    
                    (1,558
                    )
                    
                    
                    (9,883
                    )Net
      intersegment income (expense)
                    
                    
                    (1,446
                    )
                    
                    
                    (113
                    )
                    
                    
                    1,559
                    
                    
                    
                    -Income
      (loss) before taxes
                    
                    
                    2,999
                    
                    
                    
                    610
                    
                    
                    
                    (19
                    )
                    
                    
                    3,590Income
      tax (expense) benefit
                    
                    
                    (1,155
                    )
                    
                    
                    (229
                    )
                    
                    
                    7
                    
                    
                    
                    (1,377
                    )Net
      income
                    
                    $
                    1,844
                    
                    
                    $
                    381
                    
                    
                    $
                    (12
                    )
                    
                    $
                    2,213Total
      assets
                    
                    $
                    1,052,860
                    
                    
                    $
                    19,723
                    
                    
                    $
                    3,351
                    
                    
                    $
                    1,075,934





Note 11 – New Accounting
Pronouncements





Pronouncements
adopted





Accounting Standards Update (“ASU”)
No. 2009-16, “Transfers and Servicing (Topic 860) – Accounting for Transfers of
Financial Assets”. New accounting guidance under ASU 2009-16 amends prior
accounting guidance to enhance reporting about transfers of financial assets,
including securitizations, and where companies have continuing exposure to the
risks related to transferred financial assets. This guidance eliminates the
concept of a “qualifying special-purpose entity” and changes the requirements
for derecognizing financial assets. This guidance also requires additional
disclosures about all continuing involvements with transferred financial assets
including information about gains and losses resulting from transfers during the
period. This new accounting guidance became effective January 1, 2010 and
did not have a significant impact on the Company’s financial
statements.





ASU No. 2009-17, “Consolidations
(Topic 810) – Improvements to Financial Reporting by Enterprises Involved with
Variable Interest Entities”.New accounting guidance under ASU
2009-17 amends prior guidance to change how a company determines when an entity
that is insufficiently capitalized or is not controlled through voting (or
similar rights) should be consolidated. The determination of whether a company
is required to consolidate an entity is based on, among other things, an
entity’s purpose and design and a company’s ability to direct the activities of
the entity that most significantly impact the entity’s economic performance.
This guidance requires additional disclosures about the reporting entity’s
involvement with variable-interest entities and any significant changes in risk
exposure due to that involvement as well as its affect on the entity’s financial
statements. This new accounting guidance became effective January 1, 2010
and did not have a significant impact on the Company’s financial
statements.


15





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 the remainder of this report are to Shore Bancshares, Inc.
and its consolidated subsidiaries.





Forward-Looking
Information


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





Introduction


The
following discussion and analysis is intended as a review of significant factors
affecting the Company’s financial condition and results of operations 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, 2009.





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”), CNB
located in Centreville, Maryland (“CNB”), and The Felton Bank located in Felton,
Delaware (“Felton Bank”) (collectively, the “Banks”).  The Banks
operate 19 full service branches in Kent County, Queen Anne’s County, Talbot
County, Caroline County and Dorchester County in Maryland and Kent County,
Delaware.  The Company engages in the insurance business through three
insurance producer firms, The Avon-Dixon Agency, LLC, Elliott Wilson Insurance,
LLC and Jack Martin Associates, Inc.; a wholesale insurance company, TSGIA,
Inc.; and two insurance premium finance companies, Mubell Finance, LLC and ESFS,
Inc. (all of the foregoing are collectively referred to as the “Insurance
Subsidiary”).  The Company engages in the mortgage brokerage business
through Wye Mortgage Group, LLC.  Each of these entities is a
wholly-owned subsidiary of Shore Bancshares, Inc.





