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, 2005

OR

o
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. Employer
Incorporation 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 period 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  o

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes  x   No  o

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o   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: 5,546,494 issued and outstanding shares of common stock as of November 1, 2005.

 

INDEX

   
Page
     
3
     
3
     
 
3
   
 
4
     
 
5
     
 
6
     
 
7
     
10
     
16
     
17
     
 
     
18
     
 
19
     
20
 
 
-2-

PART I - FINANCIAL INFORMATION
 
Item 1.   Financial Statements.
 
SHORE BANCSHARES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
           
   
September 30,
 
December 31,
 
ASSETS:
 
2005
 
2004
 
   
(unaudited)
     
Cash and due from banks
 
$
27,329
 
$
22,051
 
Interest bearing deposits with other banks
   
4,418
   
961
 
Federal funds sold
   
36,814
   
20,539
 
Investment securities:
             
Held-to-maturity, at amortized cost (fair value of, $14,889 and $15,802, respectively)
   
14,852
   
15,662
 
Available for sale, at fair value
   
111,912
   
103,434
 
Loans, less allowance for credit losses ($4,980 and $4,692, respectively)
   
606,859
   
590,766
 
Insurance premiums receivable
   
372
   
386
 
Premises and equipment, net
   
14,200
   
13,070
 
Accrued interest receivable on loans and investment securities
   
3,993
   
3,275
 
Investment in unconsolidated subsidiary
   
915
   
859
 
Goodwill
   
11,939
   
11,939
 
Other intangible assets
   
1,990
   
2,242
 
Deferred income taxes
   
1,724
   
1,543
 
Other real estate owned
   
337
   
391
 
Other assets
   
3,998
   
3,480
 
TOTAL ASSETS
 
$
841,652
 
$
790,598
 
               
LIABILITIES:
             
Deposits:
             
Noninterest bearing demand
 
$
110,538
 
$
102,672
 
NOW and Super NOW
   
110,909
   
112,327
 
Certificates of deposit $100,000 or more
   
105,841
   
91,315
 
Other time and savings
   
374,683
   
352,358
 
Total Deposits
   
701,971
   
658,672
 
Accrued Interest Payable
   
951
   
630
 
Short term borrowings
   
29,832
   
27,106
 
Long term debt
   
5,000
   
5,000
 
Contingent earn-out payments payable
   
513
   
3,313
 
Other liabilities
   
3,705
   
2,901
 
TOTAL LIABILITIES
   
741,972
   
697,622
 
               
STOCKHOLDERS’ EQUITY:
             
Common stock, par value $.01; authorized 35,000,000 shares; issued and outstanding:
             
September 30, 2005 5,546,446
             
December 31, 2004 5,515,198
   
55
   
55
 
Additional paid in capital
   
28,789
   
28,017
 
Retained earnings
   
71,668
   
65,182
 
Accumulated other comprehensive loss
   
(832
)
 
(278
)
TOTAL STOCKHOLDERS’ EQUITY
   
99,680
   
92,976
 
TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY
 
$
841,652
 
$
790,598
 
               
               
See accompanying notes to Condensed Consolidated Financial Statements.
 


SHORE BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Dollars in thousands, except per share amounts)
           
   
Three months ended
 
Nine months ended
 
   
September 30,
 
September 30,
 
   
2005
 
2004
 
2005
 
2004
 
INTEREST INCOME
                 
Loans, including fees
 
$
10,779
 
$
8,657
 
$
30,573
 
$
23,819
 
Interest and dividends on investment securities:
                         
Taxable
   
979
   
1,088
   
2,788
   
3,380
 
Tax-exempt
   
142
   
146
   
435
   
450
 
Other interest income
   
336
   
90
   
737
   
227
 
Total interest income
   
12,236
   
9,981
   
34,533
   
27,876
 
                           
INTEREST EXPENSE
                         
Certificates of deposit, $100,000 or more
   
935
   
589
   
2,447
   
1,730
 
Other deposits
   
2,034
   
1,568
   
5,480
   
4,608
 
Other interest
   
202
   
120
   
534
   
325
 
Total interest expense
   
3,171
   
2,277
   
8,461
   
6,663
 
                           
NET INTEREST INCOME
   
9,065
   
7,704
   
26,072
   
21,213
 
PROVISION FOR CREDIT LOSSES
   
220
   
165
   
580
   
370
 
                           
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES
   
8,845
   
7,539
   
25,492
   
20,843
 
                           
NONINTEREST INCOME
                         
Service charges on deposit accounts
   
788
   
658
   
2,077
   
1,811
 
Gain on sale of securities
   
–
   
(13
)
 
58
   
1
 
Insurance agency commissions
   
1,206
   
1,577
   
4,994
   
4,985
 
Other noninterest income
   
564
   
492
   
1,629
   
1,447
 
Total noninterest income
   
2,558
   
2,714
   
8,758
   
8,244
 
                           
NONINTEREST EXPENSE
                         
Salaries and employee benefits
   
3,965
   
3,519
   
11,680
   
10,167
 
Expenses of premises and equipment
   
695
   
594
   
1,986
   
1,757
 
Other noninterest expense
   
1,733
   
1,571
   
5,099
   
4,559
 
Total noninterest expense
   
6,393
   
5,684
   
18,765
   
16,483
 
                           
INCOME BEFORE TAXES
   
5,010
   
4,569
   
15,485
   
12,604
 
Federal and state income tax expense
   
1,868
   
1,634
   
5,736
   
4,553
 
NET INCOME
 
$
3,142
 
$
2,935
 
$
9,749
 
$
8,051
 
                           
Basic earnings per common share
 
$
0.57
 
$
0.53
 
$
1.76
 
$
1.47
 
Diluted earnings per common share
 
$
0.56
 
$
0.53
 
$
1.75
 
$
1.46
 
Dividends declared per common share
 
$
0.21
 
$
0.18
 
$
0.59
 
$
0.54
 
                           
                           
See accompanying notes to Condensed Consolidated Financial Statements.
 

 
SHORE BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)
(Dollars in thousands, except per share amounts)
                       
               
Accumulated
     
       
Additional
     
other
 
Total
 
   
Common
 
Paid in
 
Retained
 
Comprehensive
 
Stockholders’
 
   
Stock
 
Capital
 
Earnings
 
Income(loss)
 
Equity
 
                       
Balances, January 1, 2004
 
$
54
 
$
24,231
 
$
58,932
 
$
310
 
$
83,527
 
                                 
Comprehensive income:
                               
Net income
   
–
   
–
   
8,051
   
–
   
8,051
 
                                 
Other comprehensive income, net of tax:
                               
Unrealized loss on available for sale securities , net of reclassification adjustment of $242
   
–
   
–
   
–
   
(435
)
 
(435
)
Total comprehensive income
                           
7,616
 
                                 
Shares issued
   
1
   
3,740
   
–
   
–
   
3,741
 
Cash dividends paid $0.54 per share
   
–
   
–
   
(2,955
)
 
–
   
(2,955
)
Balances, September 30, 2004
 
$
55
 
$
27,971
 
$
64,028
 
$
(125
)
$
91,929
 
                                 
Balances, January 1, 2005
 
$
55
 
$
28,017
 
$
65,182
 
$
(278
)
$
92,976
 
                                 
Comprehensive income:
                               
Net income
   
–
   
–
   
9,749
   
–
   
9,749
 
                                 
Other comprehensive income, net of tax:
                               
Unrealized loss on available for sale securities, net of reclassification adjustment of $56
   
–
   
–
   
–
   
(554
)
 
(554
)
Total comprehensive income
                           
9,195
 
                                 
Shares issued
   
–
   
772
   
–
   
–
   
772
 
Cash dividends paid $0.59 per share
   
–
   
–
   
(3,263
)
 
–
   
(3,263
)
Balances, September 30, 2005
 
$
55
 
$
28,789
 
$
71,668
 
$
(832
)
$
99,680
 
                                 
See accompanying Notes to Condensed Consolidated Financial Statements
 


SHORE BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
           
   
For the Nine Months Ended
 
   
September 30,
 
   
2005
 
2004
 
CASH FLOWS FROM OPERATING ACTIVITIES:
         
Net Income
 
$
9,749
 
$
8,051
 
Adjustments to reconcile net income to net cash provided by operating activities:
             
Depreciation and amortization
   
1,076
   
1,092
 
Discount accretion on debt securities
   
(91
)
 
(90
)
Provision for credit losses
   
580
   
370
 
Deferred income taxes
   
167
      –  
Gain on sale of securities
   
(58
)
 
(1
)
Deferred gain on sale of premise and equipment
   
(176
)
 
–
 
Valuation on other real estate owned
   
54
   
–
 
Equity in earnings of unconsolidated subsidiary
   
(56
)
 
(20
)
Net changes in:
             
Insurance premiums receivable
   
24
   
649
 
Accrued interest receivable
   
(718
)
 
(21
)
Other assets
   
(527
)
 
(23
)
Accrued interest payable on deposits
   
321
   
(47
)
Accrued expenses
   
805
   
69
 
Net cash provided by operating activities
   
11,150
   
10,029
 
               
CASH FLOWS FROM INVESTING ACTIVITIES:
             
Proceeds from maturities and principal payments of securities available for sale
   
13,724
   
52,607
 
Proceeds from sale of investment securities available for sale
   
2,010
   
13,931
 
Purchase of securities available for sale
   
(25,080
)
 
(31,224
)
Proceeds from maturities and principal payments of securities held to maturity
   
792
   
1,911
 
Purchase of securities held to maturity
   
–
   
(2,056
)
Net increase in loans
   
(16,673
)
 
