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 March 31,
2009





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
charter)





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





2005 5thAvenue, 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 if
the registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act.  YES [   ]  NO
[X]




Indicate by check mark if
the registrant is not required to file reports pursuant to Section 13 or Section
15(d) of the Act. YES [   ] NO [X]




Indicate by check mark
whether the registrant (1) has filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.   YES [X]  NO
[   ]




Indicate by check mark
whether the registrant has submitted electronically and posted on its corporate
Web site, if any, every Interactive Data File required to be submitted and
posted pursuant to Rule 405 of regulation S-T (§232.405 of this chapter) during
the proceeding 12 months (or for such shorter period that the registrant was
required to submit and post such files).  Yes
[   ]   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 “accelerated filer,” “large 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 smallerreporting
      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 ]




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









As
of May 11, 2008, there were issued and outstanding 3,000,095 shares of the
registrant’s common stock.








SOUND
FINANCIAL, INC.


FORM
10-Q


TABLE OF
CONTENTS





Page
      NumberPART
      IFINANCIAL INFORMATIONItem
      1.    Financial StatementsConsolidated Balance Sheets as
      of March 31, 2009 (unaudited) and December 31, 2008
            2Consolidated Statements of
      Income For the Three months Ended March 31, 2009 and 2008
      (unaudited)
            3Consolidated Statements of Cash
      Flows For the three Months Ended March 31, 2009 and 2008
      (unaudited)
            4Selected
      Notes to Consolidated Financial Statements
            5Item
      2.Management's Discussion and Analysis of Financial Condition and Results
      of Operations
            13Item
      3.Quantitative and Qualitative Disclosures About Market Risk
            19Item
      4.Controls and Procedures
            19PART
      IIOTHER INFORMATIONItem
      1.       Legal Proceedings
            20Item
      1A      Risk Factors
            20Item
      2.       Unregistered Sales of Equity
      Securities and Use of Proceeds
            20Item
      3.       Defaults Upon Senior
      Securities
            21Item
      4.       Submission of Matters to a Vote of
      Security Holders
            21Item
      5.       Other Information
            21Item
      6.       Exhibits
            22SIGNATURESEXHIBITS




















PART
I         FINANCIAL
INFORMATION





Item
1           Financial Statements





SOUND
FINANCIAL, INC. AND SUBSIDIARY


Consolidated
Balance Sheets


(Unaudited)


MARCH
      31,
                2009
              
              
              DECEMBER
      31,
                2008ASSETSCash
      and cash equivalents
              
              $
              6,418,754
              
              
              $
              5,607,800Securities
      available-for-sale (AFS), at fair value
              
              
              12,823,617
              
              
              
              8,929,798Federal
      home loan bank (FHLB) stock, at cost
              
              
              2,444,000
              
              
              
              2,444,000Loans
      held for sale
              
              
              4,223,500
              
              
              
              955,595Loans
              
              
              265,443,169
              
              
              
              263,712,797Less
      allowance for loan losses
              
              
              (1,472,334
              )
              
              
              (1,305,950
              )Total
      loans, net
              
              
              263,970,835
              
              
              
              262,406,847Accrued
      interest receivable
              
              
              1,355,157
              
              
              
              1,219,645Premises
      and equipment, net
              
              
              1,856,840
              
              
              
              1,545,705Bank-owned
      life insurance
              
              
              6,261,055
              
              
              
              6,195,055Mortgage
      servicing rights
              
              
              942,222
              
              
              
              863,146Other
      real estate owned
              
              
              1,671,911
              
              
              
              1,250,531Other
      assets
              
              
              1,441,747
              
              
              
              2,079,177Total
      assets
              
              $
              303,409,638
              
              
              $
              293,497,299


LIABILITIES


DepositsInterest-bearing
              
              $
              234,575,165
              
              
              $
              209,583,218Noninterest-bearing
      demand
              
              
              15,242,637
              
              
              
              13,176,999Total
      deposits
              
              
              249,817,802
              
              
              
              222,760,217FHLB
      advances
              
              
              25,000,000
              
              
              
              42,219,355Accrued
      interest payable
              
              
              252,014
              
              
              
              259,757Other
      liabilities
              
              
              2,252,684
              
              
              
              1,825,143Advance
      payments from borrowers for taxes and insurance
              
              
              568,661
              
              
              
              330,319Total
      liabilities
              
              
              277,891,161
              
              
              
              267,394,791COMMITMENTS ANDCONTINGENCIES (NOTE 4)STOCKHOLDERS'
      EQUITYPreferred
      stock, $0.01 par value, 1,000,000 shares authorized
              
              
              -
              
              
              
              -Common
      stock, $0.01 par value, 24,000,000 shares authorized, 3,000,095
                shares
      issued and 2,896,091 outstanding as of March 31, 2009, and
                2,948,063
      shares issued and 2,844,059 shares outstanding as of
                December
      31, 2008
              
              
              30,001
              
              
              
              29,480Additional
      paid-in capital
              
              
              11,773,001
              
              
              
              11,936,035Unearned
      shares - Employee Stock Ownership Plan (“ESOP”)
              
              
              (1,040,040
              )
              
              
              (1,057,997
              )Retained
      earnings
              
              
              16,009,461
              
              
              
              15,987,547Accumulated
      other comprehensive loss, net of tax
              
              
              (1,253,946
              )
              
              
              (792,557
              )Total
      stockholders’ equity
              
              
              25,518,477
              
              
              
              26,102,508Total
      liabilities and stockholders’ equity
              
              $
              303,409,638
              
              
              $
              293,497,299




See notes to consolidated financial
statements.