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





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





Critical
Accounting Policies


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





We
believe that our most critical accounting policy relates to the allowance for
credit losses.  The allowance for credit losses is an estimate of the
losses that may be sustained in the loan portfolio.  The allowance is
based on two basic principles of accounting: (i) Topic 450, “Contingencies”, of the
Financial Accounting Standards Board’s Accounting Standards Codification
(“ASC”), which requires that losses be accrued when they are probable of
occurring and estimable, and (ii) ASC Topic 310, “Receivables”, 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.


16





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





For the
first quarter of 2010, the Company reported a net loss of $1.6 million, or
diluted loss per common share of $(0.19), compared to net income of $1.9
million, or diluted earnings per common share of $0.22, for the first quarter of
2009.  For the fourth quarter of 2009, net income was $1.2 million, or
$0.14 diluted earnings per common share.  The first quarter of 2010
included a provision for credit losses of $7.6 million, which was $5.7 million
and $3.9 million higher than the comparable amounts for the first and fourth
quarters of 2009, respectively.





Annualized
return on average assets was (0.55)% for the three months ended March 31, 2010,
compared to 0.72% for the same period in 2009.  Annualized return on
average stockholders’ equity was (4.95)% for the first quarter of 2010, compared
to 5.05% for the first quarter of 2009.  For the fourth quarter of
2009, annualized return on average assets was 0.41% and return on average equity
was 3.75%.





RESULTS
OF OPERATIONS





Net
Interest Income


Net
interest income for the three months ended March 31, 2010 was $10.4 million, an
increase of 3.4% when compared to the same period last year.  Higher
average earning assets and lower rates paid on interest bearing liabilities were
sufficient to offset the decline in yields on earning assets.  The net
interest margin was 3.95% for the first quarter of 2010, a decrease of 14 basis
points when compared to the first quarter of 2009.  Net interest
income decreased 3.8% from the fourth quarter of 2009, primarily due to a
decline in average earning assets.  However, the net interest margin
increased five basis points from 3.90% for the fourth quarter of
2009.


17





Interest
income was $13.8 million for the first quarter of 2010, a decrease of 4.4% from
the first quarter of 2009.  Average earning assets increased 6.9%
during the first quarter of 2010 when compared to the same period in 2009, while
yields earned decreased 63 basis points to 5.24%.  Average loans
increased slightly more than 1.0%, while the yield earned on loans decreased 42
basis points.  Loans comprised 84.7% of total average earning assets
for the first quarter of 2010, a decrease from the 89.3% for the first quarter
of 2009.  This reflects a shift in the mix of earning assets from
loans to securities and federal funds sold which, combined, comprised 14.4% of
total earning assets, compared to 10.5% for the first quarter of 2009. Interest
income decreased 6.4% when compared to the fourth quarter of
2009.  Average earning assets declined 2.7% during the first quarter
of 2010 when compared to the fourth quarter of 2009, while yields earned
declined 9 basis points.





Interest
expense decreased 22.1% for the three months ended March 31, 2010 when compared
to the same period last year. Average interest bearing liabilities increased
11.4%, while rates paid decreased 67 basis points to 1.58%.  During
the second quarter of 2009, the Company began to participate in the Promontory
Insured Network Deposits Program (“IND”).  The $118.6 million increase
in average interest bearing deposits for the first quarter of 2010 over the same
period of 2009 included approximately $87.2 million from the IND
program.  The Company incurs the largest amount of interest expense
from time deposits.  For the three months ended March  31,
2010, the average balance of certificates of deposit $100,000 or more increased
8.8% when compared to the same period last year, while the average rate paid on
these certificates of deposit decreased 118 basis points to
2.24%.  Average other time deposits decreased 5.6% and the rate paid
on average other time deposits decreased 86 basis points, when comparing the
first quarter of 2010 to the first quarter of 2009.  Expanded levels
of FDIC insurance coverage contributed to the shift from other time deposits to
certificates of deposit $100,000 or more.  When comparing the first
quarter of 2010 to the fourth quarter of 2009, interest expense decreased 13.6%
because average interest bearing liabilities decreased 2.0% and rates paid
decreased 17 basis points.




18


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 March 31, 2010 and 2009.





