", t^/-- "41; t <\s§^Wi'r?>i * 3; fK^; I < ,i ^ . ^ iv A '-•-. t I. r . n ^A ir"» -i f^i<£)$ii:mW SHORE BANCSHARES FAMILY OF COMPANIES SHORE BANCSHARIES, INC. Banking. Insurance. Investments. Community. 2011 ANNUAL REPORT ^J^v::''--«|Ni;i;:*#- :r:?^ f s u a i ll feiiSk-feif IAJS;;--;; C • SELECTED FINANCIAL DATA Years Ended December 31, (Dollars in thousands, except per share data) 2011 2010 2009 2008 2007 RESULTS OF OPERATIONS: Interest income Interest expense Net interest income Provision for credit losses Net interest income after provision for credit losses Noninterest income Noninterest expense (Loss) income before income taxes Income tax (benefit) expense Net (loss) income Preferred stock dividends and discount accretion Net (loss) income available to common shareholders PER COMMON SHARE DATA: Net (loss) income - basic Net (loss) income - diluted Dividends paid Book value (at year end) Tangible book value (at year end)' FINANCIAL CONDITION (at year end): Loans Assets Deposits Long-term debt Stockholders' equity $50,852 11,088 39,764 19,470 20,294 17,318 39,167 (1,555) (658) (897) $55,461 12,822 42,639 21,119 21,520 18,041 41,720 (2,159) (492) (1,667) $(897) $(1,667) $58,789 17,411 41,378 8,986 32,392 19,541 40,248 11,685 4,412 7,273 1,876 $5,397 $61,474 21,555 39,919 3,337 36,582 20,350 38,370 18,562 7,092 11,470 — $11,470 $65,141 24,105 41,036 1,724 39,312 14,679 32,539 21,452 8,002 13,450 — $13,450 $(0.11) (0.11) 0.09 14.34 12.37 $(0.20) (0.20) 0.24 14.51 12.32 $0.64 0.64 0.64 15.18 12.64 $1.37 1.37 0.64 15.16 12.55 $1.61 1.60 0.64 14.35 11.68 $ 841,050 1,158,193 1,009,919 455 121,249 $ 895,404 1,130,311 979,516 932 122,513 $ 916,557 1,156,516 990,937 1,429 127,810 $ 888,528 1,044,641 845,371 7,947 127,385 $776,350 956,911 765,895 12,485 120,235 PERFORMANCE RATIOS (for the year): Return on average total assets Return on average stockholders' equity Net interest margin Efficiency ratio^ Dividend payout ratio Average stockholders' equity to average total assets (0.08)% (0.74) 3.74 68.35 (81.82) 10.66 (0.15)% (1.33) 4.02 68.75 (120.00) 11.05 0.48% 4.00 3.90 66.07 100.00 11.96 1.13% 9.22 4.23 63.66 46.72 12.30 1.42% 11.79 4.64 58.40 39.75 12.04 ' Total stockholders' equity, net of goodwill and other intangible assets, divided by the number ofshares of common stock outstanding at year end. - Noninterest expense as a percentage oftotal revenue (net interest income plus total noninterest income). Lower ratios indicate improved productivity. ASSETS LOANS AND DEPOSITS 1,157 1 , 30 1,158 ALLOWANCE FOR CREDIT LOSSES TO LOANS PROVISION FOR CREDIT LOSSES $24 S20 S16 S12 $8 S4 2007 2008 2009 2010 2011 2008 2009 2010 2011 2007 2008 2009 2010 2011 2007 2008 2009 2010 2011 Loans | Deposits LETTER TO STOCKHOLDERS To Our Stockholders, Although our results for 2011 improved over 2010, we experienced a second consecu tive year in which we incurred a net loss as the depressed state of Delmarva's real estate driven economy remained largely unchanged. It is both disappointing and frustrating for the Board and our Management team to quantify this year's "improvement" in terms of merely halving the net loss that we posted a year earlier. Even though the tough external operating environment continued to produce a myriad of challenges that were not within our power to control, we can confidently report that all of our people and resources were diligently focused on those fundamental issues where we could make a direct impact, such as improving credit quality, conserving our strong capital position, adding new talent, growing deposit market share, and controlling expenses. First and foremost, we continued to address a variety of credit quality issues during 2011. We consistently reviewed existing credits in our loan portfolios, looking for early warning signs of potential problems. This is a criti cal ongoing process. Many of our longtime relationships are with real estate developers with very resilient track records, but in this unprecedented period of depressed property values and real estate sales, the landscape has changed materially. Where there has been deterioration, we are aggressively pursuing workout strategies with borrowers experienc