Sound Financial (SNFL) 10-Q 2008 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2008

OR

[  ]           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from _______ to ________

Commission file number:     000-52889

SOUND FINANCIAL, INC.

(Exact name of registrant as specified in its charger

United States	26-0776123
(State or other jurisdiction of incorporation of organization)	(IRS Employer Identification No.)

2005 5th Avenue, Second Floor, Seattle, Washington 98121

(Address of principal executive offices)

(206) 448-0884

(Registrant’s telephone number)

None                                                      

(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 and 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 [   ]

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

Large accelerated filer  _____ Accelerated filer  _____

Non-accelerated filer    _____ Smaller reporting company X

(Do not check if smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [   ]                           No [X]

State the number of shares outstanding of each issuer's classes of common equity, as of the latest practicable date:

As of November 11, 2008, there were issued and outstanding 2,832,503 shares of the registrant’s common stock.

SOUND FINANCIAL, INC.

Index

	Page Number
PART I   FINANCIAL INFORMATION
Item 1.     Financial Statements
Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007	2
Consolidated Statements of Income For the Three and Nine Months Ended September 30, 2008 and 2007	3
Consolidated Statements of Cash Flows For the Nine Months Periods Ended September 30, 2008 and 2007	4
Notes to Consolidated Financial Statements	5
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.   Quantitative and Qualitative Disclosures About Market Risk	20
Item 4T.  Controls and Procedures	20
PART II     OTHER INFORMATION
Item 1.        Legal Proceedings	21
Item 1A       Risk Factors	21
Item 2.       Unregistered Sales of Equity Securities and Use of Proceeds	21
Item 3.       Defaults Upon Senior Securities	21
Item 4.       Submission of Matters to a Vote of Security Holders	22
Item 5.       Other Information	22
Item 6.       Exhibits	22
SIGNATURES
EXHIBITS

PART I          FINANCIAL INFORMATION

Item 1            Financial Statements

SOUND FINANCIAL, INC. AND SUBSIDIARY

Consolidated Balance Sheets

	SEPTEMBER 30,			DECEMBER 31,
	2008 (Unaudited)			2007
ASSETS
Cash and cash equivalents	$	4,292,032		$	6,104,963
Securities available-for-sale (AFS), at fair value		8,825,566			71,245
Federal home loan bank (FHLB) stock, at cost		2,134,500			1,319,500
Loans held for sale		686,203			822,129
Loans		267,612,274			220,233,447
Less allowance for loan losses		(1,156,954	)		(827,688	)
Total loans		266,455,320			219,405,759
Accrued interest receivable		1,250,693			1,051,476
Premises and equipment, net		1,479,863			1,404,853
Bank-owned life insurance		4,152,373			4,035,412
Mortgage servicing rights		865,470			864,946
Other real estate owned		-			817,108
Other assets		777,076			1,068,008
Total assets	$	290,919,096		$	236,965,399

LIABILITIES

Deposits
Interest-bearing	$	190,867,879		$	189,501,253
Noninterest-bearing demand		18,529,307			13,289,946
Total deposits		209,397,186			202,791,199
FHLB advances		51,969,355			15,869,355
Accrued interest payable		269,234			210,518
Other liabilities		2,163,033			1,951,786
Advance payments from borrowers for taxes and insurance		531,089			254,213
Total liabilities		264,329,897			221,077,071
COMMITMENTS AND CONTINGENCIES (NOTE 4)
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par value, 1,000,000 shares authorized		-			-
Common stock, $0.01 par value, 24,000,000 shares authorized, 2,948,063 shares issued and 2,832,503 outstanding as of September 30, 2008, no shares issued and outstanding as of December 31, 2007		29,481			-
Additional paid-in capital		11,936,034
Unearned shares - Employee Stock Ownership Plan (“ESOP”)		(1,155,600	)		-
Retained earnings		16,081,742			15,885,167
Accumulated other comprehensive (loss) income, net of tax		(302,458	)		3,161
Total stockholders’ equity		26,589,199			15,888,328
Total liabilities and stockholders’ equity	$	290,919,096		$	236,965,399

See notes to consolidated financial statements.

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SOUND FINANCIAL, INC. AND SUBSIDIARY

Consolidated Statements of Income

(Unaudited)

	THREE MONTHS ENDED						NINE MONTHS ENDED
	SEPTEMBER 30,						SEPTEMBER 30,
	2008			2007			2008			2007
INTEREST INCOME
Loans, including fees	$	4,349,017		$	3,951,511		$	12,038,343		$	11,086,582
Interest and dividends on investments,
cash and cash equivalents		161,528			19,927			363,097			35,401
Total interest income		4,510,545			3,971,438			12,401,440			11,121,983
INTEREST EXPENSE
Deposits		1,560,398			1,780,738			4,795,378			4,778,078
FHLB advances		394,494			331,685			933,885			1,061,394
Total interest expense		1,954,892			2,112,423			5,729,263			5,839,472
NET INTEREST INCOME		2,555,653			1,859,015			6,672,177			5,282,511
PROVISION FOR LOAN LOSSES		250,000			175,000			760,000			175,000
NET INTEREST INCOME
AFTER PROVISION
FOR LOAN LOSSES		2,305,653			1,684,015			5,912,177			5,107,511
NONINTEREST INCOME
Service charges and fee income		474,006			359,145			1,431,482			1,257,652
Earnings on cash surrender value
of bank-owned life insurance		38,214			39,450			116,961			117,852
Mortgage servicing income		76,266			80,672			251,019			222,701
Gain on sale of investment		-			-			153,633			-
Loss on sale of assets		(64,404	)		(1,999	)		(94,582	)		(22,679	)
Gain (loss) on sale of loans		34,976			4,961			(10,823	)		9,826
Total noninterest income		559,058			482,229			1,847,690			1,585,352
NONINTEREST EXPENSE
Salaries and benefits		1,323,455			990,445			3,626,561			2,949,067
Operations		762,634			576,531			2,184,338			1,612,484
Charitable contributions		22,700			6,267			255,070			26,266
Occupancy		258,820			242,286			736,523			654,640
Data processing		189,023			275,365			580,170			788,604
Total noninterest expense		2,566,632			2,090,894			7,382,662			6,031,061
INCOME BEFORE PROVISION
FOR INCOME TAXES		308,079			75,350			377,205			661,802
PROVISION FOR INCOME TAXES		85,000			3,320			74,500			178,500
NET INCOME	$	223,079		$	72,030		$	302,705		$	483,302
OTHER COMPREHENSIVE INCOME (LOSS)	$	65,068		$	71,892		$	(2,914	)	$	485,268
BASIC EARNINGS PER SHARE	$	0.08			N/A		$	0.11			N/A
DILUTED EARNINGS PER SHARE	$	0.08			N/A		$	0.11			N/A

                          See notes to consolidated financial statements

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SOUND FINANCIAL, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

(Unaudited)