For the Three Months Ended
                  
                  
                  For the Three Months EndedMarch 31, 2010
                  
                  
                  March 31, 2009Average
                  
                  
                  Income(1)/
                  
                  
                  Yield/
                  
                  
                  Average
                  
                  
                  Income(1)/
                  
                  
                  Yield/(Dollars in thousands)
                  
                  Balance
                  
                  
                  Expense
                  
                  
                  Rate
                  
                  
                  Balance
                  
                  
                  Expense
                  
                  
                  RateEarning
      assetsLoans
      (2), (3)
                  
                  $
                  910,374
                  
                  
                  $
                  12,910
                  
                  
                  
                  5.75
                  %
                  
                  $
                  898,494
                  
                  
                  $
                  13,660
                  
                  
                  
                  6.17
                  %Investment
      securitiesTaxable
                  
                  
                  103,488
                  
                  
                  
                  882
                  
                  
                  
                  3.45
                  
                  
                  
                  74,852
                  
                  
                  
                  756
                  
                  
                  
                  4.10Tax-exempt
                  
                  
                  6,764
                  
                  
                  
                  90
                  
                  
                  
                  5.39
                  
                  
                  
                  9,105
                  
                  
                  
                  131
                  
                  
                  
                  5.84Federal
      funds sold
                  
                  
                  46,553
                  
                  
                  
                  12
                  
                  
                  
                  0.11
                  
                  
                  
                  21,585
                  
                  
                  
                  7
                  
                  
                  
                  0.14Interest
      bearing deposits
                  
                  
                  8,246
                  
                  
                  
                  1
                  
                  
                  
                  0.06
                  
                  
                  
                  2,250
                  
                  
                  
                  1
                  
                  
                  
                  0.14Total
      earning assets
                  
                  
                  1,075,425
                  
                  
                  
                  13,895
                  
                  
                  
                  5.24
                  %
                  
                  
                  1,006,286
                  
                  
                  
                  14,555
                  
                  
                  
                  5.87
                  %Cash
      and due from banks
                  
                  
                  14,422
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  12,857Other
      assets
                  
                  
                  67,914
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  49,232Allowance
      for credit losses
                  
                  
                  (12,154
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (9,654
                  )Total
      assets
                  
                  $
                  1,145,607
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  1,058,721Interest
      bearing liabilitiesDemand
      deposits
                  
                  $
                  127,986
                  
                  
                  
                  80
                  
                  
                  
                  0.25
                  %
                  
                  $
                  121,109
                  
                  
                  
                  72
                  
                  
                  
                  0.24
                  %Money
      market and savings deposits
                  
                  
                  256,818
                  
                  
                  
                  428
                  
                  
                  
                  0.68
                  
                  
                  
                  153,141
                  
                  
                  
                  174
                  
                  
                  
                  0.46Certificates
      of deposit $100,000 or more
                  
                  
                  259,538
                  
                  
                  
                  1,433
                  
                  
                  
                  2.24
                  
                  
                  
                  238,602
                  
                  
                  
                  2,012
                  
                  
                  
                  3.42Other
      time deposits
                  
                  
                  219,731
                  
                  
                  
                  1,444
                  
                  
                  
                  2.67
                  
                  
                  
                  232,660
                  
                  
                  
                  2,027
                  
                  
                  
                  3.53Interest
      bearing deposits
                  
                  
                  864,073
                  
                  
                  
                  3,385
                  
                  
                  
                  1.59
                  
                  
                  
                  745,512
                  
                  
                  
                  4,285
                  
                  
                  
                  2.33Short-term
      borrowings
                  
                  
                  18,032
                  
                  
                  
                  32
                  
                  
                  
                  0.71
                  
                  
                  
                  39,581
                  
                  
                  
                  49
                  
                  
                  
                  0.50Long-term
      debt
                  
                  
                  1,429
                  
                  
                  
                  16
                  
                  
                  
                  4.45
                  
                  
                  