(63,295
)
Proceeds from sale of premise and equipment
   
912
   
–
 
Purchase of premises and equipment
   
(2,559
)
 
(1,113
)
Purchase of other real estate owned
   
–
   
(117
)
Proceeds from sale of investment in unconsolidated subsidiary
    –    
380
 
Acquisition net of stock issued
   
–
   
(235
)
Deferred earn out payment, net of stock issued
   
(2,400
)
 
–
 
Net cash used in investing activities
   
(29,274
)
 
(29,211
)
               
CASH FLOWS FROM FINANCING ACTIVITIES:
             
Net increase in demand, NOW, money market and savings deposits
   
6,444
   
9,887
 
Net increase in certificates of deposit
   
36,854
   
(2,914
)
Net increase in short term borrowings
   
2,726
   
9,867
 
Proceeds from issuance of common stock
   
373
   
533
 
Dividends paid
   
(3,263
)
 
(2,955
)
Net cash provided by financing activities
   
43,134
   
14,418
 
               
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
   
25,010
   
(4,764
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
   
43,551
   
46,731
 
CASH AND CASH EQUIVALENTS AT END OF PERIOD
 
$
68,561
 
$
41,967
 
               
               
See accompanying notes to Condensed Consolidated Financial Statements
 

 
Shore Bancshares, Inc.
Notes to Condensed Consolidated Financial Statements
For the Nine Month Periods Ended September 30, 2005 and 2004
(Unaudited)

1)
The consolidated financial statements include the accounts of Shore Bancshares, Inc. and its subsidiaries (collectively referred to in these Notes as the “Company”) with all significant intercompany transactions eliminated. The consolidated financial statements conform to accounting principles generally accepted in the United States of America 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, 2005, the results of operations for the three- and nine-month periods ended September 30, 2005 and 2004, the changes in stockholders’ equity for the nine-months ended September 30, 2005 and 2004, and cash flows for the nine-month periods ended September 30, 2005 and 2004, have been included. All such adjustments are of a normal recurring nature. The amounts as of December 31, 2004 were derived from audited financial statements. The results of operations for the three and nine-month periods ended September 30, 2005 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, 2004.

2)
 
Year to date basic earnings per share is derived by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. The diluted earnings per share calculation is derived by dividing net income by the weighted average number of shares outstanding during the period, adjusted for the dilutive effect of outstanding stock options. Information relating to the calculation of earnings per share is summarized as follows:
 
   
Three Months Ended
 
Nine Months Ended
 
   
September 30,
 
  September 30,
 
   
2005
 
2004
 
2005
 
2004
 
   
(in thousands, except per share data)
 
                   
Net Income
 
$
3,142
 
$
2,935
 
$
9,749
 
$
8,051
 
                           
Weighted Average Shares Outstanding - Basic
   
5,545
   
5,513
   
5,532
   
5,472
 
Dilutive securities
   
33
   
44
   
34
   
45
 
Weighted Average Shares Outstanding - Diluted
   
5,578
   
5,557
   
5,566
   
5,517
 
                           
Net income per common share – Basic
 
$
0.57
 
$
0.53
 
$
1.76
 
$
1.47
 
                           
Net income per common share – Diluted
 
$
0.56
 
$
0.53
 
$
1.75
 
$
1.46
 

As of September 30, 2005 and 2004, there were 4,000 shares excluded from the diluted earnings per share computations because the option price exceeded the average market price and therefore, their effect would be anti-dilutive.

3)
 
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 loans principal balance. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received.
 
 

Information with respect to impaired loans and the related valuation allowance is shown below:
 
(Dollars in thousands)
 
September 30, 2005
 
December 31, 2004
 
           
Impaired loans with valuation allowance
 
$
880
 
$
1,246
 
Impaired loans with no valuation allowance
   
4
   
223
 
Total impaired loans
 
$
884
 
$
1,469
 
               
Allowance for credit losses applicable to impaired loans
 
$
495
 
$
442
 
Allowance for credit losses applicable to other than impaired loans
   
4,485
   
4,250
 
Total allowance for credit losses
 
$
4,980
 
$
4,692
 
               
Interest income on impaired loans recorded on the cash basis
 
$
102
 
$
11
 
               
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.

4)
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, 2005, total commitments to extend credit were approximately $196,529,000. Outstanding letters of credit were approximately $17,786,000 at September 30, 2005.

5)
The Company has adopted the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-based Compensation” and related interpretations in accounting for its stock compensation plans. No compensation expense related to the plans was recorded during the three- and nine-month periods ended September 30, 2005 and 2004. If the Company had elected to recognize compensation cost based on fair value at the vesting dates for awards under the plans consistent with the method prescribed by SFAS No. 123, net income and earnings per share would have been changed to the pro forma amounts as follows (dollars in thousands, except per share data):
 
     
 
Three-Month Period Ended
 
Nine-Month Period Ended
 
   
September 30,
 
September 30,
 
   
2005
 
2004
 
2005
 
2004
 
Net income:
                 
As reported
 
$
3,142
 
$
2,935
 
$
9,749
 
$
8,051
 
Less pro forma stock-based compensation expense determined under the fair value method, net of related tax effects
   
(8
)
 
–
   
(44
)
 
(29
)
Pro forma net income
 
$
3,134
 
$
2,935
 
$
9,705
 
$
8,022
 
                           
Basic earnings per share:
                         
As reported
 
$
0.57
 
$
0.53
 
$
1.76
 
$
1.47
 
Pro forma
   
0.57
   
0.53
   
1.75
   
1.47
 
                           
Diluted earnings per share
                       
As reported
 
$
0.56
 
$
0.53
 
$
1.75
 
$
1.46
 
Pro forma
   
0.56
   
0.53
   
1.74
   
1.45
 
 
 
6)
The Company operates two primary businesses: 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 in Delaware through its 16-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.

Selected financial information by line of business for the nine months ended September 30 is included in the following table:
 
   
Community
 
Insurance products
 
Parent
 
Intersegment
 
Consolidated
 
(In thousands)
 
banking
 
and services
 
Company(a)
 
Transactions
 
Total
 
                       
2005
                     
                       
Net Interest income
 
$
26,069
 
$
–
 
$
3
 
$
–
 
$
26,072
 
Provision for credit losses
   
580
   
–
   
–
   
–
   
580
 
Net interest income after provision
   
25,489
   
–
   
3
   
–
   
25,492
 
Noninterest income
   
3,687
   
5,155
   
2,014
   
(2,098
)
 
8,758
 
Noninterest expense
   
14,300
   
4,433
   
2,130
   
(2,098
)
 
18,765
 
Income before taxes
   
14,876
   
722
   
(113
)
 
–
   
15,485
 
Income tax expense
   
5,495
   
286
   
(45
)
 
–
   
5,736
 
Net income
 
$
9,381
 
$
436
 
$
(68
)
$
–
 
$
9,749
 
                                 
Intersegment revenue(expense)
 
$
(1,776
)
$
(86
)
$
1,862
 
$
–
 
$
–
 
Average assets
 
$
802,086
 
$
9,683
 
$
3,456
 
$
–
 
$
815,225
 
                                 
2004
                               
                                 
Net Interest income
 
$
21,212
   
–
 
$
1
 
$
–
 
$
21,213
 
Provision for credit losses
   
370
   
–
   
–
   
–
   
370
 
Net interest income after provision
   
20,842
   
–
   
1
   
–
   
20,843
 
Noninterest income
   
3,055
   
5,148
   
1,679
   
(1,638
)
 
8,244
 
Noninterest expense
   
12,254
   
4,182
   
1,685
   
(1,638
)
 
16,483
 
Income before taxes
   
11,643
   
966
   
(5
)
 
–
   
12,604
 
Income tax expense
   
4,173
   
382
   
(2
)
 
–
   
4,553
 
Net income
 
$
7,470
 
$
584
   
(3
)
 
–
 
$
8,051
 
                                 
Intersegment revenue(expense)
 
$
(1,461
)
$
(138
)
$
1,599
 
$
–
 
$
–
 
Average assets
 
$
761,981
 
$
6,527
 
$
3,273
 
$
–
 
$
771,781
 
                                 
(a)
Amount included in Parent Company relates to services provided to subsidiaries by the Company and rental income.

7)
On April 1, 2004, the Company completed its merger with Midstate Bancorp, Inc., a Delaware bank holding company (“Midstate Bancorp”). Pursuant to the merger agreement, each share of common stock of Midstate Bancorp was converted into the right to receive (i) $31.00 in cash, plus (ii) 0.8732 shares of the common stock of the Corporation, with cash being paid in lieu of fractional shares at the rate of $33.83 per share. The Company paid $2,953,710 in cash and issued 82,786 shares of common stock to stockholders of Midstate Bancorp in connection with the Merger. The Company recorded approximately $2,636,000 of Goodwill and $968,000 of other intangible assets as a result of the acquisition.

8)
On September 23, 2005, the Company finalized a Sale-Leaseback transaction with an unrelated third party in respect of the property located in Felton, Delaware that is used by Felton Bank for its main office location. As part of this transaction, the Company entered into a 20-year leaseback calling for annual rent of $84,525. The gain on the sale portion of the transaction of approximately $176,000 has been deferred and will be recognized over the life of the lease.

 

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

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 Management’s 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 Shore Bancshares, Inc. and its subsidiaries operate, inflation, fluctuations in interest rates, legislation, and governmental regulation. These risks and uncertainties are described in more detail in Exhibit 99.1 “Risk Factors” to the Annual Report of Shore Bancshares, Inc. on Form 10-K for the year ended December 31, 2004. Actual results may differ materially from such forward-looking statements, and Management assumes no obligation to update forward-looking statements at any time.