	NINE MONTHS ENDED
	SEPTEMBER 30,
	2008			2007
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	302,705		$	483,302
Adjustments to reconcile net income to net cash from operating activities
Amortization of net (premium) discount on investments		(59,722	)		3,544
Provision for loan losses		760,000			175,000
Depreciation and amortization		297,709			249,523
Additions to mortgage servicing rights		(246,103	)		(175,990	)
Amortization of mortgage servicing rights		245,579			188,273
Increase in cash surrender value of bank owned life insurance		(116,961	)		(117,852	)
Proceeds from sale of mortgage loans		20,722,651			18,397,102
Originations of mortgage loans held for sale		(20,586,725	)		(18,383,343	)
Loss on sale of other real estate owned		58,971			-
(Gain) loss on sale of loans		10,823			(9,285	)
Loss on sale of assets		35,611			22,138
(Decrease) increase in operating assets and liabilities
Change in accrued interest receivable		(199,217	)		(178,026	)
Change in other assets		290,932			104,217
Change in accrued interest payable		58,716			68,653
Change in accounts payable and other liabilities		211,247			559,526
Net cash from operating activities		1,786,216			1,386,782
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturities of AFS investments		624,983			54,453
Purchase of AFS investments		(9,625,201	)		-
Purchase of bank owned life insurance		-			(600,000	)
Purchase of FHLB Stock		(815,000	)		-
Net increase in loans		(48,348,979	)		(16,829,788	)
Net improvements to OREO		(157,304	)		-
Proceeds from sale of OREO		1,408,425			-
Purchases of premises and equipment		(372,719	)		(182,159	)
Net cash from investing activities		(57,285,795	)		(17,557,494	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits		6,605,987			16,035,056
Proceeds from FHLB advances		36,550,000			-
Repayment of FHLB advances		(450,000	)		(1,010,000	)
Net proceeds from stock issuance		10,809,915			-
Cash dividends paid		(106,130	)		-
Net change in advances from borrowers for taxes and insurance		276,876			159,054
Net cash from financing activities		53,686,648			15,184,110
INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS		(1,812,931	)		(986,602	)
CASH AND CASH EQUIVALENTS, beginning of period		6,104,963			5,649,306
CASH AND CASH EQUIVALENTS, end of period	$	4,292,032		$	4,662,704
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid on deposits and FHLB advances	$	5,670,547		$	5,770,819
Transfers of mortgage loans held for sale	$	1,565,122		$	-
Net transfer to other real estate owned	$	492,984		$	-

                                         See notes to consolidated financial statements.

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SOUND FINANCIAL, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

1.           BASIS OF PRESENTATION

The accompanying financial information is unaudited and has been prepared from the consolidated financial statements of Sound Financial, Inc. (“Sound Financial” or the “Company”) and its wholly owned subsidiary, Sound Community Bank (“Bank”). These consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Article 8 of Regulation S-X and do not include all disclosures required by generally accepted accounting principles for a complete presentation of the Company's financial condition and results of operations.  In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair representation of the results of operations for such periods.  The results for the interim periods are not necessarily indicative of results for a full year.  For further information, refer to the consolidated financial statements and footnotes for the year ended December 31, 2007, included in the Company's Annual Report on Form 10-K.

Certain amounts in the prior quarters’ financial statements have been reclassified to conform to the current presentation.  These classifications do not have an impact on previously reported net income, retained earnings or earnings per share.

2.           RECENT ACCOUNTING DEVELOPMENTS

In June 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (“FSP EITF 03-6-1”). The FSP EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share under the two-class method. The FSP affects entities that accrue cash dividends on share-based payment awards during the awards’ service period when the dividends do not need to be returned if the employees forfeit the awards. FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008. The Company does not accrue cash dividends and, therefore, does not anticipate that this issuance will materially impact the Company’s consolidated financial condition or results of operations.

In May 2008, the FASB issued Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles (“FAS 162”).  This Statement identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (“GAAP”) in the United States.  Any effect of applying the provisions of this Statement shall be reported as a change in accounting principle in accordance with FASB Statement No. 154, Accounting Changes and Error Corrections (“FAS 154”). An entity shall follow the disclosure requirements of that Statement, and additionally, disclose the accounting principles that were used before and after the application of the provisions of this Statement and the reason why applying this Statement resulted in a change in accounting principle.  FAS 162 is not expected to have a material impact on our consolidated financial statements as our financial statements are already presented in conformity with GAAP.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133 (“SFAS 161”).  This Statement requires enhanced disclosures about an entity’s derivative and hedging activities and is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.  The Company does not use derivative instruments.  The adoption of

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this Statement is not expected to have a material impact on the Company’s financial condition or results of operations.

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 157, Fair Value Measurements (“FAS 157”).  This statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  This statement establishes a fair value hierarchy for the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset.  The standard is effective for fiscal years beginning after November 15, 2007.  In February 2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 157-2, Effective Date of FASB Statement No. 157.  This FSP delays the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years.  We elected a partial deferral of FAS 157 under the provisions of FSP 157-2 related to the measurement of fair value used when evaluating goodwill, other intangible assets and other long-lived assets for impairment.  We are currently evaluating the impact of FSP 157-2 on our financial statements. The impact of partially adopting FAS 157 effective January 1, 2008, was not material to our financial statements.  Please refer to Note 3 for disclosures related to the adoption of FAS 157.

In October 2008, the FASB issued FSP FAS No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. The FSP clarifies the application of FAS No. 157, Fair Value Measurements, when the market for a financial asset is not active. The FSP was effective upon issuance, including reporting for prior periods for which financial statements have not been issued. The adoption of the FSP for reporting as of September 30, 2008, did not have a material impact on our consolidated financial statements.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (“SFAS 160”).  SFAS 160 establishes accounting and reporting standards that require that the ownership interests in subsidiaries held by parties other than the parent be clearly identified, labeled, and presented in the consolidated statement of financial position within equity, but separate from the parent’s equity; the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; and changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary be accounted for consistently.

SFAS 160 also requires that any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value when a subsidiary is deconsolidated. SFAS 160 also sets forth the disclosure requirements to identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. SFAS 160 must be applied prospectively as of the beginning of the fiscal year in which SFAS 160 is initially applied, except for the presentation and disclosure requirements. The presentation and disclosure requirements are applied retrospectively for all periods presented.  We do not have a noncontrolling interest in one or more subsidiaries. Accordingly, we do not anticipate that the initial application of SFAS 160 will have a material impact on our financial statements.

In December 2007, the FASB issued Statement No. 141(R), Business Combinations (“SFAS 141(R)”).  SFAS 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree and recognizes and measures the goodwill acquired in the business

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combination or a gain from a bargain purchase. SFAS 141(R) also sets forth the disclosures required to be made in the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  Accordingly, we will apply SFAS 141(R) to business combinations occurring on or after January 1, 2009.

