UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
One)





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





For the
quarterly period ended June 30,
2008





OR





[  ]           TRANSITION
REPORT UNDER 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 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.  (Check one)





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 August 11, 2008, there were issued and outstanding 2,948,063 shares of the
registrant’s common stock.











SOUND
FINANCIAL, INC.





Index




Page
      NumberPART
      I
              FINANCIAL
      INFORMATIONItem
      1.
              Financial
      StatementsConsolidated
      Balance Sheets as of June 30, 2008 and
                December
      31, 2007
              1Consolidated
      Statements of Income For the Three-Month
                and
      Six-Month Periods ended June 30, 2008 and 2007
              3Consolidated
      Statements of Cash Flows For the Six-
                Month
      Periods Ended June 30, 2008 and 2007
              4Notes
      to Consolidated Financial Statements
              5Item
      2.
              Management's
      Discussion and Analysis of
                Financial
      Condition and Results of Operations
              10Item
      3.
              Quantitative
      and Qualitative Disclosures About
                Market
      Risk
              18Item
      4T.
              Controls
      and Procedures
              18PART
      II
              OTHER
      INFORMATIONItem
      1.
              Legal
      Proceedings
              18Item
      1A
              Risk
      Factors
              18Item
      2.
              Unregistered
      Sales of Equity Securities and Use
                of
      Proceeds
              19Item
      3.
              Defaults
      Upon Senior Securities
              19Item
      4.
              Submission
      of Matters to a Vote of Security
                Holders
              19Item
      5.
              Other
      Information
              19Item
      6.
              Exhibits
              20SIGNATURESEXHIBITS








PART
I          FINANCIAL
INFORMATION





Item
1            Financial Statements





SOUND
FINANCIAL, INC. AND SUBSIDIARY


Consolidated
Balance Sheets





ASSETS





JUNE
      30,
            
            
            DECEMBER
      31,2008
              (Unaudited)
            
            
            2007CASH
      AND CASH EQUIVALENTS
            
            $
            7,126,640
            
            
            $
            6,104,963SECURITIES
      AVAILABLE-FOR-SALE,
      at fair value
            
            
            8,251,078
            
            
            
            71,245FEDERAL
      HOME LOAN BANK(FHLB)
      STOCK, at cost
            
            
            1,903,500
            
            
            
            1,319,500LOANS
      HELD FOR SALE
            
            
            2,598,630
            
            
            
            822,129LOANS
            
            
            243,195,096
            
            
            
            220,233,447Less
      allowance for loan losses
            
            
            (946,332
            )
            
            
            (827,688
            )Loans,
      net
            
            
            242,248,764
            
            
            
            219,405,759ACCRUED
      INTEREST RECEIVABLE
            
            
            1,175,341
            
            
            
            1,051,476PREMISES
      AND EQUIPMENT, net
            
            
            1,501,943
            
            
            
            1,404,853CASH
      SURRENDER VALUE OFBANK
      OWNED LIFE INSURANCE
            
            
            4,114,159
            
            
            
            4,035,412MORTGAGE
      SERVICING RIGHTS
            
            
            872,635
            
            
            
            864,946OTHER
      REAL ESTATE OWNED
            
            
            1,233,189
            
            
            
            817,108OTHER
      ASSETS
            
            
            318,788
            
            
            
            1,068,008Total
      assets
            
            $
            271,344,667
            
            
            $
            236,965,399








See
notes to consolidated financial statements.


1





SOUND
FINANCIAL, INC. AND SUBSIDIARY


Consolidated
Balance Sheets





LIABILITIES
AND STOCKHOLDERS' EQUITY





JUNE
      30,
            
            
            DECEMBER
      31,2008
              (Unaudited)
            
            
            2007DEPOSITSInterest-bearing
            
            $
            179,411,185
            
            
            $
            189,501,253Noninterest-bearing
      demand
            
            
            18,215,641
            
            
            
            13,289,946Total
      deposits
            
            
            197,626,826
            
            
            
            202,791,199FHLB
      ADVANCES
            
            
            44,369,355
            
            
            
            15,869,355ACCRUED
      INTEREST PAYABLE
            
            
            247,786
            
            
            
            210,518ACCOUNTS
      PAYABLE ANDOTHER
      LIABILITIES
            
            
            2,238,971
            
            
            
            1,951,786ADVANCE
      PAYMENTS FROMBORROWERS
      FOR TAXESAND
      INSURANCE
            
            
            284,467
            
            
            
            254,213Total
      liabilities
            
            
            244,767,405
            
            
            
