UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

__________

FORM 10-K

[X]	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended December 31, 2011
	OR
[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from to

COMMISSION FILE NUMBER 000-52889

Sound Financial, Inc.

(Exact Name of Registrant as Specified in its Charter)

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

2005 5th Avenue, Suite 200, Seattle Washington		98121
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (206) 448-0884

Securities Registered Pursuant to Section 12(b) of the Act:

None

Securities Registered Pursuant to Section 12(g) of the Act:

Title of each class

Common Stock, par value $.01 per share

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

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

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

Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES [X] NO [ ]

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

Indicate by checkmark 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,” 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 checkmark whether the registrant is a shell Company (as defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X]

The aggregate market value of the voting and non-voting common equity held by non-affiliates as of June 30, 2011, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $7.1 million. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.)

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date.

As of March 16, 2012, there were 2,949,045 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

None

PART I

Item 1.Business

Special Note Regarding Forward-Looking Statements

When used in this Form 10-K the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” “intends” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about future performance. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated, including, among other things,

·	changes in economic conditions, either nationally or in our market area;

·	fluctuations in interest rates;

·	the risks of lending and investing activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of our allowance for loan losses;

·	the possibility of other-than-temporary impairments of securities held in our securities portfolio;

·	our ability to access cost-effective funding;

·	fluctuations in the demand for loans, the number of unsold homes, land and other properties, and fluctuations in real estate values and both residential and commercial and multifamily real estate market conditions in our market area;

·	secondary market conditions for loans and our ability to sell loans in the secondary market;

·	our ability to attract and retain deposits;

·	our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and expected cost savings and other benefits within the anticipated time frames or at all,;

·	legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules;

·	monetary and fiscal policies of the Federal Reserve and the U.S. Government and other governmental initiatives affecting the financial services industry;

results of examinations of Sound Financial and Sound Community Bank by their regulators, including the possibility that the regulators may, among other things, require us to increase our allowance for loan losses or to write-down assets, change Sound Community Bank’s regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;

·	increases in premiums for deposit insurance;

·	our ability to control operating costs and expenses;

·	the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;

·	difficulties in reducing risks associated with the loans on our balance sheet;

·	staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;

·	computer systems on which we depend could fail or experience a security breach;

·	our ability to retain key members of our senior management team;

·	costs and effects of litigation, including settlements and judgments;

·	our ability to implement our business strategies;

·	increased competitive pressures among financial services companies;

·	changes in consumer spending, borrowing and savings habits;

·	the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;

·	our ability to pay dividends on our common stock;

·	adverse changes in the securities markets;

·	the inability of key third-party providers to perform their obligations to us;

·	changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; and

·	other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described from time to time in our filings with the Securities and Exchange Commission (“SEC”).

We wish to advise readers not to place undue reliance on any forward-looking statements and that the factors listed above could materially affect our financial performance and could cause our actual results for future periods to differ materially from any such forward-looking statements expressed with respect to future periods and could negatively affect our stock price performance.

We do not undertake and specifically decline any obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

References in this document to “we,” “us,” and “our” means Sound Financial, Inc. and its wholly-owned subsidiary, Sound Community Bank, unless the context otherwise requires.

General

Sound Financial, Inc. (“Sound Financial”) is a federally chartered stock holding company and is subject to regulation by the Board of Governors of the Federal Reserve System (“Federal Reserve”). Sound Financial was incorporated on January 8, 2008, as part of Sound Community Bank’s reorganization into the mutual holding company form of organization. As part of the reorganization, Sound Community Bank (i) converted to a stock savings bank as the successor to Sound Community Bank in its mutual form (which was originally chartered as a credit union in 1953); (ii) organized Sound Financial, which owns 100% of the common stock of Sound Community Bank; and (iii) organized Sound Community MHC, which acquired 54.9% of the common stock of Sound Financial in the reorganization. Sound MHC has no other activities or operations other than its ownership of Sound Financial. Sound Financial has no significant assets other than all of the outstanding shares of common stock of Sound Community Bank, its loan to our Employee Stock Ownership Plan and certain liquid assets.

On January 27, 2012, the boards of the Sound Financial, Sound Community Bank and Sound Community MHC adopted a plan to reorganize into a full stock company and undertake a “second step” offering of new shares of common stock. The reorganization and offering, which is subject to regulatory, shareholder and depositor approval, is expected to be completed during the summer of 2012. As part of the reorganization, Sound Community Bank will become a wholly owned subsidiary of a to-be-formed stock corporation. Shares of common stock of Sound Financial, other than those held by Sound Community MHC, will be converted into shares of common stock in Sound Financial Bancorp, a new to-be-formed stock corporation, using an exchange ratio designed to preserve current stockholders’ (other than Sound Community MHC) percentage ownership interests in Sound Financial, Inc. Shares owned by Sound Community MHC will be retired, and new shares representing that ownership will be offered and sold to Sound Community Bank’s eligible depositors, Sound Community Bank’s tax-qualified employee benefit plans and members of the general public as set forth in the Plan of Conversion and Reorganization of Sound Community MHC. The Plan of Conversion and Reorganization of Sound Community MHC was filed on January 30, 2012 with the SEC in a Current Report on Form 8-K.

Substantially all of Sound Financial’s business is conducted through Sound Community Bank, which is a federal savings bank subject to extensive regulation by the Office of the Comptroller of the Currency (“OCC”). Sound Community Bank’s deposits are insured up to applicable limits by the Federal Deposit Insurance Corporation (“FDIC”). At December 31, 2011, Sound Financial had total consolidated assets of $339.7 million, net loans of $295.6 million, deposits of $300.0 million and stockholders’ equity of $28.7 million. The shares of Sound Financial are traded on the OTC Bulletin Board under the symbol “SNFL.” Our executive offices are located at 2005 5th Avenue – Suite 200, Seattle, Washington, 98121.

Our 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 and multifamily, consumer and commercial business loans and, to a lesser extent, construction and land 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. As part of our business, we focus on residential mortgage loan originations, many of which we sell to Fannie Mae. We sell these loans with servicing retained to maintain the direct customer relationship and promote our emphasis on strong customer service.

Our operating revenues are derived principally from earnings on interest earning assets, service charges and fees, and gains on the sale of loans. Our primary sources of funds are deposits, Federal Home Loan Bank (“FHLB”) advances and other borrowings, and payments received on loans and securities. We offer a variety of deposit accounts that provide a wide range of interest rates and terms, generally including savings, money market, term certificate and demand accounts.

In July 2010, Sound Financial and Sound Community Bank each entered into a Memorandum of Understanding (“MOU”) with the Office of Thrift Supervision (“OTS”) (which is now enforced by the OCC as successor to the OTS) to address the regulator’s concerns about certain deficiencies or weaknesses at Sound Community Bank. Under its MOU, Sound Community Bank committed to achieving by March 31, 2011, and, thereafter, maintaining an 8.0% core capital ratio and a 12.0% total risk-based capital ratio, after funding an adequate allowance for loan and lease losses.

At December 31, 2011, Sound Community Bank’s core and total risk-based capital ratios were 8.33% and 12.03%. See “- Capital Resources.” Sound Community Bank also committed to: (1) prepare and follow a business plan subject to regulatory oversight through the end of 2012; (2) prepare and implement a plan to reduce classified assets; (3) not pay any dividends or make any other capital distributions without regulatory approval; and (4) not increase its level of brokered deposits above the level on November 24, 2009 without regulatory approval. In its MOU, Sound Financial committed to: (1) assist Sound Community Bank in meeting the capital ratios in its MOU; (2) not declare or pay any cash dividends or redeem any stock without regulatory approval; (3) not accept any dividends from Sound Community Bank or any other payments that would reduce the capital of Sound Community Bank; (4) not increase or renew any debt without regulatory approval; and (5) prepare and implement a plan subjectto regulatory oversight addressing how it will meet its financial obligations through the end of 2012. In July 2011, Sound Financial’s MOU was terminated and Sound Community Bank’s MOU was modified to remove the prohibition relating to its ability to pay dividends to Sound Financial. In March 2012, Sound Community Bank’s MOU was also terminated.

For additional information about our business, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation - General.”

Market Area

We consider our primary market area to be the Puget Sound region. We are headquartered in Seattle, Washington and have five retail offices. Three of our offices are located within the Seattle-Tacoma-Bellevue Metropolitan Statistical Area (“Seattle MSA”), which consists of King, Pierce and Snohomish counties. Based on the most recent branch deposit data provided by the FDIC, our share of deposits in that market was approximately 0.28%. Two offices, in Clallam County, have 4.6% of the deposits in that market. See “- Competition.”

Our market area includes a diverse population of management, professional and sales personnel, office employees, manufacturing and transportation workers, service industry workers and government employees, as well as retired and self-employed individuals. The population has a skilled work force with a wide range of education levels and ethnic backgrounds. Major employment sectors include information and communications technology, financial services, manufacturing, maritime, biotechnology, education, health and social services, retail trades, transportation and professional services. The largest employers headquartered in our market area include Boeing, Microsoft, Costco, Nordstrom, Amazon.com, Starbucks, University of Washington and Weyerhaeuser.

Weak economic conditions and ongoing strains in the financial and housing markets which have generally continued into 2012 in portions of the United States, including our market area, have presented an unusually challenging environment for banks and their holding companies, including us. Due to these adverse conditions, our market area has experienced substantial home price declines, historically low levels of existing home sale activity, high levels of foreclosures and above average unemployment rates. For the month of December 2011, the Seattle MSA reported an unemployment rate of 7.8%, as compared to the national average of 8.3%, according to the latest available information from the Bureau of Labor Statistics. Home prices have also continued to decline over the past year. According to Case-Shiller, home prices in the Seattle MSA have decreased by 6.3% between November 2010 and November 2011. This compares unfavorably to the national average home price index decrease of 3.7%.

King County has the largest population of any county in the State of Washington, covers approximately 2,100 square miles, and is located on the Puget Sound. It has approximately 1.9 million residents and a median household income of approximately $66,000. King County has a diversified economic base with many industries including shipping and transportation, aerospace (Boeing) and computer technology and biotech industries. According to the Washington State Employment Security Department, the unemployment rate for King County decreased to 7.2% at December 2011 from 8.3% at December 2010.

Pierce County has the second largest population of any county in the State of Washington, covers approximately 1,700 square miles and is located along western Puget Sound. It has approximately 795,000 residents and a median household income of approximately $56,000. The Pierce County economy is diversified with the presence of military related government employment (Fort Lewis Army Base and McChord Air Force Base), transportation and shipping employment (Port of Tacoma), and aerospace related employment (Boeing). According to the Washington State Employment Security Department the unemployment rate for Pierce County remained unchanged at 9.1% as of December 2011 and 2010.

Snohomish County has the third largest population of any county in the State of Washington, covers approximately 2,100 square miles and is located on Puget Sound touching the northern border of King County. It has approximately 713,000 residents and a median household income of approximately $65,000. The economy of Snohomish County is diversified with the presence of military related government employment (Everett Homeport Naval Base), aerospace related employment (Boeing) and retail trade. The unemployment rate for Snohomish County decreased to 8.2% in 2011 from 10.1% in 2010.

Clallam County, with a population of approximately 71,000, is ranked 18th among the counties in the State of Washington. It is bordered by the Pacific Ocean and the Strait of Juan de Fuca and covers 1,700 square miles, including the westernmost portion of the continental United States. It has approximately 36,000 households and median household income of approximately $44,000. The economy of Clallam County is primarily manufacturing and shipping, with a non-seasonal adjusted unemployment rate of 10.4% at December 2011. The Sequim Dungeness Valley continues to be a growing retirement location. Our offices are in Port Angeles and Sequim, the two largest cities in the county.

Lending Activities

The following table presents information concerning the composition of our loan portfolio, including loans held for sale by the type of loan as of December 31, for the dates indicated:

	2011					2010					2009					2008					2007
	Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent			Amount			Percent
	(Dollars in thousands)
Real estate loans:
One- to four-family	$	96,305		31.86	%	$	99,215		33.01	%	$	107,318		36.63	%	$	90,863		34.33	%	$	84,788			38.37	%
Home equity		39,656		13.12			44,829		14.91			50,445		17.22			54,557		20.61			45,374			20.53
Commercial and multifamily		106,016		35.07			93,053		30.96			72,035		24.58			48,730		18.41			25,013			11.32
Construction and land		17,805		5.89			16,650		5.54			10,000		3.41			12,220		4.62			8,622			3.90
Total real estate loans		259,782		85.93			253,747		84.42			239,798		81.84			206,370		77.97			163,797			74.12

Consumer loans:
Manufactured homes		18,444		6.10			20,043		6.67			21,473		7.33			22,723		8.58			22,495			10.18
Other consumer		10,920		3.61			12,110		4.03			13,945		4.76			17,951		6.78			23,896			10.81
Total consumer loans		29,364		9.71			32,153		10.70			35,418		12.09			40,674		15.37			46,391			20.99

Commercial business loans		13,163		4.35			14,678		4.88			17,800		6.07			17,668		6.67			10,803			4.89

Total loans		302,309		100.00	%		300,578		100.00	%		293,016		100.00	%		264,712		100.00	%		220,991			100.00	%
Less:
Deferred fees and discounts		406					431					334					43					(65	)
Loans held for sale		1,807					901					2,857					956					822
Allowance for loan losses		4,455					4,436					3,468					1,306					828
Total loans, net	$	295,641				$	294,810				$	286,357				$	262,407				$	219,406

The following table shows the composition of our loan portfolio in dollar amounts and in percentages by fixed and adjustable rate loans as of December 31, for the dates indicated.