ing financial difficulties. Despite these efforts, charge-offs reached an all time high of $20.6 million, compared to $18.5 in 2010, as we made tough decisions to move problem credits through the resolution pipeline and ultimately remove them from our balance sheet. During the year, the balance of our loan portfolio declined by $54.4 million, while non- accrual loans increased $15.1 million, putting negative pressure on our net interest margin. The decline in our loan portfolio was a direct result ofthe competition among community and regional banks for quality loans, which re mains intense and largely rate driven. Custom ers are often looking to lock in longer-term fixed-rate loans that are not typically offered by community banks, and are, therefore, seek ing out larger regional institutions for these low-margin transactions. Conversely, deposits remained plentiful, as large depositors continued to seek the safety of expanded FDIC insurance, and retail custom ers continued to recognize the convenience of our branch network, our high quality cus tomer service, and the benefits of dealing with Delmarva's dominant locally-managed bank of choice. Financial Results As noted above, the Company reported a net loss of $897 thousand for 2011, compared to a net loss for 2010 of $1.7 million. Diluted net loss per share was $0.11 compared to a diluted net loss per share of $0.20 for 2010. The 2011 results were once again significantly driven by the provision for credit losses which totaled $19.5 million, compared to $21.1 million for 2010, and a goodwill and other intangible assets impairment charge of $1.3 million compared to a charge of $3.1 million in 2010. The entire impairment charge in 2011 related to the Com pany's insurance operations, whereas in 2010 approximately half related to the Felton Bank. Our return on average assets for 2011 was (0.08)%, compared to (0.15)% for 2010. The re turn on average equity was (0.74)% and (1.33)% for 2011 and 2010, respectively, while the re turn on average tangible equity was 0.32% and 1.05% for 2011 and 2010, respectively Total as sets were $1,158 billion at December 31, 2011, a $27.9 million increase over 2010. The increase was attributable to increased customer deposits of $30.4 million. This deposit growth, coupled with a decline in loans, resulted in increases in cash balances, primarily interest bearing deposits with other banks, and an increase in the Company's investment portfolio. The shifting oflnterest bearing assets from loans to cash balances and investments with lower overall yields resulted in a decline in the total earning assets yield of 44 basis points to 4.78%. Despite a reduction in the rate paid for interest bearing liabilities from 1.46% for 2010 to 1.26% for 2011, the Company's net interest margin declined 28 basis points to 3.74%. This resulted in a net interest income decline of $2.9 million. W. Moorhead Vermilye Chief Executive Officer Christopher F. Spurry Chairman ofthe Board Lloyd L. "Scott" Beatty, Jr. President and COO Noninterest income also declined in 2011 due to reduced insurance agency commis sion income and service charges on deposit accounts. The Company sold investment securities, realizing $563 thousand in gains, which offset some of the decline in nonin terest income. Management implemented cost cut ting measures during 2011 and was able to reduce expenses assodated with salaries and wages by $652 thousand. However, those savings were offset by elevated costs related to managing credit quality, such as increased levels of collection expense and write downs on other real estate owned. The overall reduction in noninterest expenses, excluding the provision for credit losses, was otherwise attributable to the reduction in the goodwill and other intangible assets impairment charge of $1.7 million and the reduced FDIC premium expense of $536 thousand resulting from changes to the FDIC assessment method. Credit Quality Despite recent indications of improve ments in the real estate market, during most of 2011 the real estate markets in counties in which the Company operates remained de pressed, underperforming when compared to other counties outside of our footprint