2






SOUND
FINANCIAL, INC. AND SUBSIDIARY


Consolidated
Statements of Income and Comprehensive Loss


(Unaudited)





THREE
      MONTHS ENDEDMARCH
      31,2009
                  
                  
                  2008INTEREST
      INCOMELoans,
      including fees
                  
                  $
                  4,354,335
                  
                  
                  $
                  3,772,432Interest
      and dividends on investments, cash and cash equivalents
                  
                  
                  183,267
                  
                  
                  
                  56,512Total
      interest income
                  
                  
                  4,537,602
                  
                  
                  
                  3,828,944INTEREST
      EXPENSEDeposits
                  
                  
                  1,655,966
                  
                  
                  
                  1,708,104FHLB
      advances
                  
                  
                  251,707
                  
                  
                  
                  221,823Total
      interest expense
                  
                  
                  1,907,673
                  
                  
                  
                  1,929,927NET
      INTEREST INCOME
                  
                  
                  2,629,929
                  
                  
                  
                  1,899,017PROVISION
      FOR LOAN LOSSES
                  
                  
                  450,000
                  
                  
                  
                  160,000NET
      INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
                  
                  
                  2,179,929
                  
                  
                  
                  1,739,017NONINTEREST
      INCOMEService
      charges and fee income
                  
                  
                  513,356
                  
                  
                  
                  491,320Earnings
      on cash surrender value of bank-owned life insurance
                  
                  
                  66,000
                  
                  
                  
                  38,012Mortgage
      servicing income
                  
                  
                  174,918
                  
                  
                  
                  103,100Gain
      on sale of investment
                  
                  
                  -
                  
                  
                  
                  153,633Loss
      on sale of assets
                  
                  
                  (192,864
                  )
                  
                  
                  (28,775
                  )Gain
      (loss) on sale of loans
                  
                  
                  23,984
                  
                  
                  
                  (26,276
                  )Total
      noninterest income
                  
                  
                  585,394
                  
                  
                  
                  731,014NONINTEREST
      EXPENSESalaries
      and benefits
                  
                  
                  1,397,815
                  
                  
                  
                  1,116,612Operations
                  
                  
                  809,744
                  
                  
                  
                  688,937Charitable
      contributions
                  
                  
                  17,186
                  
                  
                  
                  213,551Occupancy
                  
                  
                  270,176
                  
                  
                  
                  226,991Data
      processing
                  
                  
                  188,773
                  
                  
                  
                  226,015Total
      noninterest expense
                  
                  
                  2,683,694
                  
                  
                  
                  2,472,106INCOME
      (LOSS) BEFORE PROVISION(BENEFIT)
      FOR INCOME TAXES
                  
                  
                  81,629
                  
                  
                  
                  (2,075
                  )PROVISION
      (BENEFIT) FOR INCOME TAXES
                  
                  
                  6,650
                  
                  
                  
                  (19,500
                  )NET
      INCOME
                  
                  $
                  74,979
                  
                  
                  $
                  17,425UNREALIZED
      LOSS ON AVAILABLE-FOR-SALE SECURITIES
                  
                  
                  (461,389
                  )
                  
                  
                  (63,823
                  )OTHER COMPREHENSIVE
      LOSS, NET OF TAX
                  
                  
                  (386,410
                  )
                  
                  
                  (46,398
                  )BASIC
      EARNINGS PER SHARE
                  
                  $
                  0.03
                  
                  
                  $
                  0.01DILUTED
      EARNINGS PER SHARE
                  
                  $
                  0.03
                  
                  
                  $
                  0.01


See
notes to consolidated financial statements


3


SOUND
FINANCIAL, INC. AND SUBSIDIARY


Consolidated
Statements of Cash Flows


(Unaudited)


THREE
      MONTHS ENDEDMARCH
      31,2009
              
              
              2008CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      income
              
              $
              74,979
              
              
              $
              17,425Adjustments
      to reconcile net income to net cash
                from
      operating activitiesAccretion
      of discount on investments
              
              
              (33,627
              )
              
              
              (4,315
              )Provision
      for loan losses
              
              
              450,000
              
              
              
              160,000Depreciation
      and amortization
              
              
              113,421
              
              
              
              93,828Additions
      to mortgage servicing rights
              
              
              (211,609
              )
              
              
              (88,302
              )Amortization
      of mortgage servicing rights
              
              
              132,533
              
              
              
              67,726Stock-based
      compensation expense
              
              
              30,000
              
              
              
              -Increase
      in cash surrender value of bank owned life insurance
              
              
              (66,000
              )
              
              
              (38,012
              )Proceeds
      from sale of mortgage loans
              
              
              21,883,576
              
              
              
              8,344,592Originations
      of mortgage loans held for sale
              
              
              (25,175,465
              )
              
              
              (10,868,942
              )Loss
      on sale of other real estate owned
              
              
              25,716
              
              
              
              28,775(Gain)
      loss on sale of loans
              
              
              23,984
              
              
              
              26,276Changes
      in operating assets and liabilities:Accrued
      interest receivable
              
              
              (135,512
              )
              
              
              (6,839
              )Other
      assets
              
              
              875,115
              
              
              
              687,390Accrued
      interest payable
              
              
              (7,743
              )
              
              
              35,123Accounts
      payable and other liabilities
              
              
              397,540
              
              
              
              1,534Net
      cash from operating activities
              
              
              (1,623,092
              )
              
              
              (1,543,741
              )CASH
      FLOWS FROM INVESTING ACTIVITIESProceeds
      from maturities of available for sale investments
              
              
              377,585
              
              
              
              10,625Purchase
      of available for sale investments
              
              
              (4,936,851
              )
              
              
              (4,991,291
              )Net
      increase in loans
              
              
              (2,643,270
              )
              
              
              (8,979,972
              )Net
      improvements to other real estate owned
              
              
              (15,345
              )
              
              
              (108,678
              )Proceeds
      from sale of other real estate owned
              
              
              197,532
              
              
              