	2011					2010					2009					2008					2007
	Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent			Amount			Percent

Fixed- rate loans:	(Dollars in thousands)
Real estate loans:
One- to four-family(1)	$	79,952		26.45	%	$	80,831		26.89	%	$	88,201		30.10	%	$	72,439		27.37	%	$	66,335			30.02	%
Home equity		9,276		3.07			10,294		3.42			12,009		4.10			15,613		5.90			17,814			8.05
Commercial and multifamily		45,034		14.90			40,491		13.47			27,373		9.34			26,035		9.84			17,250			7.81
Construction and land		17,458		5.77			10,907		3.63			9,453		3.23			10,323		3.90			5,583			2.53
Total real estate loans		151,720		50.19			142,523		47.41			137,036		46.77			124,410		47.01			106,982			48.41

Manufactured homes		18,444		6.10			20,043		6.67			21,473		7.33			22,723		8.58			22,495			10.18
Other consumer		9,730		3.22			10,772		3.58			12,372		4.22			16,248		6.14			22,197			10.04
Commercial business		8,041		2.66			8,293		2.76			11,157		3.80			7,551		2.85			5,539			2.51
Total fixed-rate loans		187,935		62.17			181,631		60.43			182,038		62.13			170,932		64.58			157,213			71.14

Adjustable- rate loans:
Real estate loans:
One- to four-family		16,353		5.41			18,384		6.11			19,117		6.52			18,424		6.96			18,453			8.35
Home equity		30,380		10.05			34,535		11.49			38,436		13.12			38,944		14.71			27,560			12.47
Commercial and multifamily		60,982		20.17			52,562		17.49			44,662		15.24			22,695		8.57			7,763			3.51
Construction and land		347		0.11			5,743		1.91			547		0.19			1,897		0.72			3,039			1.38
Total real estate loans		108,062		35.75			111,224		37.00			102,762		35.07			81,960		30.96			56,815			25.71

Other consumer		1,190		0.39			1,338		0.45			1,573		0.54			1,703		0.64			1,697			0.77
Commercial business		5,122		1.69			6,385		2.12			6,643		2.27			10,117		3.82			5,264			2.38
Total adjustable-rate loans		114,374		37.83			118,947		39.57			110,978		37.87			93,780		35.42			63,778			28.86

Total loans		302,309		100.00	%		300,578		100.00	%		293,016		100.00	%	$	264,712		100.00	%		220,991			100.00	%
Less:
Deferred fees and discounts		406					431					334					43					(65	)
Loans held for sale		1,807					901					2,857					956					822
Allowance for loan losses		4,455					4,436					3,468					1,306					828
Total loans, net	$	295,641				$	294,810				$	286,357				$	262,407				$	219,406

___________________________

(1) Includes 30-year loans with a one-time rate adjustment five to seven years after origination, which at December 31, 2011, totaled $30.9 million, or 38.6% of our fixed-rate one-to-four-family mortgages.

The following table illustrates the contractual maturity of our loan portfolio at December 31, 2011. Mortgages that have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The total amount of loans due after December 31, 2012, which have predetermined interest rates, is $172.5 million, while the total amount of loans due after such date, which have floating or adjustable interest rates, is $111.3 million. The table does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.

	Real Estate Mortgage
	One- to Four-					Home Equity					Commercial and					Construction															Commercial
	Family					Loans					Multifamily					and Land					Manufactured Homes					Other Consumer					Business					Total(1)
			Weighted					Weighted					Weighted					Weighted					Weighted					Weighted					Weighted					Weighted
			Average					Average					Average					Average					Average					Average					Average					Average
	Amount		Rate			Amount		Rate			Amount		Rate			Amount		Rate			Amount		Rate			Amount		Rate			Amount		Rate			Amount		Rate
	(Dollars in thousands)
2012(2)	$	4,061		6.19	%	$	1,216		6.76	%	$	1,688		6.50	%	$	7,831		6.41	%	$	40		6.97	%	$	1,106		11.87	%	$	2,556		6.01	%	$	18,498		6.62	%
2013		3,499		6.37			366		5.28			795		5.87			728		5.75			54		7.76			783		8.50			518		6.24			6,743		6.42
2014		2,878		6.39			179		5.99			2,303		5.37			2,461		7.08			458		7.33			1,704		7.37			1,986		6.00			11,968		6.39
2015		3,313		6.40			646		5.86			8,030		5.74			355		6.91			306		7.48			705		8.32			983		4.95			14,338		6.04
2016 to 2018		18,147		5.89			7,964		5.13			14,979		6.17			1,055		7.18			1,278		8.34			2,022		7.00			5,134		6.59			50,579		6.04
2019 to 2022		2,006		4.41			24,945		5.64			69,552		6.17			2,054		7.23			5,650		8.93			1,455		6.79			1,213		5.48			106,876		6.04
2023 to 2026		3,773		4.46			1,677		7.09			932		6.34			2,199		7.03			7,128		7.89			1,548		6.32			-		-			17,257		5.36
2027 and following		58,628		4.87			2,663		7.63			7,737		6.53			1,122		6.47			3,530		7.66			1,597		6.64			773		3.53			76,050		5.01
Total	$	96,305		4.96	%	$	39,656		5.77	%	$	106,016		6.15	%	$	17,805		6.73	%	$	18,444		8.17	%	$	10,920		7.54	%	$	13,163		5.97	%	$	302,309		5.52	%

___________________________________________

(1) Excludes deferred fees and discounts of $406,000.

(2) Includes demand loans, loans having no stated maturity, overdraft loans and loans held for sale.

Lending Authority. Our President and Chief Executive Officer may approve unsecured loans up to $500,000 and all types of secured loans up to $1.25 million. Our Executive Vice President and Chief Credit Officer may approve secured loans up to $500,000 and unsecured loans up to $250,000. Any loans over the President and/Chief Executive Officer’s lending authority or loans otherwise outside our general underwriting guidelines must be approved by the Board Loan Committee.

Largest Borrowing Relationships. At December 31, 2011, the maximum amount under federal law that we could lend to any one borrower and the borrower’s related entities was approximately $4.6 million. Of our five largest borrowing relationships, three are primarily business relationships and two relationships have credit extended to both the individual borrower and their businesses. Our five largest relationships totaled $18.8 million in the aggregate, or 6.2% of our $302.3 million gross loan portfolio, at December 31, 2011. The largest relationship consists of $4.1 million in loans to a business collateralized by commercial real estate. The next four largest lending relationships at December 31, 2011, were a $4.0 million loan to a business, collateralized by multifamily; $3.8 million in loans to commonly owned businesses collateralized by multifamily; $3.6 million in loans to commonly owned businesses collateralized by multifamily; and $3.4 million to a business collateralized by multifamily. As of December 31, 2011, all of these loans were performing in accordance with their repayment terms. At December 31, 2011, we had three other lending relationships that exceeded $3.0 million. All of the loans in these three lending relationships were performing in accordance with their repayment terms as of December 31, 2011.

One- to Four-Family Real Estate Lending. Our primary lending activity consists of the origination of loans secured by first mortgages on one- to four-family residences, substantially all of which are secured by property located in our geographic lending area. We originate both fixed-rate loans and adjustable-rate loans.

Most of our loans are written using generally accepted underwriting guidelines, and are readily saleable to Fannie Mae or other private investors. A portion of the one- to four-family loans we originate are retained in our portfolio while the majority are sold into the secondary market to Fannie Mae, with servicing retained for continued customer contact, relationship building and to increase non-interest income. This mortgage banking element of our residential lending business allows us to originate more loans with the same funds by reinvesting sales proceeds in more residential mortgage loans. The sale of mortgage loans reduces our interest rate risk, provides a stream of servicing income that improves earnings, enhances liquidity and enables us to originate more loans at our current capital level than if we held them in portfolio. We are currently selling all our conforming fixed-rate loans, on a servicing retained basis. Our pricing strategy for mortgage loans includes establishing interest rates that are competitive with other local financial institutions and consistent with our internal asset and liability management objectives. During the year ended December 31, 2011, we originated $66.9 million of one- to four-family fixed-rate mortgage loans and no one- to four-family adjustable rate mortgage (“ARM”) loans. See “- Loan Originations, Purchases, Sales, Repayments and Servicing.” At December 31, 2011, one- to four-family residential mortgage loans (including $1.8 million of loans held for sale) totaled $96.3 million, or 31.9%, of our gross loan portfolio, of which $80.0 million were fixed-rate loans and $16.4 million were ARM loans.

Substantially all of the one- to four-family residential mortgage loans we retain in our portfolio consist of loans that are "non-conforming" because they do not satisfy acreage limits, income, credit or various other requirements imposed by Fannie Mae or other secondary market purchasers. Some of these loans are also originated to meet the needs of borrowers who cannot otherwise satisfy Fannie Mae credit requirements because of personal and financial reasons (i.e., divorce, bankruptcy, length of time employed, etc.), and other aspects, which do not conform to Fannie Mae's guidelines. Such borrowers may have higher debt-to-income ratios, or the loans are secured by unique properties in rural markets for which there are no sales of comparable properties to support the value according to secondary market requirements. We may require additional collateral or lower loan-to-value ratios to reduce the risk of these loans. We believe that these loans satisfy a need in our market area. As a result, subject to market conditions, we intend to continue to originate these types of loans.

We generally underwrite our one- to four-family loans based on the applicant’s employment and credit history and the appraised value of the subject property. We generally lend up to 80% of the lesser of the appraised value or purchase price for one- to four-family first mortgage loans and non-owner occupied first mortgage loans. At December 31, 2011 we had $3.2 million of non-owner occupied first mortgage loans. For first mortgage loans with a loan-to-value ratio in excess of 80%, we generally require private mortgage insurance in order to reduce our exposure to 80% or charge a higher interest rate. Properties securing our one- to four-family loans are generally

appraised by independent fee appraisers who are selected in accordance with criteria approved by the Board of Directors. For loans that are less than $250,000, we may use an automated valuation model provided by Freddie Mac in lieu of an appraisal. We generally require title insurance policies on all first mortgage real estate loans originated. Homeowners, liability, fire and, if required, flood insurance policies are also required for one-to four-family loans. Our real estate loans generally contain a “due on sale” clause allowing us to declare the unpaid principal balance due and payable upon the sale of the security property. The average size of our one- to four-family residential loans was approximately $111,000 at December 31, 2011.

Fixed-rate loans secured by one- to four-family residences have contractual maturities of up to 30 years, however, at December 31, 2011 we had $1.8 million of one- to four-family loans with an original contractual maturity of 40 years which were originated prior to 2008. All of these loans are fully amortizing, with payments due monthly. Our portfolio of fixed-rate loans also includes $30.9 million of loans with an initial seven year term and a 30-year amortization period with a borrower refinancing option at a fixed rate at the end of the initial term as long as the loan has met certain performance criterion. In addition, prior to 2011 we originated for portfolio five and seven year balloon reset loans (which are loans that are originated with a fixed interest rate for the initial five or seven years, and thereafter incur one interest rate change based on current market interest rates in which the new rate remains in effect for the remainder of the loan term) based on a 30-year amortization period.

ARM loans are offered with annual adjustments and life-time rate caps that vary based on the product, generally with a maximum annual rate change of 2.0% and a maximum overall rate change of 6.0%. We generally use the rate on one-year Treasury Bills to re-price our ARM loans, however, $9.6 million of our ARM loans are to employees that re-price based on a margin of 1% over our average 12 month cost of funds. As a consequence of using caps, the interest rates on ARM loans may not be as rate sensitive as our cost of funds. Furthermore, because loan indexes may not respond perfectly to changes in market interest rates, upward adjustments on loans may occur more slowly than increases in our cost of interest-bearing liabilities, especially during periods of rapidly increasing interest rates. Because of these characteristics, yields on ARM loans may not be sufficient to offset increases in our cost of funds.

ARM loans generally pose different credit risks than fixed-rate loans, primarily because as interest rates rise, the borrower’s payment rises, which increases the potential for default. The majority of these loans have been originated within the past several years, when rates were historically low. We intend to expand our fully amortizing ARM loans, by offering ARM loans having a fixed interest rate for the first one, three, five, or seven years, followed by a periodic adjustable interest rate for the remaining term. Given the recent market environment, however, the production of ARM loans has been substantially reduced because borrowers favor fixed rate mortgages.

Home Equity Lending. We originate home equity loans that consist of fixed-rate loans and variable-rate lines of credit. We originate home equity loans in amounts of up to 80% of the value of the collateral, minus any senior liens on the property; however, prior to 2010 we originated home equity loans in amounts of up to 100% of the value of the collateral, minus any senior liens on the property. Home equity lines of credit are typically originated for up to $250,000 with an adjustable rate of interest, based on the one-year Treasury Bill rate plus a margin. Home equity lines of credit generally have up to a twelve-year draw period, during which time the funds may be paid down and redrawn up to the committed amount. Once the draw period has lapsed, the payment is amortized over a twelve-year period based on the loan balance at that time. We charge a $50 annual fee on each outstanding home equity line of credit and require monthly interest-only payments on the entire drawn amount. At December 31, 2011, home equity lines of credit totaled $30.3 million, or 10.1% of our gross loan portfolio. At December 31, 2011, unfunded commitments on these lines of credit totaled $14.5 million.

Our fixed-rate home equity loans are originated in amounts, together with the amount of the existing first mortgage, of up to 90% of the appraised value of the subject property. These loans may have terms of up to 20 years and are fully amortizing. At December 31, 2011, fixed-rate home equity loans totaled $9.3 million, or 3.1% of our gross loan portfolio.

Commercial and Multifamily Real Estate Lending. We offer a variety of commercial and multifamily loans. Most of these loans are secured by commercial income producing properties, including retail centers, multifamily apartment buildings, warehouses, and office buildings located in our market area. At December 31,2011, commercial and multifamily loans totaled $106.0 million, or 35.1% of our gross loan portfolio, compared to $93.1 million, or 31.0% of our gross loan portfolio as of December 31, 2010.

Our loans secured by commercial and multifamily real estate are generally originated with a variable interest rate, fixed for a five-year term and a 20- to 25-year amortization period. At the end of the initial five-year term, there is a balloon payment or the loan re-prices based on an independent index plus a margin of 1% to 4% for another five years. Loan-to-value ratios on our commercial and multifamily loans typically do not exceed 80% of the lower of cost or appraised value of the property securing the loan at origination.