in the states of Maryland and Delaware. As a result and because most of our lending is tied to the real estate market, credit qual ity continued to deteriorate in 2011. Total adversely classified loans increased $19.2 million, with $8.9 million ofthe increase relating to construction loans and $9.9 mil lion of the increase relating to loans secured by residential real estate. Nonaccrual loans increased $15.1 million totaling $51.4 million at December 31, 2011. Most ofthe increase in nonaccruals was attributable to loans secured by residential real estate and commercial real estate. Accruing restruc tured loans remained relatively unchanged at $25.2 million. We are continuing to work aggressively with customers to enter into prudent work out arrangements to mini mize our losses. Capital Position One ofthe most significant consider ations for our Company, and the banking industry in general, has been the need to maintain capital at sufficient levels. We are pleased to report that we have been able to do this throughout the adverse economic conditions that existed throughout 2011. Our regulatory capital ratios are strong, with total risk based capital of 13.8% at December 31, 2011, compared to 13.07% one year ago, solidly above the level to be classified by regulatory authorities as "well capitalized." Our decision to reduce the quarterly dividend to $0.01 in May of 2011 was necessary to ensure capital remained at appropriate levels as we continue to absorb the costs of improving our credit quality. Strategic Initiatives As of January 1, 2012, our retail insur ance division added two talented execu tives with considerable experience, as Rich Trippe was appointed President and CEO and Donna Sposa was named Vice Presi dent and COO. Both join our organization with impressive resumes in the insurance industry. Terry Mead, the former CEO, has retired after 24 years with Avon-Dixon, but remains available to support the new lead ers during the transition. We wish Terry the very best in his retirement and thank him for his help in building such a great organi zation. Rich and Donna have begun an aggressive plan to improve upon the technology platforms available to our agents and support staff in order to optimize overall marketing and sales efforts across our insurance lines of business and to improve operating efficiency. In the first quarter of 2012, the Banks will undertake the replacement ofall ATMs in order to comply with the Americans with Disabilities Act. The new standards require all bank ATMs to support voice guid ance and keypad controls for the visually impaired. Another significant project for the Company is the construction of the new Camden Delaware branch of CNB in order to relocate the existing branch that is inside the local Walmart store. We also plan to roll out a new mobile banking platform to customers in early 2012. Looking Ahead to 2012 We expect to devote the majority of our efforts in 2012 toward further improve ment of credit quality and earnings. On the credit quality side, this will involve closely monitoring the health of existing credit, continuing to focus intensely on prudent loan workouts, and reducing the level of nonperforming assets on our balance sheet through orderly liquidation of loan collateral and other real estate owned. As for the improvement of earnings, we have undertaken a variety ofbusiness develop ment initiatives planned to attract selected new relationships, originate quality loans to reverse the decline in the loan portfolio, and grow deposit share. We have realigned key team leaders and other personnel to proactively conduct business development initiatives, as we clearly recognize there are solid opportunities, even in this environ ment, for our organization as the dominant independent banking company on the Delmarva Peninsula. We are confident that we understand how to effectively deploy our resources to be ideally positioned for recovery from the current economic recession. On an encouraging but cautious note, recent data indicates that the number of sales transactions in some of our local real estate markets has increased. However, valuations have by no means returned to