**CASCADE
      FINANCIAL CORPORATION SELECTED FINANCIAL DATA**


*(Dollars
      in thousands, except per share data* )




**FOR
                  THE YEARS ENDED****DECEMBER
                  31,****2006**
              
              **2005**
              
              **2004**
              
              **2003**
              
              **2002**Interest
                  income
              
              $
              82,658
              
              $
              67,802
              
              $
              55,316
              
              $
              50,363
              
              $
              52,470Interest
                  expense
              
              
              43,268
              
              
              31,276
              
              
              22,919
              
              
              22,753
              
              
              26,446Net
                  interest income
              
              
              39,390
              
              
              36,526
              
              
              32,397
              
              
              27,610
              
              
              26,024Provision
                  for loan losses
              
              
              1,000
              
              
              945
              
              
              675
              
              
              1,275
              
              
              1,895Net
                  interest income after provision
                for
                  loan losses
              
              
              38,390
              
              
              35,581
              
              
              31,722
              
              
              26,335
              
              
              24,129Other
                  income
              
              
              6,026
              
              
              6,333
              
              
              4,747
              
              
              5,306
              
              
              4,039Other
                  expense
              
              
              24,586
              
              
              22,606
              
              
              20,317
              
              
              17,733
              
              
              16,321Income
                  before income taxes
              
              
              19,830
              
              
              19,308
              
              
              16,152
              
              
              13,908
              
              
              11,847Net
                  income
              
              
              13,355
              
              
              13,046
              
              
              10,785
              
              
              9,599
              
              
              8,072Net
                  income per common share, basic*(1)*
              
              
              1.11
              
              
              1.09
              
              
              0.96
              
              
              0.94
              
              
              0.81Net
                  income per common share, diluted*(1)*
              
              
              1.08
              
              
              1.06
              
              
              0.93
              
              
              0.90
              
              
              0.78Book
                  value per share*(1)*
              
              
              9.53
              
              
              8.76
              
              
              8.06
              
              
              6.21
              
              
              5.59**AT
                  DECEMBER 31,****2006**
              
              
              **2005**
              
              
              **2004**
              
              
              **2003**
              
              
              **2002**Assets
              
              $
              1,345,254
              
              $
              1,211,784
              
              $
              1,088,955
              
              $
              885,220
              
              $
              804,463Loans,
                  net
              
              
              996,015
              
              
              867,049
              
              
              794,466
              
              
              567,094
              
              
              546,677Cash
                  and securities
              
              
              282,301
              
              
              278,747
              
              
              228,644
              
              
              290,537
              
              
              229,880Deposits
              
              
              855,449
              
              
              795,768
              
              
              721,908
              
              
              564,314
              
              
              509,850Borrowings
              
              
              121,485
              
              
              66,270
              
              
              36,356
              
              
              50,123
              
              
              30,879FHLB
                  advances
              
              
              243,000
              
              
              236,000
              
              
              228,000
              
              
              200,000
              
              
              197,500Stockholders’
                  equity
              
              
              115,199
              
              
              105,193
              
              
              96,250
              
              
              63,957
              
              
              56,640Nonperforming
                  loans
              
              
              851
              
              
              1,987
              
              
              532
              
              
              1,921
              
              
              956**FINANCIAL
                  RATIOS****FOR
                  THE YEARS ENDED****DECEMBER
                  31,****2006**
              
              
              **2005**
              
              
              **2004**
              
              
              **2003**
              
              
              **2002**Return
                  on assets
              
              
              1.05
              %
              
              1.13
              %
              
              1.09
              %
              
              1.13
              %
              
              1.05
              %Return
                  on equity
              
              
              12.24
              
              
              13.13
              
              
              13.22
              
              
              15.81
              
              
              15.49Return
                  on tangible equity
              
              
              16.08
              
              
              17.82
              
              
              16.24
              
              
              15.81
              
              
              15.49Net
                  interest margin
              
              
              3.26
              
              
              3.35
              
              
              3.44
              
              
              3.35
              
              
              3.44Efficiency
                  ratio
              
              
              54.14
              
              
              52.75
              
              
              54.70
              
              
              53.87
              
              
              54.29Dividend
                  payout ratio
              
              
              28.43
              
              
              25.66
              
              
              25.81
              
              
              18.31
              
              
              8.21Average
                  stockholders’ equity
                to
                  average assets
              
              
              8.55
              
              
              8.60
              
              
              8.25
              
              
              7.15
              
              
              6.75Total
                  risk-based capital to risk-
                weighted
                  assets
              
              
              11.22
              
              
              10.86
              
              
              11.18
              
              
              13.42
              
              
              13.30Tier
                  1 capital to average total assets
              
              
              8.99
              
              
              8.23
              
              
              8.14
              
              
              8.49
              
              
              8.20


*(1)* ** *Per
      common share data is retroactively adjusted to reflect all stock splits and
      stock dividends*