Loans secured by commercial and multifamily real estate are generally underwritten based on the net operating income of the property, quality and location of the real estate, the credit history and financial strength of the borrower and the quality of management involved with the property. The net operating income, which is the income derived from the operation of the property less all operating expenses, must be sufficient to cover the payments related to the outstanding debt plus an additional coverage requirement. We generally impose a minimum debt coverage ratio of approximately 1.20 for originated loans secured by income producing commercial properties. If the borrower is other than an individual, we generally require the personal guaranty of the borrower. We also generally require an assignment of rents or leases in order to be assured that the cash flow from the project will be used to repay the debt. Appraisals on properties securing commercial and multifamily loans are performed by independent state certified or licensed fee appraisers and approved by the Board Loan Committee. In order to monitor the adequacy of cash flows on income-producing properties, the borrower is required to provide, at a minimum, annual financial information. From time to time we also acquire participation interests in commercial and multifamily loans originated by other financial institutions secured by properties located in our market area. At December 31, 2011, we held $3.3 million in commercial and multifamily loan participations.

Historically, loans secured by commercial and multifamily properties generally involve different credit risks than one- to four-family properties, including because they cannot be sold as easily on the secondary market. These loans typically involve larger balances to single borrowers or groups of related borrowers. Because payments on loans secured by commercial and multifamily properties are often dependent on the successful operation or management of the properties, repayment of these loans may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced, or if leases are not obtained or renewed, the borrower’s ability to repay the loan may be impaired. Commercial and multifamily loans also expose a lender to greater credit risk than loans secured by one-to four-family because the collateral securing these loans typically cannot be sold as easily as one-to four-family. In addition, most of our commercial and multifamily loans are not fully amortizing and contain large balloon payments upon maturity. Such balloon payments may require the borrower to either sell or refinance the underlying property in order to make the payment, which may increase the risk of default or non-payment. Our largest single commercial and multifamily borrowing relationship at December 31, 2011, totaled $4.1 million and is collateralized by four commercial real estate notes. At December 31, 2011, these loans were performing in accordance with its repayment terms.

The following table displays information on commercial and multifamily loans by type at December 31, 2011 and 2010:

	2011					2010
	Amount		Percent			Amount		Percent
	(dollars in thousands)
Multifamily residential	$	39,233		37.01	%	$	42,411		45.58	%
Gas station / Convenience store		7,918		7.47			1,772		1.90
Mobile Home Parks		1,605		1.51			8,266		8.88
Office buildings		8,491		8.01			3,256		3.50
Warehouses		14,113		13.31			2,279		2.45
Other non-owner occupied commercial real estate		18,230		17.20			14,103		15.16
Other owner-occupied commercial real estate		16,426		15.49			20,966		22.53
Total	$	106,016		100.00	%	$	93,053		100.00	%

Construction and Land Lending. We originate construction loans secured by single-family residences and commercial and multifamily real estate. We also originate land and lot loans, which are secured by raw land or developed lots on which the borrower intends to build a residence, and land acquisition and development loans. At December 31, 2011, our construction and land loans totaled $17.8 million, or 5.9% of our gross loan portfolio. At December 31, 2011, unfunded construction loan commitments totaled $4.9 million.

Construction loans to individuals and contractors for the construction and acquisition of personal residences totaled $7.3 million, or 40.9% of our construction and land portfolio. We originate these loans whether or not the collateral property underlying the loan is under contract for sale. At December 31, 2011, construction loans to contractors for homes that were not pre-sold totaled $1.9 million.

The composition of, and location of underlying collateral securing, our construction and land loan portfolio including loan commitments at December 31, 2011 was as follows:

Type	Olympic Peninsula		Puget Sound		Other		Total
	(In thousands)
Commercial and multifamily construction	$	-	$	584	$	66	$	650
Residential construction		2,359		3,035		-		5,394
Land and lot loans		7,072		1,849		956		9,877
Speculative residential construction		130		1,754		-		1,884
Total	$	9,561	$	7,222	$	1,022	$	17,805

The composition of, and location of underlying collateral securing, our construction and land loan portfolio including loan commitments at December 31, 2010 was as follows:

Type	Olympic Peninsula		Puget Sound		Other		Total
	(In thousands)
Commercial and multifamily construction	$	-	$	-	$	-	$	-
Residential construction		964		2,436		-		3,400
Land and lot loans		8,197		3,105		978		12,280
Speculative residential construction		69		901		-		970
Total	$	9,230	$	6,442	$	978	$	16,650

Our residential construction loans generally provide for the payment of interest only during the construction phase, which is typically up to nine months. We typically convert construction loans to individuals to permanent loans on completion of construction but do not require take-out financing prior to origination. At the end of the construction phase, the construction loan generally either converts to a longer term mortgage loan or is paid off through a permanent loan from another lender. Residential construction loans are made up to the lesser of a maximum loan-to-value ratio of 100% of cost or 80% of appraised value at completion; however, we generally do not originate construction loans which exceed the lower of 80% loan to cost or appraised value without securing adequate private mortgage insurance or other form of credit enhancement such as the Federal Housing Administration or other governmental guarantee.

At December 31, 2011, our largest residential construction mortgage loan commitment was for $1.5 million, of which $1.3 million had been disbursed. This loan was performing according to its repayment terms. The average outstanding residential construction loan balance was approximately $402,000 at December 31, 2011. Before making a commitment to fund a residential construction loan, we require an appraisal of the subject property by an independent licensed appraiser. During the construction phase, we make periodic inspections of the construction site and loan proceeds are disbursed directly to the contractors or borrowers as construction progresses. Typically, disbursements are made in monthly draws during the construction period. Loan proceeds are disbursed after inspection based on the percentage of completion method. We also require general liability, builder’s risk hazard insurance, title insurance, and flood insurance (as applicable, for properties located or to be built in a designated flood hazard area) on all construction loans.

We also originate developed lot and land loans to individuals intending to construct in the future a residence on the property. We will generally originate these loans in an amount up to 75% of the lower of the purchase price or appraisal. These lot and land loans are secured by a first lien on the property and have a fixed rate of interest with a maximum amortization of 20 years. At December 31, 2011, lot and land loans totaled $9.2 million or 51.6% of our construction and land portfolio.

We make land acquisition and development loans to experienced builders or residential lot developers in our market area. The maximum loan-to-value limit applicable to these loans is generally 75% of the appraised market value upon completion of the project. We do not require any cash equity from the borrower if there is sufficient equity in the land being used as collateral. Development plans are required from developers prior to making the loan. Our loan officers are required to personally visit the proposed site of the development and the sites of competing developments. We require that developers maintain adequate insurance coverage. Land acquisition and development loans generally are originated with a loan term up to 24 months, have adjustable rates of interest based on the Wall Street Journal Prime Rate and require interest only payment during the term of the loan. Development loan proceeds are disbursed periodically in increments as construction progresses and as inspection by our approved inspectors warrant. We also require these loans to be paid on an accelerated basis as the lots are sold, so that we are repaid before all the lots are sold. At December 31, 2011, we had $693,000 in land acquisition and development loans. At December 31, 2011 our largest land acquisition and development loan consisted of a $570,000 loan, secured by single family residential lots located in our market area. At December 31, 2011, this loan was performing in accordance with its repayment terms.

We also offer commercial and multifamily construction loans. These loans are underwritten with terms similar to our permanent commercial real estate loans with special construction financing for up to 12 months under terms similar to our residential construction loans. At December 31, 2011, we had $650,000 in commercial and multifamily construction loans.

Construction and land financing is generally considered to involve a higher degree of credit risk than longer-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. If the estimate of construction costs is inaccurate, we may be required to advance funds beyond the amount originally committed in order to protect the value of the property and may have to hold the property for an indeterminate period of time. Additionally, if the estimate of value is inaccurate, we may be confronted with a project that, when completed, has a value that is insufficient to generate full payment. Land loans also pose additional risk because of the lack of income being produced by the property and the potential illiquid nature of the collateral. The value of the lots securing our loans may be affected by the success of the development in which they are located. As a result, construction loans and land loans often involve the disbursement of funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness, rather than the ability of the borrower or guarantor to repay principal and interest. The nature of these loans is also such that they are generally more difficult to monitor. In addition, speculative construction loans to a builder are often associated with homes that are not pre-sold, and thus pose a greater potential risk than construction loans to individuals on their personal residences.

Consumer Lending. We offer a variety of secured consumer loans, including new and used manufactured homes, floating homes, automobiles, boats and recreational vehicle loans, and loans secured by savings deposits. We also offer unsecured consumer loans. We originate our consumer loans primarily in our market area. All of our consumer loans are originated on a direct basis.

We originate new and used manufactured home loans to borrowers who intend to use the home as a primary residence. The yields on these loans are higher than that on our other residential lending products and the portfolio has performed reasonably well with an acceptable level of risk and loss in exchange for the higher yield.Our weighted average yield on manufactured home loans at December 31, 2011 was 8.17%, compared to 5.23% for one- to four-family mortgages, excluding loans held for sale. At December 31, 2011, these loans totaled $18.4 million, or 62.8% of our consumer loans and 6.1% of our gross loan portfolio. For used manufactured homes, loans are generally made for up to 90% of the lesser of the appraised value or purchase price up to $200,000, and with terms typically up to 20 years. On new manufactured homes, loans are generally made for up to 80% of the lesser of the appraised value or purchase price up to $200,000, and with terms typically up to 20 years. We generally charge a 1% fee at origination. We underwrite these loans based on our review of creditworthiness of the borrower, including credit scores, and the value of the collateral, for which we hold a security interest under Washington law.

Manufactured home loans are higher risk than loans secured by residential real property, though this risk is reduced if the owner also owns the land on which the home is located. A small portion of our manufactured home loans involve properties on which we also have financed the land for the owner. The primary additional risk in manufactured home loans is the difficulty in obtaining adequate value for the collateral due to the cost and limited ability to move the collateral. Several manufactured home parks in the Puget Sound area are closing, though governmental requirements have slowed down the process. In addition to the cost of moving a manufactured home, it is difficult for these borrowers to find a new location for their home. As a result, we may be subject to increased defaults and lower recovery on repossession as the available sites for manufactured homes within our market area declines. These loans tend to be made to retired individuals and first-time homebuyers. First-time homebuyers of manufactured homes tend to be a higher credit risk than first-time homebuyers of single family residences, due to more limited financial resources. As a result, these loans have a higher probability of default, higher delinquency rates and greater servicing and collateral recovery costs than single family residential loans and other types of consumer loans. We take into account this additional risk as a component of our allowance for loan losses methodology. We attempt to work out delinquent loans with the borrower and, if that is not successful, any repossessed manufactured homes are repossessed and sold. At December 31, 2011, there were no nonperforming manufactured home loans although we did have three properties valued at $118,000 in our other real estate owned (“OREO”) and repossessed assets portfolio.

We make loans on new and used automobiles. Our automobile loan portfolio totaled $2.3 million at December 31, 2011, or 7.8% of our consumer loan portfolio and 0.8% of our gross loan portfolio. Automobile loans may be written for a term of up to 72 months and have fixed rates of interest. Loan-to-value ratios are up to 90% of the lesser of the purchase price or the National Automobile Dealers Association value for auto loans, including tax, licenses, title and mechanical breakdown and gap insurance. We follow our internal underwriting guidelines in evaluating automobile loans, including credit scoring, verification of employment, reviewing debt to income ratios and valuation of the underlying collateral.

Our consumer loans also include loans secured by new and used boats, floating homes, motorcycles and recreational vehicles, loans secured by deposits and unsecured consumer loans, all of which, at December 31, 2011, totaled $8.6 million or 29.3% of our consumer loan portfolio and 2.8% of our gross loan portfolio. Loans secured by boats, floating homes, motorcycles and recreational vehicles typically have terms from five to 15 years depending on the collateral and loan-to-value ratios up to 90%. These loans may be made with fixed or adjustable interest rates. Our unsecured consumer loans have either a fixed rate of interest generally for a maximum term of 48 months, or are revolving lines of credit of generally up to $50,000. At December 31, 2011, unfunded commitments on our unsecured consumer lines of credit totaled $2.5 million, and the average outstanding balance on these lines was approximately $626.

Consumer loans (other than our manufactured and floating homes) generally have shorter terms to maturity, which reduces our exposure to changes in interest rates. In addition, management believes that offering consumer loan products helps to expand and create stronger ties to our existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities.

Consumer loans generally entail greater risk than do one- to four-family residential mortgage loans, particularly in the case of consumer loans that are secured by rapidly depreciable assets, such as manufactured homes, automobiles, boats and recreational vehicles. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. As a result, consumer loan collections are dependent on the borrower’s continuing financial stability and, thus, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.

Commercial Business Lending. At December 31, 2011, commercial business loans totaled $13.2 million, or 4.4% of our gross loan portfolio. Substantially all of our commercial business loans have been to borrowers in our market area. Our commercial business lending activities encompass loans with a variety of purposes and security, including loans to finance commercial vehicles and equipment. Approximately $1.3 million of our commercial business loans at December 31, 2011 were unsecured. Our commercial business lending policy includes credit file documentation and analysis of the borrower’s background, capacity to repay the loan, the adequacy of the borrower’s capital and collateral, as well as an evaluation of other conditions affecting the borrower. Analysis of the borrower’s past, present and future cash flows is also an important aspect of our credit analysis. We generally require personal guarantees on both our secured and unsecured commercial business loans. Nonetheless, commercial business loans are believed to carry higher credit risk than residential mortgage loans.

Our interest rates on commercial business loans are dependent on the type of lending. Our secured commercial business loans typically have a loan to value ratio of up to 80% and are term loans ranging from three to seven years. Secured commercial business term loans generally have a fixed rated based on the FHLB amortizing rate. In addition, we typically charge loan fees of 1% to 2% of the principal amount at origination, depending on the credit quality and account relationships of the borrower. Business lines of credit are usually adjustable-rate and are based on the prime rate as reported in the West Coast edition of the Wall Street Journal plus 1% to 3%, and are generally originated with both a floor and ceiling to the interest rate. Our business lines of credit have terms ranging from 12 months to 24 months and provide for interest-only monthly payments during the term.

Our commercial business loans are primarily made based on the cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The borrowers’ cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Most often, this collateral is accounts receivable, inventory, equipment or real estate. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Other collateral securing loans may depreciate over time, may be difficult to appraise, may be illiquid and may fluctuate in value based on the specific type of business and equipment used. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself (which, in turn, is often dependent in part upon general economic conditions).