            221,077,071STOCKHOLDERS’
      EQUITYPreferred
      stock, $0.01 par value, 1,000,000 shares
              authorized, no shares issued and outstanding as of
              June 30, 2008 and December 31, 2007
            
            
            -
            
            
            
            -Common
      stock, $0.01 par value, 24,000,000 shares
              authorized, 2,948,063 shares issued and 2,832,503
              outstanding as of June 30, 2008, no shares issued and
              outstanding as of December 31, 2007
            
            
            29,481
            
            
            
            -Additional
      paid-in capital
            
            
            11,883,034Unearned shares - Employee Stock Ownership Plan (“ESOP”)
            
            
            (1,155,600
            )
            
            
            -Retained
      earnings
            
            
            15,964,794
            
            
            
            15,885,167Accumulated
      other comprehensive (loss) income, net
            
            
            (144,447
            )
            
            
            3,161Total
      stockholders’ equity
            
            
            26,577,262
            
            
            
            15,888,328Total
      liabilities and stockholders’ equity
            
            $
            271,344,667
            
            
            $
            236,965,399





See
notes to consolidated financial statements.








2








SOUND
FINANCIAL, INC. AND SUBSIDIARY


Consolidated
Statements of Income


(Unaudited)


THREE
      MONTHS ENDED
            
            
            SIX
      MONTHS ENDEDJUNE
      30,
            
            
            JUNE
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007INTEREST
      INCOMELoans,
      including fees
            
            $
            3,916,894
            
            
            $
            3,620,053
            
            
            $
            7,689,326
            
            
            $
            7,135,071Interest
      and dividends oninvestments,
      and cashequivalents
            
            
            145,058
            
            
            
            8,497
            
            
            
            201,570
            
            
            
            15,474Total
      interest income
            
            
            4,061,952
            
            
            
            3,628,550
            
            
            
            7,890,896
            
            
            
            7,150,545INTEREST
      EXPENSEDeposits
            
            
            1,526,876
            
            
            
            1,542,336
            
            
            
            3,234,980
            
            
            
            2,997,340FHLB
      advances
            
            
            317,568
            
            
            
            382,858
            
            
            
            539,391
            
            
            
            729,709Total
      interest expense
            
            
            1,844,444
            
            
            
            1,925,194
            
            
            
            3,774,371
            
            
            
            3,727,049NET
      INTEREST INCOME
            
            
            2,217,508
            
            
            
            1,703,356
            
            
            
            4,116,525
            
            
            
            3,423,496PROVISION
      FOR LOAN LOSSES
            
            
            350,000
            
            
            
            -
            
            
            
            510,000
            
            
            
            -NET
      INTEREST INCOMEAFTER
      PROVISIONFOR
      LOAN LOSSES
            
            
            1,867,508
            
            
            
            1,703,356
            
            
            
            3,606,525
            
            
            
            3,423,496NONINTEREST
      INCOMEService
      charges and fee income
            
            
            466,155
            
            
            
            483,734
            
            
            
            957,475
            
            
            
            898,507Earnings
      on cash surrender valueof
      bank owned life insurance
            
            
            40,735
            
            
            
            38,294
            
            
            
            78,747
            
            
            
            78,402Mortgage
      servicing income
            
            
            71,653
            
            
            
            58,564
            
            
            
            174,753
            
            
            
            142,029Gain
      on sale of investment
            
            
            -
            
            
            
            -
            
            
            
            153,633
            
            
            
            -Loss
      on sale of assets
            
            
            (1,402
            )
            
            
            (13,862
            )
            
            
            (30,177
            )
            
            
            (20,680
            )Gain
      (loss) on sale of loans
            
            
            (19,523
            )
            
            
            3,546
            
            
            
            (45,799
            )
            
            
            4,865Total
      noninterest income
            
            
            557,618
            
            
            
            570,276
            
            
            
            1,288,632
            
            
            
            1,103,123NONINTEREST
      EXPENSESalaries
      and benefits
            
            
            1,186,494
            
            
            
            976,592
            
            
            
            2,303,106
            
            
            
            1,958,622Operations
            
            
            732,767
            
            
            
            577,417
            
            
            
            1,421,704
            
            
            
            1,025,357Charitable
      contributions
            
            
            18,819
            
            
            
            9,560
            
            
            
            232,370
            
            
            
            30,588Occupancy
            
            
            250,711
            
            
            
            216,426
            
            
            
            477,702
            
            
            
            412,361Data
      processing
            
            
            165,133
            
            
            
            285,377
            
            
            
            391,148
            
            
            
            513,239Total
      noninterest expense
            
            
            2,353,924
            
            
            
