UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2013

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

For the transition period from _______ to ________

Commission file number:                                           001-54280

SUNSHINE FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

Maryland	36-4678532
(State or other jurisdiction of incorporation of organization)	(IRS Employer Identification No.)

1400 East Park Avenue, Tallahassee, Florida  32301

(Address of principal executive offices; Zip Code)

(850) 219-7200

(Registrant’s telephone number, including area code)

None

(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes xNo ¨

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

Large accelerated filer [  ]                                                                                         Accelerated filer [  ]

Non-accelerated filer   [  ] (Do not check if a smaller reporting company)                          Smaller reporting company [X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

APPLICABLE ONLY TO CORPORATE ISSUERS

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

At November 14, 2013, there were issued and outstanding 1,208,754 shares of the issuer’s common stock.

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Index

	Page Number
PART I                 FINANCIAL INFORMATION
Item 1.     Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2013 (Unaudited) and December 31, 2012	2
Condensed Consolidated Statements of Operations for the Three-Month and Nine-Month Periods Ended September 30, 2013 and 2012 (Unaudited)	3
Condensed Consolidated Statements of Stockholders' Equity for the Nine-Month Periods Ended September 30, 2013 and 2012 (Unaudited)	4
Condensed Consolidated Statements of Cash Flows For the Nine-Month Periods Ended September 30, 2013 and 2012 (Unaudited)	5
Notes to Condensed Consolidated Financial Statements	6-22
Item 2.     Management's Discussion and Analysis of Financial Condition and Results of Operations	23-34
Item 3.     Quantitative and Qualitative Disclosure About Market Risk	35
Item 4.     Controls and Procedures	35
PART II     OTHER INFORMATION
Item 1.     Legal Proceedings	36
Item 1A.  Risk Factors	36
Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds	36
Item 3.     Defaults Upon Senior Securities	36
Item 4.     Mine Safety Disclosures	36
Item 5.     Other Information	36
Item 6.     Exhibits	36
SIGNATURES	37
EXHIBIT INDEX

1

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

Condensed Consolidated Balance Sheets

($ in thousands, except share information)

	At September 30, 2013			At December 31, 2012
	(Unaudited)
Assets
Cash and due from banks	$	1,177			1,529
Interest-bearing deposits with banks		27,638			25,380
Cash and cash equivalents		28,815			26,909
Securities held to maturity (fair value of $18,043 and $15,658)		18,348			15,441
Loans, net of allowance for loan losses of $1,404 and $1,533		93,091			95,335
Premises and equipment, net		5,082			3,321
Federal Home Loan Bank stock, at cost		177			218
Deferred income taxes		2,484			2,712
Accrued interest receivable		293			367
Foreclosed real estate		566			1,878
Other assets		1,067			1,259
Total assets	$	149,923			147,440
Liabilities and Stockholders’ Equity
Liabilities:
Noninterest-bearing deposit accounts		23,522			23,185
Money-market deposit accounts		32,550			31,910
Savings accounts		37,238			35,204
Time deposits		30,457			31,363
Total deposits		123,767			121,662
Official checks		408			442
Advances by borrowers for taxes and insurance		231			29
Other liabilities		481			372
Total liabilities		124,887			122,505
Stockholders' equity:
Preferred stock, $0.01 par value, 1,000,000 shares authorized, none       issued and outstanding		-			-
Common stock, $.01 par value, 6,000,000 shares authorized,      1,208,754 and 1,234,454 shares issued and outstanding at      September 30, 2013 and December 31, 2012, respectively		12			12
Additional paid in capital		11,116			11,481
Retained earnings		14,686			14,285
Unearned Employee Stock Ownership Plan shares		(778	)		(843	)
Total stockholders' equity		25,036			24,935
Total liabilities and stockholders’ equity	$	149,923			147,440

See accompanying Notes to Condensed Consolidated Financial Statements.

2

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations (Unaudited)

(In thousands, except per share information)

	Three Months Ended  September 30,						Nine Months Ended  September 30,
	2013			2012			2013		2012
Interest income:
Loans	$	1,311			1,392			4,008		4,256
Securities, held to maturity		95			66			252		180
Other		14			16			48		46
Total interest income		1,420			1,474			4,308		4,482
Interest expense:
Deposit accounts		100			128			309		439
Net interest income		1,320			1,346			3,999		4,043
Provision for loan losses		50			270			2		1,450
Net interest income after provision for loan losses		1,270			1,076			3,997		2,593
Noninterest income:
Fees and service charges on deposit accounts		449			532			1,401		1,572
(Loss) gain on loan sales		(7	)		148			401		257
Gain on sale of foreclosed real estate		126			19			301		3
Fees and charges on loans		25			23			70		75
Other		8			8			155		38
Total noninterest income		601			730			2,328		1,945
Noninterest expenses:
Salaries and employee benefits		851			862			2,651		2,645
Occupancy and equipment		308			270			870		826
Data processing services		198			202			580		579
Professional fees		153			164			549		519
FDIC insurance		30			32			91		90
Advertising and promotion		19			13			56		50
Telephone and postage		58			84			181		202
Foreclosed real estate		52			96			167		217
Other		130			161			526		486
Total noninterest expenses		1,799			1,884			5,671		5,614
Earnings (loss) before income taxes		72			(78	)		654		(1,076	)
Income taxes (benefit)		26			(34	)		253		(406	)
Net earnings (loss)	$	46			(44	)		401		(670	)
Basic earnings (loss) per common share	$	0.04			(0.04	)		0.35		(0.58	)
Diluted earnings (loss) per common share	$	0.04			(0.04	)		0.34		(0.58	)
Cash dividends per common share	$	-			-			-		-

See accompanying Notes to Condensed Consolidated Financial Statements.

3

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders' Equity

Nine Months Ended September 30, 2013 and 2012

($ in thousands)

												Unearned
												Employee
												Stock
						Additional						Ownership			Total
	Common Stock					Paid In			Retained			Plan			Stockholders'
	Shares			Amount		Capital			Earnings			Shares			Equity
Balance, December 31, 2011		1,234,454		$	12		11,487			14,813			(927	)		25,385
Net loss (unaudited)		-			-		-			(670	)		-			(670	)
Common stock allocated     to Employee Stock Ownership     Plan ("ESOP") participants (unaudited)		-			-		(4	)		-			62			58
Balance, September 30, 2012 (unaudited)		1,234,454		$	12		11,483			14,143			(865	)		24,773
Balance, December 31, 2012		1,234,454			12		11,481			14,285			(843	)		24,935
Net earnings (unaudited)		-			-		-			401			-			401
Stock based compensation  expense (unaudited)		-			-		58			-			-			58
Repurchase of common stock (unaudited)		(25,700	)		-		(400	)		-			-			(400	)
Common stock allocated to ESOP     participants (unaudited)		-			-		(23	)		-			65			42
Balance, September 30, 2013 (unaudited)		1,208,754		$	12		11,116			14,686			(778	)		25,036

See accompanying Notes to Condensed Consolidated Financial Statements.

4

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)

(In thousands)

	Nine Months Ended  September 30,
	2013			2012
Cash flows from operating activities:
Net earnings (loss)	$	401			(670	)
Adjustments to reconcile net earnings (loss) to net cash from operating activities:
Depreciation		406			371
Provision for loan losses		2			1,450
Deferred income taxes (benefit)		228			(406	)
Net accretion of premiums/discounts on securities		51			55
Net amortization of deferred loan fees and costs		4			9
Loans originated for sale		(7,791	)		(10,227	)
Proceeds from loans sold		8,754			10,484
Gain on sale of loans		(401	)		(257	)
ESOP compensation expense		42			58
Stock-based compensation expense		58			-
Decrease  in accrued interest receivable		74			69
Decrease in other assets		192			78
(Gain) loss on sale of foreclosed real estate		(301	)		3
Write-down of foreclosed real estate		28			101
Decrease in official checks		(34	)		(19	)
Net increase in advances by borrowers for taxes and insurance		202			254
Increase in other liabilities		109			57
Net cash provided by operating activities		2,024			1,410
Cash flows from investing activities:
Net purchases of securities held-to-maturity		(2,958	)		(5,617	)
Net decrease in loans		940			6,628
Net purchases of premises and equipment		(2,167	)		(142	)
Redemption of Federal Home Loan Bank stock		41			29
Proceeds from sale of foreclosed real estate		2,321			542
Net cash (used in) provided by investing activities		(1,823	)		1,440
Cash flows from financing activities:
Net increase in deposits		2,105			1,399
Repurchase of common stock		(400	)		-
Net cash provided by financing activities		1,705			1,399
Increase in cash and cash equivalents		1,906			4,249
Cash and cash equivalents at beginning of period		26,909			25,055
Cash and cash equivalents at end of period	$	28,815			29,304
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Income taxes	$	25			-
Interest	$	309			439
Noncash transaction-
Transfer from loans to foreclosed real estate	$	736			2,102

See accompanying Notes to Condensed Consolidated Financial Statements.