***This
      statement has not been reviewed, or confirmed for accuracy or relevance, by
      the
      Federal Deposit Insurance Corporation.***




9


**MANAGEMENT
      DISCUSSION AND ANALYSIS**


The
      following discussion is provided for the consolidated operations of Cascade
      Financial Corporation (the “Corporation”)
      as of December 31, 2006. The Corporation has only one operating subsidiary:
      Cascade Bank (the “Bank”). The purpose of this discussion is to focus on
      significant factors concerning the Corporation’s financial condition and results
      of operations, and to provide a more comprehensive review of the Corporation’s operating
      results and financial condition than can be obtained from reading the
      consolidated financial statements alone. This discussion should be read with
      the
      consolidated financial statements and the notes thereto.


In
      addition to historical information, this report contains certain
      "forward-looking statements" within the meaning of the Private Securities
      Litigation Reform Act of 1995 ("PSLRA"). This statement is included for the
      express purpose of availing the Corporation of the protections of the safe
      harbor provisions of the PSLRA. The forward-looking statements contained herein
      are subject to factors, risks, and uncertainties that may cause actual results
      to differ materially from those projected. The following items are among the
      factors that could cause actual results to differ materially from the
      forward-looking statements: higher than expected loan delinquency rates; general
      economic conditions, including their impact on capital expenditures; business
      conditions in the banking industry; recent world events and their impact on
      interest rates, businesses, and customers; the regulatory environment; new
      legislation; vendor quality and efficiency; employee retention factors;
      rapidly-changing technology; competitive factors, including increased
      competition with community, regional, and national financial institutions;
      fluctuating interest rate environments; and similar matters. Readers are
      cautioned not to place undue reliance on these forward-looking statements,
      which
      reflect management's analysis only as of the date of the statement. The
      Corporation undertakes no obligation to publicly revise or update these
      forward-looking statements to reflect events or circumstances that arise after
      the date of this report. Readers should carefully review the risk factors
      described in this and other documents the Corporation files from time to time
      with the Securities and Exchange Commission.





**Acquisition**


On
      June
      3, 2004, the Corporation acquired Issaquah Bancshares, Inc. (“Issaquah”). The
      acquisition was accounted for using the purchase method of accounting and
      accordingly, the assets and liabilities were recorded based on their fair values
      at the acquisition date. Shares of Issaquah were exchanged for cash or cash
      and
      shares of the Corporation resulting in the issuance of 1,597,279 new shares.
      The
      merger enhanced Cascade’s commercial banking franchise by expanding Cascade’s
      presence in east King County. Total Issaquah assets on June 3, 2004, were
      approximately $131.0 million and the total value of the transaction, both cash
      and stock, was approximately $34.3 million as measured under the provisions
      of
      FAS 141. In addition to the shares issued, the Corporation paid cash of $9.5
      million in connection with the merger. The Bank booked $26.3 million in
      intangible assets associated with the transaction including $25.2 million in
      goodwill and a $1.1 million core deposit intangible that is being amortized
      using the straight-line method over an eight-year period of time.





**Critical
      Accounting Estimates**


Corporations
      may apply certain critical accounting estimates requiring management to make
      subjective or complex judgments, often as a result of the need to estimate
      the
      effect of matters that are inherently uncertain. The Bank considers its only
      material critical accounting estimate to be the allowance for loan
      losses. We
      believe that the accounting estimate related to the allowance for loan losses
      is
      a "critical accounting estimate" because: (1) it is highly susceptible to change
      from period to period because it requires management to make assumptions about
      future losses on loans; and (2) the impact of a sudden large loss could
      significantly reduce the allowance and potentially require increased provisions
      to replenish the allowance, which would negatively affect earnings.


The
      allowance for loan losses is established through a provision for loan losses
      charged against earnings. The balance of the allowance for loan losses is
      maintained at the amount management believes will be adequate to absorb known
      and inherent losses in the loan portfolio. The appropriate balance of the
      allowance for loan losses is determined by applying estimated loss factors
      to
      the credit exposure from outstanding loans. Estimated loss factors are based
      on
      subjective measurements including management’s assessment of the internal risk
      classifications, changes in the nature of the loan portfolio, industry
      concentrations, and the impact of current local, regional and national economic
      factors on the quality of the loan portfolio. Changes in these estimates and
      assumptions are reasonably possible and may have a material impact on the
      Corporation’s consolidated financial statements, results of operation, or
      liquidity.


For
      additional information regarding the allowance for loan losses, its relation
      to
      the provision for loan losses and risk related to asset quality, see Note 4
      in
      the Consolidated Financial Statements for the year ended December 31, 2006,
      and
“Management’s Discussion and Analysis of Financial Condition and Results of
      Operation - Provision for Loan Losses.”