            2,065,372
            
            
            
            4,826,030
            
            
            
            3,940,167INCOME
      BEFORE PROVISION (BENEFIT)FOR
      INCOME TAXES
            
            
            71,202
            
            
            
            208,260
            
            
            
            69,127
            
            
            
            586,452PROVISION(BENEFIT)
      FOR INCOME TAXES
            
            
            9,000
            
            
            
            56,350
            
            
            
            (10,500
            )
            
            
            175,180NET
      INCOME
            
            $
            62,202
            
            
            $
            151,910
            
            
            $
            79,627
            
            
            $
            411,272OTHER
      COMPREHENSIVE INCOME (LOSS)
            
            $
            (21,583
            )
            
            $
            2,315
            
            
            $
            (67,981
            )
            
            $
            413,376BASIC
      EARNINGS PER SHARE
            
            $
            0.02
            
            
            
            N/A
            
            
            $
            0.03
            
            
            
            N/ADILUTED
      EARNINGS PER SHARE
            
            $
            0.02
            
            
            
            N/A
            
            
            $
            0.03
            
            
            
            N/A


See
notes to consolidated financial statements


3


SOUND
FINANCIAL, INC. AND SUBSIDIARY


Consolidated
Statements of Cash Flows


(Unaudited)




SIX
      MONTHS ENDEDJUNE
      30,2008
            
            
            2007CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      income
            
            $
            79,627
            
            
            $
            411,272Adjustments
      to reconcile net income to net cash from operating
    activities(Accretion)
      amortization of net discount/premium
              on
      investments
            
            
            (32,126
            )
            
            
            3,544Provision
      for loan losses
            
            
            510,000
            
            
            
            -Depreciation
      and amortization
            
            
            190,493
            
            
            
            169,590Additions
      to mortgage servicing rights
            
            
            (70,531
            )
            
            
            (109,568
            )Amortization
      of mortgage servicing rights
            
            
            62,842
            
            
            
            123,437Earnings
      on cash surrender value ofbank
      owned life insurance
            
            
            (78,747
            )
            
            
            (78,402
            )Proceeds
      from sales of mortgage loans
            
            
            14,574,058
            
            
            
            10,728,714Originations
      of mortgage loans held for sale
            
            
            (18,192,572
            )
            
            
            (10,730,091
            )Gain
      (loss) on sale of loans
            
            
            45,799
            
            
            
            (4,865
            )Loss
      on sale of assets
            
            
            30,177
            
            
            
            20,680(Decrease)
      increase in operating assets and liabilitiesChange
      in accrued interest receivable
            
            
            (123,865
            )
            
            
            (34,335
            )Change
      in other assets
            
            
            749,220
            
            
            
            1,260,554Change
      in accrued interest payable
            
            
            37,268
            
            
            
            89,881Change
      in accounts payable and other liabilities
            
            
            287,185
            
            
            
            224,017Net
      cash from operating activities
            
            
            (1,931,172
            )
            
            
            2,074,428CASH
      FLOWS FROM INVESTING ACTIVITIESProceeds
      from maturities ofavailable-for-sale
      investments
            
            
            336,969
            
            
            
            51,720Purchase
      of available-for sale investments
            
            
            (8,632,284
            )
            
            
            -Purchase
      of bank owned life insurance
            
            
            -
            
            
            
            (600,000
            )Purchase
      of FHLB Stock
            
            
            (584,000
            )
            
            
            -Net
      increase in loans
            
            
            (22,198,049
            )
            
            
            (8,880,894
            )Proceeds
      from sale of OREO
            
            
            195,000
            
            
            
            -Purchases
      of premises and equipment
            
            
            (287,583
            )
            
            
            (110,979
            )Net
      cash from investing activities
            
            
            (31,169,947
            )
            
            
            (9,540,153
            )CASH
      FLOWS FROM FINANCING ACTIVITIESNet
      decrease in deposits
            
            
            (5,164,373
            )
            
            
            2,581,133Proceeds
      from FHLB advances
            
            
            28,800,000
            
            
            
            5,940,000Repayment
      of FHLB advances
            
            
            (300,000
            )
            
            
            (300,000
            )Net
      proceeds from stock issuance
            
            
            10,756,915
            
            
            
            -Net
      change in advances from borrowers for taxes and insurance
            
            
            30,254
            
            
            
            (9,425
            )Net
      cash from financing activities
            
            
            34,122,796
            
            
            
            8,211,708INCREASE
      (DECREASE) IN CASHAND
      CASH EQUIVALENTS
            
            
            1,021,677
            
            
            
            745,983CASH
      AND CASH EQUIVALENTS, beginning of period
            
            
            6,104,963
            
            
            
            5,649,306CASH
      AND CASH EQUIVALENTS, end of period
            
            $
            7,126,640
            
            
            $
            6,395,289SUPPLEMENTAL
      CASH FLOW INFORMATIONInterest
      paid on deposits and FHLB advances
            
            $
            3,737,103
            
            
            $
            3,637,168Transfers
      of mortgage loans held for sale
            
            $
            1,565,122
            
            
            $
            -Net
      transfer to other real estate owned
            
            $
            641,258
            
            
            $
            -








See
notes to consolidated financial statements.