              195,419Purchases
      of premises and equipment
              
              
              (424,556
              )
              
              
              (133,498
              )Net
      cash from investing activities
              
              
              (7,444,905
              )
              
              
              (14,007,395
              )CASH
      FLOWS FROM FINANCING ACTIVITIESNet
      increase in deposits
              
              
              27,057,585
              
              
              
              (3,248,494
              )Proceeds
      from FHLB advances
              
              
              -
              
              
              
              10,000,000Repayment
      of FHLB advances
              
              
              (17,219,355
              )
              
              
              (150,000
              )Net
      proceeds from stock issuance
              
              
              -
              
              
              
              10,809,915Repurchase
      of common stock
              
              
              (144,556
              )
              
              
              -Cash
      dividends paid
              
              
              (53,065
              )Net
      change in advances from borrowers for taxes and insurance
              
              
              238,342
              
              
              
              193,779Net
      cash from financing activities
              
              
              9,878,951
              
              
              
              17,605,200INCREASE
      (DECREASE) IN CASHAND
      CASH EQUIVALENTS
              
              
              810,954
              
              
              
              2,054,064CASH
      AND CASH EQUIVALENTS, beginning of period
              
              
              5,607,800
              
              
              
              6,104,963CASH
      AND CASH EQUIVALENTS, end of period
              
              $
              6,418,754
              
              
              $
              8,159,027SUPPLEMENTAL
      CASH FLOW INFORMATIONInterest
      paid on deposits and FHLB advances
              
              $
              1,915,416
              
              
              $
              1,894,804Net
      transfer of loans to other real estate owned
              
              $
              629,283
              
              
              $
              272,984




See
notes to consolidated financial statements.






4






SOUND
FINANCIAL, INC. AND SUBSIDIARY


SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





Note
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 (“the
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, 2008, 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 thecurrentpresentation.  These
classifications do not have animpacton previously reported net income,
retained earnings or earnings per share.





Note
2 – Newly Issued But Not Yet Effective Accounting Standards





In
April 2009, the FASB issued the following three FASB Staff Positions
(“FSPs”) intended to provide additional application guidance and enhance
disclosures regarding fair value measurements and impairments of
securities:




FSP
Statement of Financial Accounting Standards (“SFAS”) 157-4, “Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly,” provides
additional guidance for estimating fair value in accordance with SFAS
No. 157 when the volume and level of activity for the asset or liability
have decreased significantly.  FSP FAS 157-4 also provides guidance on
identifying circumstances that indicate a transaction is not orderly.  The
provisions of FSP FAS 157-4 are effective for the Company’s interim period
ending on June 30, 2009.  Management is currently evaluating the
effect that the provisions of FSP FAS 157-4 may have on our consolidated balance
sheets and statements of income.




FSP SFAS
107-1 and Accounting Principals Board (“APB”) 28-1, “Interim Disclosures about Fair
Value of Financial Instruments,” requires disclosures about fair value of
financial instruments in interim reporting periods of publicly traded companies
that were previously only required to be disclosed in annual financial
statements.  The provisions of FSP SFAS 107-1 and APB 28-1 are effective
for the Company’s interim period ending on June 30, 2009.  As FSP SFAS
107-1 and APB 28-1 amends only the disclosure requirements about fair value of
financial instruments in interim periods, the adoption of FSP SFAS 107-1 and APB
28-1 is not expected to affect our consolidated balance sheets or statements of
income.




FSP SFAS
115-2 and SFAS 124-2, “Recognition and Presentation of
Other-Than-Temporary Impairments,” amends current other-than-temporary
impairment guidance in GAAP for debt securities to make the guidance more
operational and to improve the presentation and disclosure of
other-than-temporary impairments on debt and equity securities in the financial
statements.  This FSP does not amend existing recognition and measurement
guidance related to other-than-temporary impairments of equity securities. 
The provisions of FSP SFAS 115-2 and SFAS 124-2 are effective for the Company’s
interim period ending on






5








SOUND
FINANCIAL, INC. AND SUBSIDIARY


SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





June 30,
2009.  Management is currently evaluating the effect that the provisions of
FSP SFAS 115-2 and SFAS 124-2 may have on our consolidated balance sheets and
statements of income.





Note 3
– Fair Value Measurements





SFAS 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.  SFAS 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:





Available
for Sale Securities: Available for sale securities 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 certain collateralized
mortgage obligations (CMOs).








6








SOUND
FINANCIAL, INC. AND SUBSIDIARY


SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





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 March 31, 2009, loans held for sale were
carried at cost.





Mortgage
Servicing Rights:The fair value
of mortgage servicing rights is estimated using a discounted cash flow
model. These assets are classified as Level 2.  At March 31,
2009, 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.




Other Real Estate Owned (“OREO”): OREOconsists 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 March 31, 2009:


Fair
      Value at March 31, 2009Description
                                  Total
                                  
                                  Level
      1
                                  
                                  Level
      2
                                  
                                  Level
      3Available
      for Sale Securities
                                  $12,823,617
                                  
                                  -
                                  
                                  $9,246,747
                                  
                                  $3,576,870





The
following table presents the balance of assets measured at fair value on a
nonrecurring basis at March 31, 2009, and the total losses resulting from these
fair value adjustments for the three months ended March 31, 2009:





Fair
      Value at March 31, 2009
              
              Three
      Months
                EndedMarch
      31, 2009Description
              Total
              
              Level
      1
              
              Level
      2
              
              Level
      3
              
              Total
      LossesLoans
      Held for Sale
              $4,223,500
              
              -
              
              $4,223,500
              
              -
              
              -Mortgage
      Servicing Rights
              $942,222
              
              -
              
              $942,222
              
              -
              
              -OREO
      and Foreclosed Assets
              $2,021,583
              
              -
              
              -
              
              $2,021,583
              
              $   25,715Impaired
      Loans
              $9,837,026
              
              -
              
              -
              
              $9,837,026
              
              $
      283,816Total
              $17,024,331
              
              -
              
              $5,165,722
              
              $11,858,609
              
              $
      309,531





The loss represents impairments on
collateral dependent loans,
OREO, and foreclosed assetsfor fair value adjustments based on the fair value of the collateral. 
Foreclosed assets are included in other assets on the consolidated balance
sheet.





