UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





þ
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934 FOR THE QUARTERLY PERIOD ENDED June 30,
      2008




OR




 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934 FOR TRANSITION PERIOD FROM
      ______________TO_________________




Commission
file number0-25286





CASCADE FINANCIAL
CORPORATION


(Exact
name of registrant as specified in its charter)





Washington
            
            91-1661954(State
      or other jurisdiction of incorporation or organization)
            
            (IRS
      Employer Identification No.)2828
      Colby AvenueEverett,
      Washington
            
            98201(Address
      of principal executive offices)
            
            (Zip
      Code)(425)
      339-5500(Registrant's
      telephone number, including area
code)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding twelve 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 ninety days. Yes þ     No
 ̈




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




Large
Accelerated Filer  ̈    Accelerated
Filer þ    Non-Accelerated
Filer  ̈    Smaller
Reporting Company  ̈




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




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




Class
            Outstanding as of July 31,
    2008Common
      Stock ($.01 par value)
            12,047,927




1




CASCADE FINANCIAL
CORPORATION


FORM
10-Q


For the Quarter Ended June 30, 2008




INDEX





PAGEPART I — Financial
    Information:Item 1
            —
      Financial Statements:—
      Condensed Consolidated Balance Sheets
            3—
      Condensed Consolidated Statements of Income
            4—
      Consolidated Statements of Comprehensive Income
            5—
      Condensed Consolidated Statements of Cash Flows
            6—
      Notes to Condensed Consolidated Financial Statements
            8Item 2
            —
      Management’s Discussion and Analysis of Financial Condition and Results
      of
      Operations
            13Item 3
            —
      Quantitative and Qualitative Disclosures about Market Risk
            25Item 4
            —
      Controls and Procedures
            26PART II — Other
Information:Item 1
            —
      Legal Proceedings
            27Item 1A
            —
      Risk Factors
            27Item 2
            —
      Unregistered Sales of Equity Securities and Use of
Proceeds
            27Item 3
            —
      Defaults Upon Senior Securities
            28Item 4
            —
      Submission of Matters to a Vote of Security Holders
            28Item 5
            —
      Other Information
            28Item 6
            —
      Exhibits
            28Signatures
            29




2




PART I –– FINANCIAL
INFORMATION





Item
1 – Financial Statements





CASCADE
FINANCIAL CORPORATION AND SUBSIDIARY


CONDENSED
CONSOLIDATED BALANCE SHEETS


(unaudited)


(Dollars
      in thousands except share and per share amounts)
            
            June
      30,
            
            
            December
      31,2008
            
            
            2007ASSETSCash
      on hand and in banks
            
            $
            13,921
            
            
            $
            12,911Interest-earning
      deposits in other institutions
            
            
            1,850
            
            
            
            1,619Securities
      available-for-sale, fair value
            
            
            123,630
            
            
            
            82,860Federal
      Home Loan Bank (FHLB) Stock
            
            
            11,920
            
            
            
            11,920Securities
      held-to-maturity, amortized cost
            
            
            137,065
            
            
            
            137,238Loans,
      net
            
            
            1,178,093
            
            
            
            1,092,776Goodwill
            
            
            24,585
            
            
            
            24,585Core
      deposit intangible, net
            
            
            564
            
            
            
            634Premises
      and equipment, net
            
            
            15,778
            
            
            
            14,160Cash
      surrender value of bank-owned life insurance (BOLI)
            
            
            23,133
            
            
            
            22,658Deferred
      tax asset
            
            
            2,585
            
            
            
            1,574Accrued
      interest receivable and other assets
            
            
            14,496
            
            
            
            14,653TOTAL
      ASSETS
            
            $
            1,547,620
            
            
            $
            1,417,588LIABILITIES AND STOCKHOLDERS’
      EQUITYLiabilities:Deposits
            
            $
            990,561
            
            
            $
            904,896FHLB
      advances
            
            
            250,000
            
            
            
            231,000Securities
      sold under agreements to repurchase
            
            
            120,641
            
            
            
            120,625Federal
      Reserve Term Auction Facility (TAF)
            
            
            25,000
            
            
            
            -Junior
      subordinated debentures payable
            
            
            15,465
            
            
            
            15,465Junior
      subordinated debentures payable, at fair value
            
            
            10,924
            
            
            
            11,422Advance
      payments by borrowers for taxes and insurance
            
            
            401
            
            
            
            502Dividends
      payable
            
            
            -
            
            
            
            1,082Accrued
      interest payable, expenses and other liabilities
            
            
            8,980
            
            
            
            10,500TOTAL
      LIABILITIES
            
            
            1,421,972
            
            
            
            1,295,492Stockholders’ Equity:Preferred
      stock, $.01 par value, Authorized 500,000 shares;no
      shares issued or outstanding
            
            
            -
            
            
            
            -Common
      stock, $.01 par value, Authorized 25,000,000 shares;issued
      and outstanding 12,047,927 shares at June 30, 2008,and
      12,023,685 shares at December 31, 2007
            
            
            120
            
            
            
            120Additional
      paid-in capital
            
            
            40,549
            
            
            
            40,322Retained
      earnings, substantially restricted
            
            
            87,456
            
            
            
            82,169Accumulated
      other comprehensive (loss), net of tax
            
            
            (2,477
            )
            
            
            (515
            )TOTAL
      STOCKHOLDERS’ EQUITY
            
            
            125,648
            
            
            
            122,096TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
            
            $
            1,547,620
            
            
            $
            1,417,588








See notes
to condensed consolidated financial statements


3


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF INCOME


(unaudited)





(Dollars
      in thousands except
            
            Three
      months ended
            
            
            Six
      months endedshare
      and per share amounts)
            
            June
      30,
            
            
            June
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Interest income:Loans
            
            $
            19,038
            
            
            $
            20,403
            
            
            $
            38,346
            
            
            $
            40,110Securities
      held-for-trading
            
            
            -
            
            
            
            616
            
            
            
            -
            
            
            
            1,369Securities
      available-for-sale
            
            
            1,680
            
            
            
            980
            
            
            
            3,206
            
            
            
            1,988FHLB
      dividends
            
            
            42
            
            
            
            18
            
            
            
            72
            
            
            
            30Securities
      held-to-maturity
            
            
            1,991
            
            
            
            1,054
            
            
            
            4,075
            
            
            
            2,017Interest-earning
      deposits
            
            
            42
            
            
            
            718
            
            
            
            108
            
            
            
            906Total
      interest income
            
            
            22,793
            
            
            
            23,789
            
            
            
            45,807
            
            
            
            46,420Interest
      expense:Deposits
            
            
            6,591
            
            
            
            9,165
            
            
            
            14,557
            
            
            
            17,573FHLB
      advances and other borrowings
            
            
            4,227
            
            
            
            3,103
            
            
            
            8,270
            
            
            
            6,519Junior
      subordinated debentures
            
            
            530
            
            
            
            530
            
            
            
            1,060
            
            
            
            1,060Total
      interest expense
            
            
            11,348
            
            
            
            12,798
            
            
            
            23,887
            
            
            
            25,152Net
      interest income
            
            
            11,445
            
            
            
            10,991
            
            
            
            21,920
            
            
            
            21,268Provision
      for loan losses
            
            
            1,200
            
            
            
            250
            
            
            
            3,590
            
            
            
            500Net
      interest income after provision for loan losses
            
            
            10,245
            
            
            
            10,741
            
            
            
            18,330
            
            
            
            20,768Other
      income:Checking
      fees
            
            
            1,277
            
            
            
            960
            
            
            
            2,312
            
            
            
            1,834Service
      fees
            
            
            313
            
            
            
            275
            
            
            
            545
            
            
            
            529BOLI
            
            
            259
            
            
            
            200
            
            
            
            519
            
            
            
            395Net
      gain (loss) on sales/calls of securities
            
            
            19
            
            
            
            (459
            )
            
            
            483
            
            
            
            (459
            )Gain
      on sale of loans
            
            
            45
            
            
            
            33
            
            
            
            83
            
            
            
            121Net
      gain on fair value of financial instruments
            
            
            193
            
            
            
            138
            
            
            
            498
            
            
            
            653Net
      gain on FHLB advances
            
            
            -
            
            
            
            569
            
            
            
            -
            
            
            
            569Other
            
            
            111
            
            
            
            118
            
            
            
            231
            
            
            
            243Total
      other income
            
            
            2,217
            
            
            
            1,834
            
            
            
            4,671
            
            
            
            3,885Other
      expenses:Compensation
      and employee benefits
            
            
            3,609
            
            
            
            3,441
            
            
            
            7,250
            
            
            
            6,814Occupancy
            
            
            988
            
            
            
            845
            
            
            
            1,940
            
            
            
            1,699Marketing
            
            
            325
            
            
            
            251
            
            
            
            562
            
            
            
            593Other
            
            
            2,329
            
            
            
            2,011
            
            
            
            4,434
            
            
            
            3,865Total
      other expenses
            
            
            7,251
            
            
            
            6,548
            
            
            
            14,186
            
            
            
            12,971Income
      before provision for federal income taxes
            
            
            5,211
            
            
            
            6,027
            
            
            
            8,815
            
            
            
            11,682Provision
      for federal income taxes
            
            
            1,577
            
            
            
            2,044
            
            
            
            2,567
            
            
            
            3,934Net
      income
            
            $
            3,634
            
            
            $
            3,983
            
            
            $
            6,248
            
            
            $
            7,748Net
      income per common share, basic
            
            $
            0.30
            
            
            $
            0.33
            
            
            $
            0.52
            
            
            $
            0.64Weighted
      average number of shares outstanding, basic
            
            
            12,047,927
            
            
            
            12,055,278
            
            
            
            12,041,001
            
            
            
            12,075,413Net
      income per share, diluted
            
            $
            0.30
            
            
            $
            0.32
            
            
            $
            0.51
            
            
            $
            0.63Weighted
      average number of shares outstanding, diluted
            
            
            12,162,848
            
            
            
            12,305,667
            
            
            
            12,185,563
            
            
            
            12,342,216Dividends
      declared per share
            
            $
            0.000
            
            
            $
            0.080
            
            
            $
            0.090
            
            
            $
            0.160








See notes
to condensed consolidated financial statements


4




CASCADE
FINANCIAL CORPORATION AND SUBSIDIARY


CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME


(unaudited)








Three
      months ended
            
            
            Six
      months Ended(Dollars
      in thousands)
            
            June
      30,
            
            
            June
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Net
      Income
            
            $
            3,634
            
            
            $
            3,983
            
            
            $
            6,248
            
            
            $
            7,748Increase
      in unrealized (loss) gain on securitiesavailable-for-sale,
      net of tax (benefit) expenseof
      $(960) and $(280) for the three monthsended
      June 30, 2008, and 2007, respectively,and
      $(1,186) and $596 for the six monthsJune
      30, 2008, and 2007, respectively.
            