4






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 period ended
December 31, 2007, included in the Company's Annual Report on Form
10-K.





2.          RECENT
ACCOUNTING DEVELOPMENTS





In June 2008, the FASB issued Staff
Position 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 anticipatethat this issuance will
materiallyimpact the
Company’s consolidated financialcondition 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 this Statement is not expected to have a
material impact on the Company’s financial condition or results of
operations.






5





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
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





Effective
January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements for
all financial assets and liabilities measured and reported on a fair value
basis. 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.At adoption, there was no
material effect on the Company's financial position or results of
operations.





Fair
Value Hierarchy





As
defined in SFAS No.157, fair value is the price that would be received to sell
an asset or paid to transfer a liability (i.e., exit price) in an orderly
transaction between market participants at the measurement date. In determining
fair value, the Company utilizes valuation techniques that maximize the use of
observable inputs and minimize the use of unobservable inputs. Observable inputs
reflect market-derived or market-based information obtained from independent
sources, while unobservable inputs reflect the Company's estimate about market
data. Based on the observability of the inputs used in






6






the
valuation techniques, the Company classifies its financial assets and
liabilities measured and disclosed at fair value in accordance with the
three-level hierarchy established under SFAS No. 157. This hierarchy ranks the
quality and reliability of the information used to determine fair
values.





Level 1:
Valuations are based on quoted prices in active markets for identical assets or
liabilities. Since valuations are based on quoted prices that are readily and
regularly available in an active market, valuation of these products does not
entail a significant degree of judgment.





Level 2:
Valuations are based on quoted prices for similar instruments in active markets,
quoted prices for identical or similar instruments in markets that are not
active and model-based valuations for which all significant assumptions are
observable or can be corroborated by observable market data.





Level 3:
Valuations are based on unobservable inputs that are supported by little or no
market activity and that are significant to the fair value of the assets or
liabilities. Values are determined using pricing models and discounted cash flow
models and include management judgment and estimation which may be
significant.





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.





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.





Fair
      Value at June 30, 2008Description
            
            Total
            
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3Available
      for Sale Securities
            
            $
            8,251,078
            
            
            $
            67,686
            
            
            $
            8,183,392
            
            
            $
            -Total
      Assets measured at fair value
            
            $
            8,251,078
            
            
            $
            67,686
            
            
            $
            8,251,078
            
            
            $
            -










7












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


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 materialadverse effect on the business or
financial condition of the Company.




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.




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 June 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.


8


6.           LOANS




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




June
      30,
              2008
            
            
            December
      31,
              2007Real
      estate loansOne-
      to four-family
            
            $
            89,267,855
            
            
            $
            83,965,522Home
      equity
            
            
            49,563,537
            
            
            
            45,373,749Commercial
            
            
            37,285,817
            
            
            
            25,013,481Construction
      or development
            
            
            9,266,673
            
            
            
            8,621,743185,383,882
            
            
            
            162,974,495Consumer
      loansManufactured
      homes
            
            
            22,521,598
            
            
            
            22,495,034Automobile
            
            
            12,365,476
            
            
            
            15,077,564Other
            
            
            7,623,524
            
            
            
            8,818,01242,510,598
            
            
            
            46,390,610Commercial
      business loans
            
            
            15,265,458
            
            
            
            10,802,911243,159,938
            
            
            
            220,168,016Deferred
      loan origination costs
            
            
            35,158
            
            
            
            65,431Allowance
      for loan losses
            
            
            (946,332
            )
            
            
            (827,688
            )Total
      loans, net
            
            $
            242,248,764
            
            
            $
            219,405,759





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




Six
      Months Ended
              June
      30,2008
            
            
            2007Balance
      at beginning of period
            
            $
            827,688
            
            
            $
            822,393Provision
      for loan losses
            
            
            510,000
            
            
            
            -Recoveries
            
            
            77,855
            
            
            
            139,379Charge-offs
            
            
            (469,211
            )
            
            
            (287,592
            )Balance
      at end of period
            
            $
            946,332
            
            
            $
            674,180







As of
June 30, 2008 and December 31, 2007, management determined that the bank did not
have any loans that would be defined as impaired.






