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

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

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

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

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

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

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

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

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

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

RECENT DEVELOPMENTS

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

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

OVERVIEW

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

RESULTS OF OPERATIONS

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

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

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

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

                                   For the Three Months Ended                      For the Three Months Ended
                                         March 31, 2009                                  March 31, 2008
                             Average        Income(1)/        Yield/         Average        Income(1)/        Yield/
(Dollars in thousands)       Balance         Expense           Rate          Balance         Expense           Rate
Earning assets
Loans (2), (3)             $   898,494     $     13,660           6.17 %   $   796,849     $     14,601           7.37 %
Investment securities:
Taxable                         74,852              756           4.10          91,556            1,080           4.74
Tax-exempt                       9,105              131           5.84          12,676              190           6.01
Federal funds sold              21,585                7           0.14          16,237              122           3.03
Interest bearing
deposits                         2,250                1           0.14           4,204               38           3.64
Total earning assets         1,006,286           14,555           5.87 %       921,522           16,031           7.00 %
Cash and due from banks         12,857                                          16,648
Other assets                    49,232                                          55,013
Allowance for credit
losses                          (9,654 )                                        (7,716 )
Total assets               $ 1,058,721                                     $   985,467

Interest bearing
liabilities
Demand deposits            $   121,109               72           0.24 %   $   115,215              171           0.60 %
Money market and savings
deposits                       153,141              174           0.46         175,363              705           1.62
Certificates of deposit
$100,000 or more               238,602            2,012           3.42         180,826            2,070           4.60
Other time deposits            232,660            2,027           3.53         217,123            2,397           4.44
Interest bearing
deposits                       745,512            4,285           2.33         688,527            5,343           3.12
Short-term borrowings           39,581               49            .50          43,354              366           3.40
Long-term debt                   7,947               74           3.79          14,925              184           4.95
Total interest bearing
liabilities                    793,040            4,408           2.25 %       746,806            5,893           3.17 %
Noninterest bearing
deposits                       104,061                                         100,982
Other liabilities               10,972                                          13,940
Stockholders' equity           150,648                                         123,739
Total liabilities and
stockholders' equity       $ 1,058,721                                     $   985,467

Net interest spread                        $     10,147           3.62 %                   $     10,138           3.83 %
Net interest margin                                               4.09 %                                          4.42 %

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

(2) Average loan balances include nonaccrual loans.

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

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

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

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

ANALYSIS OF FINANCIAL CONDITION

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

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

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

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

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

                                                                 For the Three Months Ended
                                                                          March 31,
(Dollars in thousands)                                              2009               2008
Allowance balance - beginning of period                        $        9,320       $    7,551
Charge-offs:
Real estate - construction                                                (87 )              -
Real estate - residential                                                (340 )            (12 )
Real estate - commercial                                                    -                -
Commercial                                                                (98 )            (42 )
Consumer                                                                 (111 )            (63 )
Totals                                                                   (636 )           (117 )
Recoveries:
Real estate - construction                                                  -                -
Real estate - residential                                                  52                8
Real estate - commercial                                                    -                -
Commercial                                                                  4                3
Consumer                                                                   34               19
Totals                                                                     90               30
Net charge-offs                                                          (546 )            (87 )
Provision for credit losses                                               912              462
Allowance balance - end of period                              $        9,686       $    7,926

Average loans outstanding during the period                    $      898,494       $  796,849
Net charge-offs (annualized) as a percentage of average
loans outstanding during the period                                      0.25 %           0.04 %
Allowance for credit losses at period end as a percentage of
average loans                                                            1.08 %           0.99 %

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

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

Nonperforming Assets
The following table summarizes our nonperforming and past due assets:

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

. . .