5

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited)

1.    Organization and Basis of Presentation

Sunshine Financial, Inc. ("Sunshine Financial" or the "Holding Company"), a Maryland corporation, is the holding company for Sunshine Savings Bank (the "Bank") and owns all the outstanding common stock of the Bank.

The Holding Company's only business is the operation of the Bank.  The Bank through its four banking offices provides a variety of retail community banking services to individuals and businesses primarily in Leon County, Florida. The Bank's deposits are insured up to the applicable limits by the Federal Deposit Insurance Corporation. The Bank's subsidiary is Sunshine Member Insurance Services, Inc. ("SMSI"), which was established to sell automobile warranty and credit life and disability insurance products associated with loan products. Collectively the entities are referred to as the "Company."

These condensed consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Article 8-03 of Regulation S-X and do not include all disclosures required by accounting principles generally accepted in the United States of America ("GAAP") for a complete presentation of the Company's financial condition and results of operations.

In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair representation of the results of operations for such periods.  The results for the three and nine-month periods ended September 30, 2013 should not be considered as indicative of results for a full year.

2.    Recent Accounting Standards Update

In January 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2013-01 ("ASU 2013-01"), Balance Sheet (Topic 210), Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.  ASU 2013-01 clarifies that the scope of ASU 2011-11 applies to derivatives accounted for in accordance with Topic 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with Section 210-20-45 or Section 815-10-45 or subject to an enforceable master netting arrangement or similar agreement.  ASU 2013-01 is effective for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods.  An entity should provide the required disclosures retrospectively for all comparative periods presented. The adoption of ASU 2013-01 had no effect on the Company's consolidated financial statements.

(continued)

6

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

2.    Recent Accounting Standards Update, Continued

In February 2013, the FASB issued ASU 2013-02 ("ASU 2013-02"), Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (Topic 220). ASU 2013-02 requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts. The Company adopted ASU 2013-02 in January 2013 and it had no impact on the Company's consolidated financial statements.

In July 2013, the FASB issued ASU 2013-11 ("ASU 2013-11 "), Income Taxes (Topic 740) Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exist.  ASU 2013-11 requires an unrecognized tax benefit, or a portion of an unrecognized tax benefit, be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except in certain circumstances. The Company will adopt ASU 2013-11 in January 2014 and expects it will have no impact on the Company's consolidated financial statements.

Recent Regulatory Developments

Basel III Legislation.  On July 2, 2013, the Federal Reserve Board ("FRB") approved the final rules implementing the Basel Committee on Banking Supervision's capital guidelines for U.S. banks. Under the final rules, minimum requirements will increase for both the quantity and quality of capital held by the Bank. The rules include a new common equity Tier I capital to risk-weighted assets ratio of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets. The final rules also raise the minimum ratio of Tier I capital to risk-weighted assets from 4.0% to 6.0% and require a minimum leverage ratio of 4.0%. The final rules also implement strict eligibility criteria for regulatory capital instruments. On July 9, 2013, the Federal Deposit Insurance Corporation ("FDIC") also approved, as an interim final rule, the regulatory capital requirements for U.S. banks, following the actions of the FRB. The FDIC's rule is identical in substance to the final rules issued by the FRB.

The phase-in period for the final rules will begin for the Company on January 1, 2015, with full compliance with all of the final rule's requirements phased in over a multi-year schedule. We are currently evaluating the provisions of the final rules and their expected impact on us.

(continued)

7

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

3.    Earnings (Loss) Per Share

Earnings (loss) per share ("EPS") has been computed on the basis of the weighted-average number of shares of common stock outstanding. Outstanding stock options are considered dilutive securities for purposes of calculating diluted EPS which was computed using the treasury stock method. The shares purchased by the ESOP are included in the weighted-average shares when they are committed to be released (dollars in thousands, except per share amounts):

	2013						2012
			Weighted-		Per					Weighted-		Per
			Average		Share					Average		Share
	Earnings		Shares		Amount		Loss			Shares		Amount
Three Months Ended September 30,
Basic EPS:
Net earnings (loss)	$	46		1,159,054	$	0.04	$	(44	)		1,149,178	$	(0.04	)
Effect of dilutive securities-
Incremental shares from assumed      conversion of options (antidilutive      in 2012)				19,794							-
Diluted EPS:
Net earnings (loss)	$	46		1,178,848	$	0.04	$	(44	)		1,149,178	$	(0.04	)

	2013						2012
			Weighted-		Per					Weighted-		Per
			Average		Share					Average		Share
	Earnings		Shares		Amount		Loss			Shares		Amount
Nine Months Ended September 30,
Basic EPS:
Net earnings (loss)	$	401		1,156,585	$	0.35	$	(670	)		1,146,710	$	(0.58	)
Effect of dilutive securities-
Incremental shares from assumed      conversion of options (antidilutive      in 2012)				14,730							-
Diluted EPS:
Net earnings (loss)	$	401		1,171,315	$	0.34	$	(670	)		1,146,710	$	(0.58	)

 (continued)

8

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

4.    Securities Held to Maturity

Securities have been classified as held to maturity according to management intent.  The carrying amount of securities and their fair values are as follows (in thousands):

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
At September 30, 2013-
Mortgage-backed securities	$	18,348		149		(454	)		18,043
At December 31, 2012-
Mortgage-backed securities	$	15,441		239		(22	)		15,658

There were no sales of securities during the three and nine months ended September 30, 2013 or 2012. There were no securities pledged at September 30, 2013 or December 31, 2012.

5.    Loans

The loan portfolio segments and classes are as follows (in thousands):

	September 30,			December 31,
	2013			2012
Real estate mortgage loans:
One-to four-family	$	51,415			59,987
Lot loans		5,406			6,289
Commercial real estate		14,483			7,847
Construction		579			1,006
Total real estate loans		71,883			75,129
Commercial loans		149			24
Consumer loans:
Home equity		9,347			10,407
Automobile		3,930			3,043
Credit cards and unsecured		7,079			7,521
Deposit account		613			578
Other		1,292			1,428
Total consumer loans		22,261			22,977
Total loans		94,293			98,130
Less:
Loans in process		(271	)		1,199
Deferred fees and discounts		69			63
Allowance for losses		1,404			1,533
Total loans, net	$	93,091			95,335

(continued)

9

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

5.    Loans, Continued

The Company has divided the loan portfolio into three portfolio segments and ten classes, each with different risk characteristics and methodologies for assessing risk. The portfolio segments identified by the Company are as follows:

Real Estate Mortgage Loans.  Real estate mortgage loans are loans comprised of four classes: One- to four-family, Lot loans, Commercial real estate and Construction loans. The Company generally originates one- to four-family mortgage loans in amounts up to 80% of the lesser of the appraised value or purchase price of a mortgaged property, but will also permit loan-to-value ratios of up to 95%. For one- to four-family loans exceeding an 80% loan-to-value ratio, the Company generally requires the borrower to obtain private mortgage insurance covering any loss on the amount of the loan in excess of 80% in the event of foreclosure. The Company also makes loans for the purchase of developed lots for future construction of the borrower's primary residence.  We will generally originate lot loans in an amount up to 75% of the lower of the purchase price or appraisal and have a maximum amortization of up to 20 years and maturities up to 20 years. Commercial real estate loans are generally originated at 75% or less loan-to-value ratio and have amortization terms of up to 20 years and maturities of up to ten years.  Construction loans to borrowers are to finance the construction of one- to four-family, owner occupied properties. These loans are categorized as construction loans during the construction period, later converting to residential real estate loans after the construction is complete and amortization of the loan begins. Real estate construction loan funds are disbursed periodically based on the percentage of construction completed.  If the estimate of construction cost proves to be inaccurate, the Company may be compelled to advance additional funds to complete the construction with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower to repay the loan.  The Company carefully monitors these loans with on-site inspections and requires the receipt of lien waivers on funds advanced. Construction loans are typically secured by the properties under construction. Construction and lot loan lending is generally considered to involve a higher degree of credit risk than long-term permanent financing of residential properties.