9






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 June 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 $44.4 million and $15.9
million at June 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 2,710,886 and 2,836,837 shares for the quarter and
six month periods ended June 30, 2008, respectively and 0 for the quarter and
six month periods ended June 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 andResultsof 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.






10






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, and
boat and recreational vehicle loans.  We intend to continue
emphasizing our residential mortgage, home equity and consumer lending, while
also expanding our emphasis in the commercial real estate, construction and
development and commercial business lending areas.  In recent years,
we have focused on expanding our commercial lending.





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 $30.2 million and $20.2 million in
one- to four-family residential mortgage loans during the six months ended June
30, 2008 and 2007, respectively.  During these same periods, we sold
$14.6 million and $10.7 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 our growth of
interest earning assets.  We have adopted a leverage strategy to use
long-term Federal Home Loan Bank advances to fund asset and loan
growth.




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.




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, other income, operating expenses and income
taxes.







11






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 our 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 June 30, 2008 and December 31, 2007




General.  Total assets
increased by $34.4 million, or 14.5%, to $271.3 million at June 30, 2008 from
$237.0 million at December
31, 2007.  The increase was primarily the result of a$24.6 million, or
11.1%, increase in our loan portfolio, including loans held for sale, from
$221.1 million at December 31, 2007 to $245.8 million at June 30, 2008. The
increase also was the result of a $9.3 million increase in cash, cash
equivalents and securities during the first six months of 2008.  This
increase in total assets was funded primarilyby the $10.8
million capital infusion from our stock offering and $28.5 million in net
Federal Home Loan Bank advances obtained during the six month
period.




Loans.  Our
loan portfolio,
including loans held for sale, increased $24.6 million, or 11.1%, to $245.8million atJune 30, 2008, from $221.1 million
at December 31, 2007.  This
increase in our loan portfolio consisted primarily of a $12.3 million (49.1%)
increase in commercial real estate loans, a $4.2 million (9.2%) increase in home
equity loans, a $4.5 million (41.3%) increase in commercial business loans,
which was offset by a $3.9 million (8.4%) decrease in consumer
loans.  The $16.7 million, or 46.7%, increase in commercial
real estate and business loans during the quarter is consistent with our
strategy to diversify our loan portfolio and increase our amount of
higher-yielding commercial loans.  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.Our volume of residential loan
originations
increased during the first half of 2008, as compared to the level during the
last quarter of 2007.As a result,loans secured by single
family mortgages increased$5.3 million, or6.3%during the
period.




Allowance for
Loan Losses.  Our allowance for loan losses at June 30, 2008,
was $946,000, or 0.39%, of netloansreceivable, compared
to $828,000, or 0.38%, of netloansreceivable at
December 31, 2007.  The increase in the
allowance for loan losses was due tonet charge-offs of
non-performing loans of
$391,000, which
was offset by a $510,000 provision for
loan losses during the six month period ended June 30, 2008.  This provision was made as a
result of increases in our commercial and home equity loan
portfoliosand
an evaluation of prevailing housing and other market conditions.Non-performing
loans decreased to $36,000 at June 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 0.01% at June
30, 2008, from 0.19% at
December 31, 2007.  Other real estate owned increased by
$416,000, or 51.0%, during the six months ended June 30, 2008, as a result of
our acquisition of two single family residences, which was offset by the sale of
one property for $195,000, at a net loss of $33,000.




Cash and
Securities.  Cash and cash equivalents increased by $1.0
million, or 16.9%, to $7.1 million at June 30, 2008, as a result of the funds
received in our stock offering.  Our securities portfolio consists of
mortgage-backed securities, all of which are designated as
available-for-sale.  The securities portfolio increased to $8.3
million at June 30, 2008 from $71,000 at December 31, 2007.  This
significant increase reflects our purchase of $8.2 million of publicly traded,
AAA and AA rated non-agency mortgage-backed securities, which were purchased at
a discount to face value, which we believe will enhance our net interest margin
due to higher yields than if we had purchased them at par.






12






Deposits.  Total
deposits decreased by $5.2 million, or 2.5%, to $197.6 million at June 30, 2008,
from $202.8 million at December 31, 2007.  Time deposits increased
$670,000, while demand deposits and interest-bearing checking accounts decreased
$3.5 million and savings and money market accounts decreased $2.4
million.  Total deposits decreased from year-end primarily as a result
of the timing of our stock offering, which closed January 8, 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.  The increase in time deposits reflects a bank-wide emphasis to
bring additional deposits to the Bank from our existing consumer and business
customers.