Introduction
The following discussion and analysis is intended as a review of significant factors affecting the financial condition and results of operations of the Company and its consolidated subsidiaries for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and related notes presented elsewhere in this report, as well as the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. Unless the context clearly suggests otherwise, references to the “Company” in this report are to Shore Bancshares, Inc. and its consolidated subsidiaries.

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” and collectively with Talbot Bank and Centreville National Bank, the “Banks”). The Banks operate 16 full service branches in Kent, Queen Anne’s, Talbot, Caroline and Dorchester Counties in Maryland and in Kent County, Delaware. During the third quarter of 2005, Centreville National Bank established a trust department and now offers various fiduciary services to the Company’s customers. The Company additionally offers a full range of insurance products and services to its customers through The Avon-Dixon Agency, LLC, Elliott Wilson Insurance, LLC, and Mubell Finance, LLC (collectively, the “Insurance Agency”) and investment advisory services through Wye Financial Services, LLC, all of which are wholly-owned subsidiaries of the Company. The shares of the Company’s common stock are listed on the Nasdaq Capital 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
The Company’s 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 requires us to make estimates, assumptions, and judgments that affect the reported amount of assets, liabilities, revenues and expenses. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported.
 
The Company believes its 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 internal loan processes of the Company in determining the inherent loss that may be present in the Company’s 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, 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, quality of 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 the Company’s 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 the Company’s 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, construction, home equity 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, quality of loan review system and the effect of external factors such as competition and regulatory requirements. The nonspecific allowance captures losses whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowance.

OVERVIEW

Net income for the quarter ended September 30, 2005 was $3,142,000, or diluted earnings per share of $.56, compared to $2,935,000, or diluted earnings per share of $.53, for the third quarter of 2004. Net income for the nine months ended September 30, 2005 was $9,749,000, a $1,698,000 increase over the same period in 2004. On a per share basis, diluted earnings for the nine months ended September 30, 2005 were $1.75, compared to $1.46 for the same period last year. Annualized return on average assets was 1.59% for the nine months ended September 30, 2005, compared to 1.39% for the same period in 2004. Annualized return on average stockholders’ equity was 13.06% and 11.85% for the nine months ended September 30, 2005 and 2004, respectively.

RESULTS OF OPERATIONS

Net Interest Income
Net interest income for the three- and nine-month periods ended September 30, 2005 was $9,065,000 and $26,072,000, respectively, an increase of $1,361,000, or 17.7%, and $4,859,000, or 22.9%, respectively, when compared to the same periods last year. These increases are attributable to a $35,664,000 increase in average earning assets, concentrated in loans, and an overall increase in yields on earning assets. Total interest income increased by $2,255,000 and $6,657,000 for the three- and nine-month periods ended September 30, 2005, respectively, when compared to the same periods last year.
 

The Company’s net interest margin was 4.65% for the nine months ended September 30, 2005, which is 67 basis points higher than the net interest margin for the same period last year. The Company continued to increase its volume of earning assets, which averaged $755,586,000 for the nine months ended September 30, 2005, compared to $719,922,000 for the same period in 2004. Average loans totaled $602,836,000 for the nine-month period ended September 30, 2005, a $58,691,000 increase over the same period in 2004. This growth was funded with maturities in the investment portfolio and increased customer deposits. The yield on earning assets for the nine-month period ended September 30, 2005 increased 93 basis points to 6.14% from 5.21% for the same period last year. Increasing short term interest rates and a shift in the mix of earning assets from investment securities, which have lower overall yields than loans, to loans is the reason for this increase.

The overall yield on loans for the nine months ended September 30, 2005 was 6.77%, compared to 5.84% for the same period in 2004. The yield on investment securities for the first nine months of 2005 increased slightly to 3.80% from 3.67% for the same period in 2004, and the average balance of investment securities for the nine-month period ended September 30, 2005 decreased by $26,605,000 to $120,979,000 when compared to the same period in 2004. Investment portfolio maturities during the first nine months of 2005 were used primarily to fund loan growth, so growth in the overall portfolio yield has been small.

Total interest expense for the three and nine months ended September 30, 2005 was $3,171,000 and $8,461,000, respectively, an increase of $894,000 and $1,798,000, respectively, over the same periods in 2004. The increase in interest expense resulted primarily from an increased volume of interest bearing deposits during the period and increases in the rates paid on interest bearing liabilities. The market for deposits is very competitive and the Company has responded by offering higher overall rates for deposits, especially time deposits. The average balance of interest bearing deposits increased by $24,137,000 for the nine months ended September 30, 2005 when compared to the same period in 2004. The overall rate paid for interest bearing deposits increased 30 basis points to 1.83% as a result of higher rates paid for certificates of deposit. Rates paid for certificates of deposit and short-term borrowings increased as a result of higher short-term interest rates and increased competition for deposits. For the nine months ended September 30, 2005, the average balance of certificates of deposits, including those $100,000 or more, increased by $9,854,000 when compared to the same period last year, and the average rate paid for those certificates of deposit increased 71 basis points to 3.32%. Comparing the first nine months of 2005 to the same period in 2004, average interest bearing demand deposits increased by approximately $905,000 and average money management and savings deposits increased by $6,717,000.

Loans comprised 79.8% and 75.6% of total average earning assets for the nine-months ended September 30, 2005 and 2004, respectively.



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 through the first nine months of 2005:
 
   
Nine Months ended September 30, 2005
 
Nine Months ended September 30, 2004
 
   
Average
 
Income
 
Yield
 
Average
 
Income
 
Yield
 
(Dollars in thousands)
 
Balance
 
Expense
 
Rate
 
Balance
 
Expense
 
Rate
 
Earning Assets
                         
Investment securities
 
$
120,979
 
$
3,446
   
3.80
%
$
147,584
 
$
4,065
   
3.67
%
Loans
   
602,836
   
30,602
   
6.77
%
 
544,145
   
23,842
   
5.84
%
Interest bearing deposits
   
961
   
20
   
2.71
%
 
6,229
   
46
   
0.98
%
Federal funds sold
   
30,810
   
716
   
3.10
%
 
21,964
   
182
   
1.11
%
Total earning assets
   
755,586
   
34,784
   
6.14
%
 
719,922
   
28,135
   
5.21
%
Noninterest earning assets
   
59,638
               
51,859
             
Total Assets
 
$
815,224
             
$
771,781
             
                                       
Interest bearing liabilities
                                     
Interest bearing deposits
 
$
577,546
   
7,927
   
1.83
%
$
553,409
   
6,338
   
1.53
%
Short term borrowing
   
24,736
   
345
   
1.86
%
 
25,251
   
137
   
0.72
%
Long term debt
   
5,000
   
189
   
5.03
%
 
5,000
   
188
   
5.04
%
Total interest bearing liabilities
   
607,282
   
8,461
   
1.86
%
 
583,660
   
6,663
   
1.52
%
Noninterest bearing liabilities
   
111,444
               
97,522
             
Stockholders’ equity
   
96,498
               
90,599
             
Total liabilities and stockholders’ equity
 
$
815,224
             
$
771,781
             
Net interest spread
       
$
26,323
   
4.28
%
     
$
21,472
   
3.69
%
Net interest margin
               
4.65
%
             
3.98
%
                                       
(1)
All amounts are reported on a tax equivalent basis computed using the statutory federal income tax rate, exclusive of the alternative minimum tax rate, of 35% 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 declined $156,000 in the third quarter of 2005 when compared to the same period in 2004. The primary reason for the decline is a reduction in insurance agency commissions. During the third quarter of 2004 the Insurance Agency recognized a one-time commission of approximately $135,000, which contributed to the decline in insurance agency commissions when compared to 2005. Also, the Company converted its billing system during the third quarter of 2005 and customers are now billed directly by the insurance company providing coverage. Under this converted system, the Company receives commission income after the insurance company completes the billing process. The effect of this new system is that commission income is now recognized later than it was recognized a year ago. Service charges on deposit accounts continue to grow as a result of enhanced product offerings to customers. For the nine-month period ended September 30, 2005, noninterest income increased $514,000 as a result of a $266,000 increased service charges on deposit accounts, a gain on sale of securities of $57,000 and increased income from mortgage originations and sales of investment products.
 
Noninterest Expense
Total noninterest expense for the three-month period ended September 30, 2005 was $6,393,000, compared to $5,684,000 for the same period last year. For the nine months ended September 30, 2005, total noninterest expense was $18,765,000, an increase of $2,282,000 over the same period last year. Increases in salaries and benefits expense for the quarter ($446,000) and nine months ($1,513,000) relate to an increase in the number of employees, an increase in incentive compensation cost and overall salary and benefit cost increases for the year. Increases in premises and equipment expense for the quarter ($101,000) and nine months ($229,000) as well as other noninterest expense for the quarter ($162,000) and nine months ($540,000) relate to the operation of new branch facilities opened in 2004, a new branch facility opening in the fourth quarter of 2005, and overall growth of the Company, including the start-up costs associated with the establishment of Centreville National Bank’s trust department, which began operations during the third quarter of 2005.
 
 
Income Taxes
 
The effective tax rate for the three- and nine-month periods ended September 30, 2005 was 37.3% and 37.0%, respectively, compared to 35.8% and 36.1%, respectively, for the same periods last year. Management believes that there have been no changes in applicable tax laws or to the Company’s tax structure that are likely to have a future material impact on the Company’s effective tax rate.