**Critical
      Accounting Policies**


The
      Corporation’s significant accounting policies are described in Note 1 of the
      Notes to Consolidated Financial Statements included in Item 7 of this report
      and
      are essential to understanding Management's Discussion and Analysis of Financial
      Condition and Results of Operations. The preparation of financial statements
      in
      conformity with accounting principles generally accepted in the United States
      of
      America requires management to make estimates and assumptions which affect
      the
      reported amounts and disclosures. Actual results may differ from these estimates
      under different assumptions or conditions. The following policies involve a
      higher degree of judgment than do our other significant accounting policies
      detailed in Note 1 of the Notes to Consolidated Financial Statements included
      in
      Item 8 of this report.


10


*Allowance
      for Loan Losses*


The
      Bank
      reviews historical origination and charge-off relationships, charge-off
      experience factors, collection data, delinquency reports, estimates of the
      value
      of the underlying collateral, economic conditions and trends, and other
      information in order to make the necessary judgments as to the appropriateness
      of the provision for loan losses and the allowance for loan losses. Loans are
      charged-off to the allowance for loan losses when the Bank repossesses the
      collateral or the account is otherwise deemed uncollectible. The Bank believes
      that the allowance for loan losses is adequate to cover probable losses inherent
      in its loan portfolio; however, because the allowance for loan losses is based
      on estimates, there can be no assurance that the ultimate charge-off amount
      will
      not exceed the estimates.




*Investments*


The
      Bank
      classifies its investments as either available-for-sale or held-to-maturity.
      Available-for-sale securities are reported at their fair value, which is
      determined by obtaining quoted market prices. Unrealized gains and losses on
      available-for-sale securities are included in other comprehensive income and
      excluded from earnings. Realized gains and losses and declines in fair value
      judged to be other than temporary are included in earnings. The fair value
      of
      financial instruments is discussed in more detail in Note 16 of the Notes to
      Consolidated Financial Statements included in Item 8 of this
      report.





*Accrued
      Taxes*


The
      Bank
      estimates tax expense based on the amount it expects to owe various tax
      authorities. Taxes are discussed in more detail in Note 10 of the Notes to
      Consolidated Financial Statements included in Item 8 of this report. Accrued
      taxes represent the net estimated amount due or to be received from taxing
      authorities. In estimating accrued taxes, management assesses the relative
      merits and risks of the appropriate tax treatment of transactions taking into
      account statutory, judicial and regulatory guidance in the context of our tax
      position.





**FINANCIAL
      CONDITION**


**Total
      Assets**


The
      Corporation’s total assets at December 31, 2006, were $----1.3 billion, compared
      to $1.2 billion at December 31, 2005, an increase of 11.0%. The increase in
      2006
      is due entirely to internal growth. The Corporation’s total assets at December
      31, 2004, were $1.1 billion.





**Investment
      Securities**


Securities
      designated as available-for-sale decreased to $142.6 million at December 31,
      2006, versus $152.5 million at December 31, 2005. Securities designated as
      held-to-maturity increased to $96.8 million at December 31, 2006, from $95.1
      million a year earlier. The securities in both portfolios consist of notes
      issued by Government Sponsored Enterprises (“GSE” e.g. FHLB, FNMA) or
      mortgage-backed securities issued by either FNMA or FHLMC or a mortgage conduit.
      Investments include $11.9 million of Federal Home Loan Bank of Seattle stock
      at
      December 31, 2006. All investment securities received the highest credit rating
      from at least one of the major rating agencies.





**Loan
      Portfolio**


Net
      loans
      increased to $996.0 million at December 31, 2006, a -14.9% increase over $867.0
      million at December 31, 2005. Net loans were $794.5 million at December 31,
      2004.


Business
      banking loans increased from $394.0 million at December 31, 2005, to $442.4
      million at December 31, 2006, a 12.3% increase. The strong growth in this
      portfolio was the result of our ability to win new borrowing customers in a
      very
      competitive market. Net construction loans increased to $290.0 million from
      $166.0 million during the year. This portfolio experienced rapid turnover as
      the
      housing market remained very robust during the year. Commercial real estate
      loans decreased from $141.1 million at December 31, 2005, to $119.3 million
      at
      December 31, 2006. Most of the decrease was related to the sale of $29.8 million
      of loans from this category. The Corporation’s loan focus remains on small
      businesses, builders and developers in the Puget Sound Area. Construction
      lending is directed toward building single-family housing and land development
      for single-family housing. The Bank generally confines its lending to the Puget
      Sound Region of Washington state.


