**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 September 30, 2008





**OR**





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





For
      the
      transition period from ________ to ________





Commission
      file number 0-22345





**SHORE
      BANCSHARES, INC.**


(Exact
      name of registrant as specified in its charter)





Maryland
            
            52-1974638(State
                or Other Jurisdiction of
            
            (I.R.S.
                EmployerIncorporation
                or Organization)
            
            Identification
                No.)18
                East Dover Street, Easton, Maryland
            
            21601(Address
                of Principal Executive Offices)
            
            (Zip
                Code)





(410)
      822-1400


Registrant’s
      Telephone Number, Including Area Code





N/A


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





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





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





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





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





**APPLICABLE
      ONLY TO CORPORATE ISSUERS**





Indicate
      the number of shares outstanding of each of the issuer’s classes of common
      stock, as of the latest practicable date: 8,404,684 shares of common stock
      outstanding as of October 31, 2008.





**INDEX**




**Page**Part
                I.Financial Information
            2Item
                1. Financial Statements
            2Consolidated
                Balance Sheets -
              September
                30, 2008 (unaudited) and December 31, 2007
            2Consolidated
                Statements of Income -
              For
                the three and nine months ended September 30, 2008 and 2007
                (unaudited)
            3Consolidated
                Statements of Changes in Stockholders’ Equity -
              For
                the nine months ended September 30, 2008 and 2007
                (unaudited)
            4Consolidated
                Statements of Cash Flows -
              For
                the nine months ended September 30, 2008 and 2007
                (unaudited)
            5Notes
                to Consolidated Financial Statements (unaudited)
            6Item
                2. Management’s Discussion and Analysis of Financial Condition and Results
                of Operations
            12Item
                3. Quantitative and Qualitative Disclosures about Market
                Risk
            21Item
                4. Controls and Procedures
            21Part
                II. Other Information
            21Item
                1A. Risk Factors
            21Item
                6. Exhibits
            22Signatures
            22Exhibit
                Index
            23


1


**PART
      I – FINANCIAL INFORMATION**


**Item
      1. Financial Statements.**


SHORE
      BANCSHARES, INC.


CONSOLIDATED
      BALANCE SHEETS


(Dollars
      in thousands, except per share amounts)




**September 30,**
            
            December 31,**2008**
            
            2007(Unaudited)**ASSETS**Cash
                and due from banks
            
            **$**
            **21,883**
            
            $
            17,198Interest
                bearing deposits with other banks
            
            
            **513**
            
            
            3,036Federal
                funds sold
            
            
            **15,416**
            
            
            6,646Investment
                securities:Available
                for sale, at fair value
            
            
            **82,235**
            
            
            97,137Held-to-maturity,
                at amortized cost - fair value of $10,941 (2008) and $12,924
                (2007)
            
            
            **10,914**
            
            
            12,896Loans
            
            
            **865,437**
            
            
            776,350Less:
                allowance for credit losses
            
            
            **(8,618**
            **)**
            
            (7,551
            )Loans,
                net
            
            
            **856,819**
            
            
            768,799Insurance
                premiums receivable
            
            
            **1,164**
            
            
            1,083Premises
                and equipment, net
            
            
            **14,097**
            
            
            15,617Accrued
                interest receivable
            
            
            **5,023**
            
            
            5,008Investment
                in unconsolidated subsidiary
            
            
            **-**
            
            
            937Goodwill
            
            
            **15,954**
            
            
            15,954Other
                intangible assets, net
            
            
            **6,050**
            
            
            6,436Deferred
                income taxes
            
            
            **2,610**
            
            
            1,847Other
                real estate owned
            
            
            **-**
            
            
            176Other
                assets
            
            
            **4,348**
            
            
            4,141TOTAL
                ASSETS
            
            **$**
            **1,037,026**
            
            $
            956,911**LIABILITIES**Deposits:Noninterest
                bearing demand
            
            **$**
            **118,049**
            
            $
            104,081Interest
                bearing demand
            
            
            **119,144**
            
            
            115,623Money
                market and savings
            
            
            **182,397**
            
            
            169,896Certificates
                of deposit $100,000 or more
            
            
            **197,590**
            
            
            161,568Other
                time
            
            
            **222,037**
            
            
            214,727Total
                deposits
            
            
            **839,217**
            
            
            765,895Accrued
                interest payable
            
            
            **2,137**
            
            
            2,793Short-term
                borrowings
            
            
            **53,078**
            
            
            47,694Long-term
                debt
            
            
            **8,485**
            
            
            12,485Other
                liabilities
            
            
            **8,708**
            
            
            7,809TOTAL
                LIABILITIES
            
            
            **911,625**
            
            
            836,676**STOCKHOLDERS’
                EQUITY**Common
                stock, par value $.01; shares authorized - 35,000,000;
              shares
                issued and outstanding - 8,404,609 (2008) and 8,380,530
                (2007)
            
            
            **84**
            
            
            84Additional
                paid in capital
            
            
            **29,744**
            
            
            29,539Retained
                earnings
            
            
            **95,224**
            
            
            90,365Accumulated
                other comprehensive income
            
            
            **349**
            
            
            247TOTAL
                STOCKHOLDERS’ EQUITY
            
            
            **125,401**
            
            
            120,235TOTAL
                LIABILITIES AND STOCKHOLDERS’ EQUITY
            
            **$**
            **1,037,026**
            
            $
            956,911





See
      accompanying notes to Consolidated Financial Statements.


2


SHORE
      BANCSHARES, INC.


CONSOLIDATED
      STATEMENTS OF INCOME (Unaudited)


(Dollars
      in thousands, except per share amounts)




For
                the Three Months Ended
            
            For
                the Nine Months EndedSeptember
                30,
            
            September
                30,**2008**
            
            2007
            
            **2008**
            
            2007**INTEREST
                INCOME**Interest
                and fees on loans
            
            **$**
            **14,179**
            
            $
            14,732
            
            **$**
            **42,700**
            
            $
            42,566Interest
                and dividends on investment securities:Taxable
            
            
            **924**
            
            
            1,325
            
            
            **2,949**
            
            
            3,900Tax-exempt
            
            
            **95**
            
            
            128
            
            
            **327**
            
            
            387Interest
                on federal funds sold
            
            
            **79**
            
            
            178
            
            
            **284**
            
            
            988Interest
                on deposits with other banks
            
            
            **21**
            
            
            180
            
            
            **88**
            
            
            847Total
                interest income
            
            
            **15,298**
            
            
            16,543
            
            
            **46,348**
            
            
            48,688**INTEREST
                EXPENSE**Interest
                on deposits
            
            
            **4,955**
            
            
            5,493
            
            
            **15,295**
            
            
            16,263Interest
                on short-term borrowings
            
            
            **344**
            
            
            279
            
            
            **1,026**
            
            
            838Interest
                on long-term debt
            
            
            **90**
            
            
            308
            
            
            **456**
            
            
            977Total
                interest expense
            
            
            **5,389**
            
            
            6,080
            
            
            **16,777**
            
            
            18,078**NET
                INTEREST INCOME**
            
            
            **9,909**
            
            
            10,463
            
            
            **29,571**
            
            
            30,610Provision
                for credit losses
            
            
            **875**
            
            
            604
            
            
            **1,952**
            
            
            1,259**NET
                INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES**
            
            
            **9,034**
            
            
            9,859
            
            
            **27,619**
            
            
            29,351**NONINTEREST
                INCOME**Service
                charges on deposit accounts
            
            
            **923**
            
            
            949
            
            
            **2,711**
            
            
            2,420Other
                service charges and fees
            
            
            **668**
            
            
            501
            
            
            **2,169**
            
            
            1,489Gain
                on sale of investment securities
            
            
            -
            
            
            **-**
            
            
            -
            
            
            1Other
                than temporary impairment of securities
            
            
            **(371**
            **)**
            
            -
            
            
            **(371**
            **)**
            
            **-**Insurance
                agency commissions
            
            
            **2,845**
            
            
            1,403
            
            
            **9,595**
            
            
            5,004Gain
                (loss) on disposals of premises and equipment
            
            
            **1,264**
            
            
            (108
            )
            
            **1,255**
            
            
            (108
            )Loss
                on sale of investment in unconsolidated subsidiary
            