ANALYSIS OF FINANCIAL CONDITION
 
Loans
Loans, net of unearned income, totaled $611,839,000 at September 30, 2005, an increase of $16,381,000 since December 31, 2004. The growth in loans since year end is attributable to an increase in real estate mortgage loans of $20,512,000 or 4.3%. Average loans, net of unearned income, totaled $602,836,000 for the nine months ended September 30, 2005, a $58,691,000 increase when compared to the same period last year. The Company's market demand for loans remained strong through the third quarter of 2005.
 
Allowance for Credit Losses
The Company has 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-off 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. An overview of the methodology employed by Management on a quarterly basis to maintain the allowance is found above under the caption “Critical Accounting Policies”.

The provision for credit losses for the three- and nine-month periods ended September 30, 2005 was $220,000 and $580,000, respectively, compared to $165,000 and $370,000, respectively, for the same periods of 2004. The Company has experienced a decline in nonaccrual and past due loans since December 31, 2004; however, the specific allowance associated with those loans has increased slightly as a result of Management’s evaluation of each borrower’s ability to repay and the value of the underlying loan collateral. The increased provision is the result of increases in both the formula allowance and nonspecific allowance components. Growth of the loan portfolio and Management’s assessment of factors used in calculating the nonspecific allowance contributed to the increased provision. The Company continues to maintain strong underwriting guidelines, and Management believes that the local economy remains stable and that collateral values have appreciated as a result of the strength of the local real estate economy. Each of these factors has had a positive effect on the quality of the Company’s loan portfolio. The Company’s historical charge-off ratios are much lower than those of similarly sized institutions according to the most recent FDIC quarterly banking profile. Net charge-offs were $99,000 and $292,000 for the three- and nine-month periods ended September 30, 2005, respectively, compared to $95,000 and $454,000, respectively, for the same periods in 2004. Since December 31, 2004, nonaccrual loans have declined by $585,000 to $884,000. Loans past due 90 days and still accruing decreased by $2,310,000 since December 31, 2004, totaling $659,000 at September 30, 2005. The decline in loans past due is primarily attributable to a real estate loan which was paid in full during the first quarter of 2005. The Company’s ratio of nonperforming assets to total loans, including other real estate owned, remains low. The allowance for credit losses as a percentage of average loans was .83% at September 30, 2005 and .85% at December 31, 2004. Based on its quarterly evaluation of the adequacy of the allowance for credit losses, Management believes that the allowance for credit losses and the related provision are adequate at September 30, 2005.
 


The following table presents a summary of the activity in the allowance for credit losses:
 
   
Nine months Ended
 
   
September 30,
 
(Dollars in thousands)
 
2005
 
2004
 
           
Allowance balance - beginning of year
 
$
4,692
 
$
4,060
 
Charge-offs:
             
Commercial and other
   
254
   
448
 
Real estate
   
–
   
50
 
Consumer
   
110
   
92
 
Totals
   
364
   
590
 
Recoveries:
             
Commercial
   
15
   
64
 
Real estate
   
1
   
19
 
Consumer
   
56
   
53
 
Totals
   
72
   
136
 
Net charge-offs
   
292
   
454
 
Allowance of acquired institution
   
–
   
426
 
Provision for credit losses
   
580
   
370
 
Allowance balance – end of period
 
$
4,980
 
$
4,402
 
               
Average loans outstanding during period
 
$
602,836
 
$
544,145
 
               
Net charge-offs (annualized) as a percentage of average loans outstanding during period
   
0.02
%
 
0.11
%
               
Allowance for credit losses at period end as a percentage of average loans
   
0.83
%
 
0.81
%
               
Because the Company’s loans are predominately secured by real estate, weaknesses in the local real estate markets relevant to the Company may have a material adverse effect on collateral values. The Company has a concentration of construction and land development loans in its market areas. At September 30, 2005, the balance of such loans was $127,249,000 or 20.8% of total outstanding loans, compared to $97,021,000 or 16.3% at December 31, 2004. The Company does not engage in foreign lending activities.

Nonperforming Assets
The following table summarizes past due and nonperforming assets of the Company (in thousands):
 
   
September 30,
 
December 31,
 
Nonperforming Assets:
 
2005
 
2004
 
Nonaccrual loans
 
$
884
 
$
1,469
 
Other real estate owned
   
337
   
391
 
     
1,221
   
1,860
 
Past due loans still accruing
   
659
   
2,969
 
Total nonperforming and past due loans
 
$
1,880
 
$
4,829
 
               
Investment Securities
Investment securities totaled $126,764,000 at September 30, 2005, an increase of $7,668,000 when compared to December 31, 2004. The tax equivalent yield on investment securities for the nine-month period ended September 30, 2005 increased to 3.80% from 3.67% for the same period last year. This slight increase was the result of yields on bonds purchased during the nine-month period ended September 30, 2005 that were higher than those on bonds that matured during the period.
 
Deposits
Total deposits at September 30, 2005 were $701,971,000, an increase of $43,299,000 when compared to total deposits at December 31, 2004. Noninterest bearing demand account balances increased approximately $7,867,000, certificates of deposit $100,000 or more increased $14,526,000, and other time deposits increased $22,329,000 during the first nine months of 2005 when compared to the same period last year, while NOW and SuperNOW accounts declined $1,418,000.
 


Borrowed Funds
Short-term borrowings at September 30, 2005 were $29,832,000 and consisted of securities sold under agreements to repurchase and federal funds purchased. At December 31, 2004, short-term borrowings were $27,106,000 and consisted of securities sold under agreements to repurchase. The Company also had a convertible advance from the Federal Home Loan Bank of Atlanta in the amount of $5,000,000 at September 30, 2005 and 2004. The advance is due in March 2006.

Liquidity and Capital Resources
The Company derives 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 to which they have pledged collateral sufficient to permit additional borrowing of up to approximately $80 million at September 30, 2005. Management is not aware of any trends or demands, commitments, events or uncertainties that are likely to materially affect the Company’s future ability to maintain liquidity at satisfactory levels.

Total stockholders’ equity was $99.7 million at September 30, 2005, which represents an increase of 7.2% since December 31, 2004. Accumulated other comprehensive loss, which consists solely of net unrealized losses on investment securities available for sale, increased by $554,000 during the first nine months of 2005, resulting in accumulated other comprehensive loss of $832,000 at September 30, 2005.

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 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.

A comparison of the Company’s capital ratios as of September 30, 2005 to the minimum regulatory requirements is presented below:
 
       
Minimum
 
Required to be
 
   
Actual
 
Requirements
 
Well Capitalized
 
Tier 1 risk-based capital
   
13.57 %
 
 
4.00 %
 
 
6.00 %
 
Total risk-based capital
   
14.37 %
 
 
8.00 %
 
 
10.00 %  
 
Leverage ratio
   
10.71 %
 
 
3.00 %
 
 
5.00 %
 
                     
Item 3.   Quantitative and Qualitative Disclosures about Market Risk.

The Company’s principal market risk exposure is to fluctuating interest rates. The Company utilizes a simulation model to quantify the effect that hypothetical plus or minus 200 and 100 basis point changes in rates would have on net interest income and the fair value of capital. The model takes into consideration the effect of call features of investments as well as repayments of loans in periods of declining rates. When actual changes in interest rates occur, the changes in interest earning assets and interest bearing liabilities may differ from the assumptions used in the model. As of September 30, 2005 and December 31, 2004, the model produced the following sensitivity profile for net interest income and the fair value capital:
 

 
   
Immediate Change in Rates
 
   
+200
 
+100
 
-100
 
-200
 
Policy
 
   
Basis Points
 
Basis Points
 
Basis Points
 
Basis Points
 
Limit
 
                       
                       
September 30, 2005
                     
% Change in Net Interest Income
   
8.88
%
 
5.03
%
 
(5.23
%)
 
(11.64
%)
 
+ 25
%
% Change in Fair Value of Capital
   
3.29
%
 
2.27
%
 
(3.00
%)
 
(7.76
%)
 
+15
%
                                 
December 31, 2004
                               
% Change in Net Interest Income
   
8.90
%
 
5.19
%
 
(6.41
%)
 
(14.09
%)
 
+25
%
% Change in Fair Value of Capital
   
2.49
%
 
1.90
%
 
(4.08
%)
 
(10.31
%)
 
+15
%
 
The Company’s objectives and strategies in managing market risk have not materially changed since December 31, 2004 and are discussed in detail in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Market Risk Management”.


The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s 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, control 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, 2005 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 the Company’s disclosure controls and procedures are effective.

During the third quarter of 2005, there was no change in the Company’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
 

PART II - OTHER INFORMATION
 
Item 6.   Exhibits.

 
3.1
Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Company’s Form 8-K filed on December 14, 2000).

 
3.2
Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 of the Company’s Form 8-K filed on November 9, 2005).

 
10.1
Form of Employment Agreement with W. Moorhead Vermilye (incorporated by reference to Appendix XIII of Exhibit 2.1 of the Company’s Form 8-K filed on July 31, 2000).

 
10.2
Form of Employment Agreement with Daniel T. Cannon (incorporated by reference to Appendix XIII of Exhibit 2.1 of the Company’s Form 8-K filed on July 31, 2000).

 
10.3
Form of Employment Agreement with Thomas H. Evans, as amended on November 3, 2005 ( incorporated by reference to the Company’s Form 8-K filed on November 9, 2005) .

 
10.4
Separation Agreement and General Release between The Avon-Dixon Agency, LLC and Steven Fulwood (incorporated by reference to exhibit 10.11 of the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2005).