Borrowings.  Federal
Home Loan Bank advances increased $28.5 million, or 179.6%, to $44.4 million at June 30,
2008 from $15.9 million at December 31, 2007.  These additional
advances were a combination of $15 million in long-term advances and $13.8
million in overnight advances, net of repayments of an amortizing advance
totaling $300,000.  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 the new borrowings as of
June 30, 2008 is 2.96%, which is lower than our current overall cost of funds.




Equity.  Total
equity increased $10.7 million, or 67.3%, to $26.6 million at June
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 $80,000 in six month
earnings, which were offset by a decrease in Accumulated Other Comprehensive
Income (Loss) of $148,000.




Comparison
of Results of Operation for the Three and Six Months Ended June 30, 2008 and
2007




General.  Net
income decreased $90,000 to $62,000 for the three
months ended June 30, 2008 compared to $152,000 for the three months ended June
30, 2007.  The primary reasons for this
decreasein the
2008 period was the $350,000 provision for loan
losses, a $289,000 increase in non-interest expense and a $13,000
decrease in non-interest income, which were offset by a $514,000 increase in net
interest income from the quarter ended June 30, 2007.




Net
income decreased $332,000 to $80,000 for the six
months ended June 30, 2008 compared to $411,000 for the six months ended June
30, 2007.  The primary reasons for this
decreasein the
2008 period were the $510,000 provision for loan
losses and an $886,000 increase in non-interest expense which were offset
by a $693,000 increase in net interest income and an $186,000 increase in
non-interest income compared to the six months ended June 30, 2007.




Interest
Income.  Interest income increased by $433,000, or 11.9%, to
$4.1 million for the three months ended June 30, 2008 from $3.6 million for the
three months ended June 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 6.76% for the three months ended
June 30, 2007, to 6.72% for the three months ended June 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.






13






Interest
income increased by $740,000, or 10.4%, to $7.9 million for the six months ended
June 30, 2008 from $7.2 million for the six months ended June 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 6.80% for the six months ended
June 30, 2007, to 6.66% for the six months ended June 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.




Interest
Expense.  Interest expense decreased $81,000, or 4.2%, to $1.8
million for the three months ended June 30, 2008, from $1.9 million for the
three months ended June 30, 2007.  Interest expense increased $47,000,
or 1.3%, to $3.8 million for the six months ended June 30, 2008, from $3.7
million for the six months ended June 30, 2007.




The
increase in interest expense for the 2008 period reflects the increased level of
time deposits and the higher interest rates paid on those funds as a result of
the rising interest rate environment.  Our weighted average cost of
interest-bearing liabilities was 3.29% for the three months ended June 30, 2008,
compared to 3.76% for the same period in 2007. Our weighted average cost of
interest-bearing liabilities was 3.45% for the six months ended June 30, 2008,
compared to 3.65% for the same period in 2007.




Interest
paid on deposits decreased $15,000, or 1.0%, to $1.5 million for the three
months ended June 30, 2008, as compared to the three months ended June 30,
2007.  The decrease for the three month period resulted primarily from
a decrease in the weighted average cost of deposits.We experienced a 44
basis point decrease in the average rate paid on deposits
during thethree-months ended June 30, 2008 compared to the same period
in 2007.  Thisdecrease in average rates werea result of the repricing of matured certificate deposits that the bank
was able to retain at significantly lower yields.




For the
six months ended June 30, 2008, interest paid on deposits increased by $238,000,
as compared to the six months ended June 30, 2007.  The increase for
the six month period was primarily a result of higher average balances of $195.1
million for the 2008 period compared to $174.7 million for the 2007
period.  The increase in balances was offset by a lower weighted
average cost of deposits for the six months ended June 30, 2008 of 3.23%
compared to 3.43% for the six months ended June 30, 2007.




Interest
expense on Federal Home Loan Bank advances decreased $65,000, or 17.1%, to
$318,000 for the three months ended June 30, 2008 from $383,000 for the three
months ended June 30, 2007.  The decrease resulted from a decrease in
the average balance of outstanding Federal Home Loan Bank advances of $2.9
million, to $27.4 million for the three months ended June 30, 2008, from $30.3
million for the three months ended June 30, 2007.  In addition, the
cost of Federal Home Loan Bank advances decreased 41 basis points from the 2007
period to the 2008 period.