            
            (1,782
            )
            
            
            (519
            )
            
            
            (2,203
            )
            
            
            1,108Reclassification
      adjustment for loss on securitiesincluded
      in net income, net of tax benefit of$4
      and $8 for the three months ended June 30,2008,
      and 2007, respectively, and $130 and $8for
      the six months ended June 30, 2008, and2007,
      respectively.
            
            
            8
            
            
            
            15
            
            
            
            241
            
            
            
            15Comprehensive
      Income
            
            $
            1,860
            
            
            $
            3,479
            
            
            $
            4,286
            
            
            $
            8,871







See notes
to condensed consolidated financial statements




5




CASCADE
FINANCIAL CORPORATION AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(unaudited)


Six
      Months Ended
              June
      30,(Dollars
      in thousands)
            
            2008
            
            
            2007Cash
      flows from operating activities:Net
      income
            
            $
            6,248
            
            
            $
            7,748Adjustments
      to reconcile net income to net cash provided by (used
      in) operating activities:Depreciation
      and amortization of premises and equipment
            
            
            1,020
            
            
            
            894Provision
      for losses on loans
            
            
            3,590
            
            
            
            500Increase
      in cash surrender value of bank-owned life insurance
            
            
            (475
            )
            
            
            (335
            )Amortization
      of retained servicing rights
            
            
            21
            
            
            
            23Amortization
      of core deposit intangible
            
            
            70
            
            
            
            70Deferred
      federal income taxes
            
            
            (385
            )
            
            
            (1,492
            )Deferred
      loan fees, net of amortization
            
            
            (252
            )
            
            
            152Gain
      on sale of loans
            
            
            (37
            )
            
            
            -Stock-based
      compensation
            
            
            99
            
            
            
            118Excess
      tax benefit from stock-based payments
            
            
            (30
            )
            
            
            (144
            )Net
      change in fair value of financial instruments
            
            
            (498
            )
            
            
            (741
            )Net
      gain on sales/calls of securities available-for-sale
            
            
            (371
            )
            
            
            -Net
      gain on calls of securities held-to-maturity
            
            
            (112
            )
            
            
            -Net
      increase (decrease) in accrued interest receivable and other
      assets
            
            
            378
            
            
            
            (1,290
            )Net
      (decrease) increase in accrued interest payable, expenses and other
      liabilities
            
            
            (1,490
            )
            
            
            1,202Net cash provided by operating
      activities
            
            
            7,776
            
            
            
            6,705Cash
      flows from investing activities:Loans
      originated, net of principal repayments
            
            
            (83,188
            )
            
            
            (7,167
            )Net
      purchases of securities held-for-trading
            
            
            -
            
            
            
            70,223Net
      sales of securities-held-for-trading
            
            
            -
            
            
            
            (46,319
            )Net
      purchases of securities available-for-sale
            
            
            (123,896
            )
            
            
            (7,500
            )Proceeds
      from sales/calls of securities available-for-sale
            
            
            78,851
            
            
            
            6,403Principal
      repayments on securities available-for-sale
            
            
            1,627
            
            
            
            2,512Net
      purchases of securities held-to-maturity
            
            
            (77,766
            )
            
            
            (5,000
            )Proceeds
      from calls of securities held-to-maturity
            
            
            77,050
            
            
            
            -Principal
      repayments on securities held-to-maturity
            
            
            1,001
            
            
            
            1,613Purchases
      of premises and equipment
            
            
            (2,636
            )
            
            
            (2,807
            )Net
      decrease in loan participations sold
            
            
            (5,458
            )
            
            
            (2,641
            )Investment
      in Community Reinvestment Act (CRA) – low income housing
            
            
            215
            
            
            
            -Net
      cash (used in) provided by investing activities
            
            
            (134,200
            )
            
            
            9,317Subtotal,
      carried forward
            
            $
            (126,424
            )
            
            $
            16,022





See notes
to condensed consolidated financial statements





6




CASCADE
FINANCIAL CORPORATION AND SUBSIDIARY


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(unaudited)


Six
      Months EndedJune 30,(Dollars
      in thousands)
            
            2008
            
            
            2007Subtotal,
      brought forward
            
            $
            (126,424
            )
            
            $
            16,022Cash
      flows from financing activities:Proceeds
      from issuance of common stock
            
            
            221
            
            
            
            0Dividends
      paid
            
            
            (2,166
            )
            
            
            (1,936
            )Repurchase
      of common stock
            
            
            -
            
            
            
            (2,327
            )Excess
      tax benefits from stock-based payments
            
            
            30
            
            
            
            144Net
      increase in deposits
            
            
            85,665
            
            
            
            42,147Net
      increase (decrease) in FHLB advances
            
            
            19,000
            
            
            
            (46,000
            )Net
      increase in securities sold under agreements to repurchase
            
            
            16
            
            
            
            18Proceeds
      from Federal Reserve TAF
            
            
            25,000
            
            
            
            -Net
      decrease in advance payments by borrowers for taxes and
      insurance
            
            
            (101
            )
            
            
            (202
            )Net
      cash provided by (used in) financing activities
            
            
            127,665
            
            
            
            (7,786
            )Net
      increase in cash and cash equivalents
            
            
            1,241
            
            
            
            8,236Cash
      and cash equivalents at beginning of period
            
            
            14,530
            
            
            
            42,879Cash
      and cash equivalents at end of period
            
            $
            15,771
            
            
            $
            51,115Supplemental
      disclosures of cash flow information—cash paid during the period
      for:Interest
            
            $
            28,564
            
            
            $
            25,347Federal
      income taxes
            
            
            2,800
            
            
            
            3,950Supplemental
      schedule of noncash investing activities:Change
      in unrealized loss on securities available-for-sale
            
            
            (1,962
            )
            
            
            381Net
      change in real estate owned, investment property and other repossessed
      assets
            
            
            (25
            )
            
            
            -Retirement
      of common stock in retained earnings
            
            
            -
            
            
            
            95Dividends
      declared
            
            
            1,084
            
            
            
            1,930Cumulative
      adjustment of equity on adoption of SFAS No. 159
            
            
            -
            
            
            
            (3,389
            )







See notes
to condensed consolidated financial statements





7





CASCADE
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


June
30, 2008


(unaudited)





1.
            Presentation
      of Financial Information





The
accompanying financial information is unaudited and has been prepared from the
consolidated financial statements of Cascade Financial Corporation (the
“Corporation”), and its subsidiary, Cascade Bank (the “Bank” or “Cascade”). All
significant intercompany balances have been eliminated in the consolidation. In
the opinion of management, the financial information reflects all adjustments
(consisting of normal recurring adjustments) necessary for a fair presentation
of the financial condition, results of operations, and cash flows of the
Corporation pursuant to the requirements of the SEC for interim reporting.
Operating results for the six months ended June 30, 2008, are not necessarily
indicative of the results that may be expected for the year ending December 31,
2008.





Certain
information and footnote disclosures included in the Corporation’s financial
statements for the year ended December 31, 2007, have been condensed or omitted
from this report. Accordingly, these statements should be read in conjunction
with the financial statements and notes thereto included in the Corporation’s
December 31, 2007 Annual Report on Form 10-K.





2.
            Commitments
      and Contingencies





In the
normal course of business there are various commitments to fund loans to meet
the financing needs of our customers. Management does not anticipate any
material loss as a result of these commitments.





Periodically
there have been various claims and lawsuits against the Corporation or the Bank,
such as claims to enforce liens, condemnation proceedings on properties in which
the Bank holds security interests, claims involving the making and servicing of
real property loans and other issues incidental to the Corporation’s and the
Bank’s business. In the opinion of management, no material loss is expected from
any such pending lawsuits.





3.
            Recently
      Issued Accounting Standards





In
December 2007, FASB issued SFAS No. 141 (revised), Business Combinations. SFAS
No. 141R establishes principles and requirements for how an acquirer
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, any noncontrolling interest in the acquiree
and the goodwill acquired. SFAS No. 141R also establishes disclosure
requirements to enable the evaluation of the nature and financial effects of the
business combination. This statement applies prospectively to business
combinations for which the acquisition date is on or after January 1, 2009.
Accordingly, we will apply SFAS No. 141(R) to business combinations
occurring on or after January 1, 2009.





In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB
No. 51.  SFAS No. 160 establishes accounting and
reporting standards that require that the ownership interests in subsidiaries
held by parties other than the parent be clearly identified, labeled, and
presented in the consolidated statement of financial position within equity, but
separate from the parent’s equity; the amount of consolidated net income
attributable to the parent and to the


8
 noncontrolling
interest be clearly identified and presented on the face of the consolidated
statement of income; and changes in a parent’s ownership interest while the
parent retains its controlling financial interest in its subsidiary be accounted
for consistently. SFAS No. 160 also requires that any retained
noncontrolling equity investment in the former subsidiary be initially measured
at fair value when a subsidiary is deconsolidated. SFAS No. 160 also sets
forth the disclosure requirements to identify and distinguish between the
interests of the parent and the interests of the noncontrolling owners. SFAS
No. 160 applies to all entities that prepare consolidated financial
statements, except not-for-profit organizations, but will affect only those
entities that have an outstanding noncontrolling interest in one or more
subsidiaries or that deconsolidate a subsidiary. SFAS No. 160 is effective
for fiscal years, and interim periods within those fiscal years, beginning on or
after December 15, 2008. Earlier adoption is prohibited. SFAS No. 160 must
be applied prospectively as of the beginning of the fiscal year in which
SFAS No. 160 is initially applied, except for the presentation and
disclosure requirements. The presentation and disclosure requirements are
applied retrospectively for all periods presented.  We do not have a
noncontrolling interest in one or more subsidiaries. Accordingly, we do not
anticipate that the initial application of SFAS No. 160 will have an impact
on our financial statements.





In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities – an amendment of SFAS 133
(“SFAS 161”). SFAS 161 changes the disclosure requirements for SFAS
133,Accounting for Derivative
Instruments and Hedging Activities, to mention how and why an entity uses
derivative instruments, as well as how derivative instruments and related hedged
items are accounted for. SFAS 161 is effective for fiscal years beginning
on or after November 15, 2008, and is not expected to have a material impact on
our consolidated financial statements.