Commercial Loans.  Commercial loans are comprised of unsecured loans.  The Company offers unsecured commercial loans generally to its commercial real estate borrowers.

Consumer Loans.  Consumer loans are comprised of five classes: Home Equity, Automobile, Credit cards and unsecured, Deposit account and Other.  The Company offers a variety of secured consumer loans, including home equity, new and used automobile, boat and other recreational vehicle loans, and loans secured by deposit accounts.  The Company also offers unsecured consumer loans including a credit card product.  The Company originates its consumer loans primarily in its market area.  Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Loans to consumers are extended after a credit evaluation, including the creditworthiness of the borrower(s), the purpose of the credit, and the secondary source of repayment. Consumer loans are made at fixed and variable interest rates and may be made on terms of up to twenty years. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

(continued)

10

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

5.  Loans, Continued

An analysis of the change in the allowance for loan losses follows (in thousands):

	Real Estate Loans													Consumer Loans
	One-to Four- Family			Lot Loans			Commercial Real Estate			Constru- ction		Comme- rcial Loans		Home Equity			Auto- mobile			Credit Cards and Unsecured			Deposit Account		Other			Unallocated		Total
Three Months Ended September 30, 2013:
Beginning balance	$	629			92			151			1		2		229			12			168			-		87			81		1,452
Provision (credit) for loan     loss		17			22			(6	)		-		-		(18	)		(7	)		46			-		(14	)		10		50
Charge-offs		(57	)		(10	)		-			-		-		-			-			(40	)		-		-			-		(107	)
Recoveries		-			-			-			-		-		1			1			7			-		-			-		9
Ending balance	$	589			104			145			1		2		212			6			181			-		73			91		1,404
Three Months Ended September 30, 2012:
Beginning balance		670			112			-			-		-		326			8			227			-		124			-		1,467
Provision (credit) for loan     loss		143			-			20			-		-		70			(1	)		22			-		16			-		270
Charge-offs		(92	)		-			-			-		-		(63	)		-			(48	)		-		(23	)		-		(226	)
Recoveries		-			-			-			-		-		-			2			12			-		1			-		15
Ending balance	$	721			112			20			-		-		333			9			213			-		118			-		1,526
Nine Months Ended September 30, 2013:
Beginning balance		690			88			78			-		-		343			9			231			-		94			-		1,533
Provision (credit) for loan     loss		95			48			67			1		2		(290	)		(6	)		6			-		(12	)		91		2
Charge-offs		(199	)		(32	)		-			-		-		(35	)		(1	)		(104	)		-		(9	)		-		(380	)
Recoveries		3			-			-			-		-		194			4			48			-		-			-		249
Ending balance	$	589			104			145			1		2		212			6			181			-		73			91		1,404
Nine Months Ended September 30, 2012:
Beginning balance		475			144			-			-		-		235			39			337			-		99			-		1,329
Provision (credit) for loan     loss		819			91			20			-		-		387			(23	)		23			-		133			-		1,450
Charge-offs		(573	)		(128	)		-			-		-		(289	)		(17	)		(181	)		-		(116	)		-		(1,304	)
Recoveries		-			5			-			-		-		-			10			34			-		2			-		51
Ending balance	$	721			112			20			-		-		333			9			213			-		118			-		1,526

(continued)

11

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

5. Loans, Continued

	Real Estate Loans										Consumer Loans
	One-to Four- Family		Lot Loans		Commercial Real Estate		Constru- ction		Comme- rcial Loans		Home Equity		Auto- mobile		Credit Cards and Unsecured		Deposit Account		Other		Unallocated		Total
At September 30, 2013:
Individually evaluated for impairment:
Recorded investment	$	3,123		-		-		-		-		307		-		32		-		-		-		3,462
Balance in allowance     for loan losses	$	57		-		-		-		-		65		-		-		-		-		-		122
Collectively evaluated for impairment:
Recorded investment	$	48,292		5,406		14,483		579		149		9,040		3,930		7,047		613		1,292		-		90,831
Balance in allowance for     loan losses	$	532		104		145		1		2		147		6		181		-		73		91		1,282
At September 30, 2012:
Individually evaluated for impairment:
Recorded investment	$	3,289		73		-		-		-		323		-		40		-		-		-		3,725
Balance in allowance for     loan losses	$	38		-		-		-		-		1		-		-		-		-		-		39
Collectively evaluated for impairment:
Recorded investment	$	59,046		6,578		1,975		813		-		10,400		2,553		7,441		598		1,501		-		90,905
Balance in allowance for     loan losses	$	683		112		20		-		-		332		9		213		-		118		-		1,487

(continued)

12

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

5.  Loans, Continued

The following summarizes the loan credit quality (in thousands):

Credit Risk
Profile by Internally	One to Four		Lot		Commercial Real		Constru-		Comme-		Home		Auto-		Credit Cards and		Deposit
Assigned Grade:	Family		Loans		Estate		ction		rcial		Equity		mobile		Unsecured		Account		Other		Total
At September 30, 2013:
Grade:
Pass	$	47,427		5,386		14,483		579		149		8,904		3,884		7,011		613		1,164		89,600
Special mention		350		20		-		-		-		99		29		11		-		41		550
Substandard		3,638		-		-		-		-		344		17		57		-		87		4,143
Doubtful		-		-		-		-		-		-		-		-		-		-		-
Loss		-		-		-		-		-		-		-		-		-		-		-
Total	$	51,415		5,406		14,483		579		149		9,347		3.930		7,079		613		1,292		94,293
At December 31, 2012:
Grade:
Pass		55,104		6,202		7,847		1,006		24		9,935		3,010		7,473		578		1,428		92,607
Special mention		923		-		-		-		-		26		14		4		-		-		967
Substandard		3,960		87		-		-		-		446		19		44		-		-		4,556
Doubtful		-		-		-		-		-		-		-		-		-		-		-
Loss		-		-		-		-		-		-		-		-		-		-		-
Total	$	59,987		6,289		7,847		1,006		24		10,407		3,043		7,521		578		1,428		98,130

Internally assigned loan grades are defined as follows:

Pass – A Pass loan's primary source of loan repayment is satisfactory, with secondary sources very likely to be realized if necessary.

Special Mention – A Special Mention loan has potential weaknesses that deserve management's close attention.  If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or theCompany's credit position at some future date.  Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

Substandard – A Substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that theCompany will sustain some loss if the deficiencies are not corrected.

Doubtful – A loan classified Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

(continued)

13

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

5.  Loans, Continued

Loss – A loan classified Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted.  This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.

Age analysis of past-due loans is as follows (in thousands):

	Accruing Loans
					90 Days
		30-59		60-89	and		Total
	Days		Days		Greater		Past				Nonaccrual		Total
	Past Due		Past Due		Past Due		Due		Current		Loans		Loans
At September 30, 2013:
Real estate loans:
One-to four-family	$	1,951		270		-		2,221		47,895		1,299		51,415
Lot loans		-		20		-		20		5,386		-		5,406
Commercial		-		-		-		-		14,483		-		14,483
Construction		-		-		-		-		579		-		579
Commercial loans		-		-		-		-		149		-		149
Consumer loans:
Home equity		378		98		-		476		8,747		124		9,347
Automobile		29		-		-		29		3,864		37		3,930
Credit cards and unsecured		106		11		-		117		6,937		25		7,079
Deposit account		22		-		-		22		591		-		613
Other		52		41		-		93		1,112		87		1,292
Total	$	2,538		440		-		2,978		89,743		1,572		94,293
At December 31,  2012:
Real estate loans:
One-to four-family		1,310		611		-		1,921		56,033		2,033		59,987
Lot loans		96		-		-		96		6,106		87		6,289
Commercial		-		-		-		-		7,847		-		7,847
Construction		-		-		-		-		1,006		-		1,006
Commercial loans		-		-		-		-		24		-		24
Consumer loans:
Home equity		527		110		-		637		9,612		158		10,407
Automobile		-		14		-		14		3,010		19		3,043
Credit cards and unsecured		146		-		-		146		7,365		10		7,521
Deposit account		-		-		-		-		578		-		578
Other		100		-		-		100		1,328		-		1,428
Total	$	2,179		735		-		2,914		92,909		2,307		98,130

(continued)

14

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

5.  Loans, Continued

The following summarizes the amount of impaired loans (in thousands):

	With No Related Allowance Recorded				With an Allowance Recorded						Total
	Recorded Investment		Unpaid Principal Balance		Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
At September 30, 2013:
Real estate loans-
One-to four-family	$	1,910		2,094		1,213		1,213		57		3,123		3,307		57
Consumer loans:
Home equity		242		292		65		65		65		307		357		65
Credit card and unsecured		32		39		-		-		-		32		39		-
	$	2,184		2,425		1,278		1,278		122		3,462		3,703		122
At December 31, 2012:
Real estate loans:
One-to four-family		2,625		2,902		531		531		30		3,156		3,433		30
Lot loans		135		356		-		-		-		135		356		-
Consumer loans:																-
Home equity		318		476		-		-		-		318		476		-
Credit card and unsecured		38		44		-		-		-		38		44		-
	$	3,116		3,778		531		531		30		3,647		4,309		30

At September 30, 2013 and December 31, 2012, the Company's loan portfolio included primarily large groups of smaller balance homogeneous loans.  The Company considers individual single family home loans which are in the process of foreclosure for impairment, as well as all troubled debt restructurings ("TDRs") (which involve loans in which the Company forgave a portion of interest or principal or reduced the interest rate materially less than that of market rates).