Loan Originations, Purchases, Sales, Repayments and Servicing

We originate both fixed-rate and adjustable-rate loans. Our ability to originate loans, however, is dependent upon customer demand for loans in our market area. Over the past few years, we have continued to originate residential and consumer loans, and increased our emphasis on commercial and multifamily, construction and land, and commercial business lending. Demand is affected by competition and the interest rate environment. During the past few years, we, like many other financial institutions, have experienced significant prepayments on loans due to the low interest rate environment prevailing in the United States. In periods of economic uncertainty, the ability of financial institutions, including us, to originate large dollar volumes of real estate loans may be substantially reduced or restricted, with a resultant decrease in interest income. In 2011 and 2010, we did not acquire any loans. In 2009, we purchased approximately $4.2 million of seasoned multifamily residential real estate loans. In 2010, we engaged in a commercial real estate loan participation with another financial institution in the amount of $3.4 million. We underwrite participations to the same standards as an internally-originated loan.

In addition to interest earned on loans and loan origination fees, we receive fees for loan commitments, late payments and other miscellaneous services.

We also sell whole one-to four-family loans without recourse to Fannie Mae, subject to a provision for repurchase upon breach of representation, warranty or covenant. There were no loans repurchased from Fannie Mae in 2011. These loans are fixed-rate mortgages, which primarily are sold to improve our interest rate risk. These loans are generally sold for cash in amounts equal to the unpaid principal amount of the loans determined using present value yields to the buyer. These sales allow for a servicing fee on loans when the servicing is retained by us. Most one-to four-family loans sold by us are sold with servicing retained. We earned mortgage servicing income of $418,000 and $624,000 respectively, for the years ended December 31, 2011 and 2010. In November 2009, we acquired a $340.1 million loan servicing portfolio from Leader Financial Services. These loans are 100% owned by Fannie Mae and are subserviced under an agreement with a third party loan servicer who performs all servicing

including payment processing, reporting and collections. At December 31, 2011, we were servicing a $393.1 million portfolio of residential mortgage loans for Fannie Mae. These mortgage servicing rights are carried at fair value and had a value at December 31, 2011 of $2.4 million. See Note 6 to the Consolidated Financial Statements.

Sales of whole real estate loans can be beneficial to us since these sales generally generate income at the time of sale, produce future servicing income on loans where servicing is retained, provide funds for additional lending and other investments, and increase liquidity. We sold $53.7 million and $61.9 million of loans during the years ended December 31, 2011 and 2010, respectively.

Gains, losses and transfer fees on sales of one-to four-family loans and participations are recognized at the time of the sale. Our net gain on sales of residential loans for all of 2011 and 2010 were $501,000 and $785,000, respectively.

The following table shows our loan origination, sale and repayment activities for the periods indicated (includes loans held for sale):

	For the year ended December 31,
	2011		2010		2009
Originations by type:	(In thousands)
Fixed-rate:
One- to four-family	$	66,883	$	73,366	$	111,745
Home equity		2,715		1,790		1,146
Commercial and multifamily		18,356		18,298		6,969
Construction and land		9,369		6,000		3,997
Manufactured home		1,666		2,144		1,436
Other consumer		2,323		2,525		2,873
Commercial business		7,949		3,272		6,597
Total fixed-rate		109,261		107,395		134,763
Adjustable rate:
One- to four-family (1)		-		483		3,171
Home equity		1,254		1,157		3,558
Commercial and multifamily		17,454		17,698		19,961
Construction and land		943		190		38
Other consumer		106		26		27
Commercial business		3,258		3,146		1,917
Total adjustable-rate		23,015		22,700		28,672
Total loans originated		132,276		130,095		163,435
Purchases by type:
Commercial and multifamily		-		3,400		4,199
Sales and Repayments:
One- to four-family		53,684		61,908		84,299
Total loans sold		53,684		61,908		84,299
Total principal repayments		76,861		64,025		55,031
Total reductions		130,545		125,933		139,330
Net increase	$	1,731	$	7,562	$	28,304

__________________________

(1)

These loans include $0, $483,000 and $2.3 million of adjustable rate mortgage loan originations to employees at December 31, 2011, 2010 and 2009, respectively.

The decrease in originations in 2011 and 2010 compared to 2009, particularly in one-to four-family real estate loans, was due to a lack of relative demand compared to the prior period. The ability of borrowers to refinance their existing first mortgage loans was impacted by the economic environment, the housing market and the rate of unemployment both in our markets and nationwide.

Asset Quality

When a borrower fails to make a required payment on a one-to four-family loan, we attempt to cure the delinquency by contacting the borrower. In the case of loans secured by a one-to four-family property, a late notice typically is sent 15 days after the due date, and the borrower is contacted by phone within 30 days after the due date. Generally, a delinquency letter is mailed to the borrower. All delinquent accounts are reviewed by a loan account executive or branch manager who attempts to cure the delinquency by contacting the borrower once the loan is 30 days past due. If the account becomes 60 days delinquent and an acceptable repayment plan has not been agreed upon, we generally refer the account to legal counsel with instructions to prepare a notice of intent to foreclose. The notice of intent to foreclose allows the borrower up to 30 days to bring the account current. If foreclosed, typically we take title to the property and sell it directly through a real estate broker.

Delinquent consumer loans, as well as delinquent home equity loans and lines of credit, are handled in a similar manner to one-to four-family loans, except that appropriate action may be taken to collect any loan payment that is delinquent for more than 15 days. Once the loan is 90 days past due, it is classified as nonaccrual. Generally, credits are charged-off at 120 days past due, unless the Collections Department provides support for continuing its collection efforts. Our procedures for repossession and sale of consumer collateral are subject to various requirements under the applicable consumer protection laws as well as other applicable laws and the determination by us that it would be beneficial from a cost basis.

Delinquent loans are initially handled by the loan officer in charge of the loan, who is responsible for contacting the borrower. The Collections Department also works with the loan officers to see that the necessary steps are taken to collect delinquent loans. In addition, management meets weekly and reviews past due and classified loans, as well as other loans that management feels may present possible collection problems, which are reported to the board on a quarterly basis. If an acceptable workout of a delinquent loan cannot be agreed upon, we generally initiate foreclosure or repossession proceedings on any collateral securing the loan.

Delinquent Loans. The following table sets forth our loan delinquencies by type, by amount and by percentage of type at December 31, 2011.

	Loans Delinquent For:
	60-89 Days							90 Days and Over							Total Delinquent Loans
	Number		Amount		Percent of Loan Category			Number		Amount		Percent of Loan Category			Number		Amount		Percent of Loan Category
	(Dollars in thousands)
One- to four- family		8	$	935		0.97	%		14	$	2,683		2.79	%		22	$	3,618		3.76	%
Home equity		3		176		0.44			4		683		1.72			7		859		2.16
Construction and land		1		123		0.69			1		80		0.45			2		203		1.14
Manufactured homes		1		7		0.04			-		-	NM				1		7		0.04
Other consumer		4		3		0.03			-		-	NM				4		3		0.03
Total		17	$	1,244		0.41	%		19	$	3,446		1.14	%		36	$	4,690		1.55	%

Nonperforming Assets. The table below sets forth the amounts and categories of nonperforming assets in our loan portfolio. Loans are placed on nonaccrual status when the collection of principal and/or interest become doubtful or when the loan is more than 90 days past due. OREO and repossessed assets include assets acquired in settlement of loans. We had no accruing loans 90 days or more delinquent for the periods reported.

	December 31,
	2011			2010			2009			2008			2007
Nonperforming loans(1):	(Dollars in thousands)
One- to four- family	$	4,401		$	2,729		$	2,175		$	258		$	256
Home equity		873			517			1,100			340			-
Commercial and multifamily		1,219			-			222			471			-
Construction and land		80			-			1,231			59			-
Manufactured homes
Other consumer		64			-			19			64			162
Commercial business		-			-			-			60			-
Total		6,637			3,246			4,747			1,252			418

OREO and repossessed assets:
One- to four-family		478			1,102			901			1,250			817
Commercial and multifamily		2,225			1,302			-			-			-
Construction and land		-			70			115			-			-
Manufactured homes		118
Other consumer		-			151			368			284			35
Commercial business		-			-			-			190			-
Total		2,821			2,625			1,384			1,724			852

Total nonperforming assets	$	9,458		$	5,871		$	6,131		$	2,976		$	1,270
Nonperforming assets as a percentage of total assets		2.78	%		1.75	%		1.81	%		1.01	%		0.54	%

Performing restructured loans:
One- to four- family	$	2,508		$	2,836		$	3,996		$	-		$	-
Home equity		812			967			1,290			-			-
Commercial and multifamily		785			-			708			-			-
Construction and land		-			230			230			-			-
Manufactured homes		-			-			-			-			-
Other consumer		4			15			111			-			-
Commercial business		26			-			174			-			-
Total	$	4,135		$	4,048		$	6,509		$	-		$	-

___________________________________

(1) Nonperforming loans include $2.8 million, $348,000, and $1.1 million in nonperforming TDRs as of December 31, 2011, 2010 and 2009, respectively. There were no nonperforming TDRs as of December 31, 2008 or 2007.

For the year ended December 31, 2011, gross interest income that would have been recorded had the nonaccrual loans been current in accordance with their original terms amounted to $306,000, all of which was excluded in interest income for the year ended December 31, 2011.

See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition at December 31, 2011 Compared to December 31, 2010 -- Delinquencies and Nonperforming Assets” for more information on troubled assets.

Troubled Debt Restructured Loans. Troubled debt restructurings, which are accounted for under Accounting Codification Standard (“ASC”) 310-40, are loans which have renegotiated loan terms to assist borrowers who are unable to meet the original terms of their loans. Such modifications to loan terms may include a lower interest rate, a reduction in principal, or a longer term to maturity. All troubled debt restructurings are initially classified as impaired, regardless of whether the loan was performing at the time it was restructured. Once a troubled debt restructuring has performed according to its modified terms for six months and the collection of principal and interest under the revised terms is deemed probable, we remove the troubled debt restructuring from nonperforming status. At December 31, 2011, we had $4.1 million of loans that were classified as troubled debt restructurings and still on accrual. Included in nonperforming loans at December 31, 2011 and 2010 were troubled debt restructured loans of $2.8 million and $348,000, respectively.

OREO and Repossessed Assets. OREO and repossessed assets include assets acquired in settlement of loans. At December 31, 2011 OREO and repossessed assets consisted of two single family residences totaling $478,000, three commercial real estate properties totaling $2.2 million, and three manufactured homes totaling $118,000. The largest foreclosed property is a manufactured home development consisting of 28 lots and one commercial parcel, which had a book value of $1.0 million as of December 31, 2011. Subsequent to December 31, 2011 we sold our next largest foreclosed property, an $873,000 commercial real estate property at a slight gain. We do not expect to experience a material loss on any of the OREO and repossessed assets in our possession at December 31, 2011 based on current appraisals and valuation estimates.

Other Loans of Concern. In addition to the nonperforming assets set forth in the table above, as of December 31, 2011, there were 31 loans totaling $3.0 million with respect to which known information about the possible credit problems of the borrowers have caused management to have doubts as to the ability of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of such items in the nonperforming asset categories. These loans have been considered individually in management’s determination of our allowance for loan losses. The largest loan relationship of concern at December 31, 2011, totaled $570,000 and was secured by single family residential lots located in Clallam County, Washington. The remaining loans of concern consist of $1.5 million in residential first mortgages, $823,000 in construction and land loans, $420,000 in commercial business loans, $148,000 in consumer loans and $81,000 in home equity loans. Loans of concern had specific loan loss reserves of $134,000 at December 31, 2011.

Classified Assets. Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered by the OCC to be of lesser quality, as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.

When we classify problem assets as either substandard or doubtful, we may establish specific allowance for loan losses in an amount deemed prudent by management. Our determination as to the classification of our assets and the amount of our valuation allowances is subject to review by the OCC and the FDIC, which may order the establishment of additional general or specific loss allowances.

We regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of management’s review of our assets, at December 31, 2011, we had classified $15.6 million of our assets as substandard, which represented a variety of outstanding loans, non-agency mortgage backed securities, foreclosed real estate and repossessed assets. At that date, we had no assets classified as doubtful or loss. This total amount of classified assets represented 54.4% of our equity capital and 4.6% of our assets at December 31, 2011. Classified assets totaled $13.3 million, or 49.6% of our equity capital and 4.0% of our assets at December 31, 2010 and $12.1 million, or 48.1% of our equity capital and 3.6% of our assets at December 31, 2009.

Allowance for Loan Losses. We maintain an allowance for loan losses to absorb probable loan losses in the loan portfolio. The allowance is based on ongoing, monthly assessments of the estimated probable incurred losses in the loan portfolio. In evaluating the level of the allowance for loan losses, management considers the types of loans and the amount of loans in the loan portfolio, peer group information, historical loss experience, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. Large groups of smaller balance homogeneous loans, such as one-to four-family, small commercial and multifamily, home equity and consumer loans, are evaluated in the aggregate using historical loss factors and peer group data adjusted for current economic conditions. More complex loans, such as commercial and multifamily loans and commercial business loans, are evaluated individually for impairment, primarily through the evaluation of the borrower’s net operating income and available cash flow and their possible impact on collateral values.

At December 31, 2011, our allowance for loan losses was $4.5 million, or 1.5% of our total loan portfolio, compared to $4.4 million, or 1.5% of our total loan portfolio in 2010. Specific valuation reserves totaled $1.3 million and $1.1 million at December 31, 2011 and 2010, respectively.

Assessing the allowance for loan losses is inherently subjective as it requires making material estimates, including the amount and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. In the opinion of management, the allowance, when taken as a whole, properly reflects estimated probable loan losses in our loan portfolio. See Notes 1 and 5 of the Notes to Consolidated Financial Statements.