            
            **(337**
            **)**
            
            **-**
            
            
            **(337**
            **)**
            
            **-**Other
                noninterest income
            
            
            **254**
            
            
            310
            
            
            **920**
            
            
            1,158Total
                noninterest income
            
            
            **5,246**
            
            
            3,055
            
            
            **15,942**
            
            
            9,964**NONINTEREST
                EXPENSE**Salaries
                and wages
            
            
            **4,662**
            
            
            3,879
            
            
            **13,837**
            
            
            11,512Employee
                benefits
            
            
            **1,140**
            
            
            944
            
            
            **3,708**
            
            
            2,959Occupancy
                expense
            
            
            **558**
            
            
            460
            
            
            **1,594**
            
            
            1,444Furniture
                and equipment expense
            
            
            **310**
            
            
            318
            
            
            **894**
            
            
            988Data
                processing
            
            
            **486**
            
            
            454
            
            
            **1,396**
            
            
            1,353Directors’
                fees
            
            
            **131**
            
            
            136
            
            
            **426**
            
            
            427Amortization
                of other intangible assets
            
            
            **128**
            
            
            56
            
            
            **386**
            
            
            203Agency
                commissions
            
            
            **447**
            
            
            -
            
            
            **1,770**
            
            
            **-**Other
                noninterest expenses
            
            
            **1,567**
            
            
            1,352
            
            
            **4,738**
            
            
            4,351Total
                noninterest expense
            
            
            **9,429**
            
            
            7,599
            
            
            **28,749**
            
            
            23,237**INCOME
                BEFORE INCOME TAXES**
            
            
            **4,851**
            
            
            5,315
            
            
            **14,812**
            
            
            16,078Income
                tax expense
            
            
            **1,780**
            
            
            1,964
            
            
            **5,603**
            
            
            5,968**NET
                INCOME**
            
            **$**
            **3,071**
            
            $
            3,351
            
            **$**
            **9,209**
            
            $
            10,110Basic earnings per common share
            
            **$**
            **0.37**
            
            $
            0.40
            
            **$**
            **1.10**
            
            $
            1.21Diluted earnings per common share
            
            **$**
            **0.37**
            
            $
            0.40
            
            **$**
            **1.10**
            
            $
            1.20Dividends paid per common share
            
            **$**
            **0.16**
            
            $
            0.16
            
            **$**
            **0.48**
            
            $
            0.48





See
      accompanying notes to Consolidated Financial Statements.


3





SHORE
      BANCSHARES, INC.


CONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)


For
      the
      Nine Months Ended September 30, 2008 and 2007


(Dollars
      in thousands, except per share amounts)




AccumulatedAdditional
            
            
            
            Other
            
            TotalCommon
            
            Paid in
            
            Retained
            
            Comprehensive
            
            Stockholders’Stock
            
            Capital
            
            Earnings
            
            Income (Loss)
            
            EquityBalances, January 1, 2008
            
            $
            84
            
            $
            29,539
            
            $
            90,365
            
            $
            247
            
            $
            120,235Adjustment
                to initially apply EITF Issue 06-4
            
            
            -
            
            
            -
            
            
            (318
            )
            
            -
            
            
            (318
            )Comprehensive
                income:Net
                income
            
            
            -
            
            
            -
            
            
            9,209
            
            
            -
            
            
            9,209Unrealized
                gains on available-for-sale securities, net of taxes
            
            
            -
            
            
            -
            
            
            -
            
            
            102
            
            
            102Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            9,311Shares
                issued for employee stock-based awards
            
            
            -
            
            
            136
            
            
            -
            
            
            -
            
            
            136Stock-based
                compensation expense
            
            
            -
            
            
            69
            
            
            -
            
            
            -
            
            
            69Cash
                dividends paid ($0.48 per share)
            
            
            -
            
            
            -
            
            
            (4,032
            )
            
            -
            
            
            (4,032
            )Balances,
                September 30, 2008
            
            **$**
            **84**
            
            **$**
            **29,744**
            
            **$**
            **95,224**
            
            **$**
            **349**
            
            **$**
            **125,401**Balances,
                January 1, 2007
            
            $
            84
            
            $
            29,687
            
            $
            82,279
            
            $
            (723
            )
            $
            111,327Comprehensive
                income:Net
                income
            
            
            -
            
            
            -
            
            
            10,110
            
            
            -
            
            
            10,110Unrealized
                gains on available-for-sale securities, net of taxes
            
            
            -
            
            
            -
            
            
            -
            
            
            490
            
            
            490Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            10,600Shares
                issued for employee stock-based awards
            
            
            -
            
            
            46
            
            
            -
            
            
            -
            
            
            46Stock-based
                compensation expense
            
            
            -
            
            
            51
            
            
            -
            
            
            -
            
            
            51Repurchase
                and retirement of 10,234 shares
            
            
            -
            
            
            (266
            )
            
            -
            
            
            -
            
            
            (266
            )Cash
                dividends paid ($0.48 per share)
            
            
            -
            
            
            -
            
            
            (4,022
            )
            
            -
            
            
            (4,022
            )Balances,
                September 30, 2007
            
            $
            84
            
            $
            29,518
            
            $
            88,367
            
            $
            (233
            )
            $
            117,736




See
      accompanying notes to Consolidated Financial Statements.


4


SHORE
      BANCSHARES, INC.


CONSOLIDATED
      STATEMENTS OF CASH FLOWS (Unaudited)


(Dollars
      in thousands)





For the Nine Months Ended September 30,**2008**
            
            2007**CASH
                FLOWS FROM OPERATING ACTIVITIES:**Net
                income
            
            **$**
            **9,209**
            
            $
            10,110Adjustments
                to reconcile net income to net cash provided by operating
                activities:Depreciation
                and amortization
            
            
            **1,330**
            
            
            1,084Stock-based
                compensation expense
            
            
            **69**
            
            
            51Discount
                accretion on debt securities
            
            
            **(164**
            **)**
            
            (144
            )Provision
                for credit losses
            
            
            **1,952**
            
            
            1,259Gain
                on sale of securities
            
            
            **-**
            
            
            (1
            )Other
                than temporary impairment of securities
            
            
            **371**
            
            
            -(Gain)
                loss on disposals of premises and equipment
            
            
            **(1,255**
            **)**
            
            108Loss
                on sale of investment in unconsolidated subsidiary
            
            
            **337**
            
            
            **-**Loss
                (gain) on sale of other real estate owned
            
            
            **50**
            
            
            (13
            )Net
                changes in:Insurance
                premiums receivable
            
            
            **(81**
            **)**
            
            324Accrued
                interest receivable
            
            
            **(15**
            **)**
            
            (948
            )Other
                assets
            
            
            **(1,592**
            **)**
            
            (766
            )Accrued
                interest payable
            
            
            **(656**
            **)**
            
            (103
            )Other
                liabilities
            
            
            **579**
            
            
            117Net
                cash provided by operating activities
            
            
            **10,134**
            
            
            11,078**CASH
                FLOWS FROM INVESTING ACTIVITIES:**Proceeds
                from maturities and principal payments of securities available for
                sale
            
            
            **71,189**
            
            
            65,646Proceeds
                from sale of investment securities available for sale
            
            
            **-**
            
            
            500Purchases
                of securities available for sale
            
            
            **(56,416**
            **)**
            
            (58,814
            )Proceeds
                from maturities and principal payments of securitiesheld
                to maturity
            
            
            **2,991**
            
            
            1,174Purchases
                of securities held to maturity
            
            
            **(1,012**
            **)**
            
            (117
            )Net
                increase in loans
            
            
            **(90,109**
            **)**
            
            (51,774
            )Purchases
                of premises and equipment
            
            
            **(292**
            **)**
            
            (640
            )Proceeds
                from sales of premises and equipment
            
            
            **2,773**
            
            
            **-**Proceeds
                from sale of investment in unconsolidated subsidiary
            
            
            **600**
            
            
            **-**Proceeds
                from sales of other real estate owned
            
            
            **264**
            
            
            364Net
                cash used in investing activities
            
            
            **(70,012**
            **)**
            
            (43,661
            )**CASH
                FLOWS FROM FINANCING ACTIVITIES:**Net
                increase (decrease) in demand, money market and savings
                deposits
            
            
            **29,990**
            
            
            (20,318
            )Net
                increase in certificates of deposit
            
            
            **43,332**
            
            
            6,259Net
                increase in short-term borrowings
            
            
            **5,384**
            
            
            10,864Proceeds
                from issuance of long-term debt
            
            
            **3,000**
            
            
            **-**Repayment
                of long-term debt
            
            
            **(7,000**
            )
            
            (9,000
            )Proceeds
                from issuance of common stock
            
            
            **136**
            
            
            46Stock
                repurchased and retired
            
            
            -
            
            
            (266
            )Dividends
                paid
            
            
            **(4,032**
            **)**
            
            (4,022
            )Net
                cash provided by (used in) financing activities
            
            
            **70,810**
            
            
            (16,437
            )Net
                increase (decrease) in cash and cash equivalents
            
            
            **10,932**
            
            
            (49,020
            )Cash
                and cash equivalents at beginning of period
            
            
            **26,880**
            
            
            79,673Cash
                and cash equivalents at end of period
            
            **$**
            **37,812**
            
            $
            30,653Supplemental
                cash flows information:Interest
                paid
            
            **$**
            **17,433**
            
            $
            18,181Income
                taxes paid
            
            **$**
            **7,437**
            
            $
            6,474Transfers
                from loans to other real estate owned
            
            **$**
            **138**
            
            $
            698





See
      accompanying notes to Consolidated Financial Statements .