The average net investment in impaired loans and interest income recognized and received on impaired loans are as follows (in thousands):

	Average		Interest		Interest
	Recorded		Income		Income
	Investment		Recognized		Received
For the Nine Months Ended September 30, 2013:
Real estate loans:
One- to four-family	$	3,207		53		57
Lot loans		11		-		-
Consumer loans:
Home equity		264		4		5
Credit card and unsecured		34		-		-
Total	$	3,516		57		62

(continued)

15

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

5.  Loans, Continued

	Average		Interest		Interest
	Recorded		Income		Income
	Investment		Recognized		Received
For the Nine Months Ended September 30, 2012:
Real estate loans:
One- to four-family	$	3,764		49		69
Lot loans		65		-		26
Consumer loans:
Home equity		436		7		7
Credit card and unsecured		25		-		-
Total	$	4,290		56		102

Troubled debt restructurings entered into are as follows (dollars in thousands):

	Outstanding Recorded Investment
	Number
	of	Pre-	Post-
	Contracts	Modification	Modification
For the Nine Months Ended September 30, 2013:
Real estate mortgage loans:
One- to four-family-
Modified interest rates	1	$ 696	696

The Company had one troubled debt restructuring entered into during the nine months ended September 30, 2013.  The Company has not had any troubled debt restructurings which were restructured during the last twelve months that subsequently defaulted as of September 30, 2013.

Loans Held for Sale.  The Bank originates loans for sale in the secondary market.  These loans are carried at the lower of cost or estimated fair value in the aggregate.  At December 31, 2012, there were $677,000 loans held for sale.  There were $115,000 loans held for sale at September 30, 2013.  Loans held for sale are included in loans on the condensed consolidated balance sheets and generally sold within 30 days.

6.   Foreclosed Real Estate

Expenses applicable to foreclosed real estate for the three and nine months ended September 30, 2013 and 2012 are as follows (in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2013		2012		2013		2012
Write-down of foreclosed real estate	$	10		-		28		101
Operating expenses		42		96		139		116
	$	52		96		167		217

(continued)

16

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

7.    Line of Credit

The Company has an unsecured federal funds line of credit for $4.4 million with a correspondent bank and a $15.2 million line with the Federal Home Loan Bank of Atlanta collateralized by a blanket lien on qualifying loans. At September 30, 2013 and December 31, 2012, the Company had no outstanding balances on these lines.

8.    Off-Balance-Sheet Financial Instruments

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments are unused lines of credit and commitments to extend credit and may involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the balance sheets.  The contract amounts of these instruments reflect the extent of involvement the Company has in these financial instruments.

The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for unused lines of credit and commitments to extend credit is represented by the contractual amount of those instruments.  The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed-expiration dates or other termination clauses and may require payment of a fee.  Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Company evaluates each customer's credit worthiness on a case-by-case basis.  The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management's credit evaluation of the counterparty.

Unused lines of credit and commitments to extend credit typically result in loans with a market interest rate when funded.  A summary of the amounts of the Company's financial instruments, with off-balance-sheet risk follows at September 30, 2013 (in thousands):

	Contract
	Amount
Unused lines of credit (rates range from
3.90% to 15.45%)	$	16,822
Commitments to extend credit (all fixed rates
ranging from 2.99% to 6.00%)	$	1,014

(continued)

17

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

9.    Fair Value of Financial Instruments

The estimated fair values of the Company's financial instruments are as follows (in thousands):

	At September 30, 2013						At December 31, 2012
	Carrying		Fair				Carrying		Fair
	Amount		Value		Level		Amount		Value		Level
Financial assets:
Cash and cash equivalents	$	28,815		28,815		1		26,909		26,909		1
Securities held to maturity		18,348		18,043		2		15,441		15,658		2
Loans		93,091		93,301		3		95,335		95,228		3
Federal Home Loan Bank stock		177		177		3		218		218		3
Accrued interest receivable		293		293		3		367		367		3
Financial liabilities:
Deposits		123,767		120,319		3		121,662		119,741		3
Off-balance-sheet financial instruments		-		-		3		-		-		3

Discussion regarding the assumptions used to compute the estimated fair values of financial instruments can be found in Note 1 to the consolidated financial statements included in the Company's annual report on Form 10-K for the year ended December 31, 2012 filed with the U.S. Securities and Exchange Commission ("SEC") on March 25, 2013 ("2012 Form 10-K").

10.  Employee Benefit Plans

The Company has a 401(k) plan for its employees who meet certain age and length-of-service requirements. Eligible employees can contribute up to $17,500 of their compensation to the plan on a pre-tax basis. Employer matching contributions are made at 100 percent of employee contribution up to five percent. Employer contributions made to the 401(k) plan were $78,000 and $78,000 for the nine-months ended September 30, 2013 and 2012, respectively.

11.  Employee Stock Ownership Plan

Effective April 5, 2011, upon closing of its stock offering, the Holding Company established an ESOP which acquired 8% of the total number of shares of common stock sold during the initial public offering.  A total of 98,756 shares were acquired in exchange for a $988,000 note payable to the Holding Company.  The note bears interest at a fixed rate of 4.25%, is payable in annual installments and is due in 2021.   The employer expense was $11,000 for the three-month period ended September 30, 2013 and $19,000 for the three-month period ended September 30, 2012.  The employer expense was $42,000 and $58,000 for the nine-month periods ended September 30, 2013 and September 30, 2012, respectively.

 (continued)

18

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

11.  Employee Stock Ownership Plan, Continued

The ESOP shares as of September 30, 2013 were as follows:

	2013
Allocated shares at December 31, 2012		17,184
Shares released for allocation for the nine months ended
September 30, 2013		7,407
Unreleased shares as of September 30, 2013		74,165
Total ESOP shares		98,756
Fair value of unreleased shares (in thousands)	$	1,157

12.  2012 Equity Incentive Plan

On May 23, 2012, the Holding Company’s stockholders approved its 2012 Equity Incentive Plan ("Plan"). The Plan authorizes the grant of options for up to 123,445 shares of the Holding Company's common stock and makes 49,378 shares available for restricted stock awards. The options granted have ten to fifteen year terms and vest from one to five years.  At September 30, 2013, there were no restricted stock awards issued.  A summary of the activity in the Holding Company's stock options is as follows:

							Weighted-
				Weighted-			Average
				Average			Remaining	Aggregate
	Number of			Exercise			Contractual	Intrinsic
	Options			Price			Term	Value
Outstanding at September 30, 2012		--			--
Options granted		90,000			(10.75	)
Outstanding at December 31, 2012		90,000		$	10.75
Options forfeited		(8,500	)		(10.75	)
Outstanding at September 30, 2013		81,500		$	10.75		13.75 years	$	194,000
Exercisable at September 30, 2013		-		$	-

At September 30, 2013, there was approximately $292,000 unrecognized compensation expense related to nonvested stock options granted under the Plan. The cost is expected to be recognized over a weighted-average period of forty-eight months.  The total fair value of shares vesting and recognized as compensation expense was $58,000 for the nine months ended September 30, 2013.