 
10.5
Form of Executive Supplemental Retirement Plan Agreement between The Centreville National Bank of Maryland and Daniel T. Cannon (incorporated by reference to Exhibit 10.4 of the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2003).

 
10.6
Form of Life Insurance Endorsement Method Split Dollar Plan Agreement between The Centreville National Bank of Maryland and Daniel T. Cannon (incorporated by reference to Exhibit 10.5 of the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2003).

 
10.7
Form of Talbot Bank of Easton, Maryland Supplemental Deferred Compensation Plan (filed herewith).

 
10.8
Form of Talbot Bank of Easton, Maryland Supplemental Deferred Compensation Plan Trust Agreement (filed herewith).

 
10.9
1998 Employee Stock Purchase Plan, as amended (incorporated by reference to Appendix A of the Company’s definitive Proxy Statement on Schedule 14A for the 2003 Annual Meeting of Stockholders filed on March 31, 2003).

 
10.10
1998 Stock Option Plan (incorporated by reference to Exhibit 10 of the Company’s Registration Statement on Form S-8 filed with the SEC on September 25, 1998 (Registration No. 333-64319)).

 
10.11
Talbot Bancshares, Inc. Employee Stock Option Plan (incorporated by reference to Exhibit 10 of the Company’s Registration Statement on Form S-8 filed May 4, 2001 (Registration No. 333-60214)).

 
31.1
Certifications of the CEO pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith).

 
31.2
Certifications of the PAO pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith).

 
32.1
Certification of the Periodic Report by the CEO pursuant to 18 U.S.C. § 1350 (furnished herewith).

 
32.2
Certification of the Periodic Report by the PAO pursuant to 18 U.S.C. § 1350 (furnished herewith).
 
 

Signatures
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
     
  SHORE BANCSHARES, INC.
 
  		 
  		 
 
Date: November 8, 2005 By:   /s/ W. Moorhead Vermilye
 
 
W. Moorhead Vermilye
President and Chief Executive Officer
 
     
Date: November 8, 2005 By:   /s/ Susan E. Leaverton
 
 
Susan E. Leaverton
Treasurer and Principal Accounting Officer



EXHIBIT INDEX
     
Exhibit
 
Number
 
Description
     
3.1
 
Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Company’s Form 8-K filed on December 14, 2000).
     
3.2
 
Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 of the Company’s Form 8-K filed on November 9, 2005).
     
10.1
 
Form of Employment Agreement with W. Moorhead Vermilye (incorporated by reference to Appendix XIII of Exhibit 2.1 of the Company’s Form 8-K filed on July 31, 2000).
     
10.2
 
Form of Employment Agreement with Daniel T. Cannon (incorporated by reference to Appendix XIII of Exhibit 2.1 of the Company’s Form 8-K filed on July 31, 2000).
     
10.3
 
Form of Employment Agreement with Thomas H. Evans, as amended on November 3, 2005 (incorporated by reference to the Company’s Form 8-K filed on November 9, 2005).
     
10.4
 
Separation Agreement and General Release between The Avon-Dixon Agency, LLC and Steven Fulwood (incorporated by reference to exhibit 10.11 of the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2005).
     
10.5
 
Form of Executive Supplemental Retirement Plan Agreement between The Centreville National Bank of Maryland and Daniel T. Cannon (incorporated by reference to Exhibit 10.4 of the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2003).
     
10.6
 
Form of Life Insurance Endorsement Method Split Dollar Plan Agreement between The Centreville National Bank of Maryland and Daniel T. Cannon (incorporated by reference to Exhibit 10.5 of the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2003).
     
10.7
 
Form of Talbot Bank of Easton, Maryland Supplemental Deferred Compensation Plan (filed herewith).
     
10.8
 
Form of Talbot Bank of Easton, Maryland Supplemental Deferred Compensation Plan Trust Agreement (filed herewith).
     
10.9
 
1998 Employee Stock Purchase Plan, as amended (incorporated by reference to Appendix A of the Company’s definitive Proxy Statement on Schedule 14A for the 2003 Annual Meeting of Stockholders filed on March 31, 2003).
     
10.10
 
1998 Stock Option Plan (incorporated by reference to Exhibit 10 of the Company’s Registration Statement on Form S-8 filed with the SEC on September 25, 1998 (Registration No. 333-64319)).
     
10.11
 
Talbot Bancshares, Inc. Employee Stock Option Plan (incorporated by reference to Exhibit 10 of the Company’s Registration Statement on Form S-8 filed May 4, 2001 (Registration No. 333-60214)).
     
31.1
 
Certifications of the CEO pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith).
     
31.2
 
Certifications of the PAO pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith).
     
32.1
 
Certification of the Periodic Report by the CEO pursuant to 18 U.S.C. § 1350 (furnished herewith).
     
32.2
 
Certification of the Periodic Report by the PAO pursuant to 18 U.S.C. § 1350 (furnished herewith).


-20-
EXHIBIT 10.7

 

TALBOT BANK OF EASTON, MARYLAND
SUPPLEMENTAL DEFERRED COMPENSATIO N PLAN
 
Effective as of December 11, 1996




THE TALBOT BANK OF EASTON, MARYLAND
SUPPLEMENTAL DEFERRED COMPENSATION PLAN
 
Effective as of December 11, 1996
 
TABLE OF CONTENTS

 
1
1
1
1
1
1
2
2
2
2
2
2
2
 
 
 
 
 
 

 

THE TALBOT BANK OF EASTON, MARYLAND
SUPPLEMENTAL DEFERRED COMPENSATION PLAN
 
Effective as of December 11, 1996
 
RECITALS
 
The Talbot Bank of Easton, Maryland Supplemental Deferred Compensation Plan (the “Plan”) is adopted by The Talbot Bank of Easton, Maryland (the “Employer”) for its President and Chief Executive Officer. The purpose of the Plan is to provide its President and Chief Executive Officer with supplemental retirement benefits taxable pursuant to section 451 of the Internal Revenue Code of 1986, as amended (the “Code”). The Plan is intended to be a “top-hat” plan (i.e., an unfunded deferred compensation plan maintained for the Employer's President and Chief Executive Officer under sections 201(2), 301(a)(3) and 401(a)(1) of the Employee Retirement Income Security Act of 1974 (“ERISA”).
 
Accordingly, the following Plan is adopted.
 
ARTICLE 1
 
DEFINITIONS
 
1.1    ACCOUNT   means the balance credited to the Participant's or Beneficiary's Account under the Plan, including contribution credits and deemed income, gains, losses and expenses (as determined by the Employer, in its discretion) credited thereto. The Participant's or Beneficiary's Account shall be determined as of the date of reference.
 
1.2    BENEFICIARY   means any person or person so designated in accordance with the provisions of Article 7.
 
1.3    CODE   means the Internal Revenue Code of 1986 and the regulations thereunder, as amended from time to time.
 
1.4    DESIGNATION DATE   means the date or dates as of which a designation of deemed investment directions by an individual pursuant to Section 4.5, or any change in a prior designation of deemed investment directions by an individual pursuant to Section 4.5, shall become effective. The Designation Date(s) in any Plan Year shall be designated by the Employer and shall include each January 1 during which the Plan is in effect.
 
1.5    EFFECTIVE DATE   means the effective date of the Plan, which shall be December 12, 1996.
 
1.6    EMPLOYER   means The Talbot Bank of Easton, Maryland and its successors and assigns unless otherwise herein provided, or any other corporation or business organization which, with the consent of The Talbot Bank of Easton, Maryland, or its successors or assigns, assumes the Employer's obligations hereunder, or any other corporation or business organization which agrees, with the consent of The Talbot Bank of Easton, Maryland, to become a party to the Plan.
 
 
1.7    EMPLOYER CONTRIBUTION CREDITS   is defined in Section 3.1.
 
1.8    PARTICIPANT   means the Employer’s President and Chief Executive Officer, W. Moorhead Vermilye.
 
1.9    PLAN   means this The Talbot Bank Of Easton, Maryland Supplemental Deferred Compensation Plan, as amended from time to time.
 
1.10    PLAN YEAR   means the twelve (12) (or, in the case of the Plan's first Plan Year, twenty (20) day period ending on the December 31) of each year during which the Plan is in effect.
 
1.11    TRUST   means the Trust established pursuant to Article 11.
 
1.12    TRUSTEE   means the trustee of the Trust established pursuant to Article 11.
 
1.13    VALUATION DATE   means the last day of each Plan Year and any other date that the Employer, in its sole discretion, designates as a Valuation Date.
 
ARTICLE 2
 
ELIGIBILITY AND PARTICIPATION
 
2.1    REQUIREMENTS . The Employer's President and Chief Executive Officer shall be eligible to become a Participant on the Effective Date.
 
ARTICLE 3
 
CONTRIBUTIONS AND CREDITS
 
3.1    EMPLOYER CONTRIBUTION CREDITS . There shall be established and maintained a separate Account in the name of the Participant to which there shall be credited to the Participant Account for each Plan Year the sum of Twenty Thousand Dollars ($20,000).
 
The Participant's Account shall be credited or debited, as applicable, as of each Valuation Date, with deemed earnings or losses, as applicable. The amount of deemed earnings or losses shall be as determined by the Employer.
 
The Participant shall be one hundred percent (100%) vested in amounts credited to his Account.
 
3.2    CONTRIBUTIONS TO THE TRUST . An amount shall be contributed by the Employer to the Trust maintained under Section 11.1 equal to the amount required to be credited to the Participant's Account under Section 3.1. The Employer shall make a good faith effort to contribute these amounts to the Trust by December 31, of each plan year.
 