5


Shore
      Bancshares, Inc.


Notes
      to
      Consolidated Financial Statements


For
      the
      Three and Nine Months Ended September 30, 2008 and 2007


(Unaudited)





Note
      1
      - Basis of Presentation





The
      consolidated financial statements include the accounts of Shore Bancshares,
      Inc.
      (the “Company”) and its subsidiaries with all significant intercompany
      transactions eliminated. The
      consolidated financial statements conform to accounting principles generally
      accepted in the United States of America (“GAAP”) and to prevailing practices
      within the banking industry. The accompanying interim financial statements
      are
      unaudited; however, in the opinion of management all adjustments necessary
      to
      present fairly the financial position at September 30, 2008, the results of
      operations for the three and nine months ended September 30, 2008 and 2007,
      changes in stockholders’ equity for the nine months ended September 30, 2008 and
      2007, and cash flows for the nine months ended September 30, 2008 and 2007,
      have
      been included. All such adjustments are of a normal recurring nature. The
      amounts as of December 31, 2007 were derived from audited financial statements.
      The results of operations for the three and nine months ended September 30,
      2008
      are not necessarily indicative of the results to be expected for any other
      interim period or for the full year. This Quarterly Report on Form 10-Q should
      be read in conjunction with the Company’s Annual Report on Form 10-K for the
      year ended December 31, 2007.





Note
      2
– Earnings Per Share





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




For the Three Months Ended
            
            For the Nine Months EndedSeptember 30,
            
            September 30,(In thousands, except per share data)
            
            **2008**
            
            2007
            
            **2008**
            
            2007Net
                Income
            
            **$**
            **3,071**
            
            $
            3,351
            
            **$**
            **9,209**
            
            $
            10,110Weighted
                Average Shares Outstanding–Basic
            
            
            **8,388**
            
            
            8,380
            
            
            **8,382**
            
            
            8,380Dilutive
                effect of stock-based awards
            
            
            **7**
            
            
            12
            
            
            **8**
            
            
            14Weighted
                Average Shares Outstanding–Diluted
            
            
            **8,395**
            
            
            8,392
            
            
            **8,390**
            
            
            8,394Earnings
                per common share – Basic
            
            **$**
            **0.37**
            
            $
            0.40
            
            **$**
            **1.10**
            
            $
            1.21Earnings
                per common share – Diluted
            
            **$**
            **0.37**
            
            $
            0.40
            
            **$**
            **1.10**
            
            $
            1.20




There
      were 3 thousand and 16 thousand antidilutive stock-based awards excluded from
      the earnings per share calculation for the three and nine months ended September
      30, 2008, respectively. There were no antidilutive stock-based awards excluded
      from the earnings per share calculation for the three and nine months ended
      September 30, 2007.





Note
      3
– Significant Accounting Policy





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


6





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




**September 30,**
            
            December 31,
            
            September 30,(Dollars in thousands)
            
            **2008**
            
            2007
            
            2007Impaired
                loans with a valuation allowance
            
            **$**
            **2,290**
            
            $
            3,413
            
            $
            1,922Impaired
                loans with no valuation allowance
            
            
            **5,206**
            
            
            127
            
            
            1,784Total
                impaired loans
            
            **$**
            **7,496**
            
            $
            3,540
            
            $
            3,706Allowance
                for credit losses applicable to impaired loans
            
            **$**
            **318**
            
            $
            819
            
            $
            932Allowance
                for credit losses applicable to other than impaired loans
            
            
            **8,300**
            
            
            6,732
            
            
            6,289Total
                allowance for credit losses
            
            **$**
            **8,618**
            
            $
            7,551
            
            $
            7,221Average
                recorded investment in impaired loans
            
            **$**
            **4,817**
            
            $
            3,958
            
            $
            4,316





Gross
      interest income of $314 thousand for the first nine months of 2008, $404
      thousand for fiscal year 2007 and $324 thousand for the first nine months of
      2007 would have been recorded if nonaccrual loans had been current and
      performing in accordance with their original terms. Interest actually recorded
      on such loans was $193 thousand for the first nine months of 2008, $142 thousand
      for fiscal year 2007 and $133 thousand for the first nine months of 2007.





Impaired
      loans do not include groups of smaller balance homogenous loans such as
      residential mortgage and consumer


installment
      loans that are evaluated collectively for impairment. Reserves for probable
      credit losses related to these loans are


based
      upon historical loss ratios and are included in the allowance for credit
      losses.





Note
      4
– Commitments





In
      the
      normal course of business, to meet the financial needs of its customers, the
      Company’s bank subsidiaries are parties to financial instruments with
      off-balance sheet risk. These financial instruments include commitments to
      extend credit and standby letters of credit. At September 30, 2008, total
      commitments to extend credit were approximately $221.0 million. The comparable
      amount was $246.3 million at December 31, 2007. Outstanding letters of credit
      were approximately $15.9 million at September 30, 2008 and $18.3 million at
      December 31, 2007.





Note
      5
      - Stock-Based Compensation





At
      September 30, 2008, the Company had two equity compensation plans: (i) the
      Shore
      Bancshares, Inc. Employee Stock Purchase Plan (“ESPP”); and (ii) the Shore
      Bancshares, Inc. 2006 Stock and Incentive Compensation Plan (“2006 Equity
      Plan”). In addition, at September 30, 2008, stock options remained outstanding
      under the Shore Bancshares, Inc. 1998 Stock Option Plan, which plan expired
      on
      March 3, 2008. The plans are described in detail in Note 13 to the audited
      financial statements contained in the Company’s Annual Report on Form 10-K for
      the year ended December 31, 2007. Stock-based awards granted to date are
      generally time-based, vesting on each anniversary of the grant date over a
      three
      to five year period of time and, in the case of stock options, expiring 10
      years
      from the grant date. ESPP awards allow employees to purchase shares of the
      Company’s common stock at 85% of the fair market value on the date of grant.
      ESPP grants are 100% vested at date of grant and have a 27-month
      term.





During
      the three and nine months ended September 30, 2008, the Company recognized
      pre-tax stock-based compensation expense of $22 thousand and $69 thousand,
      respectively, compared to $22 thousand and $51 thousand, respectively, for
      the
      same periods last year. Stock-based compensation expense is recognized ratably
      over the requisite service period for all awards and is based on the grant-date
      fair value. Unrecognized stock-based compensation expense related to nonvested
      share-based compensation arrangements was $323 thousand as of September 30,
      2008. The weighted-average period over which this unrecognized expense was
      expected to be recognized was 3.8 years.





The
      Company estimates the fair value of stock options using the Black-Scholes
      valuation model with weighted average assumptions for dividend yield, expected
      volatility, risk-free interest rate and expected lives (in years). The expected
      dividend yield is calculated by dividing the total expected annual dividend
      payout by the average stock price. The expected volatility is based on
      historical volatility of the underlying securities. The risk-free interest
      rate
      is based on the Federal Reserve Bank’s constant maturities daily interest rate
      in effect at grant date. The expected life of the options represents the period
      of time that the Company expects the awards to be outstanding based on
      historical experience with similar awards. Stock-based compensation expense
      recognized in the consolidated statements of income for the nine months ended
      September 30, 2008 and 2007 reflected forfeitures as they occurred.


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





7




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




Weighted
            
            AggregateNumber
            
            Average
            
            Intrinsicof Shares
            
            Exercise Price
            
            ValueOutstanding at beginning of
                year
            
            
            33,797
            
            $
            15.67Granted
            
            
            -
            
            
            -Exercised
            
            
            (13,106
            )
            
            15.42Expired/Cancelled
            
            
            (2,066
            )
            
            18.47Outstanding
                at end of period
            
            
            18,625
            
            
            15.54
            
            $
            189,258Exercisable
                at end of period
            
            
            18,625
            
            $
            15.54
            
            $
            189,258





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





Options Outstanding and ExercisableWeighted AverageOptions Outstanding
            
            
            
            RemainingExercise Price
            
            Number
            
            Number
            
            Contract Life (in years)$21.33
            
            
            5,075
            
            
            5,075
            
            
            0.314.00
            
            
            3,255
            
            
            3,255
            
            
            1.313.17
            
            
            10,295
            
            
            10,295
            
            
            3.518,625
            
            
            18,625





The
      total
      intrinsic value of stock options exercised during the nine months ended
      September 30, 2008 and 2007 was approximately $80 thousand and $30 thousand,
      respectively. Cash received upon exercise of options during the first nine
      months of 2008 and 2007 was approximately $136 thousand and $46 thousand,
      respectively.