3.           FAIR VALUE OF FINANCIAL INSTRUMENTS

As discussed in Note 2, FAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  FAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active exchange markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The following is a description of the valuation methodologies used to measure and report fair value of financial assets and liabilities on a recurring or nonrecurring basis:

In determining the appropriate levels, the Company performs a detailed analysis of the assets and liabilities that are subject to SFAS No. 157. In certain cases, the inputs used to measure fair value of an asset or liability may fall into different levels of the fair value hierarchy. The level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Therefore, an item may be classified in Level 3 even though there may be some significant inputs that are readily observable.

Valuation Methodologies

A description of the valuation methodologies used for certain financial assets and financial liabilities measured at fair value is as follows:

Securities Available for Sale: Securities available for sale are recorded at fair value based on quoted market prices, if available. If quoted market prices are not available, management utilizes third-party pricing services or broker quotations from dealers in the specific instruments. Level 1 securities include those traded on an active exchange, as well as U.S. government and its agencies securities. Level 2 securities include mortgage-backed securities and certain asset-backed securities. Level 3 securities include collateralized mortgage obligations (CMOs).

Loans Held for Sale: Residential mortgage loans held for sale are recorded at the lower of cost or fair value. The fair value of fixed-rate residential loans is based on whole loan forward prices obtained from government sponsored enterprises. These loans are classified as Level 2 and are measured on a nonrecurring basis.  At September 30, 2008, loans held for sale were carried at cost.

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Mortgage Servicing Rights: The fair value of mortgage servicing rights is estimated using a discounted cash flow model. These assets are classified as Level 3. At September 30, 2008, mortgage servicing rights are carried at amortized cost.

Impaired Loans: From time to time, and on a nonrecurring basis, fair value adjustments to collateral dependent loans are recorded to reflect partial write-downs based on the current appraised value of the collateral or internally developed models which contain management’s assumptions.

OREO: Other real estate owned consists principally of properties acquired through foreclosure and are carried at the lower of cost or estimated market value less selling costs.  Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, management periodically performs valuations such that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell.

The following table presents the balances of assets measured at fair value on a recurring basis at September 30, 2008:

	Fair Value at September 30, 2008
Description	Total		Level 1		Level 2		Level 3
Available for Sale Securities	$	8,825,566	$	1,028,047	$	7,797,519	$	-

The following table presents the balance of assets measured at fair value on a nonrecurring basis at September 30, 2008, and the total losses resulting from these fair value adjustments for the nine months ended September 30, 2008 (in thousands):

									Nine Months
									Ended
	Fair Value at September 30, 2008								September 30, 2008
Description	Total		Level 1		Level 2		Level 3		Total Losses
Impaired Loans	$	5,365,703	$	-	$	-	$	5,365,703	$	262,036

The loss represents impairments on collateral dependent loans for fair value adjustments based on the fair value of the collateral.

There were no material liabilities carried at fair value, measured on a recurring or nonrecurring basis, at September 30, 2008.

4. COMMITMENT AND CONTINGENCIES

In the normal course of operations Sound Community Bank engages in a variety of financial transactions that are not recorded in our financial statements.  These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks.  These transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit

5.          LEGAL PROCEEDINGS

In November 2007, Visa Inc. (“Visa”) announced that it had reached a settlement with American Express and Discover Card related to antitrust lawsuits. The Company and other Visa member banks are obligated to fund the settlement and share in losses resulting from this litigation. The Company is not a party to the Visa litigation and its liability arises solely from the Bank’s membership interest in Visa, Inc.

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Previously, Visa announced that it completed restructuring transactions in preparation for an initial public offering of its Class A stock planned for early 2008, and, as part of those transactions, Sound Financial’s membership interest was exchanged for Class B stock of Visa. In March 2008, Visa completed its initial public offering. Using the proceeds from this offering, Visa established a $3.0 billion escrow account to cover settlements, resolution of pending litigation and related claims (“covered litigation”).

As a result of Visa’s initial public offering, we received $154,000 in proceeds from a mandatory partial redemption of our restricted Class B common stock, which is recorded in gain on sale of investment. As of September 30, 2008, the Company owns 5,699 shares of Class B common stock. These shares are restricted and may not be transferred until the later of (1) three years from the date of the initial public offering or (2) the period of time necessary to resolve the covered litigation. A conversion ratio of 0.71429 was established for the conversion rate of Class B shares into Class A shares. If the funds in the escrow account are insufficient to settle all the covered litigation, Visa may sell additional Class A shares, use the proceeds to settle litigation, and further reduce the conversion ratio. If funds remain in the escrow account after all litigation is settled, the Class B conversion ratio will be increased to reflect that surplus.

In October 2008, Visa announced that it had reached a settlement with Discover Card related to an antitrust lawsuit. The Bank and other Visa member banks are obligated to fund the settlement and share in losses resulting from this litigation that are not already provided for in the escrow account. Visa notified the Company that it had established an additional reserve related to the settlement with Discover Card that has not already been funded into the escrow account. The Company is not a party to the Visa litigation and its liability arises solely from the Bank’s membership interest in Visa.  Management’s best estimate is that the potential liability related to this case is not material to the Company’s financial statements.

Visa announced that it intends to issue additional Class A shares in the fourth quarter, and with the proceeds fully fund the escrow account to cover the remaining amount of the settlement. It is anticipated that the issuance of the additional Class A shares will reduce the conversion ratio of Class B shares into Class A shares for Visa member banks. The amount of this reduction, if any, is unknown.

In the normal course of business, the Company occasionally becomes involved in various legal proceedings.  In the opinion of management, any liability from such proceedings would not have a material adverse effect on the business or financial condition of the Company.

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6.           LOANS

The composition of the loan portfolio, excluding loans held for sale, was as follows:

	September 30, 2008			December 31, 2007
Real estate loans
One- to four-family	$	94,801,269		$	83,965,522
Home equity		53,946,627			45,373,749
Commercial		51,752,374			25,013,481
Construction or development		6,792,480			8,621,743
		207,292,750			162,974,495
Consumer loans
Manufactured homes		23,019,526			22,495,034
Automobile		11,183,442			15,077,564
Other		7,610,945			8,818,012
		41,813,913			46,390,610
Commercial business loans		18,562,957			10,802,911
		267,669,620			220,168,016
Deferred loan origination (fees) costs		(57,346	)		65,431
Allowance for loan losses		(1,156,954	)		(827,688	)
Total loans, net	$	266,455,320		$	219,405,759

The following is an analysis of the change in the allowance for loan losses:

	Nine Months Ended September 30,
	2008			2007
Balance at beginning of period	$	827,688		$	822,393
Provision for loan losses		760,000			175,000
Recoveries		130,496			187,578
Charge-offs		(561,230	)		(367,800	)
Balance at end of period	$	1,156,954		$	817,171

As of September 30, 2008 impaired loans without a valuation allowance were $3.3 million and impaired loans with a valuation allowance were $2.3 million.  The valuation allowance related to impaired loans totaled $261,000 as of September 30, 2008.