There
were no material liabilities carried at fair value, measured on a recurring or
nonrecurring basis, at March 31, 2009.







7





SOUND
FINANCIAL, INC. AND SUBSIDIARY


SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)







Note
4 – Commitments 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.





Note5– 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.




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 in 2008.  As of March 31, 2009,
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.




In December 2008, Visa deposited
additional funds into the escrow account to cover the remaining amount of the
settlement.  The deposit of funds into the escrow account further
reduced the conversion ratio applicable to Class B common stock outstanding from
0.71429 per Class A share to 0.6296 per Class A share.





As of March 31, 2009, the value of the
Class A shares was $55.60 per share.  The value of unredeemed Class A
equivalent shares owned by the Company was $199,000, and has not been reflected
in the accompanying financial statements.







8





SOUND
FINANCIAL, INC. AND SUBSIDIARY


SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





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.







Note
6 - Loans




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


March
      31,
                        2009
                      
                      
                      December
      31,
                        2008Real
      estate loansOne-
      to four-family
                      
                      $
                      91,679,541
                      
                      
                      $
                      89,907,581Home
      equity
                      
                      
                      52,649,263
                      
                      
                      
                      54,556,779Commercial
                      
                      
                      52,121,954
                      
                      
                      
                      48,729,582Construction
      or development
                      
                      
                      12,890,814
                      
                      
                      
                      12,220,170209,341,572
                      
                      
                      
                      205,414,112Consumer
      loansManufactured
      homes
                      
                      
                      22,314,208
                      
                      
                      
                      22,722,664Automobile
                      
                      
                      9,044,992
                      
                      
                      
                      10,079,522Other
                      
                      
                      7,377,234
                      
                      
                      
                      7,871,02238,736,434
                      
                      
                      
                      40,673,208Commercial
      business loans
                      
                      
                      17,463,101
                      
                      
                      
                      17,667,965Deferred
      loan origination fees
                      
                      
                      (97,938
                      )
                      
                      
                      (42,488
                      )Allowance
      for loan losses
                      
                      
                      (1,472,334
                      )
                      
                      
                      (1,305,950
                      )Total
      loans, net
                      
                      $
                      263,970,835
                      
                      
                      $
                      262,406,847


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




Three
      Months Ended
                March
      31,2009
              
              2008Balance
      at beginning of period
              $
      1,305,950
              
              $    827,688Provision
      for loan losses
              450,000
              
              160,000Recoveries
              27,293
              
              42,988Charge-offs
              (310,909)
              
              (153,849)Balance
      at end of period
              $
      1,472,334
              
              $
      876,827







9






SOUND
FINANCIAL, INC. AND SUBSIDIARY


SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





As of
March 31, 2009 impaired loans without a valuation allowance were $6.6 million
and impaired loans with a valuation allowance were $3.2 million.  The
valuation allowance related to impaired loans totaled $675,000 as of March 31,
2009.  Forgone interest on nonaccrual loans for the three months ended
March 31, 2009 was
$61,000.  Included in impaired loans at March 31, 2009 were troubled
debt restructurings of $2.6 million.  Additionally, at March 31, 2009,
there were no commitments to lend additional funds to borrowers whose loans were
classified as non-accrual or impaired.





There
were $4.6 million of impaired loans at December 31, 2008 with a total specific
allocation of the allowance for loan losses of $581,000.  The average
balance of impaired loans was $4.0 million during 2008. Forgone interest on
nonaccrual loans was $56,000 during 2008. Included in impaired loans at December
31, 2008 were troubled debt restructurings of $550,000.





Note
7 - FHLB Advances





The 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 March 31, 9, 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 $25.0 million and $42.2 million at March
31, 9, and December 31, 8, respectively.




Note
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 were 2,845,504 and 2,594,032 shares for the three month
periods ended March 31, 2009 and 2008, respectively.  ESOP shares are
considered outstanding for this calculation, unless unearned.  Diluted
earnings per share is net income divided by the weighted average number of
common shares outstanding, including dilutive restricted stock, during the
periods which were 2,897,536 and 2,594,032 shares for the three month periods
ended March 31, 2009 and 2008, respectively.  There were outstanding
options to purchase 108,398, and 0 shares of common stock at March 31, 2009 and
2008, respectively that were considered antidilutive and were therefore excluded
from the diluted earnings per share calculation.





Note9- Stock-Based
Compensation




In
November 2008, the Company’s shareholders approved the Sound Financial, Inc.
2008 Equity Incentive Plan (“Plan”).  The Plan provides for the grant
of stock options, awards of restricted stock and stock appreciation
rights.  Total compensation cost that has been charged against income
for the Plan and the related income tax benefit was $30,000 and $10,000,
respectively, for the three months ended March 31, 2009.




Stock
Options




The Plan
authorized the grant of stock options for up to 144,455 shares to its directors,
officers and employees.  Option awards are granted with an exercise
price of common stock equal to the market price of the Company’s common stock at
the date of grant.  These option awards have a vesting period of no
less than five years, with 20% vesting on the anniversary date of each grant
date, and a contractual life of ten years.  Any unexercised stock
options expire ten years after the grant date or one year after employment or
service ends.  The Company has a policy of issuing new shares upon
exercise.  Options for 108,398 shares of common stock were issued in
January 2009.  Options for 36,057 shares of common stock remain
available for grant under the Plan.