(continued)

19

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

13.  Fair Value Measurements

Impaired collateral-dependent loans are carried at fair value when the current collateral value is lower than the carrying value of the loan.  Those impaired collateral-dependent loans which are measured at fair value on a nonrecurring basis are as follows (in thousands):

	Fair Value		Level 1		Level 2		Level 3		Total Losses		Losses Recorded During the Period
At September 30, 2013:
One-to four-family	$	2,863		-		-		2,863		241		121
Home equity		242		-		-		242		115		73
Total	$	3,105		-		-		3,105		356		194
At December 31, 2012:
One-to four-family		2,160		-		-		2,160		308		232
Lot loans		52		-		-		52		221		103
Home equity		256		-		-		256		158		112
Total	$	2,468		-		-		2,468		687		447

Foreclosed real estate is recorded at fair value less estimated costs to sell.  Foreclosed real estate which is measured at fair value on a nonrecurring basis is summarized below (in thousands):

Quoted Prices

In Active

Significant

Losses

Markets for

Other

Significant

Recorded

Identical

Observable

Unobservable

During

Fair

Assets

Inputs

Inputs

Total

the

Value

(Level 1)

(Level 2)

(Level 3)

Losses

Period

At September 30, 2013 -

Foreclosed real estate

$

566

-

-

566

39

21

At December 31, 2012 -

Foreclosed real estate

$

1,878

-

-

1,878

137

95

(continued)

20

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

14.  Regulatory Matters

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's and the Bank's financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.  The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined).  Management believes, as of September 30, 2013, that the Bank met all capital adequacy requirements to which it was subject.

At September 30, 2013, the Bank was categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table.  There are no conditions or events since that notification that management believes have changed the institution's category.

The Bank's actual regulatory capital amounts and percentages are presented in the table ($ in thousands).

	Actual					Minimum For Capital Adequacy Purposes					Minimum To Be Well Capitalized Under Prompt and Corrective Action Provisions
	Amount		%			Amount		%			Amount		%
At September 30, 2013:
Total Capital to Risk-
Weighted Assets	$	19,370		21.62	%	$	7,167		8.00	%	$	8,959		10.00	%
Tier I Capital to Risk-
Weighted Assets		18,247		20.37			3,584		4.00			5,375		6.00
Tier I Capital
to Total Assets		18,247		12.36			4,428		3.00			7,380		5.00
At December 31, 2012:
Total Capital to Risk-
Weighted Assets		18,406		20.96			7,027		8.00			8,783		10.00
Tier I Capital to Risk-
Weighted Assets		17,302		19.70			3,514		4.00			5,270		6.00
Tier I Capital
to Total Assets		17,302		11.96			4,341		3.00			7,235		5.00

(continued)

21

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (Unaudited), Continued

15.  Adoption of Plan of Reorganization and Subsequent Stock Issuance

On April 5, 2011, in accordance with the plan of conversion and reorganization adopted by its Board of Directors and approved by its members, the Bank converted from a mutual holding company to a stock holding company form of organization, with the Bank becoming a wholly-owned subsidiary of the Holding Company.  The conversion and reorganization was accomplished through the sale and issuance of 1,234,454 shares of common stock at a price of $10 per share, through which the Holding Company received proceeds of approximately $10.5 million, net of offering expenses of approximately $847,000.

In accordance with Office of the Comptroller of the Currency ("OCC") (formerly Office of Thrift Supervision) regulations, upon the completion of the conversion, the Bank restricted retained earnings by establishing a liquidation account. The liquidation account will be maintained for the benefit of eligible account holders who continue to maintain their accounts at the Bank after conversion. The liquidation account will be reduced annually to the extent that eligible account holders have reduced their qualifying deposits. Subsequent increases will not restore an eligible account holder’s interest in the liquidation account. In the event of a complete liquidation of the Bank, and only in such event, each account holder will be entitled to receive a distribution from the liquidation account in an amount proportionate to the adjusted qualifying account balances then held. The Bank may not pay dividends if those dividends would reduce equity capital below the required liquidation account amount.

22

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Item 2. Management's Discussion and Analysis of

Financial Condition and Results of Operations

Forward-Looking Statements

When used in this report and in future filings by Sunshine Financial with the U.S. Securities and Exchange Commission ("SEC"), in Sunshine Financial's press releases or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases, "anticipate," "believes," "expects," "would be," "will allow," "intends to," "will likely result," "are expected to," "will continue," "is anticipated," "estimated," "projected," or similar expressions are intended to identify forward-looking statements."  These forward-looking statements include, but are not limited to:

· statements of our goals, intentions and expectations;

· statements regarding our business plans, prospects, growth and operating strategies;

· statements regarding the asset quality of our loan and investment portfolios; and

· estimates of our risks and future costs and benefits.

These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control.  In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

· the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;

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

· changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources;

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

· results of examinations of us by the Office of the Comptroller of the Currency ("OCC") or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;

· legislative or regulatory changes that adversely affect our business including the effect of the Dodd-Frank Act, changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules, including as a result of Basel III;

· our ability to attract and retain deposits;

· increases in premiums for deposit insurance;

23

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

· 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 successfully integrate any assets, liabilities, customers, systems, and management personnel we may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto;

· 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;

· 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, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods including relating to fair value accounting and loan loss reserve requirements; and

· other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere in this report and our reports filed with the SEC.

Forward-looking statements are based upon management's beliefs and assumptions at the time they are made.  We undertake no obligation to publicly update or revise any forward-looking statements included in this report or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise.  In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur and you should not put undue reliance on any forward-looking statements.

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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

General

Sunshine Financial is the holding company for its wholly owned subsidiary, Sunshine Savings Bank. Sunshine Savings Bank was originally chartered as a credit union in 1952 as Sunshine State Credit Union to serve state government employees in the metropolitan Tallahassee area.  On July 1, 2007, we converted from a state-chartered credit union known as Sunshine State Credit Union to a federal mutual savings bank known as Sunshine Savings Bank, and in 2009 reorganized into the non-stock mutual holding company structure.  On April 5, 2011, Sunshine Financial completed a public offering as part of the Sunshine Saving Bank's conversion and reorganization from a non-stock mutual holding company to a fully public stock holding company structure.  References to we, us and our throughout this document refer to Sunshine Financial and Sunshine Savings Bank, as the context requires.

We currently operate out of four full-service branch offices serving the Tallahassee, Florida metropolitan area.  Our principal business consists of attracting retail deposits from the general public and investing those funds in loans secured by first and second mortgages on one- to four-family residences, commercial real estate, home equity loans and lines of credit, lot loans, and direct automobile, credit card and other consumer loans.

On September 26, 2013 the Bank purchased the buildings, real estate, fixtures and equipment of two former bank branch offices in Tallahassee, Florida, from Centennial Bank for an aggregate purchase price of $2.1 million.  The properties have been acquired as future branch locations of the Bank.  One of the properties is located in the rapidly growing section of Southwood, which is anchored by various agencies of the State of Florida Government.  The second property is situated directly across from Tallahassee Community College and the Lively Technical Institute.  This property is also in the same market area as the Leon County School Board, the Leon County Sheriff’s Department as well as the Leon County and City of Tallahassee Maintenance Departments.  Presently, Sunshine Savings Bank has no banking facilities convenient to either of these two strategically important areas of Western and Southeast Tallahassee.  Management believes that both facilities are located in high traffic growth areas strategically important to the future growth and profitability of the Bank.

The Bank anticipates opening branches at these locations within the next few years.  In the meantime, management has estimated that this acquisition will increase the Bank’s expenses by approximately $10,000 per month, which has been more than offset through an internal reorganization.

We offer a variety of deposit accounts, which are our primary source of funding for our lending activities.

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

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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Changes in levels of interest rates affect our net interest income. A secondary source of income is noninterest income, which includes revenue we receive from providing products and services and gain on loan sales. Our noninterest expense has typically exceeded our net interest income and we have relied primarily upon noninterest income to supplement our net interest income and to achieve earnings.

Our noninterest expenses consist primarily of salaries and employee benefits, general and administrative, occupancy and equipment, data processing services, professional services, marketing expenses and expenses related to foreclosed real estate. Salaries and benefits consist primarily of the salaries and wages paid to our employees, payroll taxes, expenses for retirement and other employee benefits. Occupancy and equipment expenses, which are the fixed and variable costs of building and equipment, consist primarily of lease payments, taxes, depreciation charges, maintenance and costs of utilities.

Critical Accounting Policies

Certain of our accounting policies are important to the portrayal of our financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain.  Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances.  Facts and circumstances which could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers.  Management believes that its critical accounting policies include, determining the allowance for loan losses, valuation of foreclosed real estate and accounting for deferred income taxes.