Total
      single-family residential loans increased from $95.4 million at December 31,
      2005, to $96.4 million at December 31, 2006. The Corporation sells the vast
      majority of its 30-year fixed-rate loans, its 15-year fixed-rate loans, and
      many
      of its conforming intermediate term hybrid ARMs in the secondary mortgage
      market. Cascade sold $34.1 million of seasoned loans in the fourth quarter
      including the $29.8 million in commercial loans referenced above. Multifamily
      loans outstanding decreased from $52.1 million at December 31, 2005, to $34.7
      million at December 31, 2006. The Corporation has de-emphazied this product
      line
      due to intense pricing pressure.


Consumer
      loans decreased $4.5 million to $27.7 million as of December 31, 2006. The
      Bank’s consumer loan portfolio is comprised of home equity loans and lines of
      credit, installment loans, and credit card loans. Home equity loans generally
      take the form of a second mortgage. In terms of direct consumer loans, the
      Bank
      has not emphasized this line of business, concluding that it is at a competitive
      disadvantage against the very aggressive pricing of large banks, captive finance
      companies and the specialty credit card issuers.


11


The
      chart
      below indicates the mix of the loan portfolio as of the dates
      indicated:





**December
                31, 2006**
            
            **December
                31, 2005**
            
            **December
                31, 2004***(Dollars
                in thousands)*
            
            **AMOUNT**
            
            **PERCENT**
            
            **AMOUNT**
            
            **PERCENT**
            
            **AMOUNT**
            
            **PERCENT**Business
                banking
            
            $
            442,391
            
            
            43.78
            %
            $
            394,034
            
            
            44.75
            %
            $
            292,117
            
            
            36.21
            %Commercial
                real estate
            
            
            119,298
            
            
            11.81
            
            
            141,109
            
            
            16.02
            
            
            178,704
            
            
            22.15Total
                business-like loans
            
            
            561,689
            
            
            55.59
            
            
            535,143
            
            
            60.77
            
            
            470,821
            
            
            58.36Residential
            
            
            96,350
            
            
            9.53
            
            
            95,429
            
            
            10.83
            
            
            105,975
            
            
            13.14Construction
            
            
            289,993
            
            
            28.70
            
            
            165,957
            
            
            18.84
            
            
            107,431
            
            
            13.32Consumer
            
            
            27,686
            
            
            2.74
            
            
            32,160
            
            
            3.65
            
            
            30,125
            
            
            3.73Multifamily
            
            
            34,719
            
            
            3.44
            
            
            52,057
            
            
            5.91
            
            
            92,372
            
            
            11.45Total
                loans
            
            
            1,010,437
            
            
            100.00
            %
            
            880,746
            
            
            100.00
            %
            
            806,724
            
            
            100.00
            %Deferred
                loan fees, net
            
            
            (3,434
            )
            
            
            
            
            (3,443
            )
            
            
            
            
            (2,695
            )Allowance
                for losses on loans
            
            
            (10,988
            )
            
            
            
            
            (10,254
            )
            
            
            
            
            (9,563
            )Loans,
                net
            
            $
            996,015
            
            
            
            
            $
            867,049
            
            
            
            
            $
            794,466





**Allowance
      for Loan Losses**


Management
      provides for possible loan losses by maintaining an allowance. The allowance
      for
      loan losses reflects management’s best estimate of probable losses as of a
      particular balance sheet date, but there is no guarantee that management’s
      estimate will be sufficient to cover actual loan losses. The allowance for
      loan
      losses is maintained at a level considered adequate based on management’s
      assessment of various factors affecting the loan portfolio, including local
      economic conditions, growth of the loan portfolio, past loss experience, and
      its
      composition. Increases in the allowance for loan losses made through provisions
      primarily reflect loan growth, loan loss experience risks inherent in lending
      and the impact of the economic climate on the loan portfolio.


Management
      determines the amount of the allowance for loan losses by utilizing a loan
      grading system to determine risk in the loan portfolio and by considering the
      results of credit reviews. The loan portfolio is separated by quality and then
      by loan type. Loans of acceptable quality are evaluated as a group, by loan
      type, with a specific loss rate assigned to the total loans in each type, but
      unallocated to any individual loan. Conversely, each adversely classified loan
      is individually analyzed to determine an estimated loss amount. A valuation
      allowance is also assigned to these adversely classified loans, but at an
      assumed higher reserve rate due to the greater risk of loss. Past due and
      impaired loans are actively managed to minimize the potential loss of
      principal.


At
      December 31, 2006, the allowance for loan losses was $11.0 million (1.09% of
      total loans) compared to $10.3 million (1.16% of total loans) at December 31,
      2005, and $9.6 million (1.19% of total loans) at December 31, 2004. During
      2006,
      the Corporation added $1.0 million to the allowance compared to $945,000 in
      2005. In 2004, the Corporation assumed the $1.4 million allowance of Issaquah
      in
      the acquisition. The Corporation was able to prudently maintain its ratio of
      the
      allowance to loans outstanding due to the low level in net loan charge-offs
      and
      the small amount of nonperforming loans.