10








SOUND
FINANCIAL, INC. AND SUBSIDIARY


SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





The fair
value of each option award is estimated on the date of grant using a
Black-Scholes model that uses the assumptions noted in the table
below.  The dividend yield is based on the current quarterly dividend
in effect at the time of the grant.  Since the Company became a
publicly-held company in January 2008, the amount of historical stock price
information is limited.  As a result, the Company elected to use a
weighted-average of its peers’ historical stock prices as well as the Company’s
own historical stock prices to estimate volatility.  The


Company
bases the risk-free interest rate on the U.S. Treasury Constant Maturity Indices
in effect on the date of the grant.  The Company elected to use the
Staff Accounting Bulletin No. 107, “Share-Based Payments” permitted by the
Securities and Exchange Commission to calculate the expected
term.  This method uses the vesting term of an option along with the
contractual term, setting the expected life at a midpoint in
between.




The fair
value of options granted during 2009 was determined using the following
weighted-average assumptions as of the grant date.




Annual
      dividend yield
              
              2.20
              %Expected
      volatility
              
              30.00
              %Risk-free
      interest rate
              
              2.09
              %Expected
      term
              
              7.5
      yearsWeighted-average
      grant date fair value per option granted
              
              $2.56




A summary
of the Company’s stock option plan awards during the three month ended March 31,
2009 follows:




Weighted-
                AverageWeighted-
                Average
              
              
              Remaining
                ContractualShares
              
              
              Exercise
      Price
              
              
              Term
      in YearsOutstanding
      at the beginning of the year
              
              
              -
              
              
              $
              -Granted
              
              
              108,398
              
              
              
              7.93Exercised
              
              
              -
              
              
              
              -Forfeited
      or expired
              
              
              -
              
              
              
              -Outstanding
      at March 31, 2009
              
              
              108,398
              
              
              $
              7.93
              
              
              
              9.83Expected
      to vest assuming a 0% forfeiture rate over the vesting
term
              
              
              108,398
              
              
              $
              7.93
              
              
              
              9.83




As of
March 31, 2009, there was $264,000 of total unrecognized compensation cost
related to nonvested stock options granted under the Plan.  The cost
is expected to be recognized over the remaining weighted-average vesting period
of 9.83 years.  No options were exercisable at March 31,
2009.






11








SOUND
FINANCIAL, INC. AND SUBSIDIARY


SELECTED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





Restricted
Stock Awards




The Plan
authorized the grant of restricted stock awards amounting to 57,782 shares to
directors, officers and employees.  Compensation expense is recognized
over the vesting period of the awards based on the fair value of the stock at
the date of grant.  The restricted stock awards’ fair value is equal
to the value on the date of grant.  Shares awarded as restricted stock
vest ratably over a five year period beginning at the grant date with 20%
vesting on the anniversary date of each grant date.  In January 2009,
52,032 shares of restricted stock were issued.  There are 5,750 shares
available under the Plan for additional restricted stock awards.  In
November 2008, the Board of Directors authorized management to repurchase up to
57,782 shares of the Company’s outstanding stock over a twelve-month period in
order to fund the restricted stock awards made under the Plan.  As of
March 31, 2009, 20,200 shares have been repurchased under that repurchase
plan.




A summary
of the Company’s nonvested restricted stock awards for the quarter ended March
31, 2009 follows:





Nonvested Shares
                        
                        Shares
                        
                        
                        Weighted-
                          Average
                          Grant-Date
                          Fair Value(Dollars
      in thousands, except share data)Nonvested
      at January 1, 2009
                        
                        
                        -
                        
                        
                        
                        -Granted
                        
                        
                        52,032
                        
                        
                        $
                        7.35Vested
                        
                        
                        -
                        
                        
                        
                        -Forfeited
                        
                        
                        -
                        
                        
                        
                        -Nonvested
      at March 31, 2009
                        
                        
                        52,032
                        
                        
                        $
                        7.35Expected
      to vest assuming a 0% forfeiturerate
      over the vesting term
                        
                        
                        52,032




As of March 31, 2009,
there were $365,000 of unrecognized compensation cost related to non-vested
restricted stock granted under Plan.  The cost is expected to be recognized
over the weighted-average veseting period of 4.83 years.







Note
10 – Subsequent Events





On April
29, 2009, we entered into a Purchase and Sales
Agreement with 1st Security Bank of Washington (“1st Security”) whereby we
agreed to purchase the assets and deposit-related liabilities of the Port
Angeles 1st Security branch.  The transaction is expected to close on
or around June 26, 2009, subject to regulatory approval.  As of March
31, 2009, total deposits to be acquired were approximately $21
million.  We will also acquire related personal overdraft lines of
credit of approximately $200,000.  We will also acquire the real and
personal property of the 1st Security branch located at 1405 Front Street, Port
Angeles, WA 98362.








12










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





Forward-Looking
Statements





This Form 10-Q contains various
forward-looking statements that are based on assumptions and describe our future
plans and strategies and our expectations.  These forward-looking
statements are generally identified by words such as “believe,” “expect,”
“intend,” “anticipate,” “estimate,” “project,” or similar words.  Our
ability to predict results or the actual effect of future plans or strategies is
uncertain.  Factors which could cause actual results to differ
materially from those estimated include, but are not limited to, changes in
interest rates, general economic conditions, legislative/regulatory changes,
monetary and fiscal policies of the U.S. Government, including policies of the
U.S. Treasury and the Federal Reserve Board, the quality and composition of our
loan and investment portfolios, demand for our loan products, deposit flows, our
operating expenses, competition, demand for financial services in our market
areas and accounting principles and guidelines.  These risks and
uncertainties should be considered in evaluating forward-looking statements, and
you should not rely too much on these statements.  We do not
undertake, and specifically disclaim, any obligation to publicly revise any
forward-looking statements to reflect events or circumstances after the date of
such statements or to reflect the occurrence of anticipated or unanticipated
events.