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




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





Note
      6
– Segment Reporting





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





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


8


Selected
      financial information by line of business for the first nine months of 2008
      and
      2007 is included in the following table:




Community
            
            Insurance products
            
            Parent(Dollars in thousands)
            
            banking
            
            and services
            
            Company
            
            Total**2008**Interest
                income
            
            **$**
            **46,299**
            
            **$**
            **49**
            
            **$**
            **-**
            
            **$**
            **46,348**Interest
                expense
            
            
            **(16,676**
            **)**
            
            **-**
            
            
            **(101**
            **)**
            
            **(16,777**
            **)**Provision
                for credit losses
            
            
            **(1,952**
            **)**
            
            **-**
            
            
            **-**
            
            
            **(1,952**
            **)**Noninterest
                income
            
            
            **5,865**
            
            
            **10,077**
            
            
            **-**
            
            
            **15,942**Noninterest
                expense
            
            
            **(15,486**
            **)**
            
            **(9,128**
            **)**
            
            **(4,135**
            **)**
            
            **(28,749**
            **)**Net
                intersegment income (expense)
            
            
            **(3,577**
            **)**
            
            **(312**
            **)**
            
            **3,889**
            
            
            **-**Income
                before taxes
            
            
            **14,473**
            
            
            **686**
            
            
            **(347**
            **)**
            
            **14,812**Income
                tax (expense) benefit
            
            
            **(5,475**
            **)**
            
            **(259**
            **)**
            
            **131**
            
            
            **(5,603**
            **)**Net
                income
            
            **$**
            **8,998**
            
            **$**
            **427**
            
            **$**
            **(216**
            **)**
            **$**
            **9,209**Total
                assets
            
            **$**
            **1,013,939**
            
            **$**
            **20,332**
            
            **$**
            **2,755**
            
            **$**
            **1,037,026**2007Interest
                income
            
            $
            48,688
            
            $
            -
            
            $
            -
            
            $
            48,688Interest
                expense
            
            
            (18,078
            )
            
            -
            
            
            -
            
            
            (18,078
            )Provision
                for credit losses
            
            
            (1,259
            )
            
            -
            
            
            -
            
            
            (1,259
            )Noninterest
                income
            
            
            4,914
            
            
            5,050
            
            
            -
            
            
            9,964Noninterest
                expense
            
            
            (15,251
            )
            
            (4,132
            )
            
            (3,854
            )
            
            (23,237
            )Net
                intersegment income (expense)
            
            
            (3,457
            )
            
            (274
            )
            
            3,731
            
            
            -Income
                before taxes
            
            
            15,557
            
            
            644
            
            
            (123
            )
            
            16,078Income
                tax (expense) benefit
            
            
            (5,792
            )
            
            (255
            )
            
            79
            
            
            (5,968
            )Net
                income
            
            $
            9,765
            
            $
            389
            
            $
            (44
            )
            $
            10,110Total
                assets
            
            $
            927,468
            
            $
            9,279
            
            $
            3,130
            
            $
            939,877





Note
      7
– Fair Value Measurements




Effective
      January 1, 2008, the Company adopted Statement of Financial Accounting
      Standards (“SFAS”) No. 157, “ *Fair
      Value Measurements”* which
      provides a framework for measuring and disclosing fair value under GAAP. SFAS
      157 requires disclosures about the fair value of assets and liabilities
      recognized in the balance sheet in periods subsequent to initial recognition,
      whether the measurements are made on a recurring basis (for example, available
      for sale investment securities) or on a nonrecurring basis (for example,
      impaired loans).




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




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




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





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





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





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


9


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





Investment
      Securities Available for Sale


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





Loans


The
      Company does not record loans at fair value on a recurring basis, however,
      from
      time to time, a loan is considered impaired and an allowance for loan loss
      is
      established. Loans for which it is probable that payment of interest and
      principle will not be made in accordance with the contractual terms of the
      loan
      are considered impaired. Once a loan is identified as individually impaired,
      management measures impairment in accordance with SFAS 114, “Accounting by
      Creditors for Impairment of a Loan.” The fair value of impaired loans is
      estimated using one of several methods, including the collateral value, market
      value of similar debt, enterprise value, liquidation value and discounted cash
      flows. Those impaired loans not requiring a specific allowance represent loans
      for which the fair value of expected repayments or collateral exceed the
      recorded investment in such loans. At September 30, 2008, substantially all
      of the impaired loans were evaluated based upon the fair value of the
      collateral. In accordance with SFAS 157, impaired loans that have an allowance
      established based on the fair value of collateral require classification in
      the
      fair value hierarchy. When the fair value of the collateral is based on an
      observable market price or a current appraised value, the Company records the
      loan as nonrecurring Level 2. When an appraised value is not available or
      management determines the fair value of the collateral is further impaired
      below
      the appraised value and there is no observable market price, the Company records
      the loan as nonrecurring Level 3.





Assets
      and Liabilities Recorded at Fair Value on a Recurring Basis


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




SignificantOther
            
            SignificantQuoted
            
            Observable
            
            UnobservablePrices
            
            Inputs
            
            Inputs(Dollars in thousands)
            
            Fair Value
            
            (Level 1)
            
            (Level 2)
            
            (Level 3)Securities
                available for sale
            
            $
            82,235
            
            
            -
            
            $
            82,235
            
            
            -




Assets
      and Liabilities Recorded at Fair Value on a Nonrecurring Basis


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




SignificantOther
            
            SignificantQuoted
            
            Observable
            
            UnobservablePrices
            
            Inputs
            
            Inputs(Dollars in thousands)
            
            Fair Value
            
            (Level 1)
            
            (Level 2)
            
            (Level 3)Impaired loans
            
            $
            7,178
            
            
            -
            
            
            -
            
            $
            7,178




Impaired
      loans had a carrying amount of $7.5 million with a valuation allowance of $318
      thousand at September 30, 2008.





Note
      8
– Sale-leaseback





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


10


Note
      9
– Other Than Temporary Impairment


The
      Company currently holds 10,000 shares of Federal Home Loan Mortgage Corporation
      (Freddie Mac) preferred stock. During the third quarter of 2008, Freddie Mac
      was
      placed in a government conservatorship which negatively impacted the market
      value of its stock. The Company determined that its investment in Freddie Mac
      sustained an other than temporary impairment and recorded a $371 thousand
      impairment loss in the third quarter of 2008.





Note
      10 – New Accounting Pronouncements





**Pronouncements
      adopted**


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





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




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





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




**Pronouncements
      issued but not yet effective**


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


11


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





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





*SFAS
      No. 162, “The Hierarchy of Generally Accepted Accounting Principles.”* SFAS
      162
      identifies the sources of accounting principles and the framework for selecting
      the principles to be used in the preparation of financial statements of
      nongovernmental entities that are presented in conformity with GAAP in the
      United States (the “GAAP hierarchy”). The FASB concluded that the GAAP hierarchy
      should reside in the accounting literature established by the FASB and is
      issuing this Statement to achieve that result. This Statement is effective
      60
      days following the Security and Exchange Commission’s approval of the Public
      Company Accounting Oversight Board amendments to AU Section 411, *The
      Meaning of Present Fairly in Conformity with Generally Accepted Accounting
      Principles.* The
      Company does not expect the implementation of SFAS 162 to have a material impact
      on its consolidated financial statements.





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





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





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





**Forward-Looking
      Information**


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





**Introduction**


The
      following discussion and analysis is intended as a review of significant factors
      affecting the financial condition and results of operations of Shore Bancshares,
      Inc. and its consolidated subsidiaries for the periods indicated. This
      discussion and analysis should be read in conjunction with the unaudited
      consolidated financial statements and related notes presented in this report,
      as
      well as the audited consolidated financial statements and related notes included
      in the Annual Report of Shore Bancshares, Inc. on Form 10-K for the year ended
      December 31, 2007.


12


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





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





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





**Critical
      Accounting Policies**


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





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





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




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


13


**RECENT
      GOVERNMENT ACTIONS**





On
      October 14, 2008, the U.S. Department of the Treasury announced its capital
      purchase program designed to encourage U.S. financial institutions to build
      capital to increase the flow of financing to U.S. businesses and consumers
      and
      to support the U.S. economy. Under this program, Treasury will purchase up
      to
      $250 billion of shares of senior preferred stock from qualifying U.S. financial
      institutions. The minimum and maximum subscription amounts available to a
      participating financial institution are 1% of its risk-weighted assets and
      the
      lesser of $25 billion or 3% of its risk-weighted assets, respectively.