Net
      loan
      charge-offs were $266,000 in 2006 (or 0.03% of average loans outstanding)
      compared to $254,000 in 2005 (or 0.03% of average loans outstanding). Net
      charge-offs were $218,000 for the year ended December 31, 2004. The coverage
      ratio (the allowance for loan losses to nonperforming loans) was 1,291% at
      December 31, 2006, 516% at December 31, 2005, and 1,798% at December 31,
      2004.





**Deposit
      Accounts**


Deposit
      accounts totaled $ 855.4 million
      at December 31, 2006, an increase of $ 59.6 million
      or 7.5 %
      over
      $795.8 million at December 31, 2005. The Bank assumed $101.8 million in deposits
      with the acquisition of Issaquah in 2004. Checking account balances, primarily
      through the implementation of the High Performance Checking program, grew 15.8 %
      to
      $ 139.5 million
      during the year as the Bank continued its sales efforts to generate transaction
      accounts. Money market deposit account balances grew by 51.6 %
      to
      $ 275.3 million
      with rates competitive with those offered by money market funds. Certificates
      of
      deposit decreased 11.1 %
      to
      $ 425.5 million.
      As business banking activity increases, management expects to increase its
      noninterest-bearing or low interest accounts through the growth of commercial
      checking accounts.


The
      market for deposits has remained very competitive. It remains a key goal of
      the
      Bank to increase its demand deposit account balances.





**Other
      Borrowings**


The
      Bank
      uses Federal Home Loan Bank of Seattle (“FHLB”) advances to provide intermediate
      and longer term funding, as well as to augment deposits. At December 31, 2006,
      the Bank had $243.0 million in FHLB advances compared to $236.0 million as
      of
      December 31, 2005. For 2006, FHLB advances averaged 18.6% of assets compared
      to
      20.8% in 2005. Subject to its Line of Credit with the FHLB, the availability
      of
      collateral, and the parameters of liquidity management, the Bank will continue
      to use advances as a funding source.


The
      Bank
      also uses repurchase agreements for funding. At December 31, 2006, the Bank
      had
      executed $95.7 million in repurchase agreements compared to $51.1 million a
      year
      earlier. In 2000, the Corporation issued $10.3 million in trust preferred
      securities, which are termed “junior subordinated debentures payable.” These
      junior subordinated debentures payable have a fixed rate of 11% and mature
      on
      March 1, 2030, but are callable at a premium beginning March 1, 2010. In
      December 2004, the Corporation issued an additional $5.2 million in


12
 junior
        subordinated debentures payable. These securities have a fixed coupon of
        5.82%
        for the first 5 years and then float at three-month LIBOR plus 1.90% for
        the
        remaining 25 years. The securities are callable at par after 5 years. On
        March
        30, 2006, the Corporation issued an additional $10.3 million in junior
        subordinated debentures payable. These obligations have an initial rate of
        6.65%
        set for 5 years and then convert to a three-month LIBOR plus 1.40% for the
        remaining 25 years. The securities are callable at par after 5 years. Junior
        subordinated debentures payable are considered Tier 1 capital by financial
        institution regulators.





**Capital**


Banking
      regulations require the Bank to maintain minimum levels of capital. As
      of
      December 31, 2006, Cascade Bank remained a “well-capitalized” institution (the
      FDIC’s highest rating), under regulatory guidelines, with a core
      capital-to-asset ratio of 8.96% and a risk-based capital-to-asset ratio of
      11.20%. The Bank’s regulatory capital ratios are discussed in more detail in
      Note 13 of the Notes to Consolidated Financial Statements included in Item
      8 of
      this report.


Federal
      Reserve guidelines require the Corporation, on a consolidated basis, to maintain
      minimum levels of capital as well. At December 31, 2006, the Corporation's
      total
      risk-based capital to risk-weighted assets was 11.22 %,
      compared to 10.86% at December 31, 2005, and 11.18% at December 31, 2004. The
      Corporation projects that earnings retention and existing capital will be
      sufficient to fund anticipated asset growth and the existing level of cash
      dividends, while maintaining a “well-capitalized” designation under the FDIC and
      Federal Reserve guidelines. The Corporation has paid its shareholders a cash
      dividend on a quarterly basis since 2002. In May 2006, the Corporation paid
      a
      5-for-4 stock split. Average shares outstanding, stock options, net income
      per
      share and book value per share for all periods presented have been retroactively
      adjusted to reflect the stock split. For the year, the Corporation returned
      $ 3.6 million
      in dividends to its shareholders compared to $3.2 million in 2005. The dividend
      payout ratio (the ratio of dividends paid to net income) for 2006 was 28 %.