As of December 31, 2007, management determined that the Sound Community Bank did not have any loans that would be defined as impaired.

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7.           FHLB ADVANCES

Sound Community Bank utilizes a loan agreement with the FHLB of Seattle.  The terms of the agreement call for a blanket pledge of a portion of the Bank’s mortgage portfolio based on the outstanding balance.  At September 30, 2008, the amount available to borrow under this agreement is approximately 25% of total assets, conditional upon meeting certain collateral and stock ownership requirements.  The Bank had outstanding borrowings under this arrangement of $52.0 million and $15.9 million at September 30, 2008, and December 31, 2007, respectively.

8.           EARNINGS PER SHARE

Basic earnings per share is net income divided by the weighted average number of common shares outstanding during the periods which was 2,839,726 and 2,836,951 shares for the three month and nine month periods ended September 30, 2008, respectively, and there were no shares outstanding for the three month or nine month periods ended September 30, 2007.  ESOP shares are considered outstanding for this calculation, unless unearned.  There are currently no potentially dilutive common shares issuable under stock options or other programs.  Earnings and dividends per share are restated for all stock splits and dividends through the date of the financial statements.

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

Forward-Looking Statements

This report contains statements that are not historical or current fact and constitute forward-looking statements.  In some cases, you can identify these statements by words such as "may", "might", "will", "should", "expect", "plan", "intend", "anticipate", "believe", "estimate", "predict", "potential", or "continue", the negative of these terms and other comparable terminology.  Such forward-looking statements, which are based on various underlying assumptions and expectations and are subject to risks, uncertainties and other unknown factors, may include projections of our future financial performance based on our growth strategies and anticipated trends in our business.  These statements are only predictions based on our current expectations and projections about future events, and there are or may be important factors that could cause our actual results to be materially different from the historical results or from any future results expressed or implied by such forward-looking statements.  Unless required by law, we undertake no obligation to publicly update or revise any forward-looking statement to reflect circumstances or events after the date of this press release.

Results of operations and business are subject to various factors which could cause actual results to differ materially from these estimates and most other statements that are not historical in nature.  These factors include, but are not limited to, general and local economic conditions, changes in interest rates, deposit flows, demand for mortgage, consumer and other loans, real estate values, competition, changes in accounting principles, policies or guidelines, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services.

General

Sound Financial, Inc. (“Sound Financial” or the “Company”) was incorporated on January 8, 2008, to hold all of the stock of Sound Community Bank (“Bank”), which converted from a state-charted credit union to a federally chartered savings bank in 2003. Prior to that conversion, its name was Credit Union of the Pacific.

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In connection with its organization, Sound Financial sold 1,297,148 shares of common stock to investors at $10.00 per share in a subscription offering, which closed on January 8, 2008.  Those shares constitute 44% of the outstanding shares of common stock of Sound Financial.  In connection with the closing of the offering, Sound Financial also issued 29,480 shares of common stock to Sound Community Foundation, a charitable foundation created by the Bank in connection with the mutual holding company reorganization and subscription offering.  The remaining 1,621,435 shares of common stock of Sound Financial outstanding were issued in accordance with federal law to Sound Community MHC, a federal mutual holding company (“MHC”).

Sound Financial raised $12,971,480 in its public offering and after paying $1,005,965 in offering expenses, it contributed $8,000,000 to the Bank, lent $1,155,600 to fund its employee stock ownership plan’s purchase of shares in the offering, and retained the remaining $2,809,915 for working capital.

The Bank’s principal business consists of attracting retail deposits from the general public and investing those funds, along with borrowed funds, in loans secured by first and second mortgages on one- to four-family residences (including home equity loans and lines of credit), commercial real estate, consumer and commercial business loans and, to a lesser extent, construction and development loans.  We offer a wide variety of secured and unsecured consumer loan products, including manufactured home loans, automobile loans, boat loans and recreational vehicle loans.  We intend to continue emphasizing our residential mortgage, home equity and consumer lending, while also expanding our emphasis in commercial real estate and commercial business lending.  In recent years, we have focused on expanding our commercial loan portfolio.

As part of our business, we focus on mortgage loan originations, many of which we sell to Fannie Mae.  We sell these loans with servicing retained to maintain the direct customer relationship and promote our emphasis on strong customer service.  We originated $45.4 million and $32.3 million in one- to four-family residential mortgage loans during the nine months ended September 30, 2008 and 2007, respectively.  During these same periods, we sold $20.7 million and $18.4 million, respectively, of one- to four-family residential mortgage loans.

We offer a variety of deposit accounts, which are our primary source of funding for our lending activities.  In recent years, however, we have relied on Federal Home Loan Bank advances to augment our deposits and fund the growth of interest earning assets.  In 2008, we adopted a leverage strategy to use short and long-term Federal Home Loan Bank advances to fund asset and loan growth.

The Bank’s earnings are primarily dependent upon our net interest income, the difference between interest income and interest expense.  Interest income is a function of the balances of loans and investments outstanding during a given period and the yield earned on these loans and investments.  Interest expense is a function of the amount of deposits and borrowings outstanding during the same period and interest rates paid on these deposits and borrowings.  The Bank’s earnings are also affected by our provision for loan losses, service charges and fees, gains and losses from sales of loans and other assets, other income, operating expenses and income taxes.

Difficult market conditions and economic trends have adversely affected our industry and our business.

The Bank is significantly affected by prevailing economic conditions as well as government policies and regulations concerning, among other things, monetary and fiscal affairs, housing and financial institutions.  Deposit flows are influenced by a number of factors, including interest rates paid on competing time deposits, other investments, account maturities, and the overall level of personal income and savings.  Lending activities are influenced by the demand for funds, the number and quality of lenders, and regional economic cycles.  Sources of funds for lending activities of the Bank include primarily deposits, borrowings, payments on loans and income provided from operations.

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Dramatic declines in the housing market, with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions.  General downward economic trends, reduced availability of commercial credit and increasing unemployment have negatively impacted the credit performance of commercial and consumer credit, resulting in additional write-downs for many financial institutions.  Concerns over the stability of the financial markets and the economy also have resulted in decreased lending by many financial institutions to their customers and to each other.  This market turmoil and tightening of credit has led to increased delinquencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity.  Some financial institutions have experienced decreased access to deposits or borrowings.  The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets may adversely affect our business, results of operations and stock price.

Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our credit exposure is made more difficult and complex under these difficult market and economic conditions.  We also expect to face increased regulation and government oversight as a result of these downward trends.  This increased government action may increase our costs and limit our ability to pursue certain business opportunities.  We also may be required to pay even higher FDIC premiums than the recently increased level, because financial institution failures resulting from the depressed market conditions have depleted and may continue to deplete the FDIC insurance fund and reduce the FDIC’s ratio of reserves to insured deposits.