                  7,947
                  
                  
                  
                  74
                  
                  
                  
                  3.79Total
      interest bearing liabilities
                  
                  
                  883,534
                  
                  
                  
                  3,433
                  
                  
                  
                  1.58
                  %
                  
                  
                  793,040
                  
                  
                  
                  4,408
                  
                  
                  
                  2.25
                  %Noninterest
      bearing deposits
                  
                  
                  118,192
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  104,061Other
      liabilities
                  
                  
                  15,800
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  10,972Stockholders’
      equity
                  
                  
                  128,081
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  150,648Total
      liabilities and stockholders’ equity
                  
                  $
                  1,145,607
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  1,058,721Net
      interest spread
                  
                  
                  
                  
                  
                  $
                  10,462
                  
                  
                  
                  3.66
                  %
                  
                  
                  
                  
                  
                  $
                  10,147
                  
                  
                  
                  3.62
                  %Net
      interest margin
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3.95
                  %
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  4.09
                  %Tax-equivalent
      adjustmentLoans
                  
                  
                  
                  
                  
                  $
                  36
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  43Investment
      securities
                  
                  
                  
                  
                  
                  
                  31
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  46Loans
                  
                  
                  
                  
                  
                  $
                  67
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  89





(1)
            All
      amounts are reported on a tax equivalent basis computed using the
      statutory federal income tax rate of 34.5% for 2010 and 35.0% for 2009
      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 first quarter of 2010 decreased $468 thousand, or 8.7%, when
compared to the first quarter of 2009.   The decline in
noninterest income during the first quarter of 2010 when compared to the first
quarter of 2009 was primarily due to a decline in insurance agency commissions
and contingency payments of $446 thousand. The increase of $757 thousand, or
18.4%, when compared to the fourth quarter of 2009 was primarily a result of
$744 thousand in contingency income which is typically received in the first
quarter of each year and based on the prior year’s performance.





Noninterest
Expense


Noninterest
expense for the first quarter of 2010 increased $438 thousand, or 4.4%, when
compared to the first quarter of 2009.  The increase was primarily
attributable to higher FDIC insurance premiums of $237 thousand and write-downs
of other real estate owned of $247 thousand.  Noninterest expense
increased $946 thousand, or 10.1%, from the fourth quarter of 2009 primarily due
to lower expenses accrued for bonus and profit sharing plans and lower expenses
related to collection and other real estate owned activities during the fourth
quarter of 2009.


19





Income
Taxes


The
Company’s effective tax rate was a 41.3% benefit for the three months ended
March 31, 2010, compared to a 38.4% expense for the same period last
year.  Management is not aware of any development with respect to tax
law or our tax structure that is likely to have a material impact on our future
effective tax rate.





ANALYSIS
OF FINANCIAL CONDITION





Loans


Loans,
net of unearned income, totaled $905.2 million at March 31, 2010, a 1.2%
decrease since December 31, 2009.  Average loans were $910.4 million
for the three months ended March 31, 2010, a 1.3% increase when compared to the
same period last year.  Loan growth slowed compared to the prior year
as the weakened economy created fewer loan opportunities to originate
high-quality credits.





We have a
concentration of commercial real estate loans.  Commercial real estate
loans, excluding construction and land development loans, were approximately
$319.5 million, or 35.3% of total loans, at March 31, 2010, compared to $315.9
million, or 34.5% of total loans, at December 31, 2009.  Construction
and land development loans were $158.5 million, or 17.5% of total loans, at
March 31, 2010, compared to $161.4 million, or 17.6% of total loans, at December
31, 2009.  We do not engage in foreign or subprime lending
activities.





Because
most of our loans are secured by real estate, weaknesses in the local real
estate market and deterioration in overall economic conditions have had a
material adverse effect on the performance of our loan portfolio and the value
of the collateral securing that portfolio. We have experienced weakness in the
local real estate market and related construction industry as a result of the
widely-publicized banking crisis and its impact on the global
economy.  Thus, we have experienced higher provisions for credit
losses, loan charge-offs and nonperforming assets because of these weaknesses in
the local economy.