On
      October 31, 2008, the Corporation’s Board of Directors adopted resolutions
      authorizing the Corporation to apply for participation in the Capital Purchase
      Program. If the Corporation’s application is approved and the Board determines
      to move forward, the Corporation would issue 25,000 shares of a new class of
      stock to be known as Fixed-Rate Cumulative Perpetual Preferred Stock, Series
      A
      (the “Preferred Stock”), and issue a warrant to purchase shares of common stock
      having a market value of $3.75 million. The Preferred Stock, which would qualify
      as Tier 1 regulatory capital, would be sold for an aggregate purchase price
      of
      $25.0 million, have a liquidation preference of $1,000 per share, pay cumulative
      quarterly dividends at a rate of 5% per year for the first five years and 9%
      per
      year thereafter, and be non-voting, other than class voting rights on certain
      matters that could adversely affect the shares. Until three years following
      the
      date of issuance, the Corporation would be able to redeem the Preferred Stock
      at
      par only using proceeds from a sale of Tier 1 qualifying perpetual preferred
      stock or common stock for cash which results in gross proceeds to the
      Corporation of not less than $6.25 million. After three years, the Corporation
      would be able to redeem the Preferred Stock at par, in whole or in part, at
      its
      discretion. Any redemption is subject to the consent of the Board of Governors
      of the Federal Reserve System. Also, until three years following the sale of
      the
      Preferred Stock, or such earlier time as the Preferred Stock has been redeemed
      or transferred by Treasury, the Corporation would not, without Treasury’s
      consent, be permitted to increase the dividend per share on common stock or
      repurchase common stock.





The
      warrant would be immediately exercisable, with a 10-year term. The exercise
      price per share would be based upon the average of the closing prices of the
      Corporation’s common stock during the 20-trading day period ending on the
      trading day prior to the issuance of the Preferred Stock. The exercise price
      and
      number of shares subject to the warrant would both be subject to anti-dilution
      adjustments. Treasury would agree not to exercise voting power with respect
      to
      any shares of common stock issued upon exercise of the warrant. If the
      Corporation were to receive aggregate gross cash proceeds of at least $25
      million from one or more qualifying equity offerings of Tier 1-eligible
      perpetual preferred or common stock on or prior to December 31, 2009, then
      the
      number of shares of common stock underlying the warrant then held by Treasury
      would be reduced by one-half of the original number of shares, considering
      all
      adjustments, underlying the warrant.





The
      proceeds from the issuance would be allocated on a relative fair value basis
      between the Preferred Stock and the warrant. The Preferred Stock and the warrant
      would both be classified in stockholders’ equity in our consolidated statement
      of condition. The issuance, including dividends, would likely result in a
      reduction of basic and diluted earnings per common share.





The
      Corporation would issue the Preferred Stock and the Warrant in a private
      placement exempt from the SEC’s registration requirements, and would file a
      registration statement covering the resale of the Preferred Stock, the warrant
      and the shares of common stock underlying the warrant. Neither the Preferred
      Stock nor the warrant would be subject to any contractual restrictions on
      transfer, except that Treasury could only transfer or exercise an aggregate
      of
      one-half of the warrant shares prior to December 31, 2009, unless the
      Corporation were to receive gross proceeds from qualified equity offerings
      that
      are at least equal to the $25.0 million initially received from Treasury. During
      the period that Treasury holds any Preferred Stock, the warrant or any shares
      of
      our common stock issuable upon exercise of the warrant, we would be subject
      to
      certain restrictions on the compensation of our senior executive
      officers.





There
      can
      be no assurance that the Corporation’s application will be accepted or that,
      even if it is, the Corporation will ultimately decide to participate in the
      Capital Purchase Program.





**OVERVIEW**





Net
      income for the third quarter of 2008 was $3.1 million, or diluted earnings
      per
      share of $0.37, compared to $3.4 million, or diluted earnings per share of
      $0.40, for the third quarter of 2007. For the second quarter of 2008, net income
      was $2.8 million or $0.33 per diluted share. Annualized return on average assets
      was 1.19% for the three months ended September 30, 2008, compared to 1.42%
      for
      the same period in 2007. Annualized return on average stockholders’ equity was
      9.81% for the third quarter of 2008, compared to 11.51% for the third quarter
      of
      2007. For the second quarter of 2008, annualized return on average assets was
      1.12% and return on average equity was 8.98%. Overall, third quarter 2008
      results improved over second quarter 2008 results.





Net
      income for the first nine months of 2008 was $9.2 million, or diluted earnings
      per share of $1.10, compared to $10.1 million, or diluted earnings per share
      of
      $1.20, for the first nine months of 2007. Annualized return on average assets
      was 1.23% for the nine months ended September 30, 2008, compared to 1.43% for
      the same period in 2007. Annualized return on average stockholders’ equity was
      9.95% for the first nine months of 2008, compared to 11.76% for the first nine
      months of 2007.


14


**RESULTS
      OF OPERATIONS**





**Net
      Interest Income**


Net
      interest income for the three months ended September 30, 2008 was $9.9 million,
      a decrease of 5.3% when compared to the same period last year. Lower yields
      on
      earning assets were the primary reason for the decrease. The net interest margin
      was 4.10% for the third quarter of 2008, a decrease of 64 basis points when
      compared to the third quarter of 2007. The 225 basis-point reduction in interest
      rates by the Federal Reserve during the first nine months of 2008 had a
      significant impact on the overall yield on earning assets. Net interest income
      increased 2.9% from the second quarter of 2008 mainly due to higher loan volume.
      The net interest margin decreased just 7 basis points from 4.17% for the second
      quarter of 2008.





Interest
      income was $15.3 million for the third quarter of 2008, a decrease of 7.5%
      from
      the third quarter of 2007. Average earning assets increased 8.9% during the
      third quarter of 2008 when compared to the same period in 2007, while yields
      earned decreased 116 basis points to 6.30%. Average loans increased 15.7% while
      the yield earned on loans decreased 138 basis points. Loans comprised
      87.9% and 82.7% of total average earning assets for the quarters ended September
      30, 2008 and 2007, respectively. Interest income increased 1.1% when compared
      to
      the second quarter of 2008. Average earning assets increased 3.5% during the
      third quarter of 2008 when compared to the second quarter of 2008, while yields
      earned decreased 23 basis points.





Interest
      expense decreased 11.4% for the three months ended September 30, 2008 when
      compared to the same period last year. Average interest bearing liabilities
      increased 9.5%, while rates paid decreased 66 basis points to 2.75%. Average
      balances increased in all categories of interest bearing liabilities except
      for
      long-term debt. However, rates declined enough to reduce interest expense in
      all
      categories of interest bearing liabilities except for certificates of deposit
      $100,000 or more and short-term borrowings. The average balance of interest
      bearing deposits increased 8.6% for the quarter ended September 30, 2008 when
      compared to the same period in 2007. The overall rate paid for interest bearing
      deposits decreased 58 basis points to 2.74%. For the three months ended
      September 30, 2008, the average balance of certificates of deposits $100,000
      or
      more increased 23.1% when compared to the same period last year, and the average
      rate paid for those certificates of deposit decreased 92 basis points to 3.95%.
      Interest expense decreased 1.9% when compared to the second quarter of 2008.
      Average interest bearing liabilities increased 3.2% during the quarter ended
      September 30, 2008 when compared to the second quarter of 2008, while rates
      paid
      decreased 17 basis points.





Net
      interest income for the nine months ended September 30, 2008 was $29.6 million,
      a decrease of 3.4% when compared to the same period last year. The decrease
      was
      primarily the result of lower yields on earning assets. The net interest margin
      was 4.22% for the first nine months of 2008, a decrease of 40 basis points
      when
      compared to the first nine months of 2007.





Interest
      income was $46.3 million for the first nine months of 2008, a decrease of 4.8%
      from the first nine months of 2007. Average earning assets increased 6.0% during
      the nine months ended September 30, 2008 when compared to the same period in
      2007, while yields earned decreased 73 basis points to 6.59%. Average loans
      increased 15.1% during the first nine months of 2008, while the yield earned
      on
      loans decreased 100 basis points when compared to the same period of 2007.
      Loans
      comprised 87.2% and 80.4% of total average earning assets for the first nine
      months of 2008 and 2007, respectively.





Interest
      expense decreased 7.2% for the nine months ended September 30, 2008 when
      compared to the same period last year. Average interest bearing liabilities
      increased 6.3%, while rates paid decreased 43 basis points to 2.94%. Average
      balances increased in all categories of interest bearing liabilities except
      for
      long-term debt. However, rates declined enough to reduce interest expense in
      all
      categories of interest bearing liabilities except for certificates of deposit
      $100,000 or more and short-term borrowings. The average balance of interest
      bearing deposits increased 5.7% for the first nine months of 2008 when compared
      to the same period in 2007. The overall rate paid for interest bearing deposits
      decreased 35 basis points to 2.92%. For the nine months ended September 30,
      2008, the average balance of certificates of deposits $100,000 or more increased
      17.6% when compared to the same period last year, and the average rate paid
      for
      those certificates of deposit decreased 60 basis points to
      4.26%.