Foreclosed Real Estate.  Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure, establishing a new cost basis.  After foreclosure, valuations are periodically performed by management and the assets are carried at the lower of the new cost basis or fair value less costs to sell.  Revenue and expenses from operations are included in the condensed consolidated statements of operations.

Allowance for Loan Losses.  The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to operations.  Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance. There were no changes in the Bank's accounting policies or methodology during the periods ended September 30, 2013 or 2012.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

The allowance consists of specific and general components.  The specific component relates to loans that are classified as impaired.  For such loans, an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan.  The general component covers all other loans and is based on historical loss experience adjusted for qualitative factors.

The historical loss component of the allowance is determined by losses recognized by portfolio segment over the preceding two years. This is supplemented by the risks for each portfolio segment. Risk factors impacting loans in each of the portfolio segments include changes in lending policies and procedures, economic conditions, volume and nature of loans, lending management experience, volume of troubled loans, quality of loan review system, value of collateral-dependent loans, credit concentrations and competition and regulatory change. The historical experience is adjusted for qualitative factors such as economic conditions and other trends or uncertainties that could affect management's estimate of probable losses.

Aloan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral-dependent.

Deferred Tax Assets.  Income taxes are reflected in our financial statements to show the tax effects of the operations and transactions reported in the financial statements and consist of taxes currently payable plus deferred taxes.  Accounting principles generally accepted in the United States of America require the asset and liability approach for financial accounting and reporting for deferred income taxes.  Deferred tax assets and liabilities result from differences between the financial statement carrying amounts and the tax bases of assets and liabilities.  They are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled and are determined using the assets and liability method of accounting.  The deferred income provision represents the difference between net deferred tax asset/liability at the beginning and end of the reported period.  In formulating our deferred tax asset, we are required to estimate our income and taxes in the jurisdiction in which we operate.  This process involves estimating our actual current tax exposure for the reported period together with assessing temporary differences resulting from differing treatment of items, such as depreciation and the provision for loan losses, for tax and financial reporting purposes.  Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates.  The realization of deferred tax assets is dependent on results of future operations.  A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Comparison of Financial Condition at September 30, 2013 and December 31, 2012

General.  Total assets increased $2.5 million, or 1.7%, to $149.9 million at September 30, 2013 from $147.4 million at December 31, 2012. The increase in total assets was due primarily to increases in securities held to maturity, premises and equipment, and interest-bearing deposits with banks, partially offset by decreases in loans and foreclosed real estate.  Our securities held to maturity increased $2.9 million, premises and equipment increased $1.8 million, interest-bearing deposits with banks increased $2.3 million, loans decreased $2.2 million and foreclosed real estate decreased $1.3 million since December 31, 2012.  Premises and equipment increased as a result of the purchase of the two former bank branches discussed above and securities held to maturity increased due to purchases because of low loan demand. The net increase was funded by a $2.1 million increase in deposits, primarily savings deposit accounts.

Loans.  Our net loan portfolio decreased $2.2 million, to $93.1 million at September 30, 2013 from $95.3 million at December 31, 2012.  Commercial real estate mortgage loans increased $6.6 million, and commercial unsecured loans increased $0.1 million, while other real estate mortgage loans decreased $9.8 million and consumer loans decreased $0.7 million.   We originate and sell one- to four-family real estate mortgage loans to Freddie Mac to generate additional income.  For the nine-months ended September 30, 2013, we originated $7.8 million of one- to four-family mortgage loans for sale, and realized proceeds from sales of $8.0 million were sold to Freddie Mac.  A gain on sale of $401,000 included recording a $278,000 loan servicing asset.

Allowance for Loan Losses.  Our allowance for loan losses at September 30, 2013 was $1.4 million, or 1.49% of loans receivable, compared to $1.5 million, or 1.56% of loans receivable, at December 31, 2012.  Nonperforming loans decreased to $1.6 million at September 30, 2013 from $2.3 million at December 31, 2012 due primarily to a $744,000 decline in nonperforming single family mortgage loans primarily due to improving economic conditions in our market area and our continued focus on credit administration.  Nonperforming loans to total loans decreased to 1.67% at September 30, 2013 from 2.35% at December 31, 2012 due to the decrease in the nonperforming loans.  Loans on nonaccrual which were less than ninety days past due totaled $331,000 at September 30, 2013 compared to $323,000 million at December 31, 2012.

Deposits.  Total deposits increased $2.1 million, or 1.7%, to $123.8 million at September 30, 2013 from $121.7 million at December 31, 2012.  This increase was due primarily to increases in savings accounts, money-market deposits, and noninterest bearing, partially offset by decreases in time deposits.

Equity.  Total stockholders' equity increased $101,000 to $25.0 million at September 30, 2013.  This increase was due to net income of $401,000, stock-based compensation of $58,000, ESOP compensation expense of $42,000, offset by $400,000 in stock buy-backs for the nine-months ended September 30, 2013.

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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Results of Operations

The following tables set forth, for the periods indicated, information regarding (i) the total dollar amount of interest and dividend income of the Company from interest-earning assets and the resultant average yields; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average rates; (iii) net interest income; (iv) interest-rate spread; and (v) net interest margin. Income and yields on tax-exempt obligations have not been computed on a tax equivalent basis.  All average balances are daily average balances.  Nonaccruing loans have been included in the table as loans carrying a zero yield for the period they have been on non-accrual.

	Three Months Ended September 30,
	2013								2012
	Average Balance			Interest and Dividends		Average Yield/ Rate			Average Balance			Interest and Dividend		Average Yield/ Rate
Interest-earning assets:
Loans receivable (1)	$	94,455		$	1,311		5.55	%	$	93,452		$	1,392		5.96	%
Investments held to maturity		18,022			95		2.11			11,237			66		2.35
Other interest-earning assets (2)		23,127			14		0.24			27,217			16		0.24
Total interest-earning assets		135,604			1,420		4.19			131,906			1,474		4.47
Noninterest-earning assets		11,845								11,649
Total assets	$	147,449							$	143,555
Interest-bearing liabilities:
MMDA and statement savings		69,679			61		0.35			65,277			70		0.43
Time deposits		30,359			39		0.51			32,841			58		0.71
Total interest-bearing liabilities		100,038			100		0.40			98,118			128		0.52
Noninterest-bearing liabilities		22,144								20,665
Equity		25,267								24,772
Total liabilities and equity	$	147,449							$	143,555
Net interest income				$	1,320							$	1,346
Net interest rate spread (3)							3.79	%							3.95	%
Net interest margin (4)							3.89	%							4.08	%
Ratio of average interest-earning assets
to average interest-bearing liabilities		1.36	x							1.34	x

(1)	Includes nonaccrual loans.
(2)	Other interest-earnings assets including federal funds sold, Federal Home Loan Bank stock and interest-bearing deposits.
(3)	Interest-rate spread represents the difference between the average yield on interest-earning assets and the average rate of interest-bearing liabilities.
(4)	Net interest margin is net interest income divided by average interest-earning assets (annualized).

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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

	Nine-Months Ended September 30,
	2013								2012
	Average Balance			Interest and Dividends		Average Yield/ Rate			Average Balance			Interest and Dividend		Average Yield/ Rate
Interest-earning assets:
Loans receivable (1)	$	94,280		$	4,008		5.67	%	$	96,938		$	4,256		5.85	%
Investments held to maturity		15,865			252		2.12			9,747			180		2.46
Other interest-earning assets (2)		25,476			48		0.25			26,033			46		0.24
Total interest-earning assets		135,621			4,308		4.24			132,718			4,482		4.50
Noninterest-earning assets		11,090								10,668
Total assets	$	146,711							$	143,386
Interest-bearing liabilities:
MMDA and statement savings		68,621			184		0.36			64,000			250		0.52
Time deposits		30,624			125		0.54			33,982			189		0.74
Total interest-bearing liabilities		99,245			309		0.42			97,982			439		0.64
Noninterest-bearing liabilities		22,359								20,305
Equity		25,107								25,099
Total liabilities and equity	$	146,711							$	143,386
Net interest income				$	3,999							$	4,043
Net interest rate spread (3)							3.82	%							3.90	%
Net interest margin (4)							3.93	%							4.06	%
Ratio of average interest-earning assets
to average interest-bearing liabilities		1.37	x							1.35	x

(1)	Includes nonaccrual loans.
(2)	Other interest-earnings assets including federal funds sold, Federal Home Loan Bank stock and interest-bearing deposits.
(3)	Interest-rate spread represents the difference between the average yield on interest-earning assets and the average rate of interest-bearing liabilities.
(4)	Net interest margin is net interest income divided by average interest-earning assets (annualized).

