UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
One)





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





For the
quarterly period ended September
30, 2008





OR





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





For the
transition period from _______ to ________





Commission
file number:     000-52889









SOUND
      FINANCIAL, INC.(Exact name of
      registrant as specified in its
charger





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





2005 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.





Large
accelerated filer  _____     Accelerated
filer  _____





Non-accelerated
filer    _____     Smaller reporting
company X


(Do not check if smaller reporting
company)




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


Yes
[   ]                           No
[X]




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




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







SOUND
FINANCIAL, INC.





Index





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

















PART
I          FINANCIAL
INFORMATION





Item
1            Financial Statements





SOUND
FINANCIAL, INC. AND SUBSIDIARY


Consolidated
Balance Sheets





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


LIABILITIES


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




See notes to consolidated financial
statements.


2


SOUND
FINANCIAL, INC. AND SUBSIDIARY


Consolidated
Statements of Income


(Unaudited)





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


See
notes to consolidated financial statements


3


SOUND
FINANCIAL, INC. AND SUBSIDIARY


Consolidated
Statements of Cash Flows


(Unaudited)


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








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


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








2.           RECENT
ACCOUNTING DEVELOPMENTS





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


5


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







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




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





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





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





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


6


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





3.           FAIR
VALUE OF FINANCIAL INSTRUMENTS





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




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




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




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




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





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





Valuation
Methodologies





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





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





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


7


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





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




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





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





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





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





Nine
      MonthsEndedFair
      Value at September 30, 2008
            
            
            September
      30, 2008Description
            
            Total
            
            
            Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            Total
      LossesImpaired
      Loans
            
            $
            5,365,703
            
            
            $
            -
            
            
            $
            -
            
            
            $
            5,365,703
            
            
            $
            262,036





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





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





4.
            COMMITMENT
      AND CONTINGENCIES




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





5.          LEGAL
PROCEEDINGS




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


8




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





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





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




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





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


9


6.           LOANS




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




September
      30,
              2008
            
            
            December
      31, 2007Real
      estate loansOne-
      to four-family
            
            $
            94,801,269
            
            
            $
            83,965,522Home
      equity
            
            
            53,946,627
            
            
            
            45,373,749Commercial
            
            
            51,752,374
            
            
            
            25,013,481Construction
      or development
            
            
            6,792,480
            
            
            
            8,621,743207,292,750
            
            
            
            162,974,495Consumer
      loansManufactured
      homes
            
            
            23,019,526
            
            
            
            22,495,034Automobile
            
            
            11,183,442
            
            
            
            15,077,564Other
            
            
            7,610,945
            
            
            
            8,818,01241,813,913
            
            
            
            46,390,610Commercial
      business loans
            
            
            18,562,957
            
            
            
            10,802,911267,669,620
            
            
            
            220,168,016Deferred
      loan origination (fees) costs
            
            
            (57,346
            )
            
            
            65,431Allowance
      for loan losses
            
            
            (1,156,954
            )
            
            
            (827,688
            )Total
      loans, net
            
            $
            266,455,320
            
            
            $
            219,405,759





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




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







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





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






10






7.           FHLB
ADVANCES





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




8.           EARNINGS
PER SHARE




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







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




11


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







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





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





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




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




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




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




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




12


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







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





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





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





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





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


13


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





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





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







Critical Accounting
Policies




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




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




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




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




14


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




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




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




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




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




15


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




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




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




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




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




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




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




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




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




16


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




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




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




Net Interest
Income.  Net interest income increased $697,000, or 37.5%, to
$2.6 million for the three months ended September 30, 2008, from $1.9 million
for the three months ended September 30, 2007.  The increase in net interest
income for the threemonth 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 3.8% for the three months ended September 30, 2008, compared
to 3.3% for the three months ended September 30, 2007.




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




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




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




17


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




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




Noninterest
income increased $262,000, or 16.6%, to $1.8 million for the nine months ended
September 30, 2008, from $1.6 million for the nine months ended September 30,
2007. The primary
reason for this was the$153,000 gain on the sale on investments
resulting from the mandatory redemption of a portion of our Class B Visa, Inc.
shares as part of Visa's initial public offering.  The Bank obtained
its Visa shares, because it was a long-time Visa member, prior to the sale of
its credit card portfolio in 2006.  We continue to own 5,699 shares of
Visa Class B shares that are convertible into Class A shares.  Each
Class B share currently is convertible into 0.71429 Class A shares, which are
traded on the New York Stock Exchange.  The amount of Class A shares
the Bank could realize upon conversion of its Class B shares are expected to
change as VISA issues additional Class A shares to fund the escrow account to
cover the remaining amount
of the 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 September
30, 2008, they would have a market value of approximately
$250,000.   The increase in noninterest
income during the nine months also reflects an increase in service charges and
fee income of $174,000 as a result of higher checking account service charge
revenue, and was partially offset by the $93,000 increase in the loss on the
sale of loans and foreclosed property for the nine months ended September 30,
2008 compared to the nine months ended September 30, 2007.




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




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




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




18


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




Off-Balance
Sheet Arrangements





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




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




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





Liquidity




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




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




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




Capital




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






19






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)
            $25,549
            12.40%
            $15,372
            8.00%
            $19,664
            10.00%Core
      Capital
              (to risk-weighted assets)
            $24,393
            12.99%
            $7,866
            4.00%
            $11,799
            6.00%Core Capital
              (to total
      adjusted  assets)
            $24,393
            8.37%
            $11,656
            4.00%
            $14,570
            5.00%





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




Impact of Inflation




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




Item
3    Quantitative and Qualitative Disclosures
About Market Risk





Not
required; the Company is a smaller reporting company.




Item 4T  Controls and
Procedures





An evaluation of the Company's
disclosure controls and procedures as defined in Rule 13a -15(e) under the
Securities Exchange Act of 1934 (the "Act") as ofSeptember 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 ofSeptember 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 endedSeptember 30,
2008, that has materially
affected, or is likely to materially affect our internal control over financial
reporting.


20


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




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






PART
II      OTHER INFORMATION




Item
1          Legal Proceedings





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





Item 1A        Risk Factors





Not
required; the Company is a smaller reporting company.




Item
2           Unregistered Sales of Equity Securities
and use of Proceeds





(a)           Recent Sales of Unregistered
Securities





Nothing to report.





(b)           Use of Proceeds





Nothing to report.





(c)           Stock Repurchases





Nothing
to report.





Item
3           Defaults Upon Senior
Securities





Nothing
to report.


21


Item
4           Submission of Matters to a Vote of
Security Holders





Nothing to report.








Item
5.          Other Information




Nothing
to report.





Item
6           Exhibits





Exhibit
    Number
            Document
            Reference to
              Prior Filing
              or Exhibit
      Number
              Attached
    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.


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.November
      14, 2008
            By:
            /s/  Laura Lee
      StewartLaura
      Lee StewartPresident
      and Chief Executive OfficerNovember
      14, 2008
            By:
            /s/  Matthew P.
      DeinesMatthew
      P. DeinesExecutive
      Vice President andChief
      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