The
      Corporation is committed to managing capital for maximum shareholder benefit
      and
      maintaining protection for depositors and creditors. The Corporation manages
      various capital levels at both the holding company and subsidiary bank level
      to
      attempt to maintain adequate capital ratios and levels in accordance with
      external regulations and capital guidelines established by the Board of
      Directors.




**RESULTS
      OF OPERATIONS**


**Earnings**


Cascade
      Financial Corporation earned net income for the year ended December 31, 2006,
      of
      $ 13.4 million,
      an increase of 2.4 %
      over
      the $13.0 million net income in the year ended December 31, 2005. Earnings
      per
      fully diluted share (EPS) were $ 1.08 in 2006
      and $1.06 in 2005. In 2004, the Corporation incurred $356,000 of
      acquisition-related expenses in connection with its acquisition of Issaquah,
      which translated to approximately $0.03 a share. Without those expenses, 2004
      diluted EPS would have been $0.96. Higher net interest income due to increased
      earning assets contributed to the improved results. Income was also enhanced
      by
      increased checking fees and other service fees, which partially offset the
      decline in gains on the sale of loans and the decline in other income. The
      Corporation earned net income of $10.8 million or $0.93 per fully diluted share
      for the fiscal year ended December 31, 2004.





**Return
      on Average Equity**


Return
      on
      average equity for the year ended December 31, 2006, was 12.24 %
      compared to 13.13% for the same period of 2005. Return on average equity for
      the
      fiscal year ending December 31, 2004 was 13.22%.




**Return
      on Average Tangible Equity**


Return
      on
      average tangible equity (average equity less goodwill) was 16.08 %
      compared to 17.82% in 2005. The June 2004 acquisition of Issaquah generated
      $26.3 million in goodwill and intangibles as assets and a like amount of
      capital. Eliminating the average intangible asset and reducing the capital
      by
      the same amount produces average tangible equity.


Return
      on
      average tangible equity is determined by methods other than those in accordance
      with accounting principles generally accepted in the United States of America
      (“GAAP”). This measure excludes the average balance of acquisition-related
      goodwill and intangibles in determining average tangible shareholders’ equity.
      Management believes the presentation of this financial measure, excluding the
      impact of these items, provides useful supplemental information that is
      essential for a proper understanding of the financial results of Cascade
      Financial Corporation. This disclosure should not be viewed as a substitute
      for
      results determined to be in accordance with GAAP, nor is it necessarily
      comparable to non-GAAP performance measures that may be presented by other
      companies.


13


A
      summary
      of tangible equity follows:





*(Dollars
                in thousands)*
            
            **2006**
            
            **2005**Net
                income
            
            $
            13,355
            
            $
            13,046Average
                equity
            
            
            109,103
            
            
            99,370Average
                goodwill & intangibles
            
            
            26,040
            
            
            26,142Average
                tangible equity
            
            
            83,063
            
            
            73,228Return
                on average tangible equity
            
            
            16.08
            %
            
            17.82
            %





**Net
      Interest Income**


The
      largest component of the Corporation’s earnings is net interest income. Net
      interest income is the difference between interest earned on earning assets
      (primarily loans, interest-bearing deposits with banks, and investment
      securities) and the interest expense associated with interest-bearing
      liabilities (deposits and borrowings). Interest earned and interest paid is
      affected by general economic conditions, including the demand for loans, cost
      of
      deposits, market rates of interest, government policies, and the action of
      regulatory authorities. The Corporation’s operations are sensitive to changes in
      interest rates and the resulting impact on net interest income.


Net
      interest income for the year ended December 31, 2006, increased by 7.9 %,
      or
      $ 2.9 million,
      to $ 39.4 million
      from $36.5 million for the year ended December 31, 2005. The improvement in
      net
      interest income was primarily due to the growth in our level of average earning
      assets. Net interest income for the fiscal year ended December 31, 2004 was
      $32.4 million.


Average
      earning assets increased 10.8 %
      to
      $ 1.2 billion
      for the year ended December 31, 2006, from $1.1 billion for the year ended
      December 31, 2005. Average earning assets were $942.8 million for the year
      ended
      December 31, 2004.


Net
      interest margin is net interest income expressed as a percent of average earning
      assets. The net interest margin for the year ended December 31, 2006, was 3.26 %,
      compared to 3.35% for the year ended December 31, 2005. While the yield on
      assets has improved over the last year, liability costs have also increased.
      The
      yield on earning assets increased 62 basis
      points to 6.85 %
      in
      2006. The cost of interest-bearing liabilities increased 79 basis
      points to 4.01 %
      during
      the year. The increase was due to increases in short-term interest rates, a
      flat
      yield curve and fierce competition for deposits.