The following table sets forth an analysis of our allowance for loan losses:

	December 31,
	2011			2010			2009			2008			2007

	(Dollars in thousands)
Balance at beginning of period	$	4,436		$	3,468		$	1,306		$	828		$	822
Charge-offs:
One-to four-family		834			843			104			114			-
Home equity		1,652			1,291			1,368			62			-
Commercial and multifamily		1,353			940			74			37			-
Construction and land		159			-			-			-			-
Manufactured homes		239						-			-			-
Other consumer		255			649			577			505			483
Commercial business		310			221			149			71			-
Total charge-offs		4,802			3,944			2,272			789			483
Recoveries:
One-to four-family		11			-			-			2			-
Home equity		10			222			-			-			-
Commercial and multifamily		96			-			22			-			-
Construction and land		-			-			-			-			-
Manufactured homes		8			-			-			-			-
Other consumer		53			38			128			140			239
Commercial business		43			2			9			15			-
Total recoveries		221			262			159			157			239
Net charge-offs		4,581			3,682			2,113			632			244
Additions charged to operations		4,600			4,650			4,275			1,110			250
Balance at end of period	$	4,455		$	4,436		$	3,468		$	1,306		$	828

Net charge-offs during the period as a percentage of average loans outstanding during the period		1.53	%		1.22	%		0.75	%		0.26	%		0.11	%

Net charge-offs during the period as a percentage of average nonperforming assets		48.04	%		31.22	%		46.40	%		29.77	%		29.38	%

Allowance as a percentage of nonperforming loans		67.12	%		136.66	%		73.06	%		104.31	%		198.09	%

Allowance as a percentage of total loans (end of period)		1.47	%		1.48	%		1.18	%		0.49	%		0.37	%

market area has experienced substantial home price declines, historically low levels of existing home sale activity, high levels of foreclosures and above average unemployment rates negatively affecting the values of real estate collateral supporting our loans and resulting in increased loan delinquencies and defaults and net charge-offs during these periods.

The decrease in our allowance for loan losses as a percentage of nonperforming loans was a result of the increase in nonperforming loans during the period. The allowance for loan losses as a percentage of total loans was 1.47% and 1.48% as of December 31, 2011 and 2010, respectively.

The distribution of our allowance for losses on loans at the dates indicated is summarized as follows:


	2011					2010					2009					2008					2007
	Amount		Percent of loans in each category to total loans			Amount		Percent of loans in each category to total loans			Amount		Percent of loans in each category to total loans			Amount		Percent of loans in each category to total loans			Amount		Percent of loans in each category to total loans
	(Dollars in thousands)
Allocated at end of period to:
One- to four- family	$	1,117		31.86	%	$	909		33.01	%	$	589		36.63	%	$	321		34.33	%	$	145		38.37	%
Home equity		1,426		13.12			1,380		14.91			2,220		17.22			240		20.61			100		20.53
Commercial and multifamily		969		35.07			659		30.96			220		24.58			153		18.41			170		11.32
Construction and land		105		5.89			205		5.54			-		3.41			55		4.62			25		3.90
Manufactured homes		290		6.10			321		6.67					7.33					8.58					10.18
Other consumer		213		3.61			381		4.03			243		4.76			272		6.78			159		10.81
Commercial business		254		4.35			163		4.88			164		6.07			158		6.67			90		4.89
Unallocated		81		-			418		-			32		-			107		-			139		-
Total	$	4,455		100.00	%	$	4,436		100.00	%	$	3,468		100.00	%	$	1,306		100.00	%	$	828		100.00	%

Investment Activities

Federal savings banks have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, including callable agency securities, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds. Subject to various restrictions, federal savings banks may also invest their assets in investment grade commercial paper and corporate debt securities and mutual funds whose assets conform to the investments that the institution is otherwise authorized to make directly. See “How We Are Regulated – Sound Community Bank – OCC” for a discussion of additional restrictions on our investment activities.

Our Chief Executive Officer and Chief Financial Officer have the responsibility for the management of our investment portfolio, subject to the direction and guidance of the Board of Directors. These officers consider various factors when making decisions, including the marketability, maturity and tax consequences of the proposed investment. The maturity structure of investments will be affected by various market conditions, including the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit inflows, and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.

The general objectives of our investment portfolio will be to provide liquidity when loan demand is high, to assist in maintaining earnings when loan demand is low and to maximize earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk. Our investment quality will emphasize safer investments with the yield on those investments secondary to not taking unnecessary risk with the available funds. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset/Liability Management.”

At December 31, 2011, we owned $2.4 million in Federal Home Loan Bank of Seattle (“FHLB”) stock. As a condition of membership at the FHLB, we are required to purchase and hold a certain amount of FHLB stock. Our stock purchase requirement is based, in part, upon the outstanding principal balance of advances from the FHLB and is calculated in accordance with the Capital Plan of the FHLB. Our FHLB stock has a par value of $100, is carried at cost, and is subject to recoverability testing. The FHLB announced that it had a risk-based capital deficiency under the regulations of the Federal Housing Finance Agency (the "FHFA"), its primary regulator, as of December 31, 2008, and that it would suspend future dividends and the repurchase and redemption of outstanding common stock. As a result, the FHLB has not paid a dividend since the fourth quarter of 2008. The FHLB has communicated that it believes the calculation of risk-based capital under the current rules of the FHFA significantly overstates the market risk of the FHLB's private-label mortgage-backed securities in the current market environment and that it has enough capital to cover the risks reflected in its balance sheet. As a result, we have not recorded an impairment on our investment in FHLB stock. However, further deterioration in the FHLB's financial position may result in impairment in the value of those securities. In addition, on October 25, 2010, the FHLB received a consent order from the FHFA. The potential impact of the consent order is unknown at this time. We will continue to monitor the financial condition of the FHLB as it relates to, among other things, the recoverability of our investment.

The following table sets forth the composition of our securities portfolio and other investments at the dates indicated. At December 31, 2011, our securities portfolio did not contain securities of any issuer with an aggregate book value in excess of 10% of our equity capital.

	December 31,
	2011				2010				2009
	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
Securities available for sale	(In thousands)
Agency mortgage-backed securities	$	53	$	59	$	54	$	61	$	3,421	$	3,370
Non-agency mortgage-backed securities(1)		3,939		2,933		5,543		4,480		7,901		6,529
Total available for sale		3,992		2,992		5,597		4,541		11,322		9,899

FHLB stock		2,444		2,444		2,444		2,444		2,444		2,444
Total securities	$	6,436	$	5,436	$	8,041	$	6,985	$	13,766	$	12,343

________________________

(1)

The non-agency mortgage backed securities have an unrealized loss of $1.0 million as of December 31, 2011. These securities were purchased at a discount in 2008 and 2009. Each of these securities has performed and paid principal and interest each month as contractually committed.

The composition and maturities of our investment securities portfolio at December 31, 2011, excluding FHLB stock, are as follows: Federal agency mortgage-backed securities with an amortized cost of $53,000 and a fair value of $59,000 and a final maturity greater than ten years and non-agency mortgage-backed securities with an amortized cost of $3.9 million and a fair value of $2.9 million and a final maturity greater than ten years.

We review investment securities on an ongoing basis for the presence of other-than-temporary impairment (“OTTI”) taking into consideration current market conditions, fair value in relationship to cost, extent and nature of the change in fair value, issuer rating changes and trends, whether we intend to sell a security or if it is likely that we will be required to sell the security before recovery of our amortized cost basis of the investment, which may be maturity, and other factors. For debt securities, if we intend to sell the security or it is likely that we will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If we do not intend to sell the security and it is not more likely than not that we will be required to sell the security but we do not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected.

Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and the fair value, is recognized as a charge to other comprehensive income. Impairment losses related to all other factors are presented as separate categories within other comprehensive income.

During the year ended December 31, 2011, we recognized a $96,000 non-cash OTTI charge on three non-agency mortgage-backed securities. At December 31, 2011, the fair value of these two securities was $1.9 million. Management concluded that the decline of the estimated fair value below the cost of the securities was other than temporary and recorded a credit loss of $96,000 through non-interest income. We determined the remaining decline in value was not related to specific credit deterioration. We do not intend to sell these securities and it is more likely than not that we will not be required to sell the securities before anticipated recovery of the remaining amortized cost basis. We closely monitor our investment securities for changes in credit risk. The current market environment significantly limits our ability to mitigate our exposure to valuation changes in these securities by selling them. Accordingly, if market conditions deteriorate further and we determine our holdings of these or other investment securities are OTTI, our future earnings, shareholders’ equity, regulatory capital and continuing operations could be materially adversely affected.

Sources of Funds

General. Our sources of funds are primarily deposits, borrowings, payments of principal and interest on loans and funds provided from operations.

Deposits. We offer a variety of deposit accounts to both consumers and businesses having a wide range of interest rates and terms. Our deposits consist of savings accounts, money market deposit accounts, demand accounts and certificates of deposit. We solicit deposits primarily in our market area; however, at December 31, 2011, approximately 3.5% of our deposits were from persons outside the State of Washington. As of December 31, 2011, core deposits, which we define as our non-certificate or non-time deposit accounts, represented approximately 56.7% of total deposits, compared to 53.2% and 52.8% as of December 31, 2010 and December 31, 2009, respectively. We primarily rely on competitive pricing policies, marketing and customer service to attract and retain these deposits and we expect to continue these practices in the future.

The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates and competition. The variety of deposit accounts we offer has allowed us to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. We have become more susceptible to short-term fluctuations in deposit flows as customers have become more interest rate conscious. We manage the pricing of our deposits in keeping with our asset/liability management, liquidity and profitability objectives, subject to competitive factors. Based on our experience, we believe that our deposits are relatively stable sources of funds. Despite this stability, our ability to attract and maintain these deposits and the rates paid on them has been and will continue to be significantly affected by market conditions.

The following table sets forth our deposit flows during the periods indicated:

	For the year ended December 31,
	2011			2010			2009
	(In thousands)
Opening balance	$	278,494		$	287,564		$	222,760
Net deposits (withdrawals)		19,002			(12,771	)		58,681
Interest credited		2,501			3,701			6,123
Ending balance	$	299,997		$	278,494		$	287,564

Net increase (decrease)	$	21,503		$	(9,070	)	$	64,804

Percent increase (decrease)		7.7	%		(3.2	)%		29.1	%

The following table sets forth the dollar amount of deposits in the various types of deposit programs offered by us at the dates indicated:

		December 31,
		2011					2010					2009
		Amount		Percent of total			Amount		Percent of total			Amount		Percent of total
Transaction and Savings Deposits		(Dollars in thousands)
Noninterest-bearing checking		$	26,907		8.97	%	$	22,148		7.95	%	$	21,227		7.38	%
Interest-bearing demand			22,332		7.44	%		22,186		7.97	%		28,197		9.81	%
Savings			22,092		7.36	%		21,598		7.76	%		19,655		6.84	%
Money market			95,029		31.68	%		77,257		27.74	%		81,620		28.38	%
Escrow			3,669		1.22	%		4,922		1.77	%		977		0.34	%
Total non-certificates			170,029		56.68	%		148,111		53.18	%		151,676		52.75	%
Certificates:
Below 1.99%			108,604		36.20	%		26,132		9.38	%		7,189		2.50	%
	2.00 - 3.99%		15,423		5.14	%		90,967		32.66	%		95,695		33.28	%
	4.00 - 5.99%		5,941		1.98	%		13,275		4.77	%		32,992		11.47	%
	6.00 - 7.99%		-	NM				9		0.00	%		12		0.00	%
Total certificates			129,968		43.32	%		130,383		46.82	%		135,888		47.25	%
Total deposits		$	299,997		100.00	%	$	278,494		100.00	%	$	287,564		100.00	%

Money market account increases were primarily a result of an increased emphasis on new business relationships, customers placing maturing certificate funds into money market accounts in light of the low interest rate environment and a preference in the marketplace for insured deposits over other investments. Our noninterest-bearing checking increases were a result of our increased emphasis on attracting these and other low cost deposit accounts such as savings accounts. We require our commercial loan customers to maintain a checking or savings account with us. As our commercial lending business increases, we anticipate increases in transaction and savings deposits from our commercial customers. We are a public funds depository and as of December 31, 2011, we had $24.6 million in public funds. These funds consisted of $21.0 million in certificates of deposit, $3.5 million in money market accounts and $64,000 in checking accounts at December 31, 2011. These accounts must be 100% collateralized. We use agency mortgage-backed securities and letters of credit from the FHLB as collateral for these funds.

The following table shows rate and maturity information for our certificates of deposit at December 31, 2011:

		0.00-1.99%			2.00-3.99%			4.00-5.99%		Total			Percent of Total
	(Dollars in thousands)
Certificate accounts maturing in quarter ending:
March 31, 2012	$	9,525		$	5,048		$	869		$	15,442			11.88	%
June 30, 2012		30,264			25			398			30,687			23.61
September 30, 2012		7,184			-			688			7,872			6.06
December 31, 2012		17,057			39			729			17,825			13.71
March 31, 2013		22,320			130			721			23,171			17.83
June 30, 2013		8,122			161			1,162			9,445			7.27
September 30, 2013		1,564			15			408			1,987			1.53
December 31, 2013		5,673			-			884			6,557			5.05
March 31, 2014		3,814			525			69			4,408			3.39
June 30, 2014		1,198			361			-			1,559			1.20
September 30, 2014		223			499			-			722			0.56
December 31, 2014		714			244			-			958			0.74
Thereafter		946			8,376			13			9,335			7.18
Total	$	108,604		$	15,423		$	5,941		$	129,968			100.00	%
Percent of total		83.56	%		11.87	%		4.57	%		100.00	%

The following table indicates the amount of our certificates of deposit and other deposits by time remaining until maturity as of December 31, 2011:

	Maturity
	3 months or less		Over 3 to 6 months		Over 6 to 12 months		Over 12 months		Total
	(Dollars in thousands)
Certificates of deposit less than $100,000	$	9,366	$	12,414	$	11,219	$	22,025	$	55,024
Certificates of deposit of $100,000 or more		6,076		18,273		14,477		36,118		74,944
Total certificates of deposit	$	15,442	$	30,687	$	25,696	$	58,143	$	129,968

Borrowings. Although deposits are our primary source of funds, we may utilize borrowings as a cost-effective source of funds when they can be invested at a positive interest rate spread, for additional capacity to fund loan demand, or to meet our asset/liability management goals. Our borrowings currently consist of advances from the FHLB. See Note 10 of the Notes to Consolidated Financial Statements.