We do not expect these difficult conditions to improve in the near future.  A worsening of these conditions would likely exacerbate the adverse effects of these difficult market and economic conditions on us, our customers and the other financial institutions in our market.  As a result, we may experience increases in foreclosures, delinquencies and customer bankruptcies, as well as more restricted access to funds.

Recent legislative and regulatory initiatives to address these difficult market and economic conditions may not stabilize the U.S. banking system.

The recently enacted Emergency Economic Stabilization Act of 2008 (“EESA”) authorizes the U.S. Department of the Treasury (“Treasury Department”) to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in a troubled asset relief program (”TARP”).  The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other.  The Treasury Department has allocated $250 billion towards the TARP Capital Purchase Program (“CPP”).  Under the CPP, Treasury will purchase debt or equity securities from participating institutions.  The TARP also will include direct purchases or guarantees of troubled asset of financial institutions.  Our Board of Directors is currently evaluating whether or not to participate in the CPP.

EESA also increased FDIC deposit insurance on most accounts from $100,000 to $250,000.  This increase is in place until the end of 2009 and is not covered by deposit insurance premiums paid by the banking industry.  In addition, the FDIC has implemented two temporary programs to provide deposit insurance for the full amount of most non-interest bearing transaction accounts through the end of 2009 and to guarantee certain unsecured debt of financial institutions and their holding companies through June 2012.  Financial institutions have until December 5, 2008 to opt out of these two programs.  We expect to participate only in the program that provides unlimited deposit insurance coverage through December 31, 2009 for noninterest-bearing transaction accounts (typically business checking accounts) and certain funds swept into noninterest-bearing savings accounts.  Under that program, we will pay a 10 basis points fee (annualized) on the balance of each covered account in excess of $250,000, while the extra deposit

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insurance is in place.  At September 30, 2008, we had $6.8 million in such accounts in excess of $250,000.

Our deposit insurance premiums during the nine months ended September 30, 2008, were $110,000. Those premiums are expected to increase in 2009 due to recent strains on the FDIC deposit insurance fund due to the cost of large bank failures and increase in the number of troubled banks.  The current rates for FDIC assessments have ranged from 5 to 43 basis points, depending on the health of the insured institution.  The FDIC has proposed increasing that assessment range to 12 to 50 basis points for the first quarter of 2009.  For the remainder of 2009, it has proposed a range of 10 to 45 basis points for institutions that do not trigger risk factors for brokered deposits and unsecured debt and higher rates for those that do trigger those risk factors.  The FDIC also proposed that it could increase assessment rates in the future without formal rulemaking.

The purpose of these legislative and regulatory actions is to stabilize the volatility in the U.S. banking system.  EESA, TARP and the FDIC’s recent regulatory initiatives may not have the desired effect.  If the volatility in the market and the economy continue or worsen, our business, financial condition, results of operations, access to funds and the price of our stock could be materially and adversely impacted.

Critical Accounting Policies

We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. We consider our critical accounting policies to be those related to our allowance for loan losses, mortgage serving rights and other real estate owned.  The allowance for loan losses is maintained to cover losses that are probable and can be estimated on the date of the evaluation in accordance with U.S. generally accepted accounting principles.  It is management’s best estimate of probable incurred credit losses in our loan portfolio.  Our methodologies for analyzing the allowance for loan losses, mortgage serving rights and other real estate owned is described in our Annual Report on Form 10-K.

Comparison of Financial Condition at September 30, 2008 and December 31, 2007

General.  Total assets increased by $54.0 million, or 22.8%, to $290.9 million at September 30, 2008 from $237.0 million at December 31, 2007.  The increase was primarily the result of a $47.2 million, or 21.4%, increase in our loan portfolio, including loans held for sale, from $221.1 million at December 31, 2007 to $268.3 million at September 30, 2008. The increase also was the result of a $6.9 million increase in cash, cash equivalents and securities during the first nine months of 2008.  This increase in total assets was funded primarily by the $10.8 million capital infusion from our stock offering, a $36.1 million increase in net Federal Home Loan Bank advances and a $6.6 million increase in deposits during the nine months ended September 30, 2008.

Loans.  Our loan portfolio, including loans held for sale, increased $47.2 million, or 21.4%, to $268.3 million at September 30, 2008, from $221.1 million at December 31, 2007.  This increase in our loan portfolio consisted primarily of a $26.7 million (106.9%) increase in commercial real estate loans, a $10.8 million (12.9%) increase in one- to four-family loans, an $8.6 million (18.9%) increase in home equity loans, a $7.8 million (71.8%) increase in commercial business loans, which was offset by a $4.6 million (9.9%) decrease in consumer loans and a $1.8 million (21.2%) decrease in construction and development loans.  The $34.5 million, or 96.3%, increase in commercial real estate and business loans during the nine months ended September 30, 2008 is consistent with our strategy to diversify our loan portfolio and increase the amount of generally higher-yielding commercial loans in our portfolio.  The overall slowdown in the national housing market and the pressures of the sub-prime market failures have begun to have an impact on the housing and employment markets in the Puget Sound area.

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 Allowance for Loan Losses.  Our allowance for loan losses at September 30, 2008, was $1.2 million, or 0.43%, of net loans receivable, compared to $828,000, or 0.38%, of net loans receivable at December 31, 2007.  The increase in the allowance for loan losses was due to a $760,000 provision for loan losses recorded during the nine months ended September 30, 2008, partially offset by net charge-offs of non-performing loans totaling $431,000.  This provision was made as a result of increases in our commercial and home equity loan portfolios and an evaluation of prevailing housing and other market conditions.  Non-performing loans decreased to $106,000 at September 30, 2008, from $418,000 at December 31, 2007, primarily as a result of our enhanced collection efforts, which included contacting borrowers with past due loans earlier in the delinquency cycle.  Non-performing loans to total loans decreased to 0.04% at September 30, 2008, from 0.19% at December 31, 2007.  Other real estate owned was zero at September 30, 2008, compared $817,000 as of December 31, 2007.

Cash and Securities.  Cash and cash equivalents decreased by $1.8 million, or 29.7%, to $4.3 million at September 30, 2008.  Our securities portfolio consists of mortgage-backed securities, all of which are designated as available-for-sale.  The securities portfolio increased to $8.8 million at September 30, 2008 from $71,000 at December 31, 2007.  This significant increase reflects our purchase of non-agency mortgage-backed securities, which were purchased at a discount to face value with funds received from our initial stock offering. These non-agency mortgage-backed securities present a level of credit risk that does not exist currently with agency backed securities which are guaranteed by the United States government. In order to monitor this risk, management receives a credit surveillance report which considers various factors for each security including original credit scores, loan to value, geography, delinquency and loss history.  The report also evaluates the underlying loans within the security to project future losses based on various home price depreciation scenarios over a three year horizon.  Based on this analysis, management does not expect to incur any principal loss on any of these investments as of September 30, 2008.