**Average
      Balances and an Analysis of Average Rates Earned and Paid**


The
      following tables show 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 YEARS ENDED DECEMBER 31,****2006**
              
              **2005**
              
              **2004****INTEREST**
              
              
              
              
              
              **INTEREST**
              
              
              
              
              
              **INTEREST****AVERAGE**
              
              **AND**
              
              **YIELD/**
              
              **AVERAGE**
              
              **AND**
              
              **YIELD/**
              
              **AVERAGE**
              
              **AND**
              
              **YIELD/****BALANCE**
              
              **DIVIDEND**
              
              **COST**
              
              **BALANCE**
              
              **DIVIDEND**
              
              **COST**
              
              **BALANCE**
              
              **DIVIDEND**
              
              **COST***(Dollars
                  in thousands)***ASSETS**Interest-earning
                  assets*(1)*Residential
                  loans
              
              $
              98,476
              
              $
              5,582
              
              
              5.67
              %
              $
              104,789
              
              $
              5,882
              
              
              5.61
              %
              $
              106,187
              
              $
              6,219
              
              
              5.86
              %Multifamily
                  loans
              
              
              42,574
              
              
              2,863
              
              
              6.72
              
              
              74,650
              
              
              4,910
              
              
              6.58
              
              
              91,410
              
              
              5,839
              
              
              6.39Commercial
                  real estate loans
              
              
              144,094
              
              
              9,821
              
              
              6.82
              
              
              166,736
              
              
              10,957
              
              
              6.57
              
              
              122,958
              
              
              7,888
              
              
              6.41Construction
                  loans
              
              
              214,290
              
              
              19,376
              
              
              9.04
              
              
              133,975
              
              
              10,199
              
              
              7.61
              
              
              88,635
              
              
              5,579
              
              
              6.29Consumer
                  loans
              
              
              30,064
              
              
              2,304
              
              
              7.66
              
              
              31,352
              
              
              2,210
              
              
              7.05
              
              
              32,016
              
              
              2,254
              
              
              7.04Business
                  banking loans
              
              
              426,194
              
              
              31,158
              
              
              7.31
              
              
              343,182
              
              
              23,441
              
              
              6.83
              
              
              250,166
              
              
              16,447
              
              
              6.57Total
                  loans
              
              
              955,692
              
              
              71,104
              
              
              7.44
              
              
              854,684
              
              
              57,599
              
              
              6.74
              
              
              691,372
              
              
              44,226
              
              
              6.4Securities
                  available-for-sale
              
              
              148,917
              
              
              6,735
              
              
              4.52
              
              
              134,157
              
              
              5,582
              
              
              4.16
              
              
              155,563
              
              
              6,693
              
              
              4.3Securities
                  held-to-maturity
              
              
              96,668
              
              
              4,563
              
              
              4.72
              
              
              93,069
              
              
              4,306
              
              
              4.63
              
              
              91,747
              
              
              4,326
              
              
              4.72Daily
                  interest-earning deposits
              
              
              5,356
              
              
              256
              
              
              4.79
              
              
              6,912
              
              
              315
              
              
              4.56
              
              
              4,123
              
              
              71
              
              
              1.72Total
                  securities and interest-earning deposits
              
              
              250,941
              
              
              11,554
              
              
              4.60
              
              
              234,138
              
              
              10,203
              
              
              4.36
              
              
              251,433
              
              
              11,090
              
              
              4.41Total
                  interest-earning assets
              
              
              1,206,633
              
              
              82,658
              
              
              6.85
              %
              
              1,088,822
              
              
              67,802
              
              
              6.23
              %
              
              942,805
              
              
              55,316
              
              
              5.87
              %Noninterest-earning
                  assetsOffice
                  properties and equipment, net
              
              
              12,093
              
              
              
              
              
              
              
              
              12,741
              
              
              
              
              
              
              
              
              11,117Real
                  estate, net
              
              
              -
              
              
              
              
              
              
              
              
              328
              
              
              
              
              
              
              
              
              769Other
                  noninterest-earning assets
              
              
              56,830
              
              
              
              
              
              
              
              
              53,847
              
              
              
              
              
              
              
              
              33,976Total
                  assets
              
              $
              1,275,556
              
              
              
              
              
              
              
              $
              1,155,738
              
              
              
              
              
              
              
              $
              988,667




14




**FOR
                  THE YEARS ENDED DECEMBER 31,****2006**
              
              **2005**
              
              **2004****INTEREST**
              
              
              
              
              
              **INTEREST**
              
              
              
              
              