We are a member of and obtain advances from the FHLB, which is part of the Federal Home Loan Bank System. The twelve regional Federal Home Loan Banks provide a central credit facility for their member institutions. These advances are provided upon the security of certain of our mortgage loans and mortgage-backed securities. These advances may be made pursuant to several different credit programs, each of which has its own interest rate, range of maturities and call features, and all long-term advances are required to provide funds for residential home financing. We have entered into a loan agreement with the FHLB pursuant to which Sound Community Bank may borrow up to approximately 35% of its total assets, secured by a blanket pledge on a portion of our residential mortgage portfolio including one- to four family first and second mortgage loans, and commercial and multifamily loans. Based on eligible collateral, the total amount available under this agreement as of December 31, 2011 was $85.5 million. At the same date we had $8.5 million in FHLB advances outstanding, which had maturities between zero and six years. At December 31, 2011, we had $51.0 million in one- to four- family and commercial and multifamily loans and mortgage-backed securities available to serve as collateral for additional advances. We plan to rely in part on long-term FHLB advances to fund asset and loan growth. We also use short-term advances to meet short term liquidity needs. We are required to own stock in the FHLB based on the amount of our advances.

We also from time to time borrow from the Federal Reserve Bank of San Francisco’s “discount window” for overnight liquidity needs. In 2011, we did not borrow from the discount window.

The following table sets forth the maximum balance and average balance of borrowings for the periods indicated:

	For the year ended December 31,
	2011			2010			2009
Maximum balance:	(Dollars in thousands)
FHLB advances	$	24,596		$	33,550		$	41,950
Federal Reserve Bank advances	$	-		$	2,400		$	8,000

Average balances:
FHLB advances	$	14,249		$	23,478		$	28,364
Federal Reserve Bank advances	$	-		$	66		$	1,100

Weighted average interest rate:
FHLB advances		1.97	%		2.52	%		3.29	%
Federal Reserve Bank advances	NM				0.50	%		0.50	%

The following table sets forth certain information about our borrowings at the dates indicated:

	December 31,
	2011			2010			2009
	(Dollars in thousands)
FHLB advances	$	8,506		$	24,849		$	20,000
Federal Reserve Bank advances	$	-		$	-		$	-

Weighted average interest rate:
FHLB advances		2.17	%		1.86	%		3.27	%
Federal Reserve Bank advances	NM				0.50	%		0.50	%

Subsidiary and Other Activities

Sound Financial has one subsidiary, Sound Community Bank. Sound Community Bank has one subsidiary, which is currently inactive. Our capital investment in the inactive subsidiary as of December 31, 2011 was $2,000.

Competition

We face strong competition in attracting deposits and originating loans. Competition in originating real estate loans comes primarily from other savings institutions, commercial banks, credit unions, life insurance companies and mortgage brokers. Other savings institutions, commercial banks, credit unions and finance companies provide vigorous competition in consumer lending. Commercial business competition is primarily from local commercial banks, but other savings banks and credit unions also compete for this business. We compete by consistently delivering high-quality, personal service to our customers which results in a high level of customer satisfaction.

Our market area has a high concentration of financial institutions, many of which are branches of large money center and regional banks that have resulted from the consolidation of the banking industry in Washington and other western states. These include such large national lenders as US Bank, JP Morgan Chase, Wells Fargo, Bank of America, Key Bank and others in our market area that have greater resources than we do and offer services that we do not provide. For example, we do not offer trust services or non-FDIC insured investments. Customers who seek “one-stop shopping” may be drawn to institutions that offer services that we do not.

We attract our deposits through our branch office system. Competition for those deposits is principally from other savings institutions, commercial banks and credit unions located in the same community, as well as mutual funds and other alternative investments. We compete for these deposits by offering superior service and a variety of deposit accounts at competitive rates. Based on the most recent data provided by the FDIC, there are approximately 75 other commercial banks and savings institutions operating in the Seattle MSA and 13 other commercial banks and savings institutions in Clallam County, Washington. Based on the most recent branch deposit data provided by the FDIC, our share of deposits in the Seattle MSA was approximately 0.1%. The five largest financial institutions in that area have 74.2% of those deposits. In addition, our share of deposits in Clallam County was the third highest in the county at 10.7%, with the five largest institutions in that county having 70.0% of the deposits.

How We Are Regulated

General. Set forth below is a brief description of certain laws and regulations that are applicable to Sound Financial, Sound Community Bank and Sound Community MHC. The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations. Legislation is introduced from time to time in the United States Congress that may affect the operations of Sound Financial, Sound Community Bank and Sound Community MHC. In addition, the regulations governing us may be amended from time to time. Any such legislation or regulatory changes in the future could adversely affect our operations and financial condition. See “Restrictions on Acquisitions of Sound Financial Inc. and Sound Community Bank” for information on regulatory limits and requirements on persons or companies seeking to acquire control of those entities.

The OCC has extensive enforcement authority over all federally-chartered savings associations, including Sound Community Bank. The Federal Reserve has the same type of authority over Sound Financial and Sound Community MHC. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease-and-desist orders and removal orders and initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OCC or Federal Reserve. Except under certain circumstances, public disclosure of final enforcement actions by the OCC or Federal Reserve is required by law.

Regulatory Reform. On July 21, 2010, the President signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act imposes new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions. The following discussion summarizes significant aspects of the Dodd-Frank Act that will affect us. Regulations implementing many of these changes have not been promulgated, so we cannot determine the full impact of the Dodd-Frank Act on our business and operations at this time.

The following aspects of the Dodd-Frank Act are related to the operations of Sound Community Bank:

The OTS was merged into the OCC and the OTS’s authority to regulate and supervise federal savings associations was transferred to the OCC. The federal thrift charter has been preserved and the Federal Reserve now has authority to regulate and supervise savings and loan holding companies. The regulations of the OTS remain in effect except as modified by the OCC or the Federal Reserve. There have been no substantial modifications to these regulations to date.

The Consumer Financial Protection Bureau (the “CFPB”), an independent consumer compliance regulatory agency within the Federal Reserve, has been established. The CFPB is empowered to exercise broad regulatory, supervisory and enforcement authority over financial institutions with total assets over $10 billion with respect to both new and existing consumer financial protection laws. Smaller financial institutions, like Sound Community Bank, will be subject to supervision and enforcement by their primary federal banking regulator with respect to federal consumer financial protection laws and regulations. The CFPB also has authority to promulgate new consumer financial protection regulations and amend existing consumer financial protection regulations.

·	The Federal Deposit Insurance Act was amended to direct federal regulators to require depository institution holding companies to serve as a source of strength for their depository institution subsidiaries.

Tier 1 capital treatment for “hybrid” capital items like trust preferred securities is eliminated subject to various grandfathering and transition rules. The federal banking agencies must promulgate new rules on regulatory capital for both depository institutions and their holding companies, to include leverage capital and risk-based capital measures at least as stringent as those now applicable to Sound Community Bank under the prompt corrective action regulations. To date, the federal banking agencies have not yet established such new regulatory capital requirements.

·	The prohibition on payment of interest on demand deposits was repealed.

State consumer financial protection law will be preempted only if it would have a discriminatory effect on a federal savings association or is preempted by any other federal law. The OCC must make a preemption determination with respect to a state consumer financial protection law on a case-by-case basis with respect to a particular state law or other state law with substantively equivalent terms.

·	Deposit insurance is permanently increased to $250,000 and unlimited deposit insurance for noninterest-bearing transaction accounts applies through December 31, 2012.

·	The deposit insurance assessment base for FDIC insurance is the depository institution’s average consolidated total assets less average tangible equity during the assessment period.

The minimum reserve ratio of the Deposit Insurance Fund increased to 1.35 percent of estimated annual insured deposits or the comparable percentage of the assessment base; however, the Federal Deposit Insurance Corporation is directed to “offset the effect” of the increased reserve ratio for insured depository institutions with total consolidated assets of less than $10 billion. Pursuant to the Dodd-Frank Act, the FDIC recently issued a rule setting a designated reserve ratio at 2.0% of insured deposits.

·	Public companies are required to provide their shareholders with a non-binding vote: (i) at least once every three years on the compensation paid to executive officers, and (ii) at least once every six years on whether they should have a “say on pay” vote every one, two or three years.

·	A separate, non-binding shareholder vote is required regarding golden parachutes for named executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments.

·	Securities exchanges are required to prohibit brokers from using their own discretion to vote shares not beneficially owned by them for certain “significant” matters, which include votes on the election of directors, executive compensation matters, and any other matter determined to be significant.

Stock exchanges, not including the OTC Bulletin Board, are prohibited from listing the securities of any issuer that does not have a policy providing for (i) disclosure of its policy on incentive compensation that is based on financial information required to be reported under the securities laws, and (ii) the recovery from current or former executive officers, following an accounting restatement triggered by material noncompliance with securities law reporting requirements, of any incentive compensation paid erroneously during the three-year period preceding the date on which the restatement was required that exceeds the amount that would have been paid on the basis of the restated financial information.

·	Disclosure in annual proxy materials is required concerning the relationship between the executive compensation paid and the financial performance of the issuer.

·	Item 402 of Regulation S-K is amended to require companies to disclose the ratio of the median annual total compensation of all employees (excluding the Chief Executive Officer’s compensation) to the Chief Executive Officer’s annual total compensation.

Savings and loan holding companies, such as Sound Financial, will be subject to the same capital requirements as bank holding companies in 2015. Currently, a bank holding company with less than $500 million in assets is subject to capital requirements on a bank-only basis (except in certain unusual cases).

Regulation of Sound Community Bank

General. Sound Community Bank, as a federally-chartered savings bank, is subject to regulation and oversight by the OCC extending to all aspects of its operations. This regulation is intended for the protection of depositors and not for the purpose of protecting shareholders. Sound Community Bank is required to maintain minimum levels of regulatory capital and will be subject to certain limitations on the payment of dividends to Sound Financial. See “- Capital Requirements for Sound Community Bank” and “-Limitations on Dividends and Other Capital Distributions.” Sound Community Bank also is subject to regulation and examination by the FDIC, which insures the deposits of Sound Community Bank to the maximum extent permitted by law.

Office of the Comptroller of the Currency. The investment and lending authority of Sound Community Bank is prescribed by federal laws and regulations and Sound Community Bank is prohibited from engaging in any activities not permitted by such laws and regulations.

As a federally chartered savings bank, Sound Community Bank is required to meet a qualified thrift lender (“QTL”) test to avoid certain restrictions on its operations. This test requires Sound Community Bank to have at least 65% of its portfolio assets, as defined by regulation, in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. “Qualified thrift investments” means primarily securities, mortgage loans and other investments related to housing, home equity loans, credit card loans, education loans and other consumer loans up to a certain percentage of assets. “Portfolio assets” generally means total assets of a savings association less the sum of certain specified liquid assets, goodwill and other intangible assets, and the value of property used in the conduct of the savings association’s business. As an alternative, Sound Community Bank may also meet the QTL test by qualifying as a “domestic building and loan association” (“DBLA”) under the Internal Revenue Code of 1986. To satisfy the DBLA test, a savings association must meet a “business operations test” and a “60 percent of assets test.” The business operations test requires the business of a DBLA to consist primarily of acquiring the savings of the public and investing in loans. The 60% of assets test requires that at least 60% of a DBLA’s assets consist of assets that savings associations normally hold, except for consumer loans that are not educational loans. As of December 31, 2011, Sound Community Bank met the QTL test.

Under either test, Sound Community Bank is required to maintain a significant portion of its assets in residential-housing-related loans and investments. Any institution that fails to meet the QTL test is subject to certain restrictions on its operations and the institution’s dividend payments are limited to amounts approved by the OCC and the Federal Reserve that are necessary to meet obligations of a company that controls the institution and would be permissible for a national bank, unless within one year it meets the test, and thereafter remains a qualified thrift lender. An institution that fails the test a second time must be subjected to the restrictions and is subject to enforcement action. Any holding company of an institution that fails the test and does not re-qualify within a year must become a bank holding company. If such an institution has not converted to a bank within three years after it failed the test, it must divest all investments and cease all activities not permissible for both a national bank and a savings association.

Sound Community Bank is subject to a 35% of total assets limit on consumer loans, commercial paper and corporate debt securities, a 20% limit on commercial loans, provided that the amount in excess of 10% of total assets can only be used for small business loans, and a 400% of capital limit on non-residential real property loans. At December 31, 2011, Sound Community Bank had 8.6% of its assets in consumer loans, commercial paper and corporate debt securities, 3.9% of its assets in commercial loans and 213.3% of its capital in non-residential real property loans.

Our relationship with our depositors and borrowers is regulated to a great extent by federal laws and regulations, especially in such matters as the ownership of savings accounts and the form and content of our mortgage requirements. In addition, the branching authority of Sound Community Bank is regulated by the OCC. Sound Community Bank is generally authorized to branch nationwide.

Sound Community Bank is subject to a statutory lending limit on aggregate loans to one borrower or a related group of borrowers. That limit is equal to 15% of our unimpaired capital and surplus, except that for loans fully secured by specified readily-marketable collateral, the limit is increased to 25%. At December 31, 2011, Sound Community Bank’s lending limit under this restriction was $5.0 million. We have no loans in excess of our lending limit.

We are subject to periodic examinations by the OCC. During these examinations, the examiners may require Sound Community Bank to provide for higher general or specific loan loss reserves, which can impact our capital and earnings. As a federally-chartered savings bank, Sound Community Bank is subject to a semi-annual assessment, based upon its total assets, to fund the operations of the OCC.

The OCC has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution that fails to comply with these standards must submit a compliance plan.

The OCC has primary enforcement responsibility over savings associations and has authority to bring actions against the institution and all institution-affiliated parties, including controlling shareholders, directors, management, employees and agents, as well as independent contractors and consultants, such as attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful actions likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institutions of receivership, conservatorship or termination of deposit insurance. Civil money penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. The FDIC has the authority to recommend to the OCC that enforcement action be taken with respect to a particular savings association. If action is not taken by the OCC, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.