In May
2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles (“SFAS 162”). The FASB believes the GAAP
hierarchy should be directed to entities because it is the entity (not its
auditor) that is responsible for selecting accounting principles for financial
statements that are presented in conformity with GAAP. Accordingly, the
FASB concluded that the GAAP hierarchy should reside in the accounting
literature established by the FASB and is issuing this Statement to achieve that
result. This Statement is effective 60 days following the SEC’s approval of
the Public Company Accounting Oversight Board amendments to AU Section 411,
The Meaning of Present
Fairly in Conformity With Generally Accepted Accounting Principles, and
is not expected to have a material impact on our consolidated financial
statements.





In May
2008, the FASB issued SFAS No. 163, Accounting for Financial Guarantee
Insurance Contracts – an interpretation of SFAS 60 (“SFAS 163”). SFAS 163
clarifies SFAS 60,Accounting and Reporting by
Insurance Enterprises, by requiring expanded disclosures about financial
guarantee insurance contracts. Additionally, it requires that an insurance
enterprise recognize a claim liability prior to an event of default (insured
event) when there is evidence that credit deterioration has occurred in an
insured financial obligation. SFAS 163 is effective for financial statements
issued for fiscal years beginning after December 15, 2008, and all interim
periods within those fiscal years, except for some disclosures about
the


9
 insurance
enterprise’s risk-management activities. This Statement requires that
disclosures about the risk-management activities of the insurance enterprise be
effective for the first period (including interim periods) beginning after
issuance of this Statement. Except for those disclosures, earlier application is
not permitted. SFAS 163 is not expected to have a material impact on our
consolidated financial statements.





In June
2008, FASB issued FSP EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities.
FSP EITF 03-6-1 concludes that unvested share-based payment awards that contain
nonforfeitable rights to dividends or dividend equivalents are participating
securities and shall be included in the computation of EPS pursuant to the
two-class method. This statement is effective on fiscal years beginning after
December 15, 2008 for the Company, to be applied retrospectively.  We
are currently evaluating the impact of the adoption of FSP EITF
03-6-1.





4.           Stockholders’
Equity





a)
            Earnings
      per Share





The
following table presents the computation of basic and diluted net income per
share for the periods indicated:




Three
      Months Ended
            
            
            Six
      Months Ended(dollars
      in thousands,
            
            June
      30,
            
            
            June
      30,except
      share and per share amounts)
            
            2008
            
            
            2007
            
            
            2008
            
            
            2007Numerator:Net
      income
            
            $
            3,634
            
            
            $
            3,983
            
            
            $
            6,248
            
            
            $
            7,748Denominator:Denominator
      for basic net income per share-Weighted
      average shares
            
            
            12,047,927
            
            
            
            12,055,278
            
            
            
            12,041,001
            
            
            
            12,075,413Effect
      of dilutive securities:Stock
      options
            
            
            114,921
            
            
            
            250,389
            
            
            
            144,562
            
            
            
            266,803Denominator
      for diluted net income per share-Weighted
      average shares and assumedconversion
      of dilutive stock options
            
            
            12,162,848
            
            
            
            12,305,667
            
            
            
            12,185,563
            
            
            
            12,342,216Basic
      net income per share
            
            $
            0.30
            
            
            $
            0.33
            
            
            $
            0.52
            
            
            $
            0.64Diluted
      net income per share
            
            $
            0.30
            
            
            $
            0.32
            
            
            $
            0.51
            
            
            $
            0.63





For the
quarters ended June 30, 2008, and 2007, there were anti-dilutive options to
purchase shares of 420,709 and 173,465 respectively, excluded from the above
calculation. For the six month periods ended June 30, 2008, and 2007, there were
anti-dilutive options to purchase shares of 290,271 and 105,669 respectively,
excluded from the above calculation.





b)
            Dividends





On July 1, 2008, the Corporation
announced its twenty-fourth consecutive quarterly cash dividend payment. The
dividend was $0.09 per share and was paid on July 28, 2008, to shareholders of
record as of July 14, 2008.


10





c)
            Stock-based
      Compensation





Compensation
expense related to stock-based compensation was $99,000 for the six months ended
June 30, 2008, and $118,000 for the six months ended June 30, 2007.





Changes
in total options outstanding for the six months ended June 30, 2008, are as
follows:


Options
            
            
            Weighted-
              Average
              Exercise
              Price
      per Share
            
            
            Weighted-
              Average
              Remaining
              Contractual
              Term
              (in
      years)
            
            
            Aggregate
              Intrinsic
              ValueOutstanding
      on December 31, 2007
            
            
            595,567
            
            
            $
            9.87
            
            
            
            5.13
            
            
            $
            2,580,240Granted
            
            
            96,382
            
            
            
            12.63Exercised
            
            
            (12,890
            )
            
            
            6.93Forfeited/Canceled
            
            
            (4,375
            )
            
            
            15.12Outstanding
      on March 31, 2008
            
            
            674,684
            
            
            $
            10.29
            
            
            
            5.69
            
            
            $
            2,006,654Granted
            
            
            1,000
            
            
            
            10.90Exercised
            
            
            -Forfeited/Canceled
            
            
            -Outstanding
      on June 30, 2008
            
            
            675,684
            
            
            $
            10.29
            
            
            
            5.45
            
            
            $
            370,714Exercisable
      on June 30, 2008
            
            
            426,571
            
            
            $
            8.41
            
            
            
            3.99
            
            
            $
            370,714





The
unrecognized share-based compensation cost on unvested options at June 30, 2008,
was $324,768, which will be recognized over the estimated average life of the
options of approximately five years.





Options
are granted to certain employees and directors at prices equal to the market
value of the stock at the close of trading on the dates the options are granted.
The options granted have a term of 10 years from the grant date. Incentive stock
options granted to employees vest over a five-year period. Non-qualified options
granted to directors vest over a four-year period. Compensation expense is
recorded as if each vesting portion of the award is a separate award. We have
estimated the fair value of all stock option awards as of the date of the grant
by applying a Black-Scholes pricing valuation model. The application of this
valuation model involves assumptions that are judgmental and sensitive in the
determination of compensation expense. Key assumptions used in determining the
fair value of options granted during the six months ended June 30, 2008, were as
follows:





Expected
      price volatility
            
            
            24.00
            %Risk-free
      interest rate
            
            
            3.34
            %Dividend
      yield on underlying stock
            
            
            2.90
            %Weighted-average
      expected life in years
            
            
            5.45





The total
options authorized at June 30, 2008, were 1,180,244. Options granted in this
period were 1,000 with a fair value of $2.24 per option. The total intrinsic
value of options exercised during the six months ended June 30, 2008, was
$87,291. The total intrinsic value of options exercised during the six months
ended June 30, 2007, was $689,986.


11


Historical
information is the primary basis for the selection of the expected volatility,
projected dividend yield and expected lives of the options. The Bank uses
historical information for its key assumptions. The Bank has collected a long
history of option activity and believes that this historical information
presents the best basis for future projections. The risk-free interest rate was
selected based upon U.S. Treasury issues with a term equal to the expected life
of the option being valued at the time of the grant.





SFAS No.
123(R) requires the recognition of stock-based compensation for the number of
awards that are expected to vest. As a result, for most awards, recognized stock
compensation expense was reduced by estimated forfeitures primarily based on
historical forfeiture rates of 6.19%. Estimated forfeitures will be continually
evaluated in subsequent periods and may change based on new facts and
circumstances.





5.
            Non-Qualified
      Deferred Compensation Plan





The
Company has adopted the Cascade Bank Non-Qualified Deferred Compensation Plan
(the “Plan”) dated February 1, 2008.  The Plan is an unfunded,
non-qualified deferred compensation plan designed to provide a select group of
non-employee directors, management and highly compensated employees of Cascade
Bank, and its affiliates, an opportunity to defer a portion of their salary and
bonus. Cascade Bank may also, in its sole discretion, make contributions to
accounts on behalf of any and all eligible persons. For the quarter ended June
30, 2008, three eligible participants contributed $12,000 to the
plan.





6.
            Fair
      Value Measurements





SFAS
No. 157, Fair Value
Measurements, defines fair value, establishes a framework for measuring
fair value, establishes a three-level valuation hierarchy for disclosure of fair
value measurement and enhances disclosure requirements for fair value
measurements. The valuation hierarchy is based upon the transparency of inputs
to the valuation of an asset or liability as of the measurement date. The three
levels are defined as follows:


•
            
            Level 1
      -
            Inputs
      to the valuation methodology are quoted prices (unadjusted) for identical
      assets or liabilities in active markets.•
            
            Level 2
      -
            Inputs
      to the valuation methodology include quoted prices for similar assets and
      liabilities in active markets, and inputs that are observable for the
      asset or liability, either directly or indirectly, for substantially the
      full term of the financial instrument.•
            
            Level 3
      -
            Inputs
      to the valuation methodology are unobservable and significant to the fair
      value measurement.





Determination of fair market
values:





Junior
subordinated debentures payable are priced using discounted cash flows to the
next available redemption date on the date of valuation based on recent
issuances or quotations from brokers for comparable bank holding companies and
are considered a Level 2 input method.





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


12


The
following table presents the balances of liabilities measured at fair value on a
recurring basis at June 30, 2008, and the total gains from these fair value
adjustments for the six months ended June 30, 2008.


(Dollars
      in thousands)
            
            Fair
      Value at June 30, 2008
            
            
            Six
      Months
              Ended
      June
              30,
      2008Description
            
            Level 1
            
            
            Level 2
            
            
            Level
      3
            
            
            Total
            
            
            Total
      GainsJunior
      subordinated debentures payable
            
            $
            -
            
            
            $
            10,924
            
            
            $
            -
            
            
            $
            10,924
            
            
            $
            498Total
            
            $
            -
            
            
            $
            10,924
            
            
            $
            -
            
            
            $
            10,924
            
            
            $
            498





The
change in fair market value of the junior subordinated debentures payable is
recorded as a component of non-operating income.





The
following table presents the balance of assets measured at fair value on a
nonrecurring basis at June 30, 2008, and the total losses resulting from these
fair value adjustments for the six months ended June 30, 2008.