 
ARTICLE 4
 
ALLOCATION OF FUNDS
 
4.1    ALLOCATION OF DEEMED EARNINGS OR LOSSES ON ACCOUNTS . Subject to Section 4.5, the Participant shall have the right to direct the Employer as to how amounts in his Plan Account shall be deemed to be invested. The Employer shall direct the Trustee to invest the account maintained in the Trust on behalf of the Participant pursuant to the deemed investment directions the Employer properly has received from the Participant. The value of the Participant's Account shall be equal to the value of the account maintained under the Trust on behalf of the Participant. As of each Valuation Date of the Trust, the Participant's Account will be credited or debited to reflect the Participant's deemed investments of the Trust.
 
4.2    DEEMED INVESTMENT DIRECTIONS OF PARTICIPANTS . Subject to such limitations as may from time to time be required by law, imposed by the Employer or the Trustee or contained elsewhere in the Plan, and subject to such operating rules and procedures as may be imposed from time to time by the Employer, prior to and effective for each Designation Date, the Participant may communicate to the Employer a direction as to how his Plan Account should be deemed to be invested among such categories of deemed investments as may be made available by the Employer hereunder. Such direction shall designate the percentage (in any whole percent multiples) of each portion of the Participant's Plan Accounts which is requested to be deemed to be invested in such categories of deemed investments, and shall be subject to the following rules:
 
(a)    Any initial or subsequent deemed investment direction shall be in writing, on a form supplied by and filed with the Employer, and shall be effective as of the next Designation Date which is at least thirty (30) business days after such filing (or such shorter period as is provided by the Employer).
 
(b)    All amounts credited to the Participant's Account shall be deemed to be invested in accordance with the then effective deemed investment direction, and as of the effective date of any new deemed investment direction, all or a portion of the Participant's Account at that date shall be reallocated among the designated deemed investment funds according to the percentages specified in the new deemed investment direction unless and until a subsequent deemed investment direction shall be filed and become effective. An election concerning deemed investment choices shall continue indefinitely as provided in the Participant's most recent Participant Enrollment and Election Form, or other form specified by the Employer.
 
(c)    If the Employer receives an initial or revised deemed investment direction which it deems to be incomplete, unclear or improper, the Participant's investment direction then in effect shall remain in effect (or, in the case of a deficiency in an initial deemed investment direction, the Participant shall be deemed to have filed no deemed investment direction) until the next Designation date, unless the Employer provides for, and permits the application of, corrective action prior thereto.
 
 
(d)    If the Employer possesses (or is deemed to possess as provided in (c), above) at any time directions as to the deemed investment of less than all of a Participant’s Account, the Participant shall be deemed to have directed that the undesignated portion of the Account be deemed to be invested in a money market, fixed income or similar fund made available under the Plan as determined by the Employer in its discretion.
 
(e)    Each reference in this Section to a Participant shall be deemed to include, where applicable, a reference to a Beneficiary.
 
4.3    EXPENSES . Expenses, including Trustee fees, allocable to the administration or operation of an Account maintained under the Plan shall be charged against the assets in the Trust.
 
ARTICLE 5
 
ENTITLEMENT TO BENEFITS
 
5.1    TERMINATION OF EMPLOYMENT . The Participant shall receive payment of his Account at his termination of employment with the Employer and the Participant’s Account at the date of such termination shall be valued and payable at such termination according to the provisions of Article 6.
 
ARTICLE 6
 
DISTRIBUTION OF BENEFITS
 
6.1    AMOUNT . The Participant (or his Beneficiary) shall become entitled to receive, on or about the date of the Participant’s termination of employment with the Employer, a distribution in an aggregate amount equal to the Participant’s Account. Any payment due hereunder from the Trust which is not paid by the Trust for any reason will be paid by the Employer from its general assets.
 
6.2    METHOD OF PAYMENT .
 
(a)    Cash Payments . Payments under the Plan shall be made in cash.
 
(b)    Timing and Manner of Payment . In the case of distributions to the Participant or his Beneficiary by virtue of an entitlement pursuant to Section 5.1, an aggregate amount equal to the Participant’s Account will be paid by the Trust or the Employer, as provided by Section 6.1, in a lump sum.
 
6.3    DEATH BENEFITS . If the Participant dies before terminating his employment with the Employer and before the commencement of payments to the Participant hereunder, the entire value of the Participant's Account shall be paid, as provided in Section 6.2, to the person or persons designated in accordance with Section 7.1.
 
 
Upon the death of the Participant after payments hereunder have begun but before he has received all payments to which he is entitled under the Plan, the remaining benefit payments shall be paid to the person or persons designated in accordance with Section 7.1, in the manner in which such benefits were payable to the Participant as provided in Section 6.2.
 
ARTICLE 7
 
BENEFICIARIES: PARTICIPANT DATA
 
7.1    DESIGNATION OF BENEFICIARIES . The Participant from time to time may designate any person or persons (who may be named contingently or successively) to receive such benefits as may be payable under the Plan upon or after the Participant's death, and such designation may be changed from time to time by the Participant by filing a new designation. Each designation will revoke all prior designations by the Participant, shall be in a form prescribed by the Employer, and will be effective only when filed in writing with the Employer during the Participant's lifetime.
 
In the absence of a valid Beneficiary designation, or if, at the time any benefit payment is due to a Beneficiary, there is no living Beneficiary validly named by the Participant, the Employer pay any such benefit payment to the Participant's spouse, if then living, but otherwise to the Participant's then living descendants, if any, per   stirpes, but, if none, to the Participant's estate. In determining the existence or identity of anyone entitled to a benefit payment, the Employer may rely conclusively upon information supplied by the Participant's personal representative, executor or administrator. If a question arises as to the existence or identity of anyone entitled to receive a benefit payment as aforesaid, or if a dispute arises with respect to any such payment, then, notwithstanding the foregoing, the Employer in its sole discretion, may distribute such payment to the Participant's estate without liability for any tax or other consequences which might flow therefrom, or may take such other action as the Employer deems to be appropriate.
 
ARTICLE 8
 
AMENDMENT
 
8.1    RIGHT TO AMEND . The Employer, by written instrument executed by the Employer, shall have the right to amend the Plan, at any time and with respect to any provisions hereof, and all parties hereto or claiming any interest hereunder shall be bound by such amendment; provided, however, that no such amendment shall deprive the Participant or a Beneficiary of a right accrued hereunder prior to the date of the amendment.
 
ARTICLE 9
 
TERMINATION
 
9.1    EMPLOYER'S RIGHT TO TERMINATE OR SUSPEND PLAN . The Employer reserves the right to terminate the Plan and/or its obligation to make further credits to the Participant's Account. The Employer also reserves the right to suspend the operation of the Plan for a fixed or indeterminate period of time.
 
 
9.2    AUTOMATIC TERMINATION OF PLAN . The Plan automatically shall terminate upon the dissolution of the Employer, or upon its merger into or consolidation with any other corporation or business organization if there is a failure by the surviving corporation or business organization to adopt specifically and agree to continue the Plan.
 
9.3    SUSPENSION OF DEFERRALS . In the event of a suspension of the Plan, the Employer shall continue all aspects of the Plan, other than Employer Contribution Credits, during the period of the suspension, in which event payments hereunder will continue to be made during the period of the suspension in accordance with Articles 5 and 6.
 
9.4    SUCCESSOR TO EMPLOYER . Any corporation or other business organization which is a successor to the Employer by reason of a consolidation, merger or purchase of substantially all of the assets of the Employer shall have the right to become a party to the Plan by adopting the same by resolution of the entity's board of directors or other appropriate governing body. If, within ninety (90) days from the effective date of such consolidation, merger or sale of assets, such new entity does not become a party hereto, as above provided, the Plan automatically shall be terminated.
 
ARTICLE 10
 
THE TRUST
 
10.1    ESTABLISHMENT OF TRUST . The Employer shall establish the Trust with the Trustee pursuant to such terms and conditions as are set forth in the Trust agreement to be entered into between the Employer and the Trustee. The Trust is intended to be treated as a “grantor” trust under the Code and the establishment of the Trust is not intended to cause the Participant to realize current income on amounts contributed thereto, and the Trust shall be so interpreted.
 
ARTICLE 11
 
MISCELLANEOUS
 
11.1    LIMITATIONS ON LIABILITY OF EMPLOYER . Neither the establishment of the Plan nor any modification thereof, nor the creation of any account under the Plan, nor the payment of any benefits under the Plan shall be construed as giving to the Participant or other person any legal or equitable right against the Employer, or any officer or employer thereof except as provided by law or by any Plan provision. The Employer does not in any way guarantee the Participant's Account from loss or depreciation, whether caused by poor investment performance of a deemed investment or the inability to realize upon an investment due to an insolvency affecting an investment vehicle or any other reason. In no event shall the Employer, or any successor, employee, officer, director, agent or stockholder of the Employer, be liable to any person on account of any claim arising by reason of the provisions of the Plan or of any instrument or instruments implementing its provisions, or for the failure of the Participant, a Beneficiary or other person to be entitled to any particular tax consequences with respect to the Plan, or any credit or distribution hereunder.
 
 
11.2    CONSTRUCTION . If any provision of the Plan is held to be illegal or void, such illegality or invalidity shall not affect the remaining provisions of the Plan, but shall be fully severable, and the Plan shall be construed and enforced as if said illegal or invalid provision had never been inserted herein. For all purposes of the Plan, where the context admits, the singular shall include the plural, and the plural shall include the singular. Headings of Articles and Sections herein are inserted only for convenience of reference and are not be considered in the construction of the Plan. The laws of the State of Maryland shall govern, control and determine all questions of law arising with respect to the Plan and the interpretation and validity of its respective provisions, except where those laws are pre-empted by the laws of the United States. Participation under the Plan will not give the Participant the right to be retained in the service of the Employer nor any right or claim to any benefit under the Plan unless such right or claim has specifically accrued hereunder.
 