Deposits. ��Total deposits increased by $6.6 million, or 3.3%, to $209.4 million at September 30, 2008, from $202.8 million at December 31, 2007.  Time deposits increased $9.2 million, while savings and money market accounts increased $4.8 million. Demand deposits and interest-bearing checking accounts decreased $5.0 million during the nine months ended September 20, 2008. As of December 31, 2007, total deposits held for the prospective purchase of stock totaled $10.8 million.  These funds were held in a checking account as of December 31, 2007 and were subsequently used to purchase stock on the closing date.  Net of the decrease of the funds held for our stock offering, non interest bearing demand deposit actually increased $5.8 million as a result of an enhanced focus on commercial demand deposit accounts. The increase in time deposits, savings and money market accounts reflect a bank-wide emphasis to bring additional deposits to the bank.

Borrowings.  Federal Home Loan Bank advances increased $36.1 million, or 227.5%, to $52.0 million at September 30, 2008 from $15.9 million at December 31, 2007.  These additional advances were a combination of $15.0 million in long-term advances and $21.6 million in overnight advances, net of repayments of an amortizing advance totaling $450,000.  We continue to rely on Federal Home Loan Bank advances to fund interest earning asset growth when deposit growth is insufficient to fund such growth.  This reliance on borrowings, rather than deposits, generally increases our overall cost of funds, however in the current rate environment, the weighted average cost of new borrowings as of September 30, 2008 was 3.25%, while our weighted average cost of deposits was 2.96% at that date.

Equity.  Total equity increased $10.7 million, or 67.4%, to $26.6 million at September 30, 2008, from $15.9 million at December 31, 2007, primarily as a result of the $10.8 million capital infusion from our stock offering (net of the related ESOP loan) and $303,000 in nine month earnings, which were offset by a decrease in Accumulated Other Comprehensive Income (Loss) of $306,000.

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Comparison of Results of Operation for the Three and Nine Months Ended September 30, 2008 and 2007

General.  Net income increased $151,000 to $223,000 for the three months ended September 30, 2008 compared to $72,000 for the three months ended September 30, 2007.  The primary reasons for this increase was a $622,000 increase to net interest income after provision for loan losses and a $77,000 increase in non-interest income, which were partially offset by a $476,000 increase in non-interest expense.

Net income decreased $181,000 to $303,000 for the nine months ended September 30, 2008 compared to $483,000 for the nine months ended September 30, 2007.  The primary reasons for this decrease were the $585,000 increase in the provision for loan losses and a $1.4 million increase in non-interest expense, including a $200,000 contribution to the Sound Community Foundation, which were partially offset by a $1.4 million increase in net interest income and a $262,000 increase in non-interest income compared to the nine months ended September 30, 2007.

Interest Income.  Interest income increased by $540,000, or 13.6%, to $4.5 million for the three months ended September 30, 2008 from $4.0 million for the three months ended September 30, 2007.  The increase in interest income for the period reflects the increased amount of loans and securities outstanding during the 2008 period.

The weighted average yield on loans decreased from 7.14% for the three months ended September 30, 2007, to 6.76% for the three months ended September 30, 2008.  The decrease was primarily the result of the decrease in the prime interest rate and the 1-year Treasury bill rate, which we use to set and adjust loan rates for certain variable rate loans.  We anticipate our weighted average yield on loans will improve as we continue to emphasize higher yielding commercial real estate and business loans. However, this improvement will also depend on the movement of the prime interest rate.

Interest income increased by $1.3 million, or 11.5%, to $12.4 million for the nine months ended September 30, 2008 from $11.1 million for the nine months ended September 30, 2007.  The increase in interest income for the period reflects the increased amount of loans and securities outstanding during the 2008 period. The weighted average yield on loans decreased from 6.88% for the nine months ended September 30, 2007, to 6.73% for the nine months ended September 30, 2008 for the same reasons stated above.

Interest Expense.  Interest expense decreased $157,000, or 7.5%, to $2.0 million for the three months ended September 30, 2008, from $2.1 million for the three months ended September 30, 2007.  Interest expense decreased $110,000, or 1.9%, to $5.7 million for the nine months ended September 30, 2008, from $5.8 million for the nine months ended September 30, 2007.

The decrease in interest expense for the 2008 period reflects lower interest rates paid on new and renewed certificates of deposit in the current interest rate environment as well as decreased borrowing costs on our Federal Home Loan Bank advances.  Our weighted average cost of interest-bearing liabilities was 3.1% for the three months ended September 30, 2008, compared to 3.9% for the same period in 2007. Our weighted average cost of interest-bearing liabilities was 3.3% for the nine months ended September 30, 2008, compared to 3.7% for the same period in 2007.

Interest paid on deposits decreased $220,000, or 12.4%, to $1.6 million for the three months ended September 30, 2008, as compared to $1.8 million for the three months ended September 30, 2007.  The decrease for the three month period resulted primarily from a decrease in the weighted average cost of deposits. We experienced a 66 basis point decrease in the average rate paid on deposits during the three months ended September 30, 2008 compared to the same period in 2007.  This decrease in average rates were a result of the repricing of matured certificates of deposit that the bank was able to retain at significantly lower rates.

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For the nine months ended September 30, 2008, interest paid on deposits increased by $17,000, as compared to the nine months ended September 30, 2007.  The increase for the nine month period was primarily a result of higher average balances of $198.9 million for the 2008 period compared to $182.2 million for the 2007 period.  The increase in balances was offset by a lower weighted average cost of deposits for the nine months ended September 30, 2008 of 3.2% compared to 3.5% for the nine months ended September 30, 2007.

Interest expense on Federal Home Loan Bank advances increased $63,000, or 18.9%, to $394,000 for the three months ended September 30, 2008 from $332,000 for the three months ended September 30, 2007.  The increase resulted from an increase in the average balance of outstanding Federal Home Loan Bank advances of $21.6 million, to $46.2 million for the three months ended September 30, 2008, from $24.6 million for the three months ended September 30, 2007.  In addition, the cost of Federal Home Loan Bank advances decreased 197 basis points from the 2007 period to the 2008 period.

For the nine months ended September 30, 2008, interest expense on Federal Home Loan Bank advances decreased $128,000, or 12.0%, to $934,000 from $1.1 million for the nine months ended September 30, 2007.  The decrease resulted from a lower cost of Federal Home Loan Bank advances from a weighted average cost of 5.09% for the nine months ended September 30, 2007, to a weighted average cost of 3.67% for the nine months ended September 30, 2008.

Net Interest Income.  Net interest income increased $697,000, or 37.5%, to $2.6 million for the three months ended September 30, 2008, from $1.9 million for the three months ended September 30, 2007.  The increase in net interest income for the three month period primarily resulted from higher yields earned on our expanding commercial loan portfolio and increased income from investments purchased in 2008.  Our net interest margin was 3.8% for the three months ended September 30, 2008, compared to 3.3% for the three months ended September 30, 2007.