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





The
provision for credit losses for the three months ended March 31, 2010 and 2009
was $7.6 million and $1.9 million, respectively. The provision for credit losses
for the fourth quarter of 2009 was $3.7 million.  The continued
increased level of provision expense was the result of the overall increase in
nonperforming assets and loan charge-offs, and management’s assessment of the
worsening in general economic conditions.  We continue to emphasize
credit quality and believe that our underwriting guidelines are
strong.  However, the continuation or deepening of the current
economic recession will likely cause us to experience higher levels of provision
expense, nonperforming assets and charge-offs. As problem loans are identified,
management takes prompt action to quantify and minimize losses and also works
with the borrowers in an effort to reach mutually acceptable
resolutions.





Net
charge-offs were $5.7 million for the three months ended March 31, 2010,
compared to $546 thousand for the same period last year and $3.5 million for the
fourth quarter of 2009.  Most of the charge offs in the first quarter
of 2010 were construction loans which consisted principally of one large real
estate development loan of $3.4 million.  The allowance for credit
losses as a percentage of average loans increased to 1.41% for the first quarter
of 2010, compared to 1.19% for the first quarter of 2009 and 1.18% for the
fourth quarter of 2009.  Based on management’s quarterly evaluation of
the adequacy of the allowance for credit losses, it believes that the allowance
for credit losses and the related provision were adequate at March 31, 2010 to
provide for probable losses inherent in our loan portfolio.


20


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





For the Three Months EndedMarch 31,(Dollars in thousands)
                  
                  2010
                  
                  
                  2009Allowance
      balance – beginning of period
                  
                  $
                  10,876
                  
                  
                  $
                  9,320Charge-offs:Real
      estate – construction
                  
                  
                  (3,509
                  )
                  
                  
                  (87
                  )Real
      estate – residential
                  
                  
                  (991
                  )
                  
                  
                  (340
                  )Real
      estate – commercial
                  
                  
                  -
                  
                  
                  
                  -Commercial
                  
                  
                  (1,224
                  )
                  
                  
                  (98
                  )Consumer
                  
                  
                  (166
                  )
                  
                  
                  (111
                  )Totals
                  
                  
                  (5,890
                  )
                  
                  
                  (636
                  )Recoveries:Real
      estate – construction
                  
                  
                  -
                  
                  
                  
                  -Real
      estate – residential
                  
                  
                  38
                  
                  
                  
                  52Real
      estate – commercial
                  
                  
                  101
                  
                  
                  
                  -Commercial
                  
                  
                  3
                  
                  
                  
                  4Consumer
                  
                  
                  46
                  
                  
                  
                  34Totals
                  
                  
                  188
                  
                  
                  
                  90Net
      charge-offs
                  
                  
                  (5,702
                  )
                  
                  
                  (546
                  )Provision
      for credit losses
                  
                  
                  7,617
                  
                  
                  
                  1,935Allowance
      balance – end of period
                  
                  $
                  12,791
                  
                  
                  $
                  10,709Average
      loans outstanding during the period
                  
                  $
                  910,374
                  
                  
                  $
                  898,494Net
      charge-offs (annualized) as a percentage of average loans outstanding
      during the period
                  
                  
                  2.54
                  %
                  
                  
                  0.25
                  %Allowance
      for credit losses at period end as a percentage of average
      loans
                  
                  
                  1.41
                  %
                  
                  
                  1.19
                  %





Nonperforming
Assets


Nonperforming
assets were $32.9 million at March 31, 2010, compared to $18.9 million at
December 31, 2009.  The increase in nonaccrual loans during the first
quarter was primarily in construction loans and related largely to two borrowing
relationships. The Company has a $5.0 million participation with a regional bank
that is matured.  Through December 31, 2009, the customer made all
interest payments.  This loan migrated from 90 days past due to
nonaccrual in the first quarter of 2010.  Also during the first
quarter of 2010, a second significant construction loan relationship totaling
approximately $14.0 million was put on nonaccrual and subsequently $3.4 million
was charged off.  Total nonperforming assets to total loans and other
real estate and other assets owned increased to 3.62% at March 31, 2010,
compared to 2.05% at December 31, 2009.  Loans past due 90 days and
still accruing at March 31, 2010 decreased to $2.8 million from $7.4 million at
December 31, 2009 mainly due to the previously-mentioned migration of the $5.0
million participation from 90 days past due to nonaccrual.