pre-recession levels. We hope that as 2012 unfolds we can begin to see this activ ity translate into meaningful economic improvement that will benefit our banking and insurance operations. We look forward to a more favorable external operating environment that will allow our fine organization to return to its historical levels of success, consistency and satisfac tory returns. In the meantime, rest assured that we are relentlessly executing on every internal opportunity within our power to advance and improve Shore Bancshares. As always, we remain grateful for the support of our stockholders, customers and employees. Sincerely, W Moorhead Vermilye ^. c^I^^^<-<-^l^^^ Christopher F. Spurry LOCATIONS SHORE BANCSHARES, INC. Executive Office 18 East Dover Street Easton, MD 21601 Phone (410)763-7800 Headquarters 28969 Information Lane Easton, MD 21601 Phone (410) 763-7800 v\rww.shbi.com BANKING THE TALBOT BANK OF EASTON, MARYLAND Main Office 18 East Dover Street Easton, MD 21601 (410)822-1400 (800)673-8258 Tred Avon Square Branch 212 Marlboro Avenue Easton, MD 21601 (410)822-1400 St. Michaels Branch 1013 S.Talbot Street St. Michaels, MD 21663 (410)745-9166 Elliott Road Branch 8275 Elliott Road Easton, MD 21601 (410)822-1400 Sunburst Branch 424 Dorchester Avenue Cambridge, MD 21613 (410)228-8402 Tilghman Branch 5804 Tilghman Island Road Tilghman, MD 21671 (410) 886-9802 Trappe Branch 29349 Maple Avenue, Suite 1 Trappe, MD 21673 (410)476-3181 CNB Maryland Branches Main Office 109 N. Commerce Street Centreville,MD 21617 (410)758-1600 (877) 758-1600 Route 213 Branch 2609 Centreville Road Centreville, MD 21617 (410)758-2414 Chester Branch 300 Castle Marina Road Chester, MD 21619 (410) 604-6270 Denton Branch 850 South 5th Avenue Denton, MD 21629 (410) 820-4007 Grasonville Branch 202 Pullman Crossing Grasonville, MD 21638 (410)827-4636 Tuckahoe Branch 22151 Wes Street Ridgely.MD 21660 (410)820-2121 Stevensville Branch 408 Thompson Creek Road Stevensville, MD 21666 (410) 643-2233 'Washington Square Branch 899 Washington Avenue Chestertown, MD 21620 (410)810-0591 Delaware Branches Felton Branch 120 W. Main Street Felton, DE 19943 (302)284-4600 (800)989-4383 Milford Branch 698A N. DuPont Blvd. Milford, DE 19963 (302) 424-4600 Camden Branch 263 Walmart Drive Camden, DE 19934 (302)698-1432 INSURANCE THE AVON-DIXON AGENCY, LLC Headquarters 106 N. Harrison Street Easton, MD 21601 (410)822-0506 (800) 242-8758 Benefits Office 28969 Information Lane Easton, MD 21601 (410)822-0506 (800) 242-8758 Grasonville Office 202 Pullman Crossing Grasonville, MD 21638 (410)827-3161 (800)734-4176 :eitown •/ ..ntCountyC / / Camden • Kent County Centreville /Q Felton • 1 Denton. MARYLAND ,-' Caroline Coimty Milford • / DELAWARE Stevensville • Chesty Gr^onv? St. Michaels. EastorP.Q Tilghman • D Island Trap Cambridge • D SHORE BANCSHARES. INC. flaujiJofi. Insurance, tnvcsimciils. Commimity. SHORE BANCSHARES EXECUTIVE OffCES B THE TAIBOT BANK CNB • AVON'DIXON INSURANCE 0 TSGIA INSURANCE 23 VWE FINANCIAL ftTBUST Freestate & Son Office 105 Lawyers Row Centreville, MD 21617 (410) 758-0757 (800) 462-0658 ELLIOTT WILSON INSURANCE, LLC 106 N. Harrison Street Easton, MD 21601 (410) 820-7797 (800)235-9885 JACK MARTIN & ASSOCLVTES, INC. 135 Old Solomon's Island Road Annapolis, MD 21401 (410)626-1000 (800) 497-8101 TRI-STATE GENERAL INSURANCE AGENCY, LTD. One Plaza East, 4th Floor Salisbury, MD 21802 (410)546-1255 (800) 556-7894 INVESTMENTS WYE FINANCLVL & TRUST 16 N. Washington Street Easton, MD 21601 (410) 763-8543 NASDAQ: SHBI (410) 763-7800 SHORE BANCSHARES, INC. BOARD OF DIRECTORS Herbert L. Andrew, III, Farmer Blenda W. Armistead, Investor Lloyd L. "Scott" Beatty, Jr., President and COO, Shore Bancshares, Inc. William W. "Buck" Duncan, President and CEO, The Talbot Bank of Easton, Marylanc James A. Judge, Certified Public Accountant, Anthony, judge & Ware, LLC Neil R. LeCompte, Certified Public Accountant, Office of Neil R. LeCompte Frank E. Mason, III, President and CEO, JASCO Jerry E Pierson, President, Jerry F. Pierson, Inc. Christopher E Spurry, Chairman, President, Spurry and Associates, Inc. E Winfield Trice, Jr., President and CEO, CNB W. Moorhead Vermilye, Chief Executive Officer, Shore Bancshares, Inc. John H. Wilson, President, Coastal South ofMD, Inc. Seated, left to right: John H. 