The Plan is intended to be and at all times shall be interpreted and administered so as to qualify as an unfunded deferred compensation plan, and no provision of the Plan shall be interpreted so as to give any individual any right in any assets of the Employer which right is greater than the rights of a general unsecured creditor of the Employer.
 
11.3    SPENDTHRIFT PROVISION . No amount payable to the Participant or a Beneficiary under the Plan will, except as otherwise specifically provided by law, be subject in any manner to anticipation, alienation, attachment, garnishment, sale, transfer, assignment (either at law or in equity), levy, execution, pledge, encumbrance, charge or any other legal or equitable process, and any attempt to do so will be void; nor will any benefit be in any manner liable for or subject to the debts, liabilities, engagements or torts of the person entitled thereto. Further, (i) the withholding of taxes from Plan benefit payments, (ii) the recovery under the Plan of overpayments of benefits previously made to the Participant or Beneficiary, (iii) if applicable, the transfer of benefit rights from the Pan to another plan, or (iv) the direct deposit of benefit payments to an account in a banking institution (if not actually part of any arrangement constituting an assignment or alienation) shall not be construed as an assignment or alienation.
 
In the event that the Participant's or Beneficiary's benefits hereunder are garnished or attached by order of any court, the Employer or Trustee may bring an action or a declaratory judgment in a court of competent jurisdiction to determine the proper recipient of the benefits to be paid under the Plan. During the pendency of said action, any benefits that become payable shall be held as credits to the Participant's or Beneficiary's Account or, if the Employer or Trustee prefers, paid into the court as they become payable, to be distributed by the court to the recipient as the court deems proper at the close of said action.
 
 
IN WITNESS WHEREOF, the Employer has caused the Plan to be executed and its seal to be affixed hereto, effective as of the _____ day of ______________, 1996.
 
 
ATTEST/WITNESS    
THE TALBOT BANK OF EASTON, MARYLAND
       
       
/s/   
By:
/s/ 
   
Print:     Print Name:  Jerome M. McConnell
Date:
(SEAL)

 

-8-
EXHIBIT 10.8

THE TALBOT BANK OF EASTON, MARYLAND
SUPPLEMENTAL DEFERRED COMPENSATION PLAN
 
TRUST AGREEMENT
 
 
Effective as of December 11, 1996




THE TALBOT BANK OF EASTON, MARYLAND
SUPPLEMENTAL DEFERRED COMPENSATION PLAN TRUST AGREEMENT
 
Effective as of December 11, 1996

TABLE OF CONTENTS

ARTICLE 1
ESTABLISHMENT OF TRUST
     
1
1
1
2
     
ARTICLE 2
THE PLAN
     
2
2
2
     
ARTICLE 3
PAYMENTS TO THE PLAN PARTICIPANT OR BENEFICIARIES
     
2
2
3
     
ARTICLE 4
PAYMENTS TO EMPLOYER
     
3
     
ARTICLE 5
INVESTMENT AUTHORITY
     
3
3
     
ARTICLE 6
DISPOSITION OF INCOME
     
3
     
ARTICLE 7
RESPONSIBILITY OF THE TRUSTEE
     
4
4
     
ARTICLE 8
FEES AND EXPENSES OF THE TRUSTEE
     
4
     
ARTICLE 9
RESIGNATION AND REMOVAL OF THE TRUSTEE
     
4
4
4
5
     
ARTICLE 10
APPOINTMENT OF SUCCESSOR
     
5
     
ARTICLE 11
AMENDMENT OR TERMINATION
     
5
5
     
ARTICLE 12
MISCELLANEOUS
     
5
5
5
6
6
6
     
ARTICLE 13
EFFECTIVE DATE
     
6

 

THE TALBOT BANK OF EASTON, MARYLAND
SUPPLEMENTAL DEFERRED COMPENSATION PLAN TRUST AGREEMENT
 
RECITALS
 
THIS TRUST AGREEMENT is made and entered into effective as of the ________ day of ___________, 1996 by and between The Talbot Bank of Easton, Maryland (the “Employer”), which sponsors the Talbot Bank of Easton, Maryland, Supplemental Deferred Compensation Plan (the “Plan”), and Alex. Brown Capital Advisory & Trust Company, a corporation having trust powers under the laws of the State of Maryland (the “Trustee”).
 
The Employer has established the Plan which is intended to be a “top hat plan” (i.e., an unfunded plan of deferred compensation maintained for members of a select group of management or highly compensated employees) under sections 201(2), 301(a)(3) and 401(a)(1) of the Employee Retirement Income Security Act of 1974 (“ERISA”). The Plan has been created for the sole benefit of the Employer's President and Chief Executive Officer.
 
The Plan provides for the Employer to pay all Plan benefits from its general revenues and assets. The Employer wishes to establish an irrevocable trust fund for the purpose of providing a source from which to pay benefits under the Plan, such trust fund being subject to the claims of the Employer's creditors in the event of the Employer's bankruptcy or insolvency. Contributions to the trust fund shall be held by the Trustee and invested, reinvested and distributed in accordance with the provisions of this Trust Agreement.
 
The Trust established by this Trust Agreement is intended to be a “grantor trust,” with the result that the corpus and income of the trust are treated for tax purposes as assets and income of the Employer.
 
NOW, THEREFORE, in consideration of the mutual covenants contained herein, the Employer and the Trustee, intending to be legally bound, declare and agree as follows:
 
ARTICLE 1
 
ESTABLISHMENT OF TRUST
 
1.1    TRUST DEPOSITS . The Employer shall deposit with the Trustee, in trust, certain funds as required under the Plan, which funds shall be held and disposed of by the Trustee as provided in this Trust Agreement.
 
1.2    IRREVOCABILITY . The Trust shall be irrevocable.
 
1.3    GRANTOR TRUST . The Trust is intended to be a grantor trust, of which the Employer is the grantor, within the meaning of sub-part E, part I, subchapter J, chapter 1, subtitle A of the Internal Revenue Code of 1986, as amended, and shall be construed accordingly.
 
 
1.4    PLAN ASSETS . The principal of the Trust, and any earnings thereon, shall be held separate and apart from other funds of the Employer and shall be used exclusively for the uses and purposes of the Plan and general insolvency creditors of the Employer as herein set forth. Any assets held by the Trust will be subject to the claims of the Employer's general creditors under federal and state law.
 
ARTICLE 2
 
THE PLAN
 
2.1    BENEFIT PROVISIONS . The terms of the Plan shall govern the amount, form and timing of benefit payments under a Plan to which the Plan Participant or a Beneficiary is entitled.
 
2.2    CONFLICTS WITH TRUST . Notwithstanding any other provision of this Trust or the Plan to the contrary, in the event any provision of the Plan is inconsistent with any provision of this Trust, the terms of this Trust shall control.
 
2.3    TRUSTEE RELIANCE . Any direction received by the Trustee from the Employer concerning the Trustee's receipt, holding, disposition, investment, or other treatment of the assets of the Trust shall conclusively be deemed to be in accordance with the terms of the Plan, and the Trustee shall be entitled to rely, and shall be held harmless by the Employer in relying, on the propriety of such direction.
 
ARTICLE 3
 
PAYMENTS TO THE PLAN PARTICIPANT OR BENEFICIARIES
 
3.1    PAYMENT SCHEDULE AND TAXES . The Employer shall deliver to the Trustee a schedule (the “Payment Schedule”) that indicates the amounts payable in respect of the Plan Participant upon his becoming entitled to receive a distribution from the Plan and that provides the form in which such amounts are to be paid (as provided for and available under the Plan) and the time of commencement for the payment of such amounts. The Trustee shall make payments to the Plan Participant or his Beneficiaries in accordance with such Payment Schedule. The Employer shall make provision for the reporting and withholding of any federal, state or local taxes that may be required to be withheld with respect to the payment of benefits pursuant to the terms of the Plan and shall pay amounts withheld to the appropriate taxing authorities. The Trustee will have no responsibilities of any kind with respect to any such withholding, but shall provide to the Employer any information concerning the Trust in the possession of the Trustee which reasonably is requested by the Employer with respect to the Employer's withholding obligations under the Plan and this Trust. The Employer will indemnify and hold harmless the Trustee for any liability incurred by the Trustee with respect to such withholding.
 
3.2    PAYMENTS BY EMPLOYER . The Employer may make payment of benefits directly to the Plan Participant or his Beneficiaries as they become due under the terms of the Plan. The Employer shall notify the Trustee of the Employer's decision to make payment of benefits directly prior to the time amounts are payable to the Plan Participant or his Beneficiaries.
 
 
3.3    CESSATION OF PAYMENTS: RECOMMENCEMENT . Upon notice from the Employer, the Trustee shall suspend or, if applicable, recommence payments in accordance with the terms of such notification.
 
ARTICLE 4
 
PAYMENTS TO EMPLOYER
 
4.1    PAYMENTS TO THE EMPLOYER . Except as provided herein, the Employer shall not have any right or power to direct the Trustee to return to the Employer or to divert to others any of the Trust assets before all payments of benefits have been made to Plan Participants or his Beneficiaries pursuant to the terms of the Plan.
 