For the
six months ended June 30, 2008, interest expense on Federal Home Loan Bank
advances decreased $190,000, or 26.1%, to $539,000 from $730,000 for the six
months ended June 30, 2007.  The decrease resulted from lower average
outstanding advance balances at the Federal Home Loan Bank to $23.8 million for
the six months ended June 30, 2008, from $29.5 million for the six months ended
June 30, 2007.  In addition, the cost of Federal Home Loan Bank
advances decreased 42 basis points from the 2007 period to the 2008
period.




Net Interest
Income.  Net interest income increased $514,000, or 30.2%, to
$2.2 million for the three months ended June 30, 2008, from $1.7 million for the
three months ended June 30, 2007.  The increase in net interest
income for the three-month period primarily
resulted from higher yields earned on our
expanding
commercial loan portfolioand increased income from
investments purchased in 2008.Our net
interest margin was 3.63% for the three months ended June 30, 2008, compared to
3.21% for the three months ended June 30, 2007.






14






Net
interest income increased $693,000, or 20.2%, to $4.1 million for the six months
ended June 30, 2008, from $3.4 million for the six months ended June 30,
2007.  The
increase in net interest income for the three-month period primarily
resulted from higher yields earned on our
growing
commercial loan portfolioand increased income from
investments purchased in 2008.Our net
interest margin was 3.50% for the six months ended June 30, 2008, compared to
3.26% for the same period ended June 30, 2007.




Provision for
Loan Losses.  We establish provisions for loan losses, which
are charged to earnings, at a level required to reflect 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 $350,000 was made during
the three months ended June 30, 2008, and no provision was made during the three
months ended June 30, 2007.  A provision of $510,000 was made during
the six months ended June 30, 2008, and no provision was made during the six
months ended June 30, 2007.  This was primarily attributable toincreases innet charge-offs, increases in our commercial
loan portfolioandan increase in our overall loan portfolio.




At June
30, 2008, the annualized ratio of net charge-offs to average loans increased 18
basis points to 0.32% from 0.14% at June 30, 2007.  The ratio of
non-performing loans to total loans decreased from 0.26% at June 30, 2007 to
0.01% at June 30, 2008.




Noninterest
Income.  Noninterest income decreased $13,000, or 2.2%, to
$558,000 for the three months ended June 30, 2008, from $570,000 for the three
months ended June 30, 2007.  The primary reason for this
decrease during the 2008 period was a decrease in service charges and fee
income of $18,000 and a $20,000 loss on the sale of loans, which was offset by
an decrease in the loss on sale of assets and a $13,000 increase in mortgage
servicing income for the quarter ended June 30, 2008 compared to the same period
in 2007.




Noninterest
income increased $186,000, or 16.7%, to $1.3 million for the six months ended
June 30, 2008, from $1.1 million for the six months ended June 30, 2007. The primary reason for this
increase during the 2008 period 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 recent initial public
offering.  The Bank obtained its Visa shares, by being 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 may change depending upon whether additional
amounts of money need to be reserved by Visa to settle outstanding
litigation.  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 June 30, 2008, they would have a market value of
approximately $331,000.   The increase in noninterest
income during the six months also reflects the loss on the sale of loans and
foreclosed property totaling $76,000 for the six months ended June 30, 2008
compared to a loss of $16,000 for the six months ended June 30, 2007, and an
aggregate $92,000, or 8.2%, increase in income from service charges and fees,
the cash surrender value of bank owned life insurance and mortgage servicing
income inthe2008period, compared to the 2007
period.




Noninterest
Expense.  Noninterest expense increased $289,000, or 14.0%, to
$2.4 million for the three months ended June 30, 2008, compared to $2.1 million
for the three months ended June 30, 2007.






15






The
increase in the 2008 period was primarily the result of an increase in salaries
and benefits of $210,000 and legal costs and printing fees of $26,000 resulting
from becoming a public company. These increases were offset by a $120,000
decrease in data processing expenses resulting from streamlining certain data
processing functions.




Noninterest
expense increased $886,000, or 22.5%, to $4.8 million for the six months ended
June 30, 2008, compared to $3.9 million for the six months ended June 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 operating expenses including an increase in salaries and benefits of
$344,000 and an increase in operations expense, including legal costs and
printing fees of $396,000 resulting from becoming a public
company.  These increases were offset by a $122,000 reduction in data
processing expenses resulting from streamlining certain data processing
functions.




Income Tax
Expense (Benefit).  In the three month period ended June 30,
2008, we incurred income tax expense of $9,000 on our pre-tax income as compared
to expense of $56,000 for the three month period ended June 30,
2007.