'Wilson James A. Judge Lloyd L. "Scott" Beatty, Jr W Moorhead 'Vermilye Blenda W. Armistead Standing, left to right: Herbert L. Andrew, III Neil R. LeCompte F. Winfield Trice, Jr. Frank E. Mason, III Jerry F Pierson William W. "Buck" Duncan Christopher F. Spurry BOARD OF DIRECTORS BANKING INSURANCE T HE AVON-DIXON AGENCY, LLC ELLIOTT WILSON INSURANCE, LLC JACK MARTIN & ASSOCLVTES, INC. LLOYD L. "SCOTT" BEATTY JR. LEONARD "JAY" DAYTON, JR. JAMES DEERIN, JR. MARK M. FREESTATE DL^NA H. JOHNSON WILLIAM L. LANE, IR., Chairman DAVID C. LEE EDWARD "NED" McDONALD GEORGE T MORAN lOHN H. WILSON Officers Rich C. Trippe Donna Sposa President and CEO Vice President and COO TRI-STATE GENERAL INSURANCE AGENCY, LTD. officers Edward A. Dickerson, III Lloyd L. "Scott" Beatty Jr. Brenda Dickerson Jodi Swift President Secretary, President and c o o. Shore Bancshares Executive Vice President operations Manager INVESTMENTS WYE FINANCIAL & TRUST A DIVISION OF CNB Officers Elizabeth Spurry James M. Vermilye Senior Vice President Senior Vice President T HE TALBOT BANK OF EASTON, MARYLAND HERBERT L. ANDREW, III, Chairman BLENDA W. ARMISTEAD LLOYD L. "SCOTT" BEATTY, IR. CAROLE ANN CLEM R. MICHAEL CLEMMER, IR. lOHN W. DILLON WILLL\M W. "BUCK" DUNCAN DAVID A. FIKE DUANE E MARSHALL STEPHEN M. SHEARER CHRISTOPHER E SPURRY DAVID P. VALLL\NT W, MOORHEAD VERMILYE Officers William W "Buck" Duncan Pat Bilbrough Kevin Moran Susan E. Leaverton Laura P. Heikes President and CEO Executive Vice President Senior Vice President and SLO Vice President and CFO Vice President and Senior Operations and Compliance Officer CNB ANN B. COLLIER MARK M. FREESTATE THOMAS K. HELFENBEIN lAMES A. JUDGE CLYDE V KELLY III NEIL R. LeCOMPTE DAVID W. MOORE lERRY F. PIERSON WM. MAURICE SANGER, Chairman WILLLVM E. SYLVESTER, JR. lEFFREY E. THOMPSON E WINFIELD TRICE, IR. MARY ELLEN VALLLVNT officers F. Winfield Trice, Ir. Thomas E. Beery Charles E. Ruch, Ir. Edward C. Allen Donna J. Stevens President and CEO Senior Vice President and SLO Senior Vice President and SCO Vice President/AffiUate CFO Vice President and Senior Operations and Compliance Officer SHORE BANCSHARES, INC. OFFICERS W Moorhead Vermilye, Chief Executive Officer Lloyd L. "Scott" Beatty, Jr., President and COO Susan E. Leaverton, Treasurer and CFO W. David Morse, Secretary Andrea G. Bayline, Vice President, Internal Audit Timothy J. Berrigan, Vice President and CIO Pamela J. Councell, Vice President and CHRO Laurie H. Yorkilous, Director of Marketing Photo: Vie Bullitt House, headquarters ofthe Mid-Shore Community Foundation in historic Easton, Maryland SHORE BANCSHARES, INC. Banking. InsuFaiicc. Itnestmenls. Coimmniity. Shore Bancshares family of companies. Strong Together. SHORE BANCSHARES, INC INSURANCE Executive Office 18 East Dover Street Easton, MD 21601 Phone (410) 763-7800 Fax (410) 820-4238 Headquarters 28969 Information Lane Easton, MD 21601 Phone (410) 763-7800 Fax (410) 822-8893 www.shbi.com BANKING THE TALBOT BANK OF EASTON, MARYLAND 18 East Dover Street Easton, iMD 21601 Phone (410)822-1400 Fax (410) 820-7180 www.taIbot-bank.com CNB 109 N. Commerce Street Centreville, MD 21617 Phone (410)758-1600 Fax (410) 758-2364 www.cnb-bank.com NASDAQ: SHBI (410) 763-7800 THE AVON-DIXON AGENCY, LLC 106 N.Harrison Street Easton, MD 21601 Phone (410) 822-0506 Fax (410) 820-5629 www.avondixon.com ELLIOTT WILSON INSURANCE, LLC 106 N. Harrison Street Easton, MD 21601 Phone (410) 820-7797 Fax (410) 820-7754 www.elliottwilsonins.com JACK MARTIN & ASSOCIATES, INC. 135 Old Solomon's Island Road Annapolis, MD 21401 Phone (410)626-1000 Fax (410) 626-9966 www.jackmartin.com TRI-STATE GENERAL INSURANCE AGENCY, LTD. One Plaza East, 4th Floor Salisbury, MD 21802 Phone(410)546-1255 Fax (800)518-1904 www.tsgia.com INVESTMENTS WYE FINANCIAL & TRUST 16 N. Washington Street Easton, MD 21601 Phone (410) 763-8543 Fax (410) 763-8557 www.wvetrust.com TRANSFER AGENT Registrar & Transfer Company 10 Commerce Drive Cranford, New Jersey 07016 Investor Relations: (800) 368-5948 E-mail for investor inquiries: info@rtco.com www.rtco.com