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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Comparison of the Three Months Ended September 30, 2013 and 2012

General. Net earnings for the three months ended September 30, 2013 was $46,000 compared to a net loss of $(44,000) for the three months ended September 30, 2012, resulting in an annualized return on average assets of 0.12 % for the three months ended September 30, 2013 and annualized loss of (0.12)% for the three months ended September 30, 2012.  The increase in net earnings was due primarily to a decrease in our provision for loan loss, a decrease in our noninterest expense, partially offset by a decrease in noninterest income.

Net Interest Income.  Net interest income decreased $26,000, or 1.9%, to $1.3 million for the three months ended September 30, 2013 from $1.3 million for the same period in 2012, primarily due to the decline in the average rate of our loan portfolio, partially offset by our lower cost of deposits.  Our interest-rate-spread decreased to 3.79% for the three months ended September 30, 2013 from 3.95% for the same period in 2012, while our net interest margin decreased to 3.89% from 4.08%.  The ratio of average interest-earning assets to average interest-bearing liabilities for the three months ended September 30, 2013 increased to 1.36x, from 1.34x for the three months ended September 30, 2012.

Interest Income. Interest income for the three months ended September 30, 2013 decreased $54,000, or 3.7%, to $1.4 million from $1.5 million for the same period ended September 30, 2012.  The decrease in interest income for the three months ended September 30, 2013 was primarily due to lower average rates on loans receivable, partially offset by higher average balances of investments.  Average interest-earning investments increased to $18.0 million during the three months ended September 30, 2013 compared to $11.2 million for the three months ended September 30, 2012.  In addition, the average yield on loans decreased 41 basis points to 5.55% from 5.96%.  Overall the average yield on average earning assets decreased 28 basis points to 4.19% from 4.47%.

Interest Expense. Interest expense for the three months ended September 30, 2013 was $100,000 compared to $128,000 for the same period in 2012, a decrease of $28,000 or 21.9%.  The decrease was primarily the result of decreases in the average rate paid on time deposits, money-market deposits and statement savings accounts.  The average balance of time deposits decreased to $30.4 million for the three month period ended September 30, 2013 from $32.8 million for the same period in 2012 and the average rate paid on time deposits decreased to 0.51% from 0.71% as certificates of deposit re-priced at lower market rates. The average rate paid on MMDA and statement savings decreased from 0.43% to 0.35%.  The total cost of funds for the three months ended September 30, 2013 decreased to 0.40 % from 0.52% for the three months ended September 30, 2012, reflecting the lower interest rate environment.

Provision for Loan Losses.  We provisioned $50,000 for loan losses of for the three months ended September 30, 2013 compared to $270,000 for the same period in 2012.  The provision for loan losses reflected the decrease in net charge-offs and the decrease in nonperforming single family mortgage loans in foreclosure.  Net charge-offs for the three months ended September 30, 2013 were $98,000 compared to $211,000 for the three months ended September 30, 2012. For the three months ended September 30, 2013, net charge-offs consisted of $33,000 for credit card and unsecured loans, $57,000 for one-to four-family loans, $10,000 for lot loans, a net recovery of $1,000 for home equity loans, and a net recovery of $1,000 for automobile loans.  For the same period in 2012, net charge-offs consisted of $36,000 for credit card and unsecured loans, $63,000 for home equity  loans, $92,000 for one-to four-family loans, $22,000 for other consumer loans, and a net recovery of $2,000 for automobile loans. As of September 30, 2013, the Bank was in the process of foreclosure on seven single family real estate loans.  As of September 30, 2012, the Bank was in the process of foreclosure on fifteen single family real estate loans. Nonperforming loans to total loans at September 30, 2013 were 1.67% compared to 2.72% at September 30, 2012.  The allowance for loan losses to loans receivable was 1.49% at September 30, 2013 compared to 1.61% at September 30, 2012.

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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Comparison of the Three Months Ended September 30, 2013 and 2012, Continued

Management considers the allowance for loan losses at September 30, 2013 to be adequate to cover losses inherent in the loan portfolio based on the assessment of the above-mentioned factors affecting the loan portfolio. While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future losses will not exceed the amount of the established allowance for loan losses or that any increased allowance for loan losses that may be required will not adversely impact our financial condition and results of operations. In addition, the determination of the amount of our allowance for loan losses is subject to review by bank regulators, as part of the routine examination process, which may result in additions to our provision for loan losses based upon their judgment of information available to them at the time of their examination.

Noninterest Income. Noninterest income for the three months ended September 30, 2013 decreased $129,000, or 17.7%, to $601,000 compared to $730,000 for the same period in 2012.  Gain on loan sales decreased $155,000, while fees and service charges on deposit accounts decreased $83,000 which were partially offset by a $107,000 increase in gain on sale of foreclosed real estate for the three months ended September 30, 2013, compared to the same period last year.  The primary cause for the decrease in gain on loan sales was the significantly lower volumes of loans sales. The primary cause for the decrease in fees from deposit accounts was a decrease in income from NSF fees on transaction accounts.

Noninterest Expense. Noninterest expense for the three months ended September 30, 2013 decreased $85,000, or 4.5%, to $1,799,000 compared to $1,884,000 for the same period in 2012.  The largest increase occurred in occupancy and equipment which increased $38,000, or 14.1%, to $308,000 for the three months ended September 30, 2013, from $270,000 for the same period last year.  The increase in occupancy and equipment expense was primarily due to real estate taxes and depreciation due to the purchase of two branch facilities in June 2013.  The largest decreases were telephone and postage, foreclosed real estate and other expenses.  Telephone and postage expense decreased $26,000, or 31.0%, to $58,000, foreclosed real estate expense decreased $44,000, or 45.8%, to $52,000, and other expense decreased $31,000, or 19.3% to $130,000 for the three months ended September 30, 2013.  Telephone and postage expense decreased primarily due to lower postage expense.  Foreclosed real estate expense was lower primarily due to fewer properties owned and in the process of foreclosure.  Other expense decreased due to lower loan acquisition expense and numerous other miscellaneous line items.

Income Taxes. For the three months ended September 30, 2013, we recorded income taxes of $26,000 on before tax earnings of $72,000.  For the three months ended September 30, 2012, we recorded an income tax benefit of $34,000 on a before tax loss of $78,000.  Our effective tax rate for the three months ended September 30, 2013 was 36.1% compared to (43.6)% for the same time period in 2012.

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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Comparison of the Nine Months Ended September 30, 2013 and 2012

General.  Net earnings for the nine months ended September 30, 2013 was $401,000 compared to a net loss of $(670,000) for the nine months ended September 30, 2012, resulting in an annualized return on average assets of 0.36% for the nine months ended September 30, 2013 and a net loss on average assets of (0.62) % for the nine months ended September 30, 2012.  The increase in net earnings was due primarily to a decrease in our provision for loan loss and an increase in noninterest income, partially offset by an increase in noninterest expense.

Net Interest Income.  Net interest income decreased $44,000, or 1.1%, to $ 3,999,000 for the nine months ended September 30, 2013 from $4,043,000 for the same period in 2012, primarily due to the decline in average balance and yield of our loan portfolio, partially offset by our lower cost of deposits.  Our interest-rate-spread decreased to 3.82% for the nine months ended September 30, 2013 from 3.90% for the same period in 2012, while our net interest margin decreased to 3.93% for the nine months ended September 30, 2013 from 4.06% for the same period in 2012.  The ratio of average interest-earning assets to average interest-bearing liabilities for the nine months ended September 30, 2013 increased to 1.37x, from 1.35x for the nine months ended September 30, 2012.

Interest Income. Interest income for the nine months ended September 30, 2013 decreased $174,000, or 3.9%, to $4,308,000 from $4,482,000 for the same period ended September 30, 2012.  The decrease in interest income for the nine months ended September 30, 2013 was primarily due to lower average balances of loans receivable and an 18 basis point decline in the yield earned on loans, partially offset by an increase in the average balance of investment securities.  Average balances of interest-earning loans decreased to $94.3 million during the nine months ended September 30, 2013 compared to $96.9 million for the nine months ended September 30, 2012, while the average balance of investment securities increased to $15.9 million from $9.7 million during that same period.