General




Sound
Financial Inc. was incorporated on January 8, 2008, to hold all of the stock of
the Bank, which converted from a state-charted credit union to a federally
chartered savings bank in 2003.  Prior to that conversion, the Bank
operated as Credit Union of the Pacific.




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 $1,005,000
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 $2,792,000 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 residential 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 $25.2 million and $10.9
million in one- to four-family residential mortgage loans during the three
months ended March 31, 2009 and 2008, respectively.  During these same
periods, we sold $21.9 million and $8.3 million, respectively, of one- to
four-family residential mortgage loans.






13






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 FHLB
advances to augment our deposits and fund the growth of interest earning
assets.  We have implemented a strategy to use long-term FHLB advances
to fund asset and loan growth and short-term FHLB advances to meet short-term
liquidity needs.




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.




See
“Difficult market conditions and economic trends have adversely affected our
industry and our business.” and “Recent legislative and regulatory initiatives
to address these difficult market and economic conditions may not stabilize the
U.S. banking system.” in Item 7 of our Form 10-K Annual Report for the year
ended December 31, 2008 for information about economic conditions and recent
Federal laws and regulations that impact our operations in 2009.




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, other real estate owned, and deferred tax asset
accounts.  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 are described in our
Form 10-K Annual Report for the year ended December 31, 2008.




Comparison
of Financial Condition at March 31, 2009 and December 31, 2008




General.  Total assets
increased by $9.9 million, or 3.4%, to $303.4 million at March 31, 2009 from
$293.5 million at December 31, 2008.  The increase was primarily the
result of a $4.8
million, or 1.8%, increase in our loan portfolio, including loans held for sale,
from $263.4 million at December 31, 2008 to $268.2 million at March 31,
2009.  The increase also was the result of a $4.8 million increase in
cash, cash equivalents and securities during the first three months of
2009.  This increase in total assets was funded primarilyby a $27.3
million net increase in deposits during the three months ended March 31,
2009.




Loans.  Our
loan portfolio,
including loans held for sale, increased $4.8 million, or 1.8%, to $268.2million atMarch 31, 2009, from $262.4 million
at December 31, 2008.  This
increase in our loan portfolio consisted primarily of a $3.4 million (7.0%)
increase in commercial real estate loans, a$1.7 million (2.0%) increase in one- to
four-family loans,which was offset
by a $1.9 million (4.7%) decrease in consumer loans and a $1.9 million (3.5%)
decrease in home equity loans.  The $3.4 million, or 7.0%, increase in commercial
real estate loans during the three months ended March 31, 2009 is consistent
with our strategy to diversify our loan portfolio and increase the amount of
generally higher-yielding commercial loans in our portfolio.  The $1.9
million or 3.5% decrease in home equity loans is primarily a result of consumers
taking advantage of historically low interest rates and refinancing their
homes.  The $1.9 million or 4.8% decrease in consumer loans is a
result of the general state of the economy which is heavily impacting auto, RV,
and other consumer purchases.  The overall slowdown in the national
housing market and the pressures of the sub-prime market failures have begun to
have an impact on housing and employment in the Puget Sound area.






14






Allowance for
Loan Losses.  Our allowance for loan losses at March 31, 2009,
was $1.5 million, or 0.55%, of netloansreceivable, compared
to $1.3 million, or 0.50%, of netloansreceivable at
December 31, 2008.  The increase in the
allowance for loan losses was due toa $450,000 provision for
loan losses recorded during the three months ended March 31, 2009, partiallyoffset by net
charge-offs of non-performing loans totaling$311,000.  This provision was made as a result of increases in
our commercial and first mortgage loan portfolios in the 2009 period, as
compared to the 2008 period and an evaluation of prevailing housing and other
market conditions.  Non-performing loans increased to $1.4 million at
March 31, 2009, from $1.3 million at December 31,
2008.  Non-performing loans to total loans increased to 0.53% at March
31, 2009, from 0.48% at December 31, 2008.  Other real estate owned
increased by $421,000, or 33.7% to $1.7 million at March 31, 2009, compared to
$1.3 million as of December 31, 2008.  This increase is a result of
three additional properties taken back by the Bank in the quarter and only one
sale.  The Company believes that higher non-performing assets and
charge-offs will continue going forward until the housing market and general
market conditions begin to recover.




Cash, Cash
Equivalents and Securities.  Cash and cash equivalents
increased by $811,000, or 14.4%, to $6.4 million at March 31,
2009.  Our securities portfolio consists of mortgage-backed
securities, all of which are designated as available-for-sale and FHLB stock,
which is carried at cost.  The securities portfolio increased by $3.9
million, or 34.2%, to $15.3 million at March 31, 2009 from $11.4 million at
December 31, 2008.  This increase reflects the purchase of agency
mortgage-backed securities, which were obtained as collateral for public
deposits.  Included in our investment portfolio are $6.9 million in
non-agency mortgage-backed securities.  These 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 the
risk of these securities, 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 March 31,
2009.




Deposits.  Total
deposits increased by $27.0 million, or 12.3%, to $249.8 million at March 31,
2009, from $222.8 million at December 31, 2008.  Time deposits
increased $19.6 million, while savings and money market accounts increased $6.1
million. Demand deposits and interest-bearing checking accounts increased
$392,000 during the three months ended March 31, 2009.  The increase
in time deposits, savings and money market accounts reflect a bank-wide emphasis
to generate additional low-cost deposits.