Net interest income increased $1.4 million, or 26.3%, to $6.7 million for the nine months ended September 30, 2008, from $5.3 million for the nine months ended September 30, 2007.  The increase in net interest income for the nine month period primarily resulted from increased income from investments purchased in 2008 and lower cost of funds for the period. Our net interest margin was 3.6% for the nine months ended September 30, 2008, compared to 3.3% for the same period ended September 30, 2007.

Provision for Loan Losses.  We establish provisions for loan losses, which are charged to earnings, at a level required to reflect management’s best estimate of the probable incurred credit losses in the loan portfolio.  In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect borrowers’ ability to repay, estimated value of any underlying collateral, peer group data, prevailing economic conditions, and current factors.  Large groups of smaller balance homogeneous loans, such as residential real estate, small commercial real estate, home equity and consumer loans, are evaluated in the aggregate using historical loss factors adjusted for current economic conditions and other relevant data.  Loans for which management has concerns about the borrowers’ ability to repay, are evaluated individually, and specific loss allocations are provided for these loans when necessary.

A provision of $250,000 was made during the three months ended September 30, 2008, compared to provision of $175,000 during the three months ended September 30, 2007.  A provision of $760,000 was made during the nine months ended September 30, 2008, compared to a provision of $175,000 made during the nine months ended September 30, 2007.  The higher provisions were primarily attributable to increases in net charge-offs, increases in our commercial loan portfolio, an increase in our overall loan portfolio and the overriding market conditions nationally and in the areas where we do business.

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At September 30, 2008, the annualized ratio of net charge-offs to average loans decreased 13 basis points to 0.24% from 0.37% at September 30, 2007.  The ratio of non-performing loans to total loans decreased from 0.31% at September 30, 2007 to 0.04% at September 30, 2008.

Noninterest Income.  Noninterest income increased $77,000, or 15.9%, to $559,000 for the three months ended September 30, 2008, from $482,000 for the three months ended September 30, 2007.  The primary reason for this increase was an increase in service charges and fee income of $115,000 as a result of higher checking account service charge revenue, which was partially offset by a $32,000 increase in the loss on sale of loans and repossessed assets for the three months ended September 30, 2008, compared to the same period in 2007.

  Noninterest income increased $262,000, or 16.6%, to $1.8 million for the nine months ended September 30, 2008, from $1.6 million for the nine months ended September 30, 2007. The primary reason for this was the $153,000 gain on the sale on investments resulting from the mandatory redemption of a portion of our Class B Visa, Inc. shares as part of Visa's initial public offering.  The Bank obtained its Visa shares, because it was a long-time Visa member, prior to the sale of its credit card portfolio in 2006.  We continue to own 5,699 shares of Visa Class B shares that are convertible into Class A shares.  Each Class B share currently is convertible into 0.71429 Class A shares, which are traded on the New York Stock Exchange.  The amount of Class A shares the Bank could realize upon conversion of its Class B shares are expected to change as VISA issues additional Class A shares to fund the escrow account to cover the remaining amount of the Discover settlement.  The Class B shares carry a three-year lock-up provision and may not be converted or redeemed during that period. If those shares could be converted as of September 30, 2008, they would have a market value of approximately $250,000.   The increase in noninterest income during the nine months also reflects an increase in service charges and fee income of $174,000 as a result of higher checking account service charge revenue, and was partially offset by the $93,000 increase in the loss on the sale of loans and foreclosed property for the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007.

Noninterest Expense.  Noninterest expense increased $476,000, or 22.8%, to $2.6 million for the three months ended September 30, 2008, compared to $2.1 million for the three months ended September 30, 2007.  The increase in the 2008 period was primarily the result of an increase in salaries and benefits of $333,000 and operations expenses increasing $186,000 as the result of adding additional staff to our commercial banking division and the hiring of a new Senior Vice President of Retail Banking, as well as expense related to our Employee Stock Option Plan. These increases were offset by an $86,000 decrease in data processing expenses resulting from streamlining certain data processing functions.

Noninterest expense increased $1.4 million, or 22.4%, to $7.4 million for the nine months ended September 30, 2008, compared to $6.0 million for the nine months ended September 30, 2007.  The increase in the 2008 period was primarily the result of our $200,000 charitable contribution to Sound Community Foundation (a non-stock Washington corporation we founded in connection with our stock offering) and higher salaries and benefits and operations expenses. Salaries and benefits increased $677,000, or 23.0%, to $3.6 million for the nine months ended September 30, 2008, from $2.9 million for the nine months ended September 30, 2007.  The increase in salaries and benefits was the result of adding additional staff to our commercial banking division and the hiring of a new Senior Vice President of Retail Banking, as well as expense related to our Employee Stock Option Plan. Operations expense increased $572,000, or 35.5%, to $2.2 million for the nine months ended September 30, 2008, from $1.6 million for the nine months ended September 30, 2007.  The increase in operations expense higher legal, audit and printing fees resulting from becoming a public company.  These increases were offset by a $208,000 reduction in data processing expenses resulting from streamlining certain data processing functions.

Income Tax Expense (Benefit).  For the three months ended September 30, 2008, we incurred income tax expense of $85,000 on our pre-tax income as compared to income tax expense of $3,000 for the three month period ended September 30, 2007.  For the nine months ended September 30, 2008, we

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incurred income tax expense of $75,000 on our pre-tax income as compared to income tax expense of $179,000 for the nine month period ended September 30, 2007. 

Off-Balance Sheet Arrangements

In the normal course of operations, the Bank engages in a variety of financial transactions that are not recorded in our financial statements.  These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks.  These transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit.

A summary of our off-balance sheet commitments to extend credit at September 30, 2008, is as follows:

Off-balance sheet loan commitments:
Commitments to make loans	$	1,020,000
Unfunded Letters of Credit		2,208,000
Undisbursed portion of loans closed		2,895,000
Unused lines of credit		35,692,000
Total loan commitments	$	41,815,000

Liquidity

Liquidity management is both a daily and long-term function of the management of the Company and the Bank.  Excess liquidity is generally invested in short-term investments, such as overnight deposits and federal funds.  On a longer term basis, we maintain a strategy of investing in various lending products and investment securities, including mortgage-backed securities.  The Bank uses its sources of funds primarily to meet its ongoing commitments, pay maturing deposits, fund deposit withdrawals and fund loan commitments.

We maintain cash and investments that qualify as liquid assets to maintain adequate liquidity to ensure safe and sound operation and meet demands for funds (particularly withdrawals of deposits).  At September 30, 2008, the Company had $13.1 million in cash and investment securities available for sale and $686,000 in loans held for sale generally available for its cash needs.  We can also generate funds from borrowings, primarily Federal Home Loan Bank.  At September 30, 2008, the Bank had the ability to borrow an additional $20.8 million in Federal Home Loan Bank advances.