15


**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 September 30, 2008 and 2007.




**For the Three Months Ended**
            
            For the Three Months Ended**September 30, 2008**
            
            September 30, 2007**Average**
            
            **Income(1)/**
            
            **Yield/**
            
            Average
            
            Income(1)/
            
            Yield/(Dollars in thousands)
            
            **Balance**
            
            **Expense**
            
            **Rate**
            
            Balance
            
            Expense
            
            RateEarning assetsInvestment
                securitiesTaxable
            
            **$**
            **84,713**
            
            **$**
            **924**
            
            
            **4.34**
            **%**
            $
            114,248
            
            $
            1,325
            
            
            4.64
            %Tax-exempt
            
            
            **10,320**
            
            
            **145**
            
            
            **5.63**
            
            
            13,360
            
            
            197
            
            
            5.90Loans
                (2), (3)
            
            
            **854,371**
            
            
            **14,225**
            
            
            **6.62**
            
            
            738,145
            
            
            14,770
            
            
            8.00Federal
                funds sold
            
            
            **17,921**
            
            
            **79**
            
            
            **1.74**
            
            
            13,096
            
            
            178
            
            
            5.44Interest
                bearing deposits
            
            
            **4,218**
            
            
            **21**
            
            
            **2.01**
            
            
            13,473
            
            
            180
            
            
            5.34Total
                earning assets
            
            
            **971,543**
            
            
            **15,394**
            
            
            **6.30**
            **%**
            
            892,322
            
            
            16,650
            
            
            7.46
            %Cash
                and due from banks
            
            
            **14,306**
            
            
            
            
            
            
            
            
            17,512Other
                assets
            
            
            **50,358**
            
            
            
            
            
            
            
            
            43,376Allowance
                for credit losses
            
            
            **(8,468**
            **)**
            
            
            
            
            
            
            
            (7,002
            )Total
                assets
            
            **$**
            **1,027,739**
            
            
            
            
            
            
            
            $
            946,208Interest
                bearing liabilitiesDemand
                deposits
            
            **$**
            **112,000**
            
            
            **97**
            
            
            **0.34**
            **%**
            $
            111,983
            
            
            299
            
            
            1.07
            %Money
                market and savings deposits
            
            
            **183,408**
            
            
            **673**
            
            
            **1.46**
            
            
            177,077
            
            
            811
            
            
            1.83Certificates
                of deposit $100,000 or more
            
            
            **196,810**
            
            
            **1,953**
            
            
            **3.95**
            
            
            159,917
            
            
            1,945
            
            
            4.87Other
                time deposits
            
            
            **226,110**
            
            
            **2,232**
            
            
            **3.93**
            
            
            212,341
            
            
            2,438
            
            
            4.59Interest
                bearing deposits
            
            
            **718,328**
            
            
            **4,955**
            
            
            **2.74**
            
            
            661,318
            
            
            5,493
            
            
            3.32Short-term
                borrowings
            
            
            **53,450**
            
            
            **344**
            
            
            **2.56**
            
            
            28,884
            
            
            279
            
            
            3.86Long-term
                debt
            
            
            **8,485**
            
            
            **90**
            
            
            **4.21**
            
            
            22,391
            
            
            308
            
            
            5.50Total
                interest bearing liabilities
            
            
            **780,263**
            
            
            **5,389**
            
            
            **2.75**
            **%**
            
            712,593
            
            
            6,080
            
            
            3.41
            %Noninterest
                bearing deposits
            
            
            **111,915**
            
            
            
            
            
            
            
            
            108,906Other
                liabilities
            
            
            **10,978**
            
            
            
            
            
            
            
            
            8,279Stockholders’
                equity
            
            
            **124,583**
            
            
            
            
            
            
            
            
            116,430Total
                liabilities and stockholders’ equity
            
            **$**
            **1,027,739**
            
            
            
            
            
            
            
            $
            946,208Net
                interest spread
            
            
            
            
            **$**
            **10,005**
            
            
            **3.55**
            **%**
            
            
            
            $
            10,570
            
            
            4.05
            %Net
                interest margin
            
            
            
            
            
            
            
            
            **4.10**
            **%**
            
            
            
            
            
            
            
            4.74
            %


16


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




**For the Nine Months Ended**
            
            For the Nine Months Ended**September 30, 2008**
            
            September 30, 2007**Average**
            
            **Income(1)/**
            
            **Yield/**
            
            Average
            
            Income(1)/
            
            Yield/(Dollars in thousands)
            
            **Balance**
            
            **Expense**
            
            **Rate**
            
            Balance
            
            Expense
            
            RateEarning
                assetsInvestment
                securitiesTaxable
            
            **$**
            **86,633**
            
            **$**
            **2,949**
            
            
            **4.55**
            **%**
            $
            115,248
            
            $
            3,900
            
            
            4.51
            %Tax-exempt
            
            
            **11,395**
            
            
            **502**
            
            
            **5.89**
            
            
            13,563
            
            
            596
            
            
            5.86Loans
                (2), (3)
            
            
            **824,775**
            
            
            **42,829**
            
            
            **6.94**
            
            
            716,478
            
            
            42,643
            
            
            7.94Federal
                funds sold
            
            
            **17,893**
            
            
            **284**
            
            
            **2.12**
            
            
            24,861
            
            
            988
            
            
            5.30Interest
                bearing deposits
            
            
            **4,746**
            
            
            **88**
            
            
            **2.49**
            
            
            21,533
            
            
            847
            
            
            5.24Total
                earning assets
            
            
            **945,442**
            
            
            **46,652**
            
            
            **6.59**
            **%**
            
            891,683
            
            
            48,974
            
            
            7.32
            %Cash
                and due from banks
            
            
            **14,408**
            
            
            
            
            
            
            
            
            16,869Other
                assets
            
            
            **50,690**
            
            
            
            
            
            
            
            
            43,411Allowance
                for credit losses
            
            
            **(8,097**
            **)**
            
            
            
            
            
            
            
            (6,714
            )Total
                assets
            
            **$**
            **1,002,443**
            
            
            
            
            
            
            
            $
            945,249Interest
                bearing liabilitiesDemand
                deposits
            
            **$**
            **112,309**
            
            
            **363**
            
            
            **0.43**
            **%**
            $
            111,497
            
            
            805
            
            
            0.96
            %Money
                market and savings deposits
            
            
            **180,087**
            
            
            **2,032**
            
            
            **1.51**
            
            
            178,459
            
            
            2,386
            
            
            1.78Certificates
                of deposit $100,000 or more
            
            
            **186,879**
            
            
            **5,963**
            
            
            **4.26**
            
            
            158,889
            
            
            5,794
            
            
            4.86Other
                time deposits
            
            
            **221,564**
            
            
            **6,937**
            
            
            **4.18**
            
            
            214,390
            
            
            7,278
            
            
            4.53Interest
                bearing deposits
            
            
            **700,839**
            
            
            **15,295**
            
            
            **2.92**
            
            
            663,235
            
            
            16,263
            
            
            3.27Short-term
                borrowings
            
            
            **47,409**
            
            
            **1,026**
            
            
            **2.89**
            
            
            28,841
            
            
            838
            
            
            3.88Long-term
                debt
            
            
            **12,821**
            
            
            **456**
            
            
            **4.75**
            
            
            24,129
            
            
            977
            
            
            5.40Total
                interest bearing liabilities
            
            
            **761,069**
            
            
            **16,777**
            
            
            **2.94**
            **%**
            
            716,205
            
            
            18,078
            
            
            3.37
            %Noninterest
                bearing deposits
            
            
            **106,328**
            
            
            
            
            
            
            
            
            105,957Other
                liabilities
            
            
            **11,419**
            
            
            
            
            
            
            
            
            8,453Stockholders’
                equity
            
            
            **123,627**
            
            
            
            
            
            
            
            
            114,634Total
                liabilities and stockholders’ equity
            
            **$**
            **1,002,443**
            
            
            
            
            
            
            
            $
            945,249Net
                interest spread
            
            
            
            
            **$**
            **29,875**
            
            
            **3.65**
            **%**
            
            
            
            $
            30,896
            
            
            3.95
            %Net
                interest margin
            
            
            
            
            
            
            
            
            **4.22**
            **%**
            
            
            
            
            
            
            
            4.62
            %





(1)
      All
      amounts are reported on a tax equivalent basis computed using the statutory
      federal income tax rate of 35% exclusive of the alternative
      minimum tax rate and nondeductible interest expense.


(2)
      Average loan balances include nonaccrual loans.