(Dollars
      in thousands)
            
            Fair
      Value at June 30, 2008
            
            
            Six
      Months
              Ended
      June
              30,
      2008Description
            
            Level 1
            
            
            Level 2
            
            
            Level 3
            
            
            Total
            
            
            Total LossesImpaired
      loans
            
            $
            -
            
            
            $
            -
            
            
            $
            8,007
            
            
            $
            8,007
            
            
            $
            616Total
            
            $
            -
            
            
            $
            -
            
            
            $
            8,007
            
            
            $
            8,007
            
            
            $
            616







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





The
following discussion is intended to assist in understanding the financial
condition and results of the Corporation. The information contained in this
section should be read with the unaudited condensed consolidated financial
statements and accompanying notes included in this Quarterly Report, and the
December 31, 2007 audited consolidated financial statements and accompanying
notes included in our recent Annual Report on Form 10-K.





This
section contains forward-looking statements, within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, and subject to the safe harbor created by the
Private Securities Litigation Reform Act of 1995, that are subject to risks and
uncertainties that could cause actual results to differ materially from those
projected. Those factors include, but are not limited to: the impact of national
and regional economic trends on small business loan demand in the Puget Sound
area; loan delinquency rates; the Bank’s ability to continue to attract quality
commercial business; interest rate movements; changes in the demographic make-up
of the Bank’s market area; fluctuation in demand for the Bank’s products and
services; the Corporation’s ability to attract and retain qualified people; the
risks inherent in significant construction and commercial real estate lending;
the ability to attract low-cost deposits and commercial loans; expectations for
the net interest margin; maintaining asset quality; management’s ability to
minimize interest rate exposure and the impact of interest rate movements; the
health of the local real estate market; general economic


13


conditions
and ability of the Corporation and the Bank to successfully adjust to any
changes in these conditions and other factors. These factors should be
considered in evaluating the forward-looking statements and undue reliance
should not be placed on such statements. The Corporation shall not be
responsible to update any such forward-looking statements. For a discussion of
factors that could cause actual results to differ, and for certain mandated SEC
Guide 3 information that has not materially changed since the audited
statements, please see the Corporation’s Annual Report on Form 10-K for the year
ended December 31, 2007, including but not limited to the “Risk Factors” section
and Part II, Item 1A of this Form 10-Q.





Cascade
Financial Corporation is a bank holding company incorporated in the state of
Washington. The Corporation’s sole operating subsidiary is Cascade Bank; a
Washington State chartered commercial bank. The Corporation and the Bank are
headquartered in Everett, Washington. The Bank offers loan, deposit, and other
financial services through its twenty-one branches located in Snohomish, King
and Skagit Counties (Washington).





Selected
Financial Data





The
following table sets forth certain selected financial data concerning the
Corporation for the periods indicated:




At
      or for the three months ended
              June
      30,
            
            
            At
      or for the six months ended
              June
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Return
      on average assets
            
            
            0.96
            %
            
            
            1.15
            %
            
            
            0.84
            %
            
            
            1.14
            %Return
      on average stockholders’ equity
            
            
            11.57
            
            
            
            13.76
            
            
            
            10.01
            
            
            
            13.54Average
      stockholders’ equity to average assets
            
            
            8.27
            
            
            
            8.39
            
            
            
            8.37
            
            
            
            8.44Other
      expenses to average assets
            
            
            1.90
            
            
            
            1.89
            
            
            
            1.89
            
            
            
            1.90Efficiency
      ratio
            
            
            53.07
            
            
            
            51.06
            
            
            
            53.35
            
            
            
            51.57Average
      interest-bearing assets toaverage interest-bearing
      liabilities
            
            
            111.60
            
            
            
            111.76
            
            
            
            111.67
            
            
            
            111.86








CHANGES
IN FINANCIAL CONDITION





Total
assets increased 9.2% or $130.0 million to $1.55 billion at June 30, 2008,
compared to $1.42 billion at December 31, 2007. Net loans, e.g. net of deferred
loan fees and the allowance for loan losses, increased 7.8% or $85.3 million to
$1.18 billion at June 30, 2008, from $1.09 billion at December 31,
2007.





Total investment
securities increased $40.6 million to $272.6 million at June 30, 2008, compared
to $232.0 million at December 31, 2007. The investment portfolio is concentrated
in securities issued by Government Sponsored Enterprises (GSEs, e.g. FNMA or
FHLMC) as well as mortgage-backed pass-through securities and collateralized
mortgage obligations backed by pools of single family residential mortgages
(known collectively as MBS). All investment purchases during the six months
ended June 30, 2008, were rated AAA or AA in terms of credit quality by Moody’s
and/or Standard & Poors. All MBS and GSE debt securities in the portfolio as
of June 30, 2008, were also rated AAA.


14


(Dollars
      in thousands)
            
            JUNE
      30, 2008Securities
    available-for-sale
            
            Amortized
              Cost
            
            
            Gross
              Unrealized
              Gains
              Less
      Than
              1
      Year
            
            
            Gross
              Unrealized
              Gains
              More
      Than
              1
      Year
            
            
            Gross
              Unrealized
              (Losses)
              Less
      Than
              1
      Year
            
            
            Gross
              Unrealized
              (Losses)
              More
      Than
              1
      Year
            
            
            Fair
              ValueMBS
            
            $
            35,628
            
            
            $
            -
            
            
            $
            -
            
            
            $
            (353
            )
            
            $
            (533
            )
            
            $
            34,742GSE
      notes
            
            
            71,155
            
            
            
            57
            
            
            
            -
            
            
            
            (561
            )
            
            
            -
            
            
            
            70,651Corporate/other
            
            
            20,657
            
            
            
            -
            
            
            
            -
            
            
            
            (2,420
            )
            
            
            -
            
            
            
            18,237Total
            
            $
            127,440
            
            
            $
            57
            
            
            $
            -
            
            
            $
            (3,334
            )
            
            $
            (533
            )
            
            $
            123,630Securities held-to-maturity
            
            Amortized
              Cost
            
            
            Gross
              Unrealized
              Gains
              Less
      Than
              1
      Year
            
            
            Gross
              Unrealized
              Gains
              More
      Than
              1
      Year
            
            
            Gross
              Unrealized
              (Losses)
              Less
      Than
              1
      Year
            
            
            Gross
              Unrealized
              (Losses)
              More
      Than
              1
      Year
            
            
            Fair
              ValueMBS
            
            $
            21,563
            
            
            $
            9
            
            
            $
            -
            
            
            $
            (586
            )
            
            $
            (204
            )
            
            $
            20,782GSE
      notes
            
            
            114,727
            
            
            
            3
            
            
            
            -
            
            
            
            (2,857
            )
            
            
            -
            
            
            
            111,873Corporate/other
            
            
            775
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            775Total
            
            $
            137,065
            
            
            $
            12
            
            
            $
            -
            
            
            $
            (3,443
            )
            
            $
            (204
            )
            
            $
            133,430





(Dollars
      in thousands)
            
            DECEMBER
      31, 2007Securities
    available-for-sale
            
            Amortized
              Cost
            
            
            Gross
              Unrealized
              Gains
              Less
      Than
              1
      Year
            
            
            Gross
              Unrealized
              Gains
              More
      Than
              1
      Year
            
            
            Gross
              Unrealized
              (Losses)
              Less
      Than
              1
      Year
            
            
            Gross
              Unrealized
              (Losses)
              More
      Than
              1
      Year
            
            
            Fair
              ValueMBS
            
            $
            26,286
            
            
            $
            2
            
            
            $
            5
            
            
            $
            (71
            )
            
            $
            (795
            )
            
            $
            25,427GSE
      notes
            
            
            57,366
            
            
            
            67
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            57,433Total
            
            $
            83,652
            
            
            $
            69
            
            
            $
            5
            
            
            $
            (71
            )
            
            $
            (795
            )
            
            $
            82,860Securities held-to-maturity
            
            Amortized
              Cost
            
            
            Gross
              Unrealized
              Gains
              Less
      Than
              1
      Year
            
            
            Gross
              Unrealized
              Gains
              More
      Than
              1
      Year
            
            
            Gross
              Unrealized
              (Losses)
              Less
      Than
              1
      Year
            
            
            Gross
              Unrealized
              (Losses)
              More
      Than
              1
      Year
            
            
            Fair
              ValueMBS
            
            $
            22,556
            
            
            $
            28
            
            
            $
            -
            
            
            $
            -
            
            
            $
            (643
            )
            
            $
            21,941GSE
      notes
            
            
            113,907
            
            
            
            67
            
            
            
            -
            
            
            
            (246
            )
            
            
            (149
            )
            
            
            113,579Corporate/other
            
            
            775
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            775Total
            
            $
            137,238
            
            
            $
            95
            
            
            $
            -
            
            
            $
            (246
            )
            
            $
            (792
            )
            
            $
            136,295





As of
June 30, 2008, we held seven securities in our available-for-sale portfolio and
two in our held-to-maturity portfolio that have had an unrealized loss for more
than one year. The losses on these securities have increased since December 31,
2007. The majority of the fair value loss of the available-for-sale portfolio
can be attributed to $18.5 million (book value) of GSE preferred securities. The
balance can be assigned to an increase in rates and a widening of credit
spreads. All the fair market loss in the held-to-maturity portfolio can be
ascribed to rates increasing and spreads widening. We have the ability to hold
the investments for a period of time management believes to be sufficient for a
market price recovery. We hold no securities that are backed by sub-prime loans.
We do not consider any portion of our investments to be other-than-temporarily
impaired.





At June
30, 2008, the Bank held FHLB stock of $11.9 million. On April 25, 2008, the FHLB
declared a $0.35 per share cash dividend payable on May 23, 2008. The dividend
payment was $41,721.


15


Loan
Portfolio





Virtually
all of the Bank’s loans are to businesses or individuals in the Puget Sound
area. Business loans are made to small and medium sized businesses within that
area for a wide array of purposes. Included in the business loan total are loans
secured by real estate, the majority of which the borrower is the primary tenant
of the property. Real estate construction loans are extended to builders and
developers of residential and commercial real estate. Commercial real estate
loans fund small, non-owner occupied buildings.





Residential
loans, held in the Bank’s portfolio, are generally adjustable rate loans secured
by single family residences. The Bank also originates longer term fixed rate
residential loans, but sells most of those loans into the secondary market on a
best efforts, servicing released basis. Home equity loans are primarily second
mortgages on the borrower’s primary residence. Consumer loans are
non-residential, e.g. automobiles, credit cards or boats.





Net loans
increased by $85.3 million to $1.18 billion as of June 30, 2008, compared to
$1.09 billion at December 31, 2007. In keeping with the Bank’s evolution to a
commercial bank, loans more closely associated with a commercial bank, e.g.
business, real estate construction, and commercial real estate loans, grew $25.0
million to $995.7 million as of June 30, 2008, compared to $970.7 million as of
December 31, 2007.