Interest Expense. Interest expense for the nine months ended September 30, 2013 was $309,000 compared to $439,000 for the same period in 2012, a decrease of $130,000 or 29.6%.  The decrease was primarily the result of a decrease in the average rate paid on deposits reflecting the low interest rate environment.  The average balance of time deposits decreased to $30.6 million for the nine month period ended September 30, 2013 from $34.0 million for the same period in 2012 and the average rate paid on certificates of deposit decreased to 0.54% from 0.74% as certificates of deposit re-priced at lower market rates.   The total cost of funds for the nine months ended September 30, 2013 decreased to 0.42% from 0.64% for the nine months ended September 30, 2012.

Provision for Loan Losses.  We recorded a provision for loan losses of $2,000 for the nine months ended September 30, 2013 and a provision for loan losses of $1,450,000 for the same period in 2012.  The provision for loan losses reflected the decrease in net loan charge-offs and in nonperforming single family mortgage loans in foreclosure.  Net charge-offs for the nine months ended September 30, 2013 were $131,000 compared to $1,253,000 for the nine months ended September 30, 2012. For the first nine months of 2013, net charge-offs consisted of $56,000 for credit card and unsecured loans, $32,000 for lot loans, $196,000 for one-to four-family loans, $9,000 for other  consumer loans, and a net recovery of $159,000 for home equity loans and $3,000 for automobile loans.  For the first nine months of 2012, net charge-offs consisted of $147,000 for credit card and unsecured loans, $289,000 for home equity loans, $123,000 for lot loans, $573,000 for one-to four-family loans, $114,000 for other  consumer loans, and $7,000 for automobile loans.

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SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Comparison of the Nine Months Ended September 30, 2013 and 2012, Continued

Noninterest Income. Noninterest income for the nine months ended September 30, 2013 increased $383,000, or 19.7%, to $2,328,000 compared to $1,945,000 for the same period in 2012. Gain on the sale of foreclosed real estate increased $298,000, gain on loan sales increased $144,000, and other income increased $117,000.  Gains on loans sales increased $144,000 primarily due to an increase in the mortgage servicing assets.  Fees and service charges on deposit accounts decreased $171,000 for the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012. The primary cause for the decrease in fees from deposit accounts was a decrease in income from NSF fees on transaction accounts.  Other income increased due to a one time recovery of a previously written off asset.

Noninterest Expense. Noninterest expense for the nine months ended September 30, 2013 was $5,671,000 compared to $5,614,000 for the same period in 2012, an increase of $57,000 or 1.0%.  The largest increase occurred in occupancy and equipment expense which increased $44,000, or 5.3%, to $870,000 compared to $826,000 for the same period in 2012.  The increase in occupancy and equipment expense was primarily due to real estate taxes and depreciation due to the purchase of two branch facilities in June 2013. In addition, other expense increased $40,000, or 8.2%.  The increase in other expense was due to an increase in debit card losses, appraisal fees and loan acquisition expense, and other loan expense.  Professional fees increased $30,000 from 2012 primarily due to an increase in legal and accounting fees associated with our annual meeting and complying with SEC regulations.  Telephone and postage expense decreased primarily due to lower postage expense.  Foreclosed real estate expense was lower primarily due to fewer properties owned and in the process of foreclosure.

Income Taxes. For the nine months ended September 30, 2013, we recorded income taxes of $253,000 on before tax earnings of $654,000.  For the nine months ended September 30, 2012, we recorded an income tax benefit of $406,000 on a before tax loss of $1,076,000.  Our effective tax rate for the nine months ended September 30, 2013 was 38.7% compared to (37.7)% for the same time period in 2012.

34

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

Item 3.  Quantitative and Qualitative Disclosure About Market Risk

The Company provided information about market risk in Item 7A of its 2012 Form 10-K.  There have been no material changes in our market risk since our 2012 Form 10-K.

Item 4.  Controls and Procedures

An evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the "Act")) as of September 30, 2013, was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officerand several other members of the Company's senior management.The Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures in effect as of September 30, 2013, were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is: (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.

In addition, there have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Act) that occurred during the quarter ended September 30, 2013, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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

35

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

PART II.  OTHER INFORMATION

Item 1.     Legal Proceedings

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

Item 1A.  Risk Factors

Not required for smaller reporting companies.

Item 2.     Unregistered Sales of Equity Securities and use of Proceeds

The following table sets forth information for the three months ended September 30, 2013 with respect to our repurchases of our outstanding common shares:

	Total Number of Shares Purchased	Average Price Paid per Share	Total number of shares purchased as part of publicly announced plans or programs	Maximum number of shares that may yet be purchased under the plans or programs
July 1, 2013 – July 31, 2013	---	---	---	---
August 1, 2013 – August 31, 2013	---	---	---	---
September 1, 2013 – September 30, 2013	25,700	15.55	25,700	97,745
Total	25,700	15.55	25,700	97,745

On August 28, 2013, the Company announced that its board of directors authorized the Company to purchase up to 123,445 shares, or approximately 10%, of its common stock in the open market or privately negotiated transaction from time to time over a twelve month period, subject to market conditions and other factors. The stock repurchase program will expire on August 27, 2014 unless completed sooner or otherwise extended.

Item 3.     Defaults Upon Senior Securities

Not applicable.

Item 4.     Mine Safety Disclosures

Not applicable.

Item 5.     Other Information

Nothing to report.

Item 6.     Exhibits

See Exhibit Index

36

SUNSHINE FINANCIAL, INC. AND SUBSIDIARIES

SIGNATURES

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

	SUNSHINE FINANICAL, INC.
Date:  November 14, 2013	By:	/s/ Louis O. Davis, Jr.
		Louis O. Davis, Jr.
		President and Chief Executive Officer
		(Duly Authorized Officer)
Date:  November 14, 2013	By:	/s/ Scott A. Swain
		Scott A, Swain
		Senior Vice President, Treasurer and
		Chief Financial Officer
		(Principal Financial Officer)

37

EXHIBIT INDEX

Exhibits:
3.1	Articles of Incorporation of Sunshine Financial, Inc. (incorporated herein by reference to Exhibit 3.1 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-169555))
3.2	Bylaws, as amended, of Sunshine Financial, Inc. (incorporated herein by reference to Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed with the SEC on August 28, 2013 (File No. 000-54280)))
4.0	Form of Common Stock Certificate of Sunshine Financial, Inc. (incorporated herein by reference to Exhibit 4.0 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-169555))
10.1	Employment Agreement by and between Sunshine Savings Bank and Louis O Davis, Jr. (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-169555))
10.2	Form of Change of Control Agreement by and between Sunshine Financial, Inc. and Louis O. Davis Jr. (incorporated herein by reference to Exhibit 10.2 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-169555))
10.3	Form of Change of Control Agreement by and between Sunshine Financial, Inc. and each of Brian P. Baggett and Scott A. Swain (incorporated herein by reference to Exhibit 10.3 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-169555))
10.4	Employee Severance Policy (incorporated herein by reference to Exhibit 10.4 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-169555))
10.5	Director Fee Arrangements (incorporated herein by reference to Exhibit 10.5 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2012 (File No. 000-54280))
10.6	Sunshine Financial, Inc. 2012 Equity Incentive Plan (incorporated herein by reference to Appendix A to the Registrant's Definitive Proxy Statement filed on Schedule 14A on April 20, 2012 (File No. 000-54280))
10.7	Forms of Incentive Stock Option, Non-Qualified Stock Option and Restricted Stock Agreements under the 2012 Equity Incentive Plan (incorporated by reference to the Exhibits to the Registrant's Registration Statement on Form S-8 filed with the SEC on June 29, 2012 (File No. 333-182450))
10.8	Commercial Contract for the acquisition of property located at 3641 Coolidge Ct., Tallahassee, FL. (incorporated by reference to the Registrant’s Current Report on Form 8-K filed on May 20, 2013 (File No. 000-54280))
10.9	Commercial Contract for the acquisition of property located at 503 Appleyard Dr., Tallahassee, FL.(incorporated by reference to the Registrant’s Current Report on Form 8-K filed on May 20, 2013 (File No. 000-54280))
31.1	Rule 13a-14(a) Certification of the Chief Executive Officer
31.2	Rule 13a-14(a) Certification of the Chief Financial Officer
32.0	Section 1350 Certification
101	Interactive Data Files *

¯           In accordance with Rule 406T of Regulation S-T, these interactive data files are deemed not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are not deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.