In the
six month period ended June 30, 2008, we experienced an income tax benefit of
$11,000 on our pre-tax income as compared to expense of $175,000 for the six
month period ended June 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 June 30, 2008, is as follows:




Off-balance sheet loan
      commitments:Commitments
      to make loans
            
            $
            1,020,000Unfunded
      Letters of Credit
            
            
            3,138,000Undisbursed
      portion of loans closed
            
            
            1,739,000Unused
      lines of
      credit
            
            
            36,071,000Total
      loan
      commitments
            
            $
            41,968,000





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 to fund
loan commitments.




We maintain cash and investments that
qualify as liquid assets to maintain liquidity to ensure safe and sound
operation and meet demands for funds (particularly withdrawals of
deposits).At
June 30, 2008, the Company had $15.4 million in cash and investment securities
available for sale and $2.5 million in loans held for sale generally available
for its cash needs.We can also generate funds from
borrowings, primarily Federal Home Loan Bank.  At June 30,
2008, the Bank had the ability to borrow an
additional $23.5million in Federal Home Loan Bank
advances.







16




At June 30, 2008, we had $42.0 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 June 30, 2008, totaled $50.2 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 June 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 June 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 June 30, 2008.




Actual
            
            
            Minimum Capital
                Requirements
            
            
            Minimum Required to
                Be Well Capitalized
                Under Prompt
                Corrective
                Action
      ProvisionsAmount
            
            
            Ratio
            
            
            Amount
            
            
            Ratio
            
            
            Amount
            
            
            Ratio(Dollars in
      thousands)Risk-Based Capital
              (to risk-weighted
      assets)
            
            $
            25,108
            
            
            
            13.61
            %
            
            $
            14,761
            
            
            
            8.00
            %
            
            $
            18,452
            
            
            
            10.00
            %Core Capital
              (to risk-weighted assets)
            
            $
            24,162
            
            
            
            13.09
            %
            
            $
            10,862
            
            
            
            4.00
            %
            
            $
            11,071
            
            
            
            6.00
            %Core Capital
              (to total adjusted 
      assets)
            
            $
            24,162
            
            
            
            8.89
            %
            
            $
            10,862
            
            
            
            4.00
            %
            
            $
            13,577
            
            
            
            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.







17














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 ofJune 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 ofJune 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 endedJune 30, 2008, that has materially affected, or is
likely to materially affect our internal control over financial
reporting.




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.







18








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.





Item
4     Submission of Matters to a Vote of
Security Holders





The Company conducted an Annual Meeting
of Shareholders on May 21, 2008.  At that meeting,David S. Haddad, Jr. and
Milton L. McMullenwere
elected to serve as directors for terms that expire in2011.Tyler K. Myers,Laura Lee Stewart,Robert F. Carney,Debra JonesandRogelio Riojascontinued to serve as directors after
the meeting.  Votes were cast in the election of directors as
follows:





For
            
            
            Vote
                WithheldDavid S. Haddad,
      Jr.
            
            
            2,587,454
            
            
            
            49,194Milton L.
      McMullen
            
            
            2,577,454
            
            
            
            59,194





The only other matter voted on at the
meeting was the shareholders’ ratification of the appointment ofMoss Adams,LLPas the Company’s independentregistered public
accounting firmfor the
fiscal year ending December 31, 2008.  The votes were cast on
this matteras follows:





Number
                of
    Votes
            
            
            Percentage of
      Votes
                Cast
(Including
                Abstentions)For
            
            
            2,630,184
            
            
            
            99.75
            %Against
            
            
            5,365
            
            
            
            0.20
            %Abstain
            
            
            1,099
            
            
            
            0.04
            %Broker
      Non-Votes
            
            
            0
            
            
            
            0.00
            %








Item
5.        Other Information





Nothing
      to report.





19


Item
6     Exhibits





Exhibit
    Number
            Document
            Reference to
              Prior Filing
              or Exhibit
      Number
              Attached
    Hereto2
            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
            None15
            Letterreunaudited interim financial
      information
            None18
            Letter re change in accounting
      principles
            None19
            Reports furnished to security
      holders
            None22
            Published reportregardingmatters submittedto vote of security
      holders
            None23
            Consents
            None24
            Power of
      Attorney
            None31.1
            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.


20








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.August
      14, 2008
              By:
              /s/ Laura
      Lee StewartLaura
      Lee StewartPresident
      and Chief Executive Officer


August
      14, 2008
                By:
                /s/ Matthew
      P. DeinesMatthew
      P. DeinesExecutive
      Vice President and
                  Chief Financial Officer












Exhibit
Index








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