Multifamily
loans increased $52.5 million to $63.9 million. Completed construction loans
totaling $33.0 million transferred to the multifamily category accounted for
much of the increase in this category. Home equity and consumer loans increased
$1.6 million to $29.3 million and residential loans increased by $7.7 million to
$106.0 million.  Construction loans totaling $4.0 million were
transferred to residential at the end of the construction phase of the
loan.





The
following summary reflects the Bank’s loan portfolio as of the dates
indicated:





(Dollars
      in thousands)Types of Loans
            
            June
      30, 2008
            
            
            %
      of Portfolio
            
            
            December
      31, 2007
            
            
            %
      of PortfolioBusiness
            
            $
            486,876
            
            
            
            40.7
            %
            
            $
            468,453
            
            
            
            42.3
            %Real
      estate construction(1)
            
            
            391,765
            
            
            
            32.8
            
            
            
            381,810
            
            
            
            34.4Commercial
      real estate
            
            
            117,043
            
            
            
            9.8
            
            
            
            120,421
            
            
            
            10.9Home
      equity/consumer
            
            
            29,250
            
            
            
            2.4
            
            
            
            27,688
            
            
            
            2.5Residential(2)
            
            
            106,043
            
            
            
            8.9
            
            
            
            98,384
            
            
            
            8.9Multifamily
      real estate
            
            
            63,905
            
            
            
            5.4
            
            
            
            11,397
            
            
            
            1.0Total
      loans
            
            $
            1,194,882
            
            
            
            100.0
            %
            
            $
            1,108,153
            
            
            
            100.0
            %Deferred
      loan fees
            
            
            (3,471
            )
            
            
            
            
            
            
            (3,724
            )Allowance
      for loan losses
            
            
            (13,318
            )
            
            
            
            
            
            
            (11,653
            )Loans,
      net
            
            $
            1,178,093
            
            
            
            
            
            
            $
            1,092,776





(1)
            Real
      estate construction loans are net of loans in
  process.


(2)
            Loans
      held-for-sale are included in residential loans, and at less than 1% of
      total loans, are not considered
material.





Deposits,
Other Borrowings, and Stockholders’ Equity





Checking account deposits
increased as the Bank continued to focus its sales activities on deposit
generation in general and checking/transaction accounts in particular. Total
checking account balances increased by $28.4 million between December 31, 2007
and June 30, 2008.


16


Total
deposits increased by $85.6 million from $905.0 million at December 31, 2007, to
$990.6 million at June 30, 2008. Savings and money market accounts (MMDA)
increased $13.6 million as the Bank received deposits via several accounts from
other financial services firms including securities brokers and other banks.
CD’s increased $43.5 million to $483.0 million. An increase in brokered CD’s
accounted for most of that growth.





The
following table reflects the Bank’s deposit mix as of the dates
indicated:





(Dollars
      in thousands)
            
            June
      30,
            
            
            %
      of
            
            
            December
      31,
            
            
            %
      of2008
            
            
            Deposits
            
            
            2007
            
            
            DepositsChecking
      accounts
            
            $
            166,662
            
            
            
            16.8
            %
            
            $
            138,190
            
            
            
            15.3
            %Savings
      & MMDA
            
            
            340,911
            
            
            
            34.4
            
            
            
            327,264
            
            
            
            36.2CD’s
            
            
            482,988
            
            
            
            48.8
            
            
            
            439,442
            
            
            
            48.5$
            990,561
            
            
            
            100.0
            %
            
            $
            904,896
            
            
            
            100.0
            %





FHLB
advances increased by $19.0 million from $231.0 million at December 31, 2007, to
$250.0 million at June 30, 2008, as advances offered lower costs than some
deposits. Securities sold under agreements to repurchase were unchanged at
$120.6 million at December 31, 2007, and at June 30, 2008. Cascade participates
in the Federal Reserve’s term auction facility (TAF) and as of June 30, 2008,
the Bank had $25.0 million outstanding under this program with a rate of 2.26%
for 28 days maturing July 3, 2008.  The Bank uses structured advances
and repurchase agreements to lower our cost of funds.





Total
stockholders’ equity increased $3.5 million from $122.1 million at December 31,
2007, to $125.6 million at June 30, 2008. The increase in equity was primarily
due to the retention of net income above the cash dividend paid to shareholders
and an increase in other comprehensive loss. During the six months ended June
30, 2008, no stock was repurchased under the Board approved stock repurchase
plan. Accumulated other comprehensive loss increased by $2.0 million due to an
increase in the fair value loss on available-for-sale securities.





Asset
Quality


Non-performing
assets (non-performing loans, real estate owned and other repossessed property)
totaled $32.0 million and $1.5 million at June 30, 2008, and December 31, 2007,
respectively. Non-performing loans (NPLs) consist of loans which are on
non-accrual, loans that are ninety days past due, and loans that management
otherwise has serious reservations about the collectibility of all principal and
interest owed. NPLs increased to $32.0 million at June 30, 2008, compared to
$1.5 million at December 31, 2007. Of the $32.0 million, $31.5 million were real
estate construction and land loans, including $11.6 million in one lending
relationship for land and $7.4 million in another lending relationship for
residential construction. The remaining $12.5 million consisted of two
speculative construction loans totaling $6.7 million, a land acquisition and
development loan totaling $3.7 million and a land loan totaling $2.1 million.
The other non-performing loans included two business loans totaling $288,000 and
two residential loans totaling $236,000. There was $25,000 in other repossessed
assets as of June 30, 2008, and none at December 31, 2007. There was no other
real estate owned (OREO) at June 30, 2008 or at December 31, 2007.





Management
remains concerned about the residential housing slowdown and the effect it has
had on credit quality. Inventories of homes and lots continue to increase in
Snohomish, King and Pierce counties. Management has increased monitoring of
construction and land loans and has reduced originations in these
portfolios.


17
 At June 30, 2008, the Bank’s
allowance for loan losses was $13.3 million compared to $11.7 million at
December 31, 2007. Additionally, at June 30, 2008, $113,000 was recorded in a
general valuation allowance allocated to off-balances sheet commitments, e.g.
lines of credit and construction loans in process. This reserve is recorded as
an “other liability” on the Corporation’s balance sheet. During the quarter
ended June 30, 2008, this account was reduced by $29,000 to $113,000 compared to
$142,000 at December 31, 2007. Total allowance for loan losses, which includes
the allowance for off-balance sheet commitments, was 1.12% of total loans
outstanding at June 30, 2008, compared to 1.06% at December 31, 2007. Due to the
addition of $14.8 million of loans in the quarter, total allowance for loan
losses was 42% of non-performing loans at June 30, 2008, compared to 774% at
December 31, 2007. As a result of FASB Statement No. 114, Accounting by Creditors for
Impairment of a Loan, Management has performed extensive impairment
analyses on the nonperforming loans, including updated appraisals, to determine
the adequacy of the allowance for loan losses, as well as recording appropriate
charge-offs.





The
allowance for loan losses is maintained at a level sufficient to provide for
losses based on management’s evaluation of known and inherent risks in the
portfolio. This evaluation includes analysis of the financial condition of the
borrower, the value of the collateral securing selected loans, consideration of
historical loss experience and management’s projection of trends affecting
credit quality. The increase in the dollar amount of the allowance and the
percentage of the allowance is primarily attributable to an increase in
non-performing loans and a general slowdown in the housing market. Growth in
loans outstanding, specifically in business and construction loans, also
contributed to the increase in the allowance. Management believes that the
allowance for loan losses is adequate to provide for losses that may be incurred
on non-performing loans.





During
the quarter ended June 30, 2008, loan charge-offs equaled $484,000while
recoveries were $36,000 resulting in
net charge-offs of $448,000 or 4 basis points of
total loans. Of the loans charged-off, $117,000 came from a loss on the
liquidation of inventory on a business loan and $200,000 came from a partial
write-off of a construction loan. The balance of the write downs came from
consumer and deposit related charge-offs, e.g. overdrafts. For the first six
months of 2008, net charge-offs were $1.95 million or 17 basis points of total
loans.





The
following table provides summary information concerning asset quality as of and
for the quarters ended June 30, 2008, and December 31, 2007,
respectively:





June
      30, 2008
            
            
            December
      31, 2007Non-performing
      loans to total assets
            
            
            2.07
            %
            
            
            0.11
            %Non-performing
      loans to total loans outstanding
            
            
            2.68
            
            
            
            0.14Non-performing
      assets to total assets
            
            
            2.07
            
            
            
            0.11Total
      allowance for loan losses to non-performing loans(1)
            
            
            42
            
            
            
            774Total
      allowance for loan losses to total loans(1)
            
            
            1.12
            
            
            
            1.06Net
      charge-offs to total loans
            
            
            0.04
            
            
            
            0.01(1)
      Total allowance for loan losses includes off-balance sheet loan
      commitments of $113,000 at
      June 30, 2008, and $142,000 at December 31, 2007.





18


On July
18, 2008, Cascade’s non-performing loans were reduced by $8.0 million to $24.0
million through an assumption by a qualified buyer of two loans secured by
residential real estate developments. This transaction will allow Cascade to
collect $583,000 in interest and recapture $250,000 of a previously charged-off
loan during the third quarter 2008.





Average
Balances and an Analysis of Average Rates Earned and Paid





The
following table shows average balances and interest income or interest expense,
with the resulting average yield or rate by category or average earning asset or
interest-bearing liability.