21


The
following table summarizes our nonperforming and past due assets:





March 31,
                        
                        
                        December 31,(Dollars in thousands)
                        
                        2010
                        
                        
                        2009Nonperforming
      assetsNonaccrual
      loansReal
      estate – construction
                        
                        $
                        21,384
                        
                        
                        $
                        7,163Real
      estate – residential
                        
                        
                        5,083
                        
                        
                        
                        4,246Real
      estate – commercial
                        
                        
                        2,854
                        
                        
                        
                        2,828Commercial
                        
                        
                        1,099
                        
                        
                        
                        2,028Consumer
                        
                        
                        35
                        
                        
                        
                        37Total
      nonaccrual loans
                        
                        
                        30,455
                        
                        
                        
                        16,302Other
      real estate and other assets owned
                        
                        
                        2,403
                        
                        
                        
                        2,572Total
      nonperforming assets
                        
                        
                        32,858
                        
                        
                        
                        18,874Loans
      90 days past due and still accruingReal
      estate – construction
                        
                        
                        96
                        
                        
                        
                        5,096Real
      estate – residential
                        
                        
                        1,986
                        
                        
                        
                        2,274Real
      estate – commercial
                        
                        
                        94
                        
                        
                        
                        -Commercial
                        
                        
                        518
                        
                        
                        
                        -Consumer
                        
                        
                        126
                        
                        
                        
                        55Total
      loans 90 days past due
                        
                        
                        2,820
                        
                        
                        
                        7,425Total
      nonperforming assets and past due loans
                        
                        $
                        35,678
                        
                        
                        $
                        26,299Nonperforming
      assets to total loans and other real estate and other assets
      owned
                        
                        
                        3.62
                        %
                        
                        
                        2.05
                        %Nonperforming
      assets to total assets
                        
                        
                        2.87
                        %
                        
                        
                        1.63
                        %Nonperforming
      assets and past due loans, to total loans and other real estate and other
      assets owned
                        
                        
                        3.93
                        %
                        
                        
                        2.86
                        %Nonperforming
      assets and past due loans to total assets
                        
                        
                        3.11
                        %
                        
                        
                        2.27
                        %





Investment
Securities


Investment
securities totaled $112.9 million at March 31, 2010, compared to $106.5 million
at December 31, 2009.  The average balance of investment securities
was $110.3 million for the three months ended March 31, 2010, compared to $84.0
million for the same period in 2009.  The increases in the period end
and three-month average balances reflected the investment of excess deposits.
The tax equivalent yields on investment securities were 3.58% and 4.28% for the
three months ended March 31, 2010 and 2009, respectively.





Deposits


Total
deposits at March 31, 2010 were $990.8 million, remaining relatively flat when
compared to the $990.9 million at December 31, 2009.  The decrease in
noninterest bearing demand and time deposits offset the slight increase in
interest bearing demand deposits and the 3.5% increase in money market and
savings deposits.





Short-Term
Borrowings


Short-term
borrowings at March 31, 2010 and December 31, 2009 were $14.0 million and $20.4
million, respectively.  Short-term borrowings generally consist of
securities sold under agreements to repurchase, overnight borrowings from
correspondent banks and short-term advances from the FHLB.  Short-term
advances are defined as those with original maturities of one year or
less.  The decline in short-term borrowings since December 31, 2009
was primarily due to the repayment of $3.4 million drawn on a $10.0 million line
of credit with a commercial bank.