Borrowings.  Federal
Home Loan Bank advances decreased $17.2 million, or 41.1%, to $25.0 million at
March 31, 2009 from $42.2 million at December 31, 2008.  These
paydowns were a result of our deposit growth which allowed the Bank to pay off
its entire balance of short-term advances.  The weighted average cost
of new borrowings as of March 31, 2009 was 3.66%, while our weighted average
cost of deposits was 2.64% at that date.




Equity.  Total
equity decreased $584,000, or 2.2%, to $25.5
million at March 31, 2009, from $26.1 million at December 31,
2008.  This reflects a $461,000 increase in accumulated other
comprehensive loss and a $144,000 decrease in paid in capital.  The
decrease in paid in capital was a result of the repurchase of approximately
20,200 shares in conjunction with the Bank’s 2008 Equity Incentive
Plan.






15






Comparison
of Results of Operation for the Three Months Ended March 31, 2009 and
2008




General.  Net
income increased $58,000 to $75,000 for the three months ended March 31, 2009,
compared to $17,000 for the three months ended March 31, 2008.  The primary reasons for thisincreasewasa $441,000
increase in net interest income after provision for loan losses, which was
offset by a $146,000 decrease in non-interest income and a $212,000 increase in
non-interest expense.




Interest
Income.  Interest income increased by $709,000, or 18.5%, to
$4.5 million for the three months ended March 31, 2009 from $3.8 million for the
three months ended March 31, 2008.  The increase in interest income
for the period reflects higher overall loan balances, strong residential
refinance activity, an increase in the amount of commercial loans at generally
higher rates, and higher securities balances during the 2009 period.




The
weighted average yield on loans decreased from 6.72% for the three months ended
March 31, 2008, to 6.60% for the three months ended March 31,
2009.  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 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 and our ability to
manage credit risk.




Interest
Expense.  Interest expense decreased $22,000, or 1.1%, to $1.9
million for the three months ended March 31, 2009, from $1.9 million for the
three months ended March 31, 2008.  The decrease for the period
resulted primarily from the lower interest rates paid on deposits as a result of
the falling interest rate environment.  The decrease in interest
expense for the 2009 period reflects lower interest rates paid on new and
renewed certificates of deposit and money market accounts in the current
interest rate environment but was partially offset by increased borrowing costs
on our FHLB advances.  Our weighted average cost of interest-bearing
liabilities was 2.8% for the three months ended March 31, 2009, compared to 3.6%
for the same period in 2008.




Interest
paid on deposits decreased $52,000, or 3.1%, to $1.7 million for the three
months ended March 31, 2009, as compared to $1.7 million for the three months
ended March 31, 2008.  The decrease for the three month period
resulted primarily from a decrease in the weighted average cost of deposits. We
experienced a 76 basis point decrease in the average rate paid on deposits
during the three months ended March 31, 2009 compared to the same period in
2008.  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 as well as lower interest rates paid on savings and
money market accounts.




Interest
expense on FHLB advances increased $30,000, or 13.5%, to $252,000 for the three
months ended March 31, 2009 from $222,000 for the three months ended March 31,
2008.  The increase resulted from an increase in the average balance
of outstanding FHLB advances of $9.4 million, to $29.9 million for the three
months ended March 31, 2009, from $20.5 million for the three months ended March
31, 2008.




Net Interest
Income.  Net interest income increased $731,000, or 38.5%, to
$2.6 million for the three months ended March 31, 2009, from $1.9 million for
the three months ended March 31, 2008.  The increase in net interest
income for the three-month period primarily
resulted from higher yields earned on our
expanding
commercial loan portfolio, increased income from
investments, and decreased interest expense on deposits as a result of the
falling interest rate environment.Our net
interest margin was 3.8% for the three months ended March 31, 2009,which is an
increase from the 3.4% for the three months ended March 31, 2008.






16






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 other 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 $450,000 was made during
the three months ended March 31, 2009, compared to provision of $160,000 during
the three months ended March 31, 2008.  The higher provision was
primarily attributable toincreases innet charge-offs, increases in our commercial
loan portfolio,
an increase in our overall loan portfolio and a decline in market
conditions in the areas where we do business.




At March
31, 2009, the annualized ratio of net charge-offs to average loans increased 23
basis points to 0.43% from 0.20% at March 31, 2008.  The ratio of
non-performing loans to total loans increased from 0.04% at March 31, 2008 to
1.14% at March 31, 2009.




Noninterest
Income.  Noninterest income decreased $146,000, or 19.9%, to
$585,000 for the three months ended March 31, 2009, from $731,000 for the three
months ended March 31, 2008.  The primary reasons for this
decrease was an increase in losses on sale of repossessed assets of
$193,000 and a $154,000 decrease in gains on investment sales which were
partially offset by a $72,000 increase in the mortgage servicing income as a
result of a recent increase in refinance mortgages due to the historically low
interest rate environment, a $50,000 increase in the gain on loans sold to
Fannie Mae, a $28,000 increase in the cash surrender value of BOLI and a
$122,000 increase in service charges and fee income.




The
decrease of $154,000 in gains on investment sales was primarily a result of 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 0.6296 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 Discoversettlement.  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 March 31,
2009, they would have a market value of approximately $199,000.




Noninterest
Expense.  Noninterest expense increased $212,000, or 8.6%, to
$2.7 million for the three months ended March 31, 2009, compared to $2.5 million
for the three months ended March 31, 2008.  The increase in the period
was primarily the result of an increase in salaries and benefits of
$281,000.  This increase was due to additional FTE’s compared to 2008
as well as expenses related to the 2008 Equity Incentive Plan.  These
increases were offset by a $196,000 decrease in charitable expenses and a
$37,000 decrease in data processing expenses resulting from streamlining certain
data processing functions.  The charitable expenses from the prior
period were 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).




Income Tax
Expense (Benefit).  For the three months ended March 31, 2009,
we incurred income tax expense of $6,650 on our pre-tax income as compared to an
income tax benefit of $19,500 for the three month period ended March 31,
2008.