FOR
      THE QUARTER ENDED JUNE 30,2008
            
            
            2007(Dollars
      in thousands)
            
            AVERAGE
              BALANCE
            
            
            INTEREST
              OR
              DIVIDEND
            
            
            YIELD/
              COST
            
            
            AVERAGE
              BALANCE
            
            
            INTEREST
              OR
      DIVIDEND
            
            
            YIELD/
              COSTASSETSInterest-earning
      assets (1)Residential loans
            
            $
            106,274
            
            
            $
            1,607
            
            
            
            6.05
            %
            
            $
            94,516
            
            
            $
            1,410
            
            
            
            5.97
            %Multifamily loans
            
            
            34,860
            
            
            
            654
            
            
            
            7.53
            
            
            
            18,013
            
            
            
            389
            
            
            
            8.66Commercial real estate
      loans
            
            
            113,467
            
            
            
            1,922
            
            
            
            6.80
            
            
            
            114,552
            
            
            
            1,996
            
            
            
            6.99Construction loans
            
            
            412,826
            
            
            
            6,213
            
            
            
            6.04
            
            
            
            321,865
            
            
            
            7,611
            
            
            
            9.48Consumer loans
            
            
            28,801
            
            
            
            472
            
            
            
            6.57
            
            
            
            27,678
            
            
            
            541
            
            
            
            7.83Business banking
    loans
            
            
            477,553
            
            
            
            8,170
            
            
            
            6.86
            
            
            
            455,073
            
            
            
            8,456
            
            
            
            7.45Total loans
            
            
            1,173,781
            
            
            
            19,038
            
            
            
            6.52
            
            
            
            1,031,697
            
            
            
            20,403
            
            
            
            7.93Securities
      available-for-sale
            
            
            133,309
            
            
            
            1,722
            
            
            
            5.18
            
            
            
            92,148
            
            
            
            998
            
            
            
            4.35Securities
      held-to-maturity
            
            
            136,336
            
            
            
            1,991
            
            
            
            5.86
            
            
            
            84,117
            
            
            
            1,054
            
            
            
            5.03Securities
      held-for-trading
            
            
            -
            
            
            
            -
            
            
            
            0.00
            
            
            
            46,044
            
            
            
            616
            
            
            
            5.37Daily interest-earning
      deposits
            
            
            9,632
            
            
            
            42
            
            
            
            1.76
            
            
            
            53,030
            
            
            
            718
            
            
            
            5.44Total securities and
      interest-earning deposits
            
            
            279,277
            
            
            
            3,755
            
            
            
            5.39
            
            
            
            275,339
            
            
            
            3,386
            
            
            
            4.93Total interest-earning
      assets
            
            
            1,453,058
            
            
            
            22,793
            
            
            
            6.31
            
            
            
            1,307,036
            
            
            
            23,789
            
            
            
            7.30Noninterest-earning
      assetsOffice properties and equipment,
      net
            
            
            15,573
            
            
            
            
            
            
            
            
            
            
            
            13,840Other noninterest-earning
      assets
            
            
            59,316
            
            
            
            
            
            
            
            
            
            
            
            62,976Total assets
            
            
            1,527,947
            
            
            
            
            
            
            
            
            
            
            
            1,383,852LIABILITIES
      AND EQUITYInterest-bearing
liabilitiesSavings accounts
            
            $
            11,003
            
            
            $
            14
            
            
            
            0.50
            %
            
            $
            13,811
            
            
            $
            17
            
            
            
            0.50
            %Checking accounts
            
            
            65,075
            
            
            
            244
            
            
            
            1.50
            
            
            
            53,081
            
            
            
            187
            
            
            
            1.42Money market
    accounts
            
            
            336,208
            
            
            
            1,940
            
            
            
            2.32
            
            
            
            285,853
            
            
            
            3,149
            
            
            
            4.42Certificates of
      deposit
            
            
            467,345
            
            
            
            4,392
            
            
            
            3.77
            
            
            
            463,215
            
            
            
            5,811
            
            
            
            5.03Total interest-bearing
      deposits
            
            
            879,631
            
            
            
            6,590
            
            
            
            3.01
            
            
            
            815,960
            
            
            
            9,164
            
            
            
            4.51Other interest-bearing
      liabilitiesFHLB advances
            
            
            255,140
            
            
            
            2,725
            
            
            
            4.28
            
            
            
            229,714
            
            
            
            2,544
            
            
            
            4.44Securities sold under agreements
      to repurchase
            
            
            120,839
            
            
            
            1,387
            
            
            
            4.60
            
            
            
            95,725
            
            
            
            560
            
            
            
            2.35Junior subordinated debentures
      payable
            
            
            26,549
            
            
            
            530
            
            
            
            8.01
            
            
            
            27,474
            
            
            
            530
            
            
            
            7.74Other borrowings
            
            
            19,890
            
            
            
            116
            
            
            
            2.33
            
            
            
            -
            
            
            
            -
            
            
            
            0.00Total interest-bearing
      liabilities
            
            
            1,302,049
            
            
            
            11,348
            
            
            
            3.51
            
            
            
            1,168,873
            
            
            
            12,798
            
            
            
            4.39Other liabilities
            
            
            99,514
            
            
            
            
            
            
            
            
            
            
            
            98,869Total
    liabilities
            
            
            1,401,563
            
            
            
            
            
            
            
            
            
            
            
            1,267,742Stockholders’
    equity
            
            
            126,384
            
            
            
            
            
            
            
            
            
            
            
            116,110Total liabilities and
      stockholders’ equity
            
            
            1,527,947
            
            
            
            
            
            
            
            
            
            
            
            1,383,852Net
      interest income (2)
            
            
            
            
            
            $
            11,445
            
            
            
            
            
            
            
            
            
            
            $
            10,991Interest
      rate spread (3)
            
            
            
            
            
            
            
            
            
            
            2.80
            
            
            
            
            
            
            
            
            
            
            
            2.91Net
      interest margin (4)
            
            
            
            
            
            
            3.17
            
            
            
            
            
            
            
            
            
            
            
            3.37Average
      interest-earning assets to average
              interest-bearing
      liabilities
            
            
            111.60
            %
            
            
            
            
            
            
            
            
            
            
            111.76
            %





(1)  Does
not include interest on loans 90 days or more past due.


(2)  Interest
and dividends on total interest-earning assets less interest on total
interest-bearing liabilities.


(3)  Total
interest-earning assets yield less total interest-bearing liabilities
cost.


(4)  Net
interest income as an annualized percentage of total interest-earning
assets.


19


Rate/Volume
Analysis





The
following table sets forth the effects of changing rates and volumes on net
interest income of the Corporation. Information is provided with respect to (i)
effects on interest income attributable to changes in volume (changes in volume
multiplied by prior rate); (ii) effects on interest income attributable to
changes in rate (changes in rate multiplied by prior volume); and (iii) changes
in rate/volume mix (change in rate multiplied by change in volume).





(Dollars
      in thousands)
            
            Quarter
      Ended June 30,2008
              Compared
      to Quarter Ended
              June
      30, 2007
              Increase
      (Decrease) Due toRate
            
            
            Volume
            
            
            Mix
            
            
            NetInterest-earning assetsResidential
      loans
            
            $
            20
            
            
            $
            176
            
            
            $
            1
            
            
            $
            197Multifamily
      loans
            
            
            (51
            )
            
            
            364
            
            
            
            (48
            )
            
            
            265Commercial
      real estate
            
            
            (55
            )
            
            
            (19
            )
            
            
            -
            
            
            
            (74
            )Construction
      loans
            
            
            (2,775
            )
            
            
            2,157
            
            
            
            (780
            )
            
            
            (1,398
            )Consumer
      loans
            
            
            (87
            )
            
            
            22
            
            
            
            (4
            )
            
            
            (69
            )Business
      banking loans
            
            
            (673
            )
            
            
            419
            
            
            
            (32
            )
            
            
            (286
            )Total
      loans
            
            
            (3,621
            )
            
            
            3,119
            
            
            
            (863
            )
            
            
            (1,365
            )Securities
      held-for-trading
            
            
            -
            
            
            
            (618
            )
            
            
            2
            
            
            
            (616
            )Securities
      available-for-sale
            
            
            192
            
            
            
            447
            
            
            
            85
            
            
            
            724Securities
      held-to-maturity
            
            
            175
            
            
            
            656
            
            
            
            106
            
            
            
            937Daily
      interest-earning deposits
            
            
            (488
            )
            
            
            (589
            )
            
            
            401
            
            
            
            (676
            )Total
      net change in income on interest-earning assets
            
            $
            (3,742
            )
            
            $
            3,015
            
            
            $
            (269
            )
            
            $
            (996
            )Interest-bearing
liabilitiesInterest-bearing
      depositsSavings
accounts
            
            $
            -
            
            
            $
            (3
            )
            
            $
            -
            
            
            $
            (3
            )Checking
    accounts
            
            
            11
            
            
            
            43
            
            
            
            2
            
            
            
            56Money market
      accounts
            
            
            (1,503
            )
            
            
            556
            
            
            
            (261
            )
            
            
            (1,208
            )Certificates of
      Deposit
            
            
            (1,461
            )
            
            
            52
            
            
            
            (9
            )
            
            
            (1,418
            )FHLB advances
            
            
            (72
            )
            
            
            260
            
            
            
            (7
            )
            
            
            181Securities sold under agreements
      to repurchase
            
            
            540
            
            
            
            147
            
            
            
            140
            
            
            
            827Junior subordinated debentures
      payable
            
            
            19
            
            
            
            (18
            )
            
            
            (1
            )
            
            
            -Other borrowings
            
            
            -
            
            
            
            116
            
            
            
            (1
            )
            
            
            115Total
      net change in expenses on  interest-bearing
      liabilities
            
            $
            (2,466
            )
            
            $
            1,153
            
            
            $
            (137
            )
            
            $
            (1,450
            )Net
      increase in net interest  income
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            454








RESULTS
OF OPERATIONS





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





General





Net
income decreased 8.8% to $3.6 million for the three months ended June 30, 2008,
compared to $4.0 million during the comparable period in 2007. An increase of
$950,000 to $1.2 million in the provision for loan losses accounted for part of
the difference. The Bank reversed approximately $210,000 in interest on loans
placed on non-accrual status during the quarter. Nonetheless, net interest
income increased by $454,000 and other income increased by $383,000. Net income
per diluted share was $0.30 for the quarter ended June 30, 2008, and


20
 $0.32 per
share for the quarter ended June 30, 2007, a decrease of 6.3%. Net interest
income before provision for loan losses increased to $11.4 million for the
quarter ended June 30, 2008. Total other income increased to $2.2 million for
the quarter ended June 30, 2008. Increases in checking fees and service fees
accounted for $355,000 of the increase. Total other expenses increased $703,000
to $7.3 million for the quarter ended June 30, 2008, as compared to the quarter
ended June 30, 2007. One major source of the increase in expense was FDIC
insurance premiums, which were up $150,000.





Net
income for the six months ended June 30, 2008, was $6.2 million compared with
$7.7 million during the comparable period in 2007. Net income per diluted share
was $0.51 for the six months ended June 30, 2008, compared with $0.63 in 2007.
Again, the increase in provision for loan losses was responsible for the
decrease in earnings.





Net
Interest Income





Net
interest income, before provision for loan losses, increased 4.1% or $454,000 to
$11.4 million for the three months ended June 30, 2008, compared to $11.0
million for the three months ended June 30, 2007. Average interest-earning
assets increased $146.0 million or 11.2% to $1.45 billion for the three months
ended June 30, 2008, compared to the same period in 2007. Average total loans
increased $142.1 million to $1.17 billion and average investment securities
increased $47.3 million to $270.0 million for the three months ended June 30,
2008, compared to the same quarter of the prior year.