ARTICLE 5
 
INVESTMENT AUTHORITY
 
5.1    TRUSTEE AUTHORITY . All rights associated with assets of the Trust shall be exercised by the Trustee or the person designated by Trustee, and shall in no event be exercisable by or rest with the Plan Participant or the Employer.
 
5.2    TYPES OF INVESTMENTS . The Trustee shall invest and reinvest the principal and income of the Trust Fund and keep the Trust Fund invested without distinction between principal and income in Institutional Shares of the following Flag Investor Mutual Funds managed by Alex. Brown Incorporated (or its affiliates):
 
Intermediate -Term Income Fund, Inc.
Equity Partners Fund, Inc.
Value Builder Fund, Inc.
 
Investments of the aforesaid mutual funds are subject to the Annual Fund Operating Expenses associated with each such mutual fund.
 
The Employer and the Trustee can agree from time to time to alter, amend or modify the aforesaid form of investments.
 
ARTICLE 6
 
DISPOSITION OF INCOME
 
6.1    DISPOSITION OF INCOME . During the term of this Trust, all income received by the Trust shall be accumulated and reinvested.
 
 
ARTICLE 7
 
RESPONSIBILITY OF THE TRUSTEE
 
7.1    TRUSTEE INDEMNIFICATION .
 
(a)    If the Trustee undertakes or defends any litigation arising in connection with this Trust, the Employer agrees to indemnify the Trustee against the Trustee's costs, expenses and liabilities (including, without limitation, attorneys' fees and expenses) relating thereto and to be primarily liable for such payments.
 
(b)    The Employer agrees to hold harmless and indemnify the Trustee, to the fullest extent permitted under applicable law, for any and all liabilities of any kind incurred by the Trustee in connection with the Trust (i) relating to periods of time prior to the Trustee's becoming Trustee or (ii) relating to periods of time while the Trustee is Trustee but not related to the Trustee's gross negligence, willful misconduct, or breach of its duties hereunder.
 
7.2    LIMITATION ON POWERS . Notwithstanding any powers granted to the Trustee pursuant to this Trust Agreement or to applicable law, the Trustee shall not have any power that could give this Trust the objective of carrying on a business and dividing the gains therefrom, within the meaning of section 301.7701-2 of the Procedure and Administrative Regulations promulgated pursuant to the Internal Revenue Code.
 
ARTICLE 8
 
FEES AND EXPENSES OF THE TRUSTEE
 
8.1    TRUSTEE EXPENSES AND FEES . The Employer shall pay all expenses of administering the Trust and all Trustee's fees and expenses with respect to which the Trustee is entitled to compensation or reimbursement.
 
ARTICLE 9
 
RESIGNATION AND REMOVAL OF THE TRUSTEE
 
9.1    TRUSTEE RESIGNATION . The Trustee may resign at any time by written notice to the Employer, which shall be effective thirty (30) days after receipt of such notice unless the Employer and the Trustee agree otherwise.
 
9.2    TRUSTEE REMOVAL . The Trustee may be removed by the Employer, on thirty (30) days notice or upon shorter notice accepted by the Trustee.
 
9.3    TRANSFER OF ASSETS . Upon resignation or removal of the Trustee, all assets shall subsequently be transferred to the successor Trustee, which transfer shall be completed no later than sixty (60) days after such resignation or removal.
 
 
9.4    COURT'S APPOINTMENT OF SUCCESSOR . If the Trustee resigns or is removed, a successor shall be appointed, in accordance with the following section, by the effective date of resignation or removal. If no such appointment has been made, the Trustee may apply to a court of competent jurisdiction for appointment of a successor or for instructions. All expenses of the Trustee in connection with the proceeding shall be paid by the Employer.
 
ARTICLE 10
 
APPOINTMENT OF SUCCESSOR
 
10.1    APPOINTMENT OF SUCCESSOR . If the Trustee resigns or is removed in accordance with Sections 9.1 or 9.2 hereof, the Employer may appoint any third party, such as a bank trust department or other party that may be granted corporate trustee powers under state law, as a successor to replace the Trustee upon resignation or removal. The appointment shall be effective when accepted in writing by the new trustee, who shall have all of the rights and powers of the former trustee, including ownership rights in the Trust assets. The former trustee shall execute any instrument reasonably necessary to evidence the transfer.
 
ARTICLE 11
 
AMENDMENT OR TERMINATION
 
11.1    AMENDMENT . This Trust Agreement may be amended by a written instrument executed by the Trustee and the Employer. Notwithstanding the foregoing, no such amendment shall make the Trust revocable after it has become irrevocable in accordance herewith.
 
11.2    TERMINATION . The Trust shall not terminate until the date on which the Plan Participant and his Beneficiaries no longer are entitled to benefits pursuant to the terms of Article 3 hereof. Upon termination of the Trust, any assets remaining in the Trust shall be returned to the Employer.
 
ARTICLE 12
 
MISCELLANEOUS
 
12.1    VALIDITY OF PROVISIONS . Any provision of this Trust Agreement prohibited by law shall be ineffective to the extent of any such prohibition, without invalidating the remaining provisions hereof
 
12.2    NO ASSIGNMENT OF BENEFITS . Benefits payable on behalf of a Plan participant and his or her beneficiaries under this Trust Agreement may not be anticipated, assigned (either at law or in equity), alienated, pledged, encumbered or subjected to attachment, garnishment, levy, execution or other legal or equitable process.
 
12.3    GOVERNING LAW . This Trust Agreement shall be governed by and construed in accordance with the laws of the State of Maryland.
 
 
12.4    SUCCESSOR AND ASSIGNS . This Agreement shall be binding upon and inure to the benefit of the Employer and the Trustee and their respective successors and assigns.
 
12.5    TRUSTEE'S SUCCESSORS . Any corporation into which the Trustee may be merged or with which it may be consolidated, or any corporation resulting from any merger, reorganization or consolidation to which the Trustee may be a party, or any corporation to which all or substantially all of the trust business of the Trustee may be transferred, shall be the successor of the Trustee hereunder without the execution or filing of any instrument or the performance of any act.
 
12.6    HEADINGS . Headings of the Sections and Articles of this Agreement are included for convenience only and shall not control the meaning or interpretation of any provision of this Agreement.
 
ARTICLE 13
 
EFFECTIVE DATE
 
13.1    EFFECTIVE DATE . The effective date of this Trust Agreement is December 11, 1996.
 



IN WITNESS WHEREOF, this Trust Agreement has been duly executed under seal by the parties hereto, effective as of the day and year first above written.
 
ATTEST/WITNESS:     THE TALBOT BANK OF EASTON, MARYLAND
       
       
/s/      /s/ 
   
Print Name:    
Print Name:  Jerome M. McConnell
Date:
(SEAL)
 
ATTEST/WITNESS:     ALEX, BROWN CAPITAL ADVISORY & TRUST COMPANY, TRUSTEE
       
       
/s/      /s/ 
   
Print Name:    
Print Name:
Date:
(SEAL)
 
 
 
-7-
 
EXHIBIT 31.1

CERTIFICATIONS OF THE CHIEF EXECUTIVE OFFICER
Pursuant to Securities Exchange Act Rules 13a-1 and 15d-14
As adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, W. Moorhead Vermilye, certify that:

1.       I have reviewed this quarterly report on Form 10-Q of Shore Bancshares, Inc.;

2.       Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statement made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.       Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.       The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f) and 15d-15(f)) for the registrant and have:

a.  
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b.  
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c.  
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d.  
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.       The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a.  
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b.  
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
     
Date: November 8, 2005 By:   /s/ W. Moorhead Vermilye
 
 
W. Moorhead Vermilye
President and Chief Executive Officer
 

 

EXHIBIT 31.2

CERTIFICATIONS OF THE PRINCIPAL ACCOUNTING OFFICER
Pursuant to Securities Exchange Act Rules 13a-1 and 15d-14
As adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Susan E. Leaverton, certify that:

1.       I have reviewed this quarterly report on Form 10-Q of Shore Bancshares, Inc.;

2.       Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statement made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.       Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.       The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f) and 15d-15(f)) for the registrant and have:

a.  
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b.  
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c.  
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d.  
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.       The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a.  
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b.  
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
     
Date: November 8, 2005 By:   /s/ Susan E. Leaverton
 
 
Susan E. Leaverton
Treasurer and Principal Accounting Officer


 

EXHIBIT 32.1

CERTIFICATION OF PERIODIC REPORT BY CHIEF EXECUTIVE OFFICER
Pursuant to 18 U.S.C. Section 1350
As adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Pursuant to, and for purposes only of, 18 U.S.C. § 1350, the undersigned hereby certifies that (i) the Quarterly Report of Shore Bancshares, Inc. on Form 10-Q for the quarter ended September 30, 2005 filed with the Securities and Exchange Commission (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and (ii) information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Shore Bancshares, Inc.
 
     
Date: November 8, 2005 By:   /s/ W. Moorhead Vermilye
 
 
W. Moorhead Vermilye
President/Chief Executive Officer


 
 
 

EXHIBIT 32.2

 
CERTIFICATION OF PERIODIC REPORT BY PRINCIPAL ACCOUNTING OFFICER
Pursuant to 18 U.S.C. Section 1350
As adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Pursuant to, and for purposes only of, 18 U.S.C. § 1350, the undersigned hereby certifies that (i) the Quarterly Report of Shore Bancshares, Inc. on Form 10-Q for the quarter ended September 30, 2005 filed with the Securities and Exchange Commission (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and (ii) information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Shore Bancshares, Inc.
 
     
Date: November 8, 2005 By:   /s/ Susan E. Leaverton
 
 
Susan E. Leaverton
Treasurer/Principal Accounting Officer