17






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 March 31, 2009, is as follows:




Off-balance sheet loan
      commitments:Commitments
      to make loans
              $  11,949,000Undisbursed
      portion of loans closed
              2,549,000Unused
      lines of
      credit
              31,081,000Irrevocable
      letters of credit
              1,858,000Total
      loan
      commitments
              $47,437,000





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 maintainadequateliquidity to ensure safe and sound
operation and meet demands for funds (particularly withdrawals of
deposits).At
March 31, 2009, the Company had $19.2 million in cash and investment securities
available for sale and $4.2 million in loans held for sale which are generally
available for its short-term cash needs.We can also generate funds from
borrowings, primarily FHLB.  AtMarch 31, 2009, the Bank had the ability to borrow an
additional $40.7million in FHLB advances.




At March 31, 2009, we had $47.4 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 March 31, 2009, totaled $115.6 million and have a
weighted average cost of 3.7%.  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.




Capital




The Bank
is subject to minimum capital requirements imposed by the Office of Thrift
Supervision (“OTS”).  Based on its capital levels at March 31, 2009,
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 March 31, 2009, 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.







18









The
following table shows the capital ratios of the Bank at March 31,
2009:




Actual
            Minimum Capital
                Requirements
            Minimum Required to
                Be Well-Capitalized
                Under Prompt
                Corrective
                Action
      ProvisionsAmount
            Ratio
            Amount
            Ratio
            Amount
            Ratio(Dollars in
      thousands)Core Capital
              (to total adjusted 
      assets)
            $25,492
            8.40%
            $12,137
            4.00%
            $15,172
            5.00%Core Capital
              (to risk-weighted assets)
            $25,492
            11.98%
            $8,508
            4.00%
            $12,762
            6.00%Risk-Based Capital
              (to risk-weighted
      assets)
            $26,964
            12.68%
            $17,016
            8.00%
            $21,270
            10.00%





Item
3     Quantitative and Qualitative Disclosures
About Market Risk





Not
required; the Company is a smaller reporting company.




Item
4     Controls and
Procedures





(a)
            Evaluation of Disclosure 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 ofMarch 31, 2009, 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 ofMarch 31, 2009, 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.




Weintend to continually review and
evaluate the design and effectiveness ofthe Company’sdisclosure controls and procedures and
to improvethe
Company’scontrols and
procedures over time and to correct any deficiencies thatwemay 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. Whilewebelieve the present design ofthedisclosure controls and procedures is
effective to achievethisgoal, future events affectingourbusiness 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.






19






(b)
            Changes in Internal Controls over
      Financial Reporting.






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 endedMarch 31, 2009, that has materially affected, or is
likely to materially affect our internal control over financial
reporting.






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





On November 24, 2008, the Company
announced that its Board of Directors had authorized management to repurchase up
to 57,782 shares of the Company’s outstanding stock over a twelve-month
period.  The repurchased shares were to be used to fund the restricted
stock portion of our 2008 Equity Incentive Plan.







20









Information on the shares repurchased
under this repurchase plan during the first quarter of 2009 is as
follows:


Total
      Number
                          of
      Shares
                          Purchased
                        
                        Average
                          PricePer
                          Share
                        
                        Total
      Number of
                          Shares
      Purchased as
                          Part
      of Publicly
                          Announced
      Plan
                        
                        Minimum
      Number of
                          Shares
      that May Yet
                          Be
      Purchased
                          Under
      the Plan57,782
                        (1)January
      1 - 31, 2009
                        19,200
                        
                        $    7.08
                        
                        19,200
                        
                        38,582February
      1 - 28, 2009
                        1,000
                        
                        7.10
                        
                        1,000
                        
                        37,582March
      1 - 31, 2009
                        -
                        
                        -
                        
                        -
                        
                        37,58220,200
                        
                        $    7.08
                        
                        20,200
                        
                        37,582(1)
                        Amount
      represents the number of shares available to be repurchased under the Plan
      as of the closeof
      business on December 31, 2008.





Item
3        Defaults Upon Senior
Securities





Nothing
to report.





Item
4        Submission of Matters to a Vote of
Security Holders





Nothing to report.





Item
5.       Other Information






21





Item
6                                                                             Exhibits


Exhibit
    Number
              Document
              Reference to
                Prior Filing
                or Exhibit
      Number
                Attached
    Hereto3.1
              Charter.
              *3.2
              Bylaws
              **4
              Form
      of Stock Certificate for Common Stock 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 2009
              ***10.8
              Sound
      Financial, Inc. 2008 Equity Incentive Plan
              +10.9
              Form
      of Incentive Stock Option Agreement under the 2008 Equity Incentive
      Plan
              +10.10
              Form
      of Non-Qualified Stock Option Agreement under the 2008 Equity Incentive
      Plan
              +10.11
              Form
      of Restricted Stock Agreement under the 2008 Equity Incentive
      Plan
              +31.1
              Rule 13a–14(a) Certification of
      Chief Executive Officer
              31.131.2
              Rule 13a–14(a) Certification of
      Chief Financial Officer
              31.232
              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 onNovember
      2,
      2007(File
      No.333–146196) pursuant
      to Section 5 of the Securities Act of
  1933.***
              Filed
      as an exhibit to the Company’s Form 10-K filed on March 31,
      2009.+
              Filed
      as an exhibit to the Company’s Form 8-K filed on January 29.
      2009.


22





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.May
      15, 2009
            By:
            /s/  Laura Lee
      StewartLaura
      Lee StewartPresident
      and Chief Executive OfficerMay
      15, 2009
            By:
            /s/  Matthew P.
      DeinesMatthew
      P. DeinesExecutive
      Vice President andChief
      Financial Officer