At
      or for the three
              months
      ended June 30,(Dollars in
      millions)
            
            2008
            
            
            2007Average
      interest-earning
      assets
            
            $
            1,453
            
            
            $
            1,307Average
      interest-bearing liabilities
            
            
            1,302
            
            
            
            1,170Yield
      on interest-earning
      assets
            
            
            6.31
            %
            
            
            7.30
            %Cost of
      interest-bearing liabilities
            
            
            3.51
            
            
            
            4.39Net
      interest spread
            
            
            2.80
            
            
            
            2.91Net
      interest margin
            
            
            3.17
            
            
            
            3.37





The net
interest margin decreased 20 basis points to 3.17% for the three months ended
June 30, 2008, compared to the same quarter the prior year. The yield on
interest-earning assets decreased 99 basis points to 6.31% for the three months
ended June 30, 2008, compared to 7.30% for the three months ended June 30, 2007.
Interest income, yield on interest-earning assets and net interest margin were
impacted by the reversal of approximately $210,000 in interest income related to
loans that were placed on non-accrual. This reversal was responsible for about 6
basis points of the overall margin compression. In addition, Fed rate cuts,
totaling 300 basis points in the past year, reduced the yield on approximately
$440.0 million of prime based loans. The cost of interest-bearing liabilities
decreased 88 basis points to 3.51% for the three months ended June 30, 2008,
compared to 4.39% for the same period in 2007, primarily due to decreased costs
for deposits.





Provision
for Loan Losses





Cascade’s
provision for loan losses was $1.2 million for the three months and $3.6 million
for the six months ended June 30, 2008. The provision for loan losses was
$250,000 and $500,000 for the same periods in 2007, respectively. The increase
in the provision was due to an increase in non-performing loans, net loan
charge-offs, and a general slowdown in


21
 the real
estate market. The provision for loan losses is based on the size, composition
and growth of the portfolio, and management’s evaluation of known and inherent
risks in the portfolio, as well as Cascade’s loss experience.





Other
Income





Total
other income increased $383,000 or 20.9% to $2.2 million for the three months
ended June 30, 2008, as compared to $1.8 million for the three months ended June
30, 2007. Total other income was $4.7 million and $3.9 million for the six
months ended June 30, 2008, and June 30, 2007, respectively. For the three
months ended June 30, 2008, checking fees increased to $1.3 million compared to
$960,000 for the same period in the prior year due to growth in the number of
accounts and increased activity fees. Gain on sale of loans increased $12,000
from $33,000 to $45,000 for the three months ended June 30, 2008, compared to
the same quarter in the prior year. Other service fees increased $38,000 to
$313,000 for the quarter. Bank-owned life insurance income increased $59,000 as
the Bank purchased an additional $5.0 million of insurance in December
2007.





Other
Expense





Total
other expenses were $7.3 million for the three months and $14.2 million for the
six months ended June 30, 2008, compared to $6.5 million for the three months
and $13.0 million for the six months ended June 30, 2007.





Compensation
and employee benefit expenses increased $168,000 to $3.6 million during the
three months ended June 30, 2008, compared to the same quarter last year.
Compensation and employee benefit expense was $7.3 million for the six months
ended June 30, 2008 and $6.8 million for the same period in 2007. The increased
compensation and personnel expense was primarily due to increased staffing
levels from the opening of our Shoreline and Burlington branches. The remaining
other expense categories (occupancy, marketing and other) totaled $3.6 million
for the three months and $6.9 million for the six months ended June 30, 2008,
and $3.1 million for the three months and $6.2 for the six months ended June 30,
2007





The
provision for federal income taxes decreased $467,000 to $1.6 million, a
decrease of 22.8% compared to the same period last year.  The decrease
in taxable net income before income taxes accounted for approximately $240,000
of this difference.  The tax rate for the second quarter of 2008 was
30% compared to a tax rate of 34% the prior year. The difference in the tax
rates were due to tax credits generated by CRA investments in low-income
housing, a 70% income exclusion on FNMA and FHLMC Preferred Stock investments
and an increase in tax exempt BOLI income.





Segment
Results





The
Corporation and the Bank are managed by a legal entity and not by lines of
business. The Bank’s operations include commercial banking services, such as
lending activities, business services, deposit products and other services. The
performance of the Bank as a whole is reviewed by the Board of Directors and
Management Committee.





The
Management Committee, which is the senior decision making group of the Bank, is
comprised of seven members including the President/CEO. Segment information is
not necessary to be presented in the notes to the consolidated financial
statements because operating decisions are made based on the performance of the
Corporation as a whole.


22


Liquidity
and Sources of Funds





The Bank
monitors its liquidity position to assure that it will have adequate resources
to meet its customers’ needs. Potential uses of funds are new loans; the
disbursement of construction loans in process; draws on unused business lines of
credit and unused consumer lines of credit; the purchase of investment
securities; deposit withdrawals; and repayment of FHLB advances. In terms of
commitments, as of June 30, 2008, Cascade had $100.7 million of construction
loans in process, $94.9 million in unused business lines of credit and future
business commitments, $36.4 million in unused consumer lines of credit including
credit cards, and $14.4 million in other undisbursed commitments. Recent history
indicates construction lines will be funded at 68% of commitments at any point
in time. The Bank’s business customers use approximately 55% of their credit
lines at any given time. About 42% of the home equity lines of credit are drawn
upon at any point in time. Cash flows from operations contribute to liquidity as
well as proceeds from maturities of securities and customer deposits. As
indicated on the Corporation’s Condensed Consolidated Statement of Cash Flows,
net cash from operating activities for the six months ended June 30, 2008,
contributed $7.8 million to liquidity compared to $6.7 million for the six
months ended June 30, 2007.





Funding
needs are met through existing liquidity balances, deposit growth, FHLB advances
and other borrowings, as well as the repayment of existing loans and the sale of
loans. Cascade maintains balances in FHLB deposits, which equaled $1.9 million
as of June 30, 2008, and $30.1 million at June 30, 2007.





Subject
to the availability of eligible collateral and certain requirements, the Bank’s
credit line with the FHLB-Seattle is 35% of total assets or up to approximately
$541.2 million at current asset levels. At June 30, 2008, the Bank had $250.0
million in advances and an unused line of credit from the FHLB-Seattle of
approximately $67.2 million subject to the ability to pledge eligible
collateral. The Bank also uses reverse repurchase agreements (securities sold
under agreements to repurchase) to provide a flexible source of funding. At June
30, 2008, the Bank had $120.6 million in reverse repurchase agreements
outstanding. Securities that could be pledged to secure additional funding at
the FHLB-Seattle, the repurchase market or sold for liquidity were $33.8 million
at the end of the quarter and $11.0 million as of December 31, 2007. Commercial
real estate loans totaling $367.8 million and home equity and second lien
residential loans totaling $36.8 million are being used as a source of
collateral at the FHLB. The Bank also has a total of $35.0 million in Fed funds
lines with three correspondent banks.  Cascade did not draw on
these lines during the quarter. The Bank also has a $56.1 million line of
credit (based upon pledged collateral) at the Federal Reserve Bank of San
Francisco and did borrow overnight during the quarter.As of June
30, 2008, there was an outstanding balance of $25.0million in short-term
borrowings with the Federal Reserve under the Term Auction Facility (TAF)
program.





The
recent turmoil in the credit markets did not have a direct impact on the Bank’s
liquidity management practices. Access to the FHLB, the brokered deposit market,
our correspondent banks, and the Federal Reserve remained open.


23


Capital
Resources





The
Corporation’s main source of capital is typically the retention of its net
income that is not paid in dividends. The Corporation also receives capital
through the exercise of stock options granted to employees and directors. The
Corporation permits employees and directors to tender shares of Cascade’s stock,
which they have held for a minimum of six months, to exercise
options.





The Board
of Directors authorized a stock repurchase program of up to 300,000 shares of
the Corporation’s stock at its May 2008 meeting. The repurchase program does not
obligate the Corporation to acquire any specific number of shares. The main
focus of the program is to attempt to offset the dilution created by the
exercise of stock options and other stock grants; see Part II – Other
Information, Item 2 – Unregistered Sales of Equity Securities and Use of
Proceeds.





On March
30, 2006, Cascade Capital Trust III issued $10 million in par value junior
subordinated debentures payable (Trust Preferred Securities). These securities
have a fixed rate of 6.65% for the first 5 years and then float at 3-month LIBOR
plus 1.40% for the remaining 25 years. Cascade Capital Trust III is a statutory
business trust created for the exclusive purposes of issuing and selling capital
securities and utilizing sale proceeds to acquire junior subordinated debt
issued by Cascade Financial Corporation. Accordingly, the junior subordinated
debentures are the sole assets of the Trust, and payments under the junior
subordinated debentures will be the sole revenues of the Trust. All of the
common securities of the Trust are owned by the Corporation.





On
December 15, 2004, Cascade Capital Trust II issued $5 million in par value
junior subordinated debentures payable. These securities have a fixed rate of
5.82% for the first 5 years and then float at 3-month LIBOR plus 1.90% for the
remaining 25 years. The structure of Cascade Capital Trust II is identical to
Cascade Capital Trust III.





On March
1, 2000, Cascade Capital Trust I issued $10 million par value junior
subordinated debentures payable. These securities have a fixed rate of 11% and
mature on March 1, 2030, but are callable at a premium beginning March 1, 2010
and semi-annually thereafter. The structure of Cascade Capital Trust I is
identical to Cascade Capital Trust III. In keeping with the adoption of FIN 46R,
the Corporation’s balance sheet has replaced the title of “trust preferred
securities” with “junior subordinated debentures payable,” although there have
been no changes in terms of the underlying obligations. The Trust has been
deconsolidated upon adoption of FIN 46R at December 31, 2003, and did not have a
significant impact on the Corporation’s financial condition or results of
operations.