At September 30, 2008, we had $41.8 million in outstanding loan commitments, including unused lines of credit and unfunded letters of credit.  Certificates of deposit scheduled to mature in one year or less at September 30, 2008, totaled $62.4 million.  It is management’s policy to maintain deposit rates that are competitive with other local financial institutions.  Based on this management strategy and our own experience, we believe that a majority of maturing deposits will remain with the Bank.  We do not utilize wholesale or brokered deposits to meet our funding needs.  Please refer to the cash flow statement for additional analysis of liquidity.

Capital

The Bank is subject to minimum capital requirements imposed by the Office of Thrift Supervision (“OTS”).  Based on its capital levels at September 30, 2008, the Bank exceeded these requirements as of that date and continues to exceed them as of the date of this filing.  Consistent with our goals to operate a sound and profitable organization, our policy is for the Bank to maintain a “well-capitalized” status under the capital categories of the OTS.  Based on capital levels at September 30, 2008, the Bank was considered to be well-capitalized.  Management monitors the capital levels of the Bank to provide for current and future business opportunities and to meet regulatory guidelines for “well-capitalized” institutions.  The following table shows the capital ratios of the Bank at September 30, 2008.

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	Actual		Minimum Capital Requirements		Minimum Required to Be Well-Capitalized Under Prompt Corrective  Action Provisions
	Amount	Ratio	Amount	Ratio	Amount	Ratio
	(Dollars in thousands)
Risk-Based Capital (to risk-weighted assets)	$25,549	12.40%	$15,372	8.00%	$19,664	10.00%
Core Capital (to risk-weighted assets)	$24,393	12.99%	$7,866	4.00%	$11,799	6.00%
Core Capital (to total adjusted  assets)	$24,393	8.37%	$11,656	4.00%	$14,570	5.00%

Sound Financial raised $13.0 million in its public offering, which resulted in net proceeds of $10.8 million, which increased the capital levels of the Sound Financial and the Bank.

Impact of Inflation

The effects of price changes and inflation can vary substantially for most financial institutions.   While management believes that inflation affects the growth of total assets, it believes that it is difficult to assess the overall impact.   Management believes this to be the case due to the fact that generally neither the timing nor the magnitude of the inflationary changes in the consumer price index (“CPI”) coincides with changes in interest rates.   The price of one or more of the components of the CPI may fluctuate considerably and thereby influence the overall CPI without having a corresponding affect on interest rates or upon the cost of those good and services normally purchased by the Bank.   In years of high inflation and high interest rates, intermediate and long-term interest rates tend to increase, thereby adversely impacting the market values of investment securities, mortgage loans and other long-term fixed rate loans.   In addition, higher short-term interest rates caused by inflation tend to increase the cost of funds.   In other years, the opposite may occur.

Item 3    Quantitative and Qualitative Disclosures About Market Risk

Not required; the Company is a smaller reporting company.

Item 4T  Controls and Procedures

An evaluation of the Company's disclosure controls and procedures as defined in Rule 13a -15(e) under the Securities Exchange Act of 1934 (the "Act") as of September 30, 2008, was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and several other members of the Company's senior management. The Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2008, the Company's disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is: (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and the Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. There were no changes in our internal control over financial reporting (as defined in Rule 13a - 15(f) under the Act) that occurred during the quarter ended September 30, 2008, that has materially affected, or is likely to materially affect our internal control over financial reporting.

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The Company intends to continually review and evaluate the design and effectiveness of its disclosure controls and procedures and to improve its controls and procedures over time and to correct any deficiencies that it may discover in the future. The goal is to ensure that senior management has timely access to all material financial and non-financial information concerning the Company's business. While the Company believes the present design of its disclosure controls and procedures is effective to achieve its goal, future events affecting its business may cause the Company to modify its disclosure controls and procedures.

The Company does not expect that its disclosure controls and procedures will prevent all error and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. 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 control procedure is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies and procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

PART II      OTHER INFORMATION

Item 1          Legal Proceedings

In the normal course of business, the Company occasionally becomes involved in various legal proceedings.  In the opinion of management, any liability from such proceedings would not have a material adverse effect on the business or financial condition of the Company.

Item 1A        Risk Factors

Not required; the Company is a smaller reporting company.

Item 2           Unregistered Sales of Equity Securities and use of Proceeds

(a)           Recent Sales of Unregistered Securities

Nothing to report.

(b)           Use of Proceeds

Nothing to report.

(c)           Stock Repurchases

Nothing to report.

Item 3           Defaults Upon Senior Securities

Nothing to report.

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Item 4           Submission of Matters to a Vote of Security Holders

Nothing to report.

Item 5.          Other Information

Nothing to report.

Item 6           Exhibits

Exhibit Number		Document	Reference to Prior Filing or Exhibit Number Attached Hereto
2		Plan of Reorganization and Stock Issuance	*
3.1		Charter for Sound Financial, Inc.	*
3.2		Bylaws of Sound Financial, Inc.	**
4		Form of Stock Certificate of Sound Financial, Inc.	**
10.1		Employment Agreement with Laura Lee Stewart	*
10.2		Executive Long Term Compensation Agreement with Laura Lee Stewart	*
10.3		Executive Long Term Compensation Agreement with Patricia Floyd	*
10.4		Sound Community Incentive Compensation Achievement Plan	*
10.5		Summary of Annual Bonus Plan	*
10.6		Summary of Quarterly Bonus Plan	*
10.7		Director Fee Arrangements for 2008	*
11		Statement re computation of per share earnings	None
15		Letter re unaudited interim financial information	None
18		Letter re change in accounting principles	None
19		Reports furnished to security holders	None
22		Published report regarding matters submitted to vote of security holders	None
23		Consents	None
24		Power of Attorney	None
31.1		Rule 13a–14(a) Certification of Chief Executive Officer	31.1
31.2		Rule 13a–14(a) Certification of Chief Financial Officer	31.2
32		Section 1350 Certification	32
*	Filed as an exhibit to the Company's Form SB–2 registration statement filed on September 20, 2007 (File No.333–146196) pursuant to Section 5 of the Securities Act of 1933.
**	Filed as an exhibit to Pre-effective Amendment No. 1 to the Company's Form SB–2 registration statement filed on November 2, 2007 (File No.333–146196) pursuant to Section 5 of the Securities Act of 1933.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	SOUND FINANICAL, INC.
November 14, 2008	By:	/s/  Laura Lee Stewart
		Laura Lee Stewart
		President and Chief Executive Officer
November 14, 2008	By:	/s/  Matthew P. Deines
		Matthew P. Deines
		Executive Vice President and
		Chief Financial Officer

Exhibit Index

31.1	Rule 13a–14(a) Certification of Chief Executive Officer	31.1
31.2	Rule 13a–14(a) Certification of Chief Financial Officer	31.2
32	Section 1350 Certification	32