(3)
      Interest income on loans includes amortized loan fees, net of costs, for each
      loan category and yield calculations are stated to include all.





**Noninterest
      Income**


Noninterest
      income for the third quarter of 2008 increased $2.2 million when compared to
      the
      third quarter of 2007. Service charges on deposit accounts decreased $26
      thousand, other service charges and fees increased $167 thousand, insurance
      agency commissions increased $1.4 million and other noninterest income decreased
      $56 thousand for the third quarter of 2008 when compared to the third quarter
      of
      2007. The increase in insurance agency commissions was primarily the result
      of
      the acquisition of two insurance agencies during the fourth quarter of 2007.
      Included in total noninterest income was a $1.3 million gain on the sale of
      a
      bank branch to the State of Maryland as part of a road widening project. The
      branch remains open; however, the bank intends to move the branch to a new
      facility during 2009. The gain on the branch sale was partially offset by a
      $371
      thousand other than temporary impairment of Freddie Mac Preferred Stock and
      a
      $337 thousand loss on the sale of the Company’s investment in Delmarva Bank Data
      Processing Center, Inc., an unconsolidated subsidiary. Noninterest income
      increased $52 thousand from the second quarter of 2008 primarily due to the
      $1.3
      million gain on the land and bank building sale reduced by the $708 thousand
      other than temporary impairment and loss. These increases were partially offset
      by a decrease in insurance agency commissions of $374 thousand.





Noninterest
      income for the first nine months of 2008 increased $6.0 million when compared
      to
      the first nine months of 2007. Service charges on deposit accounts increased
      $291 thousand, other service charges and fees increased $680 thousand, insurance
      agency commissions
      increased $4.6 million and other noninterest income decreased $238 thousand
      for
      the first nine months of 2008 when compared to the same period in 2007. The
      increase in other service charges and fees and insurance agency commissions
      was
      primarily the result of the acquisition of the two insurance agencies during
      the
      fourth quarter of 2007. Total noninterest income included the previously
      mentioned $1.3 million gain on the land and bank building sale and the $708
      thousand other than temporary impairment and loss.


17


**Noninterest
      Expense**


Noninterest
      expense for the third quarter of 2008 increased $1.8 million when compared
      to
      the third quarter of 2007. The increase was primarily attributable to the
      operating expenses of the two insurance agencies acquired during the fourth
      quarter of 2007. Salaries and benefits increased $979 thousand, insurance agency
      commissions increased $447 thousand and other noninterest expenses increased
      $215 thousand for the third quarter of 2008 when compared to the third quarter
      of 2007. Noninterest expense decreased $300 thousand from the second quarter
      of
      2008 primarily due to a decrease in agency commissions and other noninterest
      expenses.





Noninterest
      expense for the first nine months of 2008 increased $5.5 million when compared
      to the first nine months of 2007. The increase was primarily attributable to
      the
      operating expenses of the two insurance agencies acquired during the fourth
      quarter of 2007. Salaries and benefits increased $3.1 million, insurance agency
      commissions increased $1.8 million and other noninterest expenses increased
      $387
      thousand for the first nine months of 2008 when compared to the same period
      last
      year.





**Income
      Taxes**


The
      effective tax rate was 36.7% for the three months ended September 30, 2008,
      compared to 37.0% for the same period last year. For the nine months ended
      September 30, 2008 and 2007, the effective tax rates were 37.8% and 37.1%,
      respectively. Management believes that currently there are no additional changes
      in tax laws or to our tax structure that are likely to have a material impact
      on
      our future effective tax rate.





**ANALYSIS
      OF FINANCIAL CONDITION**





**Loans**


Loans,
      net of unearned income, totaled $865.4 million at September 30, 2008, an
      increase of $89.1 million, or 11.5%, since December 31, 2007. Average loans,
      net
      of unearned income, were $854.4 million for the three months ended September
      30,
      2008, an increase of $116.2 million, or 15.7%, when compared to the same period
      last year. Average loans, net of unearned income, were $824.8 million for the
      nine months ended September 30, 2008, an increase of $108.3 million, or 15.1%,
      when compared to the same period in 2007.





**Allowance
      for Credit Losses**


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





The
      provision for credit losses for the three months ended September 30, 2008 and
      2007 was $875 thousand and $604 thousand, respectively. The provision for credit
      losses for the second quarter of 2008 was $615 thousand. The increased provision
      for the third quarter of 2008 when compared to the third quarter of 2007 and
      the
      second quarter of 2008 reflected the continued growth in the loan portfolio,
      an
      increase in nonperforming assets and charge-offs, as well as current economic
      conditions. The provision for credit losses for the nine months ended September
      30, 2008 and 2007 was $2.0 million and $1.3 million, respectively. Management
      believes that we continue to maintain strong underwriting guidelines and
      emphasize credit quality.





Our
      historical charge-off ratios remain lower than those of similarly sized
      institutions according to the most recent Bank Holding Company Performance
      Report prepared by the Federal Reserve Board. Net charge-offs were $539 thousand
      for the three months ended September 30, 2008, compared to $268 thousand for
      the
      same period last year and $259 thousand for the second quarter of 2008. The
      allowance for credit losses as a percentage of average loans was 1.01% for
      the
      third quarter of 2008, 0.98% for the third quarter of 2007 and 1.01% for the
      second quarter of 2008. Net charge-offs were $885 thousand for the first nine
      months of 2008, compared to $338 thousand for the same period in 2007. The
      allowance for credit losses as a percentage of average loans was 1.04% for
      the
      first nine months of 2008 and 1.01% for the same period last year. Nonperforming
      assets were $7.5 million at September 30, 2008, compared to $3.7 million at
      December 31, 2007. Loans past due 90 days and still accruing at September 30,
      2008 decreased to $599 thousand from $1.6 million at December 31, 2007. Based
      on
      management’s quarterly evaluation of the adequacy of the allowance for credit
      losses, it believes that the allowance for credit losses and the related
      provision were adequate at September 30, 2008.


18


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





For the Three Months Ended
            
            For the Nine Months EndedSeptember 30,
            
            September 30,(Dollars in thousands)
            
            **2008**
            
            2007
            
            **2008**
            
            2007Allowance
                balance - beginning of period
            
            **$**
            **8,282**
            
            $
            6,885
            
            **$**
            **7,551**
            
            $
            6,300Charge-offs:Real
                estate
            
            
            **(455**
            **)**
            
            (40
            )
            
            **(526**
            **)**
            
            (40
            )Consumer
            
            
            **(63**
            **)**
            
            (52
            )
            
            **(198**
            **)**
            
            (174
            )Commercial
                and other
            
            
            **(185**
            **)**
            
            (206
            )
            
            **(381**
            **)**
            
            (241
            )Totals
            
            
            **(703**
            **)**
            
            (298
            )
            
            **(1,105**
            **)**
            
            (455
            )Recoveries:Real
                estate
            
            
            **10**
            
            
            -
            
            
            **18**
            
            
            -Consumer
            
            
            **34**
            
            
            12
            
            
            **75**
            
            
            57Commercial
                and other
            
            
            **120**
            
            
            18
            
            
            **127**
            
            
            60Totals
            
            
            **164**
            
            
            30
            
            
            **220**
            
            
            117Net
                charge-offs
            
            
            **(539**
            **)**
            
            (268
            )
            
            **(885**
            **)**
            
            (338
            )Provision
                for credit losses
            
            
            **875**
            
            
            604
            
            
            **1,952**
            
            
            1,259Allowance
                balance - end of period
            
            **$**
            **8,618**
            
            $
            7,221
            
            **$**
            **8,618**
            
            $
            7,221Average
                loans outstanding during the period
            
            **$**
            **854,371**
            
            $
            738,145
            
            **$**
            **824,775**
            
            $
            716,478Net
                charge-offs (annualized) as a percentage of average loans outstanding
                during the period
            
            
            **0.25**
            **%**
            
            0.15
            %
            
            **0.14**
            **%**
            
            0.06
            %Allowance
                for credit losses at period end as a percentage of average
                loans
            
            
            **1.01**
            **%**
            
            0.98
            %
            
            **1.04**
            **%**
            
            1.01
            %





Because
      most of our loans are secured by real estate, weaknesses in the local real
      estate market may have a material adverse effect on the performance of our
      loan
      portfolio and the value of the collateral securing that portfolio. Despite
      the
      weaknesses in the national economy and real estate market, management believes
      that the local economy and real estate market remain relatively stable. ****





We
      have a
      concentration of commercial real estate loans. Commercial real estate loans,
      excluding construction and land development loans, at September 30, 2008 were
      approximately $296.2 million, or 34.3% of total loans, compared to $249.5
      million, or 32.1% of total loans at December 31, 2007. Construction and land
      development loans at September 30, 2008 were $174.9 million, or 20.2% of total
      loans, compared to $155.5 million, or 20.0% of total loans, at December 31,
      2007. We do not engage in foreign or subprime lending activities.