Long-Term
Debt


At March
31, 2010 and December 31, 2009, the Company had $1.4 million in long-term
debt.  This debt was acquisition-related, incurred as part of the
purchase price of TSGIA, Inc. and is payable to the seller thereof, who remains
the President of that subsidiary.  The interest rate on the debt is
4.08% and principal and interest are payable in annual installments for five
years.




22




Liquidity
and Capital Resources


We derive
liquidity through increased customer deposits, maturities in the investment
portfolio, loan repayments and income from earning assets.  During the
second quarter of 2009 we began participating in the IND program which resulted
in increased deposits and liquidity.  The program has a five year term
and has a guaranteed minimum funding level of $70 million.





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 CNB are also members of the FHLB
of Atlanta and Felton Bank is a member of the FHLB of Pittsburgh, and these
banks have pledged collateral sufficient to permit additional borrowings of up
to approximately $14.3 million in the aggregate at March 31, 2010. 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 $125.1 million at March 31, 2010, compared to $127.8
million at December 31, 2009. The net loss, unrealized losses on cash flow
hedging activities and dividends paid all contributed to the decrease in
stockholders’ equity since the end of 2009.  To increase capital,
support the Company’s growth, and enhance capital ratios, management intends to
reduce dividends in 2010.  The Company reduced the quarterly common
stock dividend to $0.06 from $0.16 per share effective for
the dividend that was payable on February 26, 2010.





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 the capital ratios of Shore Bancshares, Inc. (on a consolidated
basis) as of March 31, 2010 and December 31, 2009 to the minimum regulatory
requirements is presented below:





MinimumMarch 31,
                  
                  
                  December 31,
                  
                  
                  Regulatory2010
                  
                  
                  2009
                  
                  
                  RequirementsTier
      1 risk-based capital ratio
                  
                  
                  11.54
                  %
                  
                  
                  11.45
                  %
                  
                  
                  4.00
                  %Total
      risk-based capital ratio
                  
                  
                  12.79
                  %
                  
                  
                  12.59
                  %
                  
                  
                  8.00
                  %Leverage
      ratio
                  
                  
                  9.29
                  %
                  
                  
                  9.27
                  %
                  
                  
                  4.00
                  %





Item
3.  Quantitative and Qualitative Disclosures about Market
Risk.





Our
primary market risk is to interest rate fluctuation and management has
procedures in place to evaluate and mitigate this risk.  This risk and
these procedures are discussed in Item 7 of Part II of the Annual Report of
Shore Bancshares, Inc. on Form 10-K for the year ended December 31, 2009 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, 2009.





Item
4.  Controls and Procedures.





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


23




An
evaluation of the effectiveness of these disclosure controls as of March 31,
2010 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.





There was
no change in our internal control over financial reporting during the first
quarter of 2010 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,
2009.  Management does not believe that any material changes in our
risk factors have occurred since they were last disclosed.





Item 6.  Exhibits.





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





SIGNATURES





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





SHORE
      BANCSHARES, INC.Date:
      May 7, 2010
                  BY:
                  /s/ W. Moorhead VermilyeW.
      Moorhead VermilyePresident/Chief
      Executive OfficerDate:
      May 7, 2010
                  BY:
                  /s/ Susan E. LeavertonSusan
      E. Leaverton, CPATreasurer/Principal Accounting Officer


24


EXHIBIT
INDEX





ExhibitNumber
              
              Description10.1
              
              Shore
      Bancshares, Inc. Management Incentive Plan (incorporated by reference to
      Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on April
      21, 2010).31.1
              
              Certifications
      of the CEO pursuant to Section 302 of the Sarbanes-Oxley Act (filed
      herewith).31.2
              
              Certifications
      of the PAO pursuant to Section 302 of the Sarbanes-Oxley Act (filed
      herewith).32
              
              Certification
      pursuant to Section 906 of the Sarbanes-Oxley Act (furnished
      herewith).




25