Insurance of Accounts and Regulation by the FDIC. The Deposit Insurance Fund (“DIF”) of the FDIC insures deposit accounts in Sound Community Bank up to $250,000 per separately insured depositor. Transaction accounts have unlimited coverage until December 31, 2012.

The FDIC assesses deposit insurance premiums on each FDIC-insured institution quarterly based on annualized rates for one of four risk categories applied to its deposits, subject to certain adjustments. Each institution is assigned to one of four risk categories based on its capital levels, supervisory ratings and other factors. Well capitalized institutions that are financially sound with only a few minor weaknesses are assigned to Risk Category I. Risk Categories II, III and IV present progressively greater risks to the DIF.

As a result of a decline in the reserve ratio (the ratio of the net worth of the DIF to estimated insured deposits) and concerns about expected failure costs and available liquid assets in the DIF, the FDIC adopted a rule requiring each insured institution to prepay on December 30, 2009 the estimated amount of its quarterly assessments for the fourth quarter of 2009 and all quarters through the end of 2012 (in addition to the regular quarterly assessment for the third quarter due on December 30, 2009). The prepaid amount is recorded as an asset with a zero risk weight and the institution will continue to record quarterly expenses for deposit insurance. For purposes of calculating the prepaid amount, assessments were measured at the institution’s assessment rate as of September 30, 2009, with a uniform increase of 3 basis points effective January 1, 2011, and were based on the institution’s assessment base for the third quarter of 2009, with growth assumed quarterly at an annual rate of 5%. If events cause actual assessments during the prepayment period to vary from the prepaid amount, institutions will pay excess assessments in cash, or receive a rebate of prepaid amounts not exhausted after collection of assessments due on June 30, 2013, as applicable. Collection of the prepayment does not preclude the FDIC from changing assessment rates or revising the risk-based assessment system in the future.

Beginning with the second quarter of 2011, the Dodd-Frank Act requires the FDIC’s deposit insurance assessments to be based on assets instead of deposits. The FDIC has issued rules, effective as of the second quarter of 2011, which specify that the assessment base for a bank is equal to its total average consolidated assets less average tangible capital. The FDIC assessment rates range from approximately 5 basis points to 35 basis points, depending on applicable adjustments for unsecured debt issued by an institution and brokered deposits (and to further adjustment for institutions that hold unsecured debt of other FDIC-insured institutions), until such time as the FDIC’s reserve ratio equals 1.15%. Once the FDIC’s reserve ratio reaches 1.15% and the reserve ratio for the immediately prior assessment period is less than 2.0%, the applicable assessment rates may range from 3 basis points to 30 basis points (subject to adjustments as described above). If the reserve ratio for the prior assessment period is equal to or greater than 2.0% and less than 2.5%, the assessment rates may range from 2 basis points to 28 basis points and if the prior assessment period is greater than 2.5%, the assessment rates may range from 1 basis point to 25 basis points (in each case subject to adjustments as described above. No institution may pay a dividend if it is in default on its federal deposit insurance assessment.

Transactions with Related Parties. Transactions between Sound Community Bank and its affiliates are required to be on terms as favorable to Sound Community Bank as transactions with non-affiliates, and certain of these transactions, such as loans to an affiliate, are restricted to a percentage of Sound Community Bank’s capital and require eligible collateral in specified amounts. In addition, Sound Community Bank may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of most affiliates. Sound Financial and Sound Community MHC are affiliates of Sound Community Bank.

The Sarbanes-Oxley Act of 2002 generally prohibits loans by Sound Financial to its executive officers and directors. However, the law contains a specific exception for loans by a depository institution to its executive officers and directors in compliance with federal banking laws. Under such laws, Sound Community Bank’s authority to extend credit to executive officers, directors and 10% shareholders (“insiders”), as well as entities such persons control, is limited. The laws limit both the individual and aggregate amount of loans that Sound Community Bank may make to insiders based, in part, on Sound Community Bank’s capital level and requires that certain board approval procedures be followed. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. Loans to executive officers are subject to additional limitations based on the type of loan involved.

Capital Requirements for Sound Community Bank. Pursuant to OCC regulations, Sound Community Bank is required to maintain specified levels of regulatory capital. The OCC regulations state that to be “adequately capitalized,” an institution must have a leverage ratio of at least 4.0% (3.0% if the institution is assigned a composite rating of 1), a Tier 1 risk-based capital ratio of at least 4.0% and a total risk-based capital ratio of at least 8.0%. To be “well capitalized,” an institution must have a leverage ratio of at least 5.0%, a Tier 1 risk-based capital ratio of at least 6.0%, a total risk-based capital ratio of at least 10.0% and the institution must not be subject to any OCC or OTS written agreement, order, capital directive or prompt corrective action directive. Pursuant to a memorandum of understanding with its regulator, Sound Community Bank has agreed to maintain capital ratios in excess of these requirements (8% leverage ratio and 12% risk-based capital).

The term “leverage ratio” means the ratio of Tier 1 capital to adjusted total assets. The term “Tier 1 risk-based capital ratio” means the ratio of Tier 1 capital to risk-weighted assets. The term “total risk-based capital ratio” means the ratio of total capital to risk-weighted assets.

The term “Tier 1 capital” generally consists of common shareholders’ equity and retained earnings and certain noncumulative perpetual preferred stock and related earnings, excluding most intangible assets. At December 31, 2011, Sound Community Bank had no goodwill, $613,000 of core deposit intangible assets, or disallowed servicing assets, and no deferred tax assets excluded from Tier 1 capital.

“Total capital” consists of the sum of an institution’s Tier 1 capital and the amount of its Tier 2 capital up to the amount of its Tier 1 capital. Tier 2 capital consists generally of certain cumulative and other perpetual preferred stock, certain subordinated debt and other maturing capital instruments, the amount of the institution’s allowance for loan and lease losses up to 1.25% of risk-weighted assets and certain unrealized gains on equity securities.

Risk-weighted assets are determined under the OCC capital regulations, which assign to every asset, including certain off-balance sheet items, a risk weight ranging from 0% to 200% based on the inherent risk of the asset. The OCC is authorized to require Sound Community Bank to maintain an additional amount of total capital to account for concentrations of credit risk, levels of interest rate risk, equity investments in non-financial companies and the risks of non-traditional activities or other supervisory concerns. Institutions that are not well capitalized are subject to certain restrictions on brokered deposits and interest rates on deposits.

The OCC is authorized and, under certain circumstances, required to take certain actions against savings banks that fail to meet the minimum ratios for an “adequately capitalized institution.” Any such institution must submit a capital restoration plan and, until such plan is approved by the OCC, may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. The OCC is authorized to impose additional restrictions on institutions that are less than adequately capitalized.

OCC regulations state that any institution that fails to comply with its capital plan or has Tier 1 risk-based or leverage ratios of less than 3.0% or a total risk-based capital ratio of less than 6.0% is considered “significantly undercapitalized” and is subject to one or more additional specified actions and operating restrictions that may cover all aspects of its operations and may include a forced merger or acquisition of the institution. An institution with tangible equity to total assets of less than 2.0% is “critically undercapitalized” and becomes subject to further mandatory restrictions on its operations. The OCC generally is authorized to reclassify an institution into a lower capital category and impose the restrictions applicable to such category if the institution is engaged in unsafe or unsound practices or is in an unsafe or unsound condition. The imposition by the OCC of any of these measures on Sound Community Bank may have a substantial adverse effect on its operations and profitability. In general, the FDIC must be appointed receiver for a critically undercapitalized institution whose capital is not restored within the time provided. When the FDIC as receiver liquidates an institution, the claims of depositors and the FDIC as their successor (for deposits covered by FDIC insurance) have priority over other unsecured claims against the institution.

At December 31, 2011, Sound Community Bank was considered a “well-capitalized” institution under OCC regulations. Regulatory capital is discussed further in Note 15 of the Notes to Consolidated Financial Statements contained herein. New capital regulations at least as stringent as the current regulations are required by the Dodd-Frank Act, however, such new capital regulations have not yet been established by the regulatory agencies. We cannot predict what impact such new regulations may have.

Savings and Loan Holding Company Act and Change in Bank Control Act. Any company, except a bank holding company, that acquires control of a savings association or savings and loan holding company becomes a “savings and loan holding company” subject to registration, examination and regulation by the Federal Reserve and must obtain the prior approval of the Federal Reserve under the Savings and Loan Holding Company Act before obtaining control of a savings association or savings and loan holding company. A bank holding company must obtain the prior approval of the Federal Reserve under the Bank Holding Company Act before obtaining control of a savings association or savings and loan holding company and remains subject to regulation under the Bank Holding Company Act. The term “company” includes corporations, partnerships, associations, and certain trusts and other entities. “Control” of a savings association or savings and loan holding company is deemed to exist if a company has voting control, directly or indirectly of at least 25% of any class of the savings association’s voting stock or controls in any manner the election of a majority of the directors of the savings association or savings and loan holding company, and may be presumed under other circumstances, including, but not limited to, holding 10% or more of a class of voting securities if the institution has a class of registered securities, as Sound Financial has. Control may be direct or indirect and may occur through acting in concert with one or more other persons. In addition, a savings and loan holding company must obtain Federal Reserve approval prior to acquiring voting control of more than 5% of any class of voting stock of another savings association or another savings association holding company. A provision limiting the acquisition by a bank holding company of more than 5% of the outstanding voting stock of any company is included in the Bank Holding Company Act.

Accordingly, the prior approval of the Federal Reserve Board would be required:

·	before any savings and loan holding company or bank holding company could acquire 5% or more of the common stock of Sound Financial or Sound Community Bank; and

·	before any other company could acquire 25% or more of the common stock of Sound Financial or Sound Community Bank, and may be required for an acquisition of as little as 10% of such stock.

In addition, persons that are not companies are subject to the same or similar definitions of control with respect to savings and loan holding companies and savings associations. As such, prior regulatory approval is required from the Federal Reserve in the case of control of a savings and loan holding company and from the OCC in the case of control of a savings association when a person(s) rather than a holding company seeks control of a savings and loan holding company or a savings association.

Community Reinvestment and Consumer Protection Laws. In connection with its lending and other activities, Sound Community Bank is subject to a number of federal laws designed to protect customers and promote lending to various sectors of the economy and population. These include the Equal Credit Opportunity Act, the Truth-in-Lending Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, and the Community Reinvestment Act (“CRA”). Among other things, these laws:

·	require lenders to disclose credit terms in meaningful and consistent ways;

· prohibit discrimination against an applicant in any consumer or business credit transaction;

·	prohibit discrimination in housing-related lending activities;

·	require certain lenders to collect and report applicant and borrower data regarding loans for home purchases or improvement projects;

·	require lenders to provide borrowers with information regarding the nature and cost of real estate settlements;

·	prohibit certain lending practices and limit escrow account amounts with respect to real estate transactions;

·	require financial institutions to implement identity theft prevention programs and measures to protect the confidentiality of consumer financial information; and

·	prescribe possible penalties for violations of the requirements of consumer protection statutes and regulations.

The CFPB has been given authority for amending existing consumer compliance regulations and implementing new such regulations. In addition, the Bureau is charged with examining the compliance of financial institutions with assets in excess of $10 billion with these consumer protection rules. Sound Community Bank’s compliance with consumer protection rules will be examined by the OCC since it does not meet this $10 billion asset level threshold.

In addition, federal banking regulators, pursuant to the Gramm-Leach-Bliley Act, have enacted regulations limiting the ability of banks and other financial institutions to disclose nonpublic consumer information to non-affiliated third parties. The regulations require disclosure of privacy policies and allow consumers to prevent certain personal information from being shared with non-affiliated parties.

The CRA requires the appropriate federal banking agency, in connection with its examination of a bank, to assess the bank’s record in meeting the credit needs of the communities served by the bank, including low and moderate income neighborhoods. Under the CRA, institutions are assigned a rating of “outstanding,” “satisfactory,” “needs to improve,” or “substantial non-compliance” and the appropriate federal banking agency is to take this rating into account in the evaluation of certain applications of the institution, such as an application relating to a merger or the establishment of a branch. An unsatisfactory rating may be used as the basis for the denial of such an application. The CRA also requires that all institutions make public disclosures of their CRA ratings. Sound Community Bank received a “satisfactory” rating in its most recent CRA evaluation.

Bank Secrecy Act / Anti-Money Laundering Laws. Sound Community Bank is subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA PATRIOT Act of 2001. These laws and regulations require Sound Community Bank to implement policies, procedures, and controls to detect, prevent, and report money laundering and terrorist financing and to verify the identity of their customers. Violations of these requirements can result in substantial civil and criminal sanctions. In addition, provisions of the USA PATRIOT Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing mergers and acquisitions.

Limitations on Dividends and Other Capital Distributions. OCC regulations impose various restrictions on the ability of savings institutions, including Sound Community Bank, to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. Sound Community Bank must file a notice with the OCC and the Federal Reserve before making any capital distribution. Sound Community Bank generally may make capital distributions during any calendar year in an amount up to 100% of net income for the year-to-date plus retained net income for the two preceding years, so long as it is well-capitalized after the distribution. If Sound Community Bank, however, proposes to make a capital distribution when it does not meet its capital requirements (or will not following the proposed capital distribution) or that will exceed these net income-based limitations, it must obtain the OCC’s approval prior to making such distribution. The OCC may object to any distribution based on safety and soundness concerns. Additional restrictions on Sound Community Bank dividends may apply if the bank fails the QTL test.

Dividends from Sound Financial may depend, in part, upon its receipt of dividends from Sound Community Bank. No insured depository institution may make a capital distribution if, after making the distribution, the institution would be undercapitalized. Sound Community Bank, as a federal savings bank, must notify the Federal Reserve prior to paying a dividend to Sound Financial. The Federal Reserve may disapprove a dividend if, among other things, the Federal Reserve determines that the federal savings bank would be undercapitalized on a pro forma basis or the dividend is determined to raise safety or soundness concerns or violates a prohibition contained in applicable statutes, regulations, enforcement actions or agreements between the institution (or its holding company) and a federal bank regulator.