**Nonperforming
      Assets**


The
      following table summarizes our nonperforming and past due assets:




**September 30,**
            
            December 31,(Dollars in thousands)
            
            **2008**
            
            2007Nonperforming assetsNonaccrual
                loans
            
            **$**
            **7,496**
            
            $
            3,540Other
                real estate owned
            
            
            **-**
            
            
            176Total
                nonperforming assets
            
            
            **7,496**
            
            
            3,716Loans
                90 days past due and still accruing
            
            
            **599**
            
            
            1,606Total
                nonperforming assets and past due loans
            
            **$**
            **8,095**
            
            $
            5,322





**Investment
      Securities**


Investment
      securities totaled $93.1 million at September 30, 2008, compared to $110.0
      million at December 31, 2007. The decreased balance reflects the use of proceeds
      from maturing securities to fund loan growth. The average balance of investment
      securities was $95.0 million for the three months ended September 30, 2008,
      compared to $127.6 million for the same period in 2007. The tax equivalent
      yields on investment securities were 4.48% and 4.77% for the three months ended
      September 30, 2008 and 2007, respectively. The average balance of investment
      securities was $98.0 million for the nine months ended September 30, 2008, compared
      to $128.8 million for the same period in 2007. The tax equivalent yields on
      investment securities were 4.70% and 4.65% for the nine months ended September
      30, 2008 and 2007, respectively.


19


**Deposits**


Total
      deposits at September 30, 2008 were $839.2 million, compared to $765.9 million
      at December 31, 2007. All categories of deposits grew from the comparable
      amounts at the end of 2007. The largest growth was in certificates of deposit
      of
      $100,000 or more which increased $36.0 million, or 22.3%, due primarily to
      increased deposits of a large municipal customer.





**Short-Term
      Borrowings**


Short-term
      borrowings at September 30, 2008 and December 31, 2007 were $53.1 million and
      $47.7 million, respectively. Short-term borrowings consisted of securities
      sold
      under agreements to repurchase, overnight borrowings from correspondent banks
      and short-term advances from the Federal Home Loan Bank. Short-term advances
      are
      defined as those with original maturities of one year or less.





**Long-Term
      Debt**


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





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





**Liquidity
      and Capital Resources**


We
      derive
      liquidity through increased customer deposits, maturities in the investment
      portfolio, loan repayments and income from earning assets. To the extent that
      deposits are not adequate to fund customer loan demand, liquidity needs can
      be
      met in the short-term funds markets through arrangements with correspondent
      banks. Talbot Bank and Centreville National Bank are also members of the Federal
      Home Loan Bank of Atlanta and Felton Bank is a member of the Federal Home Loan
      Bank of Pittsburgh to which they have pledged collateral sufficient to permit
      additional borrowings of up to approximately $64.7 million in the aggregate
      at
      September 30, 2008. Management is not aware of any trends or demands,
      commitments, events or uncertainties that are likely to materially affect our
      future ability to maintain liquidity at satisfactory levels.





Total
      stockholders’ equity was $125.4 million at September 30, 2008, an increase of
      4.3% since December 31, 2007. Accumulated other comprehensive income, which
      consisted solely of net unrealized gains or losses on investment securities
      available for sale, increased $102 thousand since the end of 2007, resulting
      in
      accumulated other comprehensive income of $349 thousand at September 30,
      2008.





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





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





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




Minimum**September 30,**
            
            December 31,
            
            Regulatory**2008**
            
            2007
            
            RequirementsTier 1 risk-based
                capital
            
            
            **11.65**
            **%**
            
            12.15
            %
            
            4.00
            %Total
                risk-based capital
            
            
            **12.67**
            **%**
            
            13.14
            %
            
            8.00
            %Leverage
                ratio
            
            
            **10.25**
            **%**
            
            10.50
            %
            
            4.00
            %


20


**Item
      3. Quantitative and Qualitative Disclosures about Market
      Risk.**





Our
      primary market risk is to interest rate fluctuation and management has
      procedures in place to evaluate and mitigate this risk. This risk and these
      procedures are discussed in Item 7 of Part II of the Annual Report of Shore
      Bancshares, Inc. on Form 10-K for the year ended December 31, 2007 under the
      caption “Market Risk Management”. Management believes that there have been no
      material changes in our market risks, the procedures used to evaluate and
      mitigate these risks, or our actual and simulated sensitivity positions since
      December 31, 2007.





**Item
      4. Controls and Procedures.**





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





An
      evaluation of the effectiveness of these disclosure controls as of September
      30,
      2008 was carried out under the supervision and with the participation of
      management, including the CEO and the PAO. Based on that evaluation, the
      Company’s management, including the CEO and the PAO, has concluded that our
      disclosure controls and procedures are, in fact, effective at the reasonable
      assurance level.





During
      the third quarter of 2008, there was no change in our internal control over
      financial reporting that has materially affected, or is reasonably likely to
      materially affect, our internal control over financial reporting.





**PART
      II** **–
      OTHER INFORMATION**





**Item
      1A. Risk Factors.**





The
      risks
      and uncertainties to which our financial condition and operations are subject
      are discussed in detail in Item 1A of Part I of the Annual Report of Shore
      Bancshares, Inc. on Form 10-K for the year ended December 31, 2007. Management
      does not believe that any material changes in our risk factors have occurred
      since they were last disclosed. The following discussion updates a risk factor
      that was contained in the Annual Report on Form 10-K to reflect recent changes
      in economic conditions.





**A
      majority of our business is concentrated in Maryland and Delaware; a significant
      amount of our business is concentrated in real estate lending.**





Because
      most of our loans are made to customers who reside on the Eastern Shore of
      Maryland and in Delaware, a decline in local economic conditions may have a
      greater effect on our earnings and capital than on the earnings and capital
      of
      larger financial institutions whose loan portfolios are geographically diverse.
      Further, we make many real estate secured loans, including construction and
      land
      development loans, all of which are in greater demand when interest rates are
      low and economic conditions are good. The national and local economies have
      weakened during the past two years in part due to the widely-reported problems
      in the sub-prime mortgage loan market. As a result, real estate values across
      the country, including in our market areas, have decreased and the general
      availability of credit, especially credit to be secured by real estate, has
      also
      decreased. These conditions have made it more difficult for real estate owners
      and owners of loans secured by real estate to sell their assets at the times
      and
      at the prices they desire. In addition, these conditions have increased the
      risk
      that the market values of the real estate securing our loans may deteriorate,
      which could cause us to lose money in the event a borrower fails to repay a
      loan
      and we are forced to foreclose on the property. There can be no guarantee as
      to
      when or whether economic conditions will improve.


21


Additionally,
      the Board of Governors of the Federal Reserve Board (the “FRB”) and the FDIC,
      along with the other federal banking regulators, issued final guidance on
      December 6, 2006 entitled “Concentrations in Commercial Real Estate Lending,
      Sound Risk Management Practices” directed at institutions that have particularly
      high concentrations of commercial real estate loans within their lending
      portfolios. This guidance suggests that institutions whose commercial real
      estate loans exceed certain percentages of capital should implement heightened
      risk management practices appropriate to their concentration risk and may be
      required to maintain higher capital ratios than institutions with lower
      concentrations in commercial real estate lending. Based on our commercial real
      estate concentration as of September 30, 2008, we may be subject to further
      supervisory analysis during future examinations. We cannot guarantee that any
      risk management practices we implement will be effective to prevent losses
      relating to our commercial real estate portfolio. Management cannot predict
      the
      extent to which this guidance will impact our operations or capital
      requirements.





Other
      than as discussed above, management does not believe that any material changes
      in our risk factors have occurred since December 31, 2007.





**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:
                November 6, 2008
            By:
            /s/
                W. Moorhead VermilyeW.
                Moorhead VermilyePresident/Chief
                Executive OfficerDate:
                November 6, 2008
            By:
            /s/
                Susan E.LeavertonSusan
                E. Leaverton, CPATreasurer/Principal
                Accounting Officer


22


**EXHIBIT
      INDEX**





ExhibitNumber
            
            Description31.1
            
            Certifications
                of the CEO pursuant to Section 302 of the Sarbanes-Oxley Act (filed
                herewith).31.2
            
            Certifications
                of the PAO pursuant to Section 302 of the Sarbanes-Oxley Act (filed
                herewith).32.1
            
            Certification
                of the CEO pursuant toSection
                906 of the Sarbanes-Oxley Act(furnished
                herewith).32.2
            
            Certification
                of the PAO pursuant toSection
                906 of the Sarbanes-Oxley Act(furnished
                herewith).


23