Capital
Requirements





Cascade
Bank is subject to regulatory capital requirements. Cascade Bank is in full
compliance with all capital requirements established by the FDIC and the
Washington State Department of Financial Institutions. The Bank’s regulatory
capital requirements are expressed as a percentage of assets. To be adequately
capitalized, the Bank must hold adjusted


24
 capital
levels equal to 4% of its assets and 8% of its risk-weighted assets. As of June
30, 2008, for the purposes of this calculation, the Bank’s average total assets
and total risk-weighted assets were $1.5 billion and $1.3 billion respectively.
The related excess capital amounts as of June 30, 2008, are presented in the
following table:





(Dollars
      in thousands)
            
            Adequately
      Capitalized
            
            
            Well
      CapitalizedCore
    capital
            
            Amount
            
            
            Percentage
            
            
            Amount
            
            PercentageCascade’s
      Tier 1 (Core) capital
            
            $
            125,661
            
            
            
            8.37
            %
            
            $
            125,661
            
            
            8.37
            %Minimum
      requirement
            
            
            60,058
            
            
            
            4.00
            
            
            
            90,087
            
            
            6.00Excess
            
            $
            65,603
            
            
            
            4.37
            %
            
            $
            35,574
            
            
            2.37
            %Risk-based
      capital
            
            Amount
            
            
            Percentage
            
            
            Amount
            
            PercentageCascade’s
      Risk-based capital
            
            $
            139,092
            
            
            
            10.63
            %
            
            $
            139,092
            
            
            10.63
            %Minimum
      requirement(1)
            
            
            104,691
            
            
            
            8.00
            
            
            
            130,864
            
            
            10.00Excess
            
            $
            34,401
            
            
            
            2.63
            %
            
            $
            8,228
            
            
            0.63
            %(1)Based on risk-weighted assets.





The
Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”)
provides the FDIC with broad powers to take “prompt corrective action” to
resolve problems of insured depository institutions. The actions the FDIC can
take depend upon whether the institution in question is “well capitalized,”
“adequately capitalized,” “undercapitalized,” “significantly undercapitalized”
or “critically undercapitalized.” Under FDIC guidelines, Cascade Bank is a “well
capitalized” institution as of June 30, 2008, which requires a core capital to
assets ratio of at least 6% and a risk-based capital to assets ratio of at least
10%.





The
Corporation, as a bank holding company regulated by the Federal Reserve, is also
subject to capital requirements that are similar to those for Cascade Bank. As
of June 30, 2008, the Corporation is “well capitalized” under Federal Reserve
guidelines with a Tier 1 ratio of 8.41% and a risk-based ratio of
10.67%.





Item
3 – Quantitative and Qualitative Disclosures about Market Risk





ASSET/LIABILITY
MANAGEMENT





The Bank,
like other financial institutions, is subject to fluctuations in interest rates
because its interest-bearing liabilities reprice on different terms than its
interest-earning assets. Management actively monitors the inherent interest rate
risk for the potential impact of changes in rates on the
Bank.





The Bank
uses a simulation model as its primary tool to measure its interest rate risk. A
major focus of the Bank’s asset/liability management process is to preserve and
enhance net interest income in likely interest rate scenarios. Further,
Cascade’s Board of Directors has enacted policies that establish targets for the
maximum negative impact that changes in interest rates may have on the Bank’s
net interest income, the fair value of equity and adjusted capital/asset ratios
under certain interest rate shock scenarios. Key assumptions are made to
evaluate the change to Cascade’s income and capital to changes in interest
rates. These assumptions, while deemed reasonable by management, are inherently
uncertain. As a result, the estimated effects of changes in interest rates from
the simulation model could likely be different than actual
experience.


25


Using
standard interest rate shock (an instantaneous uniform change in interest rates
at all maturities) methodology, as of June 30, 2008, the Bank is within all the
guidelines established by the Board for the changes in net interest income, fair
value of equity, and adjusted capital/asset ratios. As of June 30, 2008, the
Bank’s fair value of equity increases 4.3% in the up 200 basis point scenario
and decreases 20.1% in the down 200 basis point scenario, within the established
guideline of a maximum 30% decline. Using the same methodology, the adjusted
capital/asset ratio is 12.6% in the up 200 basis point scenario and 10.8% in the
down 200 basis point scenario, both above the 5% minimum established guideline.
The net interest income increases 0.9% in the up 200 basis point scenario and
decreases 7.7% in the down 200 basis point scenario, both within the guideline
of a 10% decline.





The Bank
has sought to manage its interest rate exposure through the structure of its
balance sheet. To limit its interest rate risk, the Bank has sought to emphasize
its loan mix toward prime based business and construction loans. In addition to
selling virtually all 15 and 30 year fixed rate residential loans, it also sells
many of its hybrid ARM residential loans. The table below summarizes the Bank’s
loan portfolio by rate type at June 30, 2008.





Type
            
            Percentage
      of PortfolioVariable
            
            
            38
            %Adjustable
            
            
            36
            %Fixed
            
            
            26
            %





The Bank
extends the maturity of its liabilities by offering long-term deposit products
to customers, and by obtaining longer term FHLB advances. As of June 30, 2008,
the entire portfolio of $249.0 million in long-term advances had original
maturities greater than one year. This portfolio consists entirely of advances
with put provisions that allow the FHLB to convert the advance to a LIBOR based,
adjustable rate borrowing under certain rate conditions and on specific
dates.





In
addition to writing options on some of its liabilities, the Bank invests in
mortgage backed securities and callable GSE securities. The Bank receives higher
yields in return by writing call options. The Bank models this optionality in
measuring, monitoring, and managing its interest rate exposure.





Item
4 - Controls and Procedures





EVALUATION
OF DISCLOSURE CONTROLS AND PROCEDURES





An
evaluation of the Registrant's disclosure controls and procedures (as defined in
section 13(a) - 14(c) of the Securities Exchange Act of 1934 (the "Act")) was
carried out under the supervision and with the participation of the Registrant's
Chief Executive Officer, Chief Financial Officer, and several other members of
the registrant's senior management as of June 30, 2008. The Registrant's Chief
Executive Officer and Chief Financial Officer concluded that the Registrant's
disclosure controls and procedures as then in effect were effective in ensuring
that the information required to be disclosed by the Registrant in the reports
it files or submits under the Act is (i) accumulated and communicated to the
Registrant's


26
 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.





CHANGES
IN INTERNAL CONTROLS





In the
quarter ended June 30, 2008, the Registrant did not make any significant changes
in, nor take any corrective actions regarding, its internal controls, or other
factors that have materially affected or are reasonably likely to materially
affect these controls.





PART II––OTHER
INFORMATION





Item
1.  Legal Proceedings




The
Corporation and the Bank are involved in litigation and have negotiations in
progress resulting from activities arising from normal operations. In the
opinion of management, none of these matters are likely to have a materially
adverse effect on the Corporation’s financial position.





Item
1A.  Risk Factors





There
have been no material changes to the risk factors disclosed in Item 1A. - Risk
Factors in our Annual Report on Form 10-K for the period ended December 31,
2007.





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




Issuer
      Purchases of Equity Securities2007 PLANTotal
      Number of Shares Purchased
            
            
            Maximum
      Number of
              Shares
      thatPeriod
            
            Total
              Number
            
            
            Average
              Price
            
            
            as
      Part of Publicly
            
            
            May
      Yet be PurchasedBeginning
            Ending
            
            of Shares
      Purchased
            
            
            Paid
      per
              Share
            
            
            Announced
              Plan
            
            
            Under
      the
              Plan
      (1)April
      1, 2008
            April
      30, 2008
            
            
            -
            
            
            $
            -
            
            
            
            -
            
            
            
            322,707May
      1, 2008
            May
      31, 2008
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            322,707Total
            
            
            
            -
            
            
            $
            -
            
            
            
            -
            
            
            
            322,707During
      the period presented there were no shares purchased.1)
      The 2007 Plan, announced in May 2007, ended on May 31,
    2008.




27




Issuer
      Purchases of Equity Securities2008 PLAN
            
            
            Total
      Number
            
            
            Maximumof Shares
      Purchased
            
            
            Number
      of
              Shares
      thatPeriod
            
            Total
              Number
            
            
            Average
              Price
            
            
            as
      Part of Publicly
            
            
            May
      Yet be PurchasedBeginning
            Ending
            
            of Shares
      Purchased
            
            
            Paid
      per
              Share
            
            
            Announced
              Plan
            
            
            Under
      the
              Plan
      (1)June
      1, 2008
            June
      30, 2008
            
            
            -
            
            
            $
            -
            
            
            
            -
            
            
            
            300,000Total
            
            
            
            -
            
            
            $
            -
            
            
            
            -
            
            
            
            300,000During
      the period presented there were no shares purchased.1) In
      May 2008, the Corporation announced a new stock repurchase plan to
      purchase up to 300,000 shares of the Corporation’s stock. The Plan
      will expire on May 31, 2009.







Item
3.  Defaults upon Senior Securities




Not applicable




Item
4.  Submission of Matters to a Vote of Security Holders




The Annual Shareholders Meeting of
the Corporation was held on April 22, 2008. The shareholders re-elected four
incumbent directors. Jim Gaffney, David W. Duce, Carol K. Nelson, and David R.
O’Connor were re-elected for a term ending in 2011.





NOMINEE
            FOR
            AGAINST/WITHHELDJim
      Gaffney
            9,649,396
            249,008David
      W. Duce
            9,631,355
            267,049Carol
      K. Nelson
            9,634,237
            264,167David
      R. O’Connor
            9,643,933
            254,471





Item
5.  Other information




Not applicable




Item
6.  Exhibits




(a)  Exhibits




31.1
            Certifications
      of the Chief Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act


31.2
            Certifications
      of the Chief Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act32
            Certification
      pursuant to Section 906 of the Sarbanes-Oxley
Act




(b)
            Reports
      on Form 8-K




On April
3, 2008, the Corporation filed a Form 8-K reporting an attached press release
announcing it expects to record a larger than normal provision for loan losses
in the first quarter of 2008, under Items 2.02 and 9.01 of Form
8-K.




On April
22, 2008, the Corporation filed a Form 8-K reporting an attached press release
announcing earnings information for the quarter ended March 31, 2008, under
Items 2.02 and 9.01 of Form 8-K.


28


(b)
            Reports
      on Form 8-K (continued)




On April
23, 2009, the Corporation filed a form 8-K/A amending its Form 8-K filed on
April 22, 2008.




On May
27, 2008, the Corporation filed a Form 8-K announcing approval of the Bank’s
Stock Repurchase Program, under Items 8.01 and 9.01 of Form 8-K.




On July
22, 2008, the Corporation filed a Form 8-K reporting an attached press release
announcing earnings information for the quarter ended June 30, 2008, under Items
2.02 and 9.01 of Form 8-K.









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.








CASCADE
      FINANCIAL CORPORATIONAugust
      7, 2008
            /s/
      Lars H. JohnsonBy:     Lars
      H. Johnson,
              Executive Vice
      President
              (Chief Financial
      Officer)


29