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

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

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

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

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.

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.

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%.

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         Rate
Earning assets
Investment securities
Taxable                        $      84,713   $        924         4.34 %  $    114,248    $      1,325         4.64 %
Tax-exempt                            10,320            145         5.63          13,360             197         5.90
Loans (2), (3)                       854,371         14,225         6.62         738,145          14,770         8.00
Federal funds sold                    17,921             79         1.74          13,096             178         5.44
Interest bearing deposits              4,218             21         2.01          13,473             180         5.34
Total earning assets                 971,543         15,394         6.30 %       892,322          16,650         7.46 %
Cash and due from banks               14,306                                      17,512
Other assets                          50,358                                      43,376
Allowance for credit losses           (8,468 )                                    (7,002 )
Total assets                   $   1,027,739                                $    946,208

Interest bearing liabilities
Demand deposits                $     112,000             97         0.34 %  $    111,983             299         1.07 %
Money market and savings
deposits                             183,408            673         1.46         177,077             811         1.83
Certificates of deposit
$100,000 or more                     196,810          1,953         3.95         159,917           1,945         4.87
Other time deposits                  226,110          2,232         3.93         212,341           2,438         4.59
Interest bearing deposits            718,328          4,955         2.74         661,318           5,493         3.32
Short-term borrowings                 53,450            344         2.56          28,884             279         3.86
Long-term debt                         8,485             90         4.21          22,391             308         5.50
Total interest bearing
liabilities                          780,263          5,389         2.75 %       712,593           6,080         3.41 %
Noninterest bearing deposits         111,915                                     108,906
Other liabilities                     10,978                                       8,279
Stockholders' equity                 124,583                                     116,430
Total liabilities and
stockholders' equity           $   1,027,739                                $    946,208

Net interest spread                            $     10,005         3.55 %                  $     10,570         4.05 %
Net interest margin                                                 4.10 %                                       4.74 %

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         Rate
Earning assets
Investment securities
Taxable                       $     86,633   $      2,949         4.55 %  $   115,248    $      3,900         4.51 %
Tax-exempt                          11,395            502         5.89         13,563             596         5.86
Loans (2), (3)                     824,775         42,829         6.94        716,478          42,643         7.94
Federal funds sold                  17,893            284         2.12         24,861             988         5.30
Interest bearing deposits            4,746             88         2.49         21,533             847         5.24
Total earning assets               945,442         46,652         6.59 %      891,683          48,974         7.32 %
Cash and due from banks             14,408                                     16,869
Other assets                        50,690                                     43,411
Allowance for credit losses         (8,097 )                                   (6,714 )
Total assets                  $  1,002,443                                $   945,249

Interest bearing
liabilities
Demand 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         1.78
Certificates of deposit
$100,000 or more                   186,879          5,963         4.26        158,889           5,794         4.86
Other time deposits                221,564          6,937         4.18        214,390           7,278         4.53
Interest bearing deposits          700,839         15,295         2.92        663,235          16,263         3.27
Short-term borrowings               47,409          1,026         2.89         28,841             838         3.88
Long-term debt                      12,821            456         4.75         24,129             977         5.40
Total interest bearing
liabilities                        761,069         16,777         2.94 %      716,205          18,078         3.37 %
Noninterest bearing
deposits                           106,328                                    105,957
Other liabilities                   11,419                                      8,453
Stockholders' equity               123,627                                    114,634
Total liabilities and
stockholders' equity          $  1,002,443                                $   945,249

Net 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 . . .