Federal Home Loan Bank System. Sound Community Bank is a member of the Federal Home Loan Bank of Seattle, one of the 12 regional Federal Home Loan Banks in the Federal Home Loan Bank System. The Federal Home Loan Bank System provides a central credit facility for member institutions. As a member of the Federal Home Loan Bank of Seattle, Sound Community Bank is required to hold shares of capital stock in that Federal Home Loan Bank. Sound Community Bank was in compliance with this requirement with an investment in Federal Home Loan Bank stock at December 31, 2011 of $2.4 million.

Regulation of Sound Financial, Inc.

Sound Financial. As a savings association holding company, Sound Financial is subject to regulation, supervision and examination by the Federal Reserve. Applicable federal law and regulations limit the activities of Sound Financial and require the approval of the Federal Reserve for any acquisition of a subsidiary, including another financial institution or holding company thereof, or a merger or acquisition of Sound Financial. In addition, the Federal Reserve has enforcement authority over Sound Financial and its non-savings institution subsidiaries. Among other things, this authority permits the Federal Reserve to restrict or prohibit activities that are determined to be a serious risk to Sound Community Bank.

Permissible Activities. Pursuant to federal law and regulations and policy, a savings and loan holding company such as Sound Financial may generally engage in the activities permitted for financial holding companies under Section 4(k) of the Bank Holding Company Act and certain other activities that have been authorized for savings and loan holding companies by regulation.

Federal law prohibits a savings and loan holding company from, directly or indirectly or through one or more subsidiaries, acquiring more than 5% of the voting stock of another savings association, or savings and loan holding company thereof, without prior written approval of the Federal Reserve or from acquiring or retaining, with certain exceptions, more than 5% of the voting stock of a non-subsidiary holding company or savings association. A savings and loan holding company is also prohibited from acquiring more than 5% of the voting stock of a company engaged in activities other than those authorized by federal law, from engaging in activities that would constitute a serious risk to the safety and soundness of its subsidiary bank or from acquiring or retaining control of a depository institution that is not insured by the FDIC. In evaluating applications by holding companies to acquire savings associations, the Federal Reserve must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors.

The Federal Reserve is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings associations in more than one state, except: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (ii) the acquisition of a savings association in another state if the laws of the state of the target savings association specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

Capital Requirements for Sound Financial. Under the Dodd-Frank Act, savings and loan holding companies will not be subject to capital requirements established by the Federal Reserve until 2015. The Federal Reserve, however, expects Sound Financial and Sound Community MHC to support Sound Community Bank, including providing additional capital to Sound Community Bank when it does not meet its capital requirements. Under the Dodd-Frank Act, the federal banking regulators must require any company that controls an FDIC-insured depository institution to serve as a source of strength for the institution, with the ability to provide financial assistance if the institution suffers financial distress. These and other Federal Reserve policies may restrict Sound Financial Inc.’s ability to pay dividends.

Federal Securities Law. The stock of Sound Financial is registered with the SEC under the Securities Exchange Act of 1934, as amended. Sound Financial is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Securities Exchange Act of 1934.

Sound Financial stock held by persons who are affiliates of Sound Financial may not be resold without registration unless sold in accordance with certain resale restrictions. For this purpose, affiliates are generally considered to be officers, directors and principal shareholders. If Sound Financial meets specified current public information requirements, each affiliate of Sound Financial will be able to sell in the public market, without registration, a limited number of shares in any three-month period.

The SEC has adopted regulations and policies under the Sarbanes-Oxley Act of 2002 that apply to Sound Financial as a registered company under the Securities Exchange Act of 1934. The stated goals of these requirements are to increase corporate responsibility, provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The SEC and Sarbanes-Oxley-related regulations and policies include very specific additional disclosure requirements and new corporate governance rules.

Federal Taxation

General. We are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to Sound Financial or Sound Community Bank. Our federal income tax returns have never been audited by the Internal Revenue Service.

We had no unrecognized tax benefits at December 31, 2011 and at December 31, 2010.

Method of Accounting. For federal income tax purposes, we currently report our income and expenses on the accrual method of accounting and use a fiscal year ending on December 31 for filing our federal income tax return.

Minimum Tax. The Internal Revenue Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain items of tax preference and adjustment, called alternative minimum taxable income. Net operating losses can offset no more than 90% of alternative minimum taxable income. The alternative minimum tax is payable to the extent that the taxpayer’s alternative minimum tax is in excess of the taxpayer’s regular tax. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. We have not been subject to the alternative minimum tax in prior years, nor do we have any such amounts available as credits for carryover.

Net Operating Loss Carryovers. A financial institution may carryback net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. This provision applies to losses incurred in taxable years beginning after August 6, 1997. In 2009, Internal Revenue Code Section 172 (b) (1) was amended to allow businesses to carry back losses incurred in 2008 and 2009 for up to five years to offset 50% of the available income from the fifth year and 100% of the available income for the other four years. At December 31, 2011, we had no net operating loss carry-forwards for federal income tax purposes.

Corporate Dividends-Received Deduction. Sound Financial has elected to file a consolidated return with Sound Community Bank. Therefore any dividends Sound Financial receives from Sound Community Bank will not be included as income to Sound Financial.

State Taxation

We are subject to a business and occupation tax imposed under Washington law at the rate of 1.8% of gross receipts. Interest received on loans secured by mortgages or deeds of trust on residential properties and certain investment securities are exempt from this tax.

Employees

At December 31, 2011, we had a total of 60 full-time employees and 16 part-time employees. Our employees are not represented by any collective bargaining group. Management considers its employee relations to be good.

Executive Officers of Sound Financial and Sound Community Bank

Officers are elected annually to serve for a one year term. There are no arrangements or understandings between the officers and any other person pursuant to which he or she was or is to be selected as an officer.

Laura Lee Stewart. Ms. Stewart, age 62, is currently President and Chief Executive Officer of Sound Community Bank and Sound Financial, Inc. Prior to joining Sound Community Bank as its President in 1989, when it was still a credit union, Ms. Stewart was Senior Vice President/Retail Banking at Great Western Bank. Ms. Stewart was selected as an inaugural member of the FDIC Community Bank Advisory Board and completed her term in 2011. She also serves on the ABA Community Bankers Council and is Vice Chair of the Washington Bankers Association. In 2011, The American Banker honored her as one of the top 25 Women to Watch in banking. Ms. Stewart’s many years of service in all areas of the financial institution operations and her duties as President and Chief Executive Officer of Sound Community Bank and Sound Financial, Inc. brings a special knowledge of the financial, economic and regulatory challenges we face and is well suited to educating the Board on these matters.

Matthew P. Deines. Mr. Deines, age 38, has served as Chief Financial Officer of Sound Community Bank since 2002 and was appointed Executive Vice President in January 2005. Mr. Deines has also served as Chief Financial Officer and Executive Vice President of Sound Financial, Inc. since its incorporation in 2008. Mr. Deines currently is responsible for management of our accounting, financial reporting, operations and information technology functions and is chair of Sound Community Bank’s asset-liability management committee. Prior to joining Sound Community Bank, Mr. Deines was an Audit Supervisor with McGladrey and Pullen, LLP and received his Washington CPA certificate in 2000. Mr. Deines received a Bachelor’s of Science Degree from Loyola Marymount University. He received an MBA degree from the University of Washington in June 2010.

Matthew F. Moran. Mr. Moran, age 49, is Executive Vice President and Chief Credit Officer responsible for all aspects of our commercial and retail lending activity. Mr. Moran joined Sound Community Bank in May 2007. Prior to that, he was a Senior Examiner with the Office of Thrift Supervision (which has since been merged into the OCC) for one year. From 2004 to 2006, he was Vice President - Commercial Credit for Inland NW Bank. From 2001 to 2004, he was Vice President and Team Leader SE Washington of Community Bancshares, a $350MM community bank where he was responsible for all new credit development in SE Washington. Mr. Moran brings more than 20 years of banking experience to Sound Community Bank, including five years with First National Bank of Omaha as the Asset/Liability Manager for the consolidated entities under First National Nebraska, Inc. a $10 billion dollar bank holding company. Prior to that, Mr. Moran spent six years as a National Bank Examiner with the OCC, where in addition to his Safety and Soundness responsibilities he also served as a specialist in the Large Bank Capital Markets Examination Program. In 2010, Mr. Moran graduated from the Pacific Coast Banking School, which is affiliated with the Graduate School of Business of the University of Washington.

Patricia Floyd. Ms. Floyd, age 66, is Senior Vice President – Human Resources of Sound Community Bank. Prior to being appointed to that position in 2002, she was a human resources official for the Shanghai American School from 1988 to 2001. Prior to that, she held various positions at Sound Community Bank when it was a credit union, including Marketing Manager, since 1986.

Internet Website

We maintain a website, www.soundcb.com. Information pertaining to us, including SEC filings, can be found by clicking the link on our site called “Investor Relations.” This Annual Report on Form 10-K and our other reports, proxy statements and other information filed with the SEC are available on that website within the Investor Relations webpage by clicking the link called “SEC Filings.” The information contained on our website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K. For more information regarding access to these filings on our website, please contact our Corporate Secretary, Sound Financial, Inc., 2005 5th Avenue, Suite 200, Seattle, Washington, 98121 or by calling (206) 448-0884.

Item 1A. Risk Factors

Not required; we are a smaller reporting company.

Item 1B. Unresolved Staff Comments

Not applicable.

Item 2.Properties

All of our offices are leased. The operating leases contain renewal options and require us to pay property taxes and operating expenses on the properties. Our total rental expense for each of the years ended December 31, 2011 and 2010 was $763,000 and $793,000, respectively. The aggregate net book value of our leasehold improvements, furniture and equipment was $2.4 million at December 31, 2011. See also Note 7 of the Notes to Consolidated Financial Statements. In the opinion of management, the facilities are adequate and suitable for our current needs. We may open additional banking offices to better serve current customers and to attract new customers in subsequent years.

The following table sets forth certain information concerning our main office and each of our branch offices at December 31, 2011.

Location	Year opened	Owned or leased	Lease expiration date
Main office:
2005 5th Avenue Seattle, WA 98121	1993	Leased	20171

Branch offices:
Cedar Plaza Branch 22807 44th Avenue West Mountlake Terrace, WA 98043	2004	Leased	20152

Tacoma Branch 2941 S. 38th Street Tacoma, WA 98409	2009	Leased	20141

Sequim Branch 541 North 5th Avenue Sequim, WA 98382	1997	Leased	20133

Port Angeles Branch 110 N. Alder Street Port Angeles, WA 98682	2010	Leased	20284

_________________

1. Lease contains no renewal option.

2. Lease provides for four five-year renewals.

3. Lease provides for two nine-year renewals.

4. Lease provides for two ten-year renewals.

We maintain depositor and borrower customer files on an on-line basis, utilizing a telecommunications network, portions of which are leased. Management has a disaster recovery plan in place with respect to the data processing system, as well as our operations as a whole.

Item 3. Legal Proceedings

From time to time we are involved as plaintiff or defendant in various legal actions arising in the normal course of business. We do not anticipate incurring any material legal fees or other liability as a result of such litigation.

Item 4. Mine Safety Disclosures

Not applicable.

PART II

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The common stock of Sound Financial is traded on the OTC Bulletin Board under the symbol "SNFL." The table below shows the high and low closing prices and quarterly dividends for our common stock for the periods indicated. This stock price information was provided by the Yahoo Finance System and is based on OTC quotations, which reflect inter-dealer prices with retail mark-up, mark-down or commissions and may not represent actual transactions.

	Stock Price		Dividends Per Share
2011 Quarters	High	Low	Dividends Per Share
First Quarter (ended 3/31/2011)	$7.50	$4.75	$0.00
Second Quarter (ended 6/30/2011)	$7.50	$6.50	$0.00
Third Quarter (ended 9/30/2011)	$6.70	$6.50	$0.00
Fourth Quarter (ended 12/31/2011)	$7.50	$6.25	$0.00

	Stock Price		Dividends Per Share
2010 Quarters	High	Low	Dividends Per Share
First Quarter (ended 3/31/2010)	$5.10	$3.85	$0.02
Second Quarter (ended 6/30/2010)	$7.00	$4.50	$0.00
Third Quarter (ended 9/30/2010)	$5.25	$4.60	$0.00
Fourth Quarter (ended 12/31/2010)	$5.00	$4.75	$0.00

At December 31, 2011 there were 2,949,045 shares outstanding and the closing price of our common stock on that date was $7.50. On that date, we had approximately 306 shareholders of record.

Our cash dividend payout policy is reviewed continually by management and the Board of Directors. As previously reported, Sound Financial and Sound Community Bank were each under a Memorandum of Understanding (“MOU”). As a result, Sound Financial suspended its policy of paying quarterly dividends. In July 2011, Sound Financial’s MOU was terminated and Sound Community Bank’s MOU was modified to remove the prohibition relating the bank’s ability to pay dividends to Sound Financial. In March 2012 Sound Community Bank’s MOU was also terminated.

The Board anticipates reinstating cash dividends, but the timing and amount have not yet been determined. Any dividends declared and paid in the future would depend upon a number of factors, including capital requirements, our financial condition and results of operations, tax considerations, statutory and regulatory limitations, and general economic conditions. No assurances can be given that any dividends will be paid or that, if paid, will not be reduced or eliminated in future periods. Our future payment of dividends may depend, in part, upon receipt of dividends from Sound Community Bank, which are restricted by federal regulations.

Information regarding our equity compensation plan is included in Item 12 of this Form 10-K.

We did not repurchase any shares of our common stock in 2011 and have no stock repurchase plan currently authorized.

Item 6.Selected Financial Data

SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

The following information is only a summary and should be read in conjunction with our consolidated financial statements and accompanying notes contained in Item 8.

	At December 31,
	2011		2010		2009
Selected Financial Condition Data:	(In thousands)
Total assets	$	339,740	$	334,639	$	337,806
Cash and cash equivalents		17,031		9,092		15,679
Loans receivable, net

Sound Financial, Inc. 10-K