              **INTEREST****AVERAGE**
              
              **AND**
              
              **YIELD/**
              
              **AVERAGE**
              
              **AND**
              
              **YIELD/**
              
              **AVERAGE**
              
              **AND**
              
              **YIELD/****BALANCE**
              
              **DIVIDEND**
              
              **COST**
              
              **BALANCE**
              
              **DIVIDEND**
              
              **COST**
              
              **BALANCE**
              
              **DIVIDEND**
              
              **COST***(Dollars
                  in thousands)***LIABILITIES
                  AND EQUITY**Interest-bearing
                  liabilitiesSavings
                  accounts
              
              $
              14,748
              
              $
              75
              
              
              0.51
              %
              $
              15,465
              
              $
              67
              
              
              0.43
              %
              $
              14,895
              
              $
              43
              
              
              0.29
              %Checking
                  accounts
              
              
              45,039
              
              
              656
              
              
              1.46
              
              
              39,618
              
              
              245
              
              
              0.62
              
              
              29,562
              
              
              93
              
              
              0.31Money
                  market accounts
              
              
              229,788
              
              
              8,505
              
              
              3.70
              
              
              170,641
              
              
              3,255
              
              
              1.91
              
              
              145,626
              
              
              1,872
              
              
              1.29Certificates
                  of deposit
              
              
              446,437
              
              
              19,339
              
              
              4.33
              
              
              467,388
              
              
              14,747
              
              
              3.16
              
              
              401,620
              
              
              9,151
              
              
              2.28Total
                  interest-bearing deposits
              
              
              736,012
              
              
              28,575
              
              
              3.88
              
              
              693,112
              
              
              18,314
              
              
              2.64
              
              
              591,703
              
              
              11,159
              
              
              1.89Other
                  interest-bearing liabilitiesFHLB
                  advances
              
              
              237,888
              
              
              11,194
              
              
              4.71
              
              
              239,896
              
              
              11,031
              
              
              4.60
              
              
              210,023
              
              
              10,601
              
              
              5.05Other
                  interest-bearing liabilities
              
              
              104,085
              
              
              3,499
              
              
              3.36
              
              
              39,495
              
              
              1,931
              
              
              4.89
              
              
              41,511
              
              
              1,159
              
              
              2.79Total
                  interest-bearing liabilities
              
              
              1,077,985
              
              
              43,268
              
              
              4.01
              
              
              972,503
              
              
              31,276
              
              
              3.22
              
              
              843,237
              
              
              22,919
              
              
              2.72Other
                  liabilities
              
              
              88,468
              
              
              
              
              
              
              
              
              83,865
              
              
              
              
              
              
              
              
              63,855Total
                  liabilities
              
              
              1,166,453
              
              
              
              
              
              
              
              
              1,056,368
              
              
              
              
              
              
              
              
              907,092Stockholders’
                  equity
              
              
              109,103
              
              
              
              
              
              
              
              
              99,370
              
              
              
              
              
              
              
              
              81,575Total
                  liabilities andstockholders’
                  equity
              
              $
              1,275,556
              
              
              
              
              
              
              
              $
              1,155,738
              
              
              
              
              
              
              
              $
              988,667Net
                  interest income*(2)*
              
              
              
              
              $
              39,390
              
              
              
              
              
              
              
              $
              36,526
              
              
              
              
              
              
              
              $
              32,397Interest
                  rate spread*(3)*
              
              
              
              
              
              
              
              
              2.84
              %
              
              
              
              
              
              
              
              3.01
              %
              
              
              
              
              
              
              
              3.15
              %Net
                  interest margin*(4)*
              
              
              
              
              
              
              
              
              3.26
              %
              
              
              
              
              
              
              
              3.35
              %
              
              
              
              
              
              
              
              3.44
              %Average
                  interest-earning assetsto
                  average interest-bearingliabilities
              
              
              111.93
              %
              
              
              
              
              
              
              
              111.96
              %
              
              
              
              
              
              
              
              111.81
              %




*(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*





**Other
      Income**


Other
      income is derived from sources other than interest and fees on earning assets.
      The Corporation’s primary sources of other income are service charge fees on
      deposit accounts, other service fees, the accretion of cash surrender value
      of
      bank owned life insurance (“BOLI”), gains on the sale of single-family
      residential loans, gains on the sale of securities, and rental income, primarily
      on space at the building that formerly served as the headquarters of Issaquah.
      Other income for the year ending December 31, 2006, was $6.0 million, compared
      to $6.3 million and $4.7 million for the same periods in 2005 and 2004,
      respectively. This decrease was attributable primarily to a $382,000 decrease
      in
      gain on sale of loans, which was partially offset by an increase of $187,000
      in
      checking fees and an increase of $240,000 in other services fees. The decrease
      in gain on sale of loans is primarily due to lower loan sales. Other income
      for
      2006 was also reduced by a $150,000 charge on the termination of an interest
      rate swap.




**Other
      Expense**


Other
      expense represents costs not associated with deposits and other interest-bearing
      liabilities. It includes expenses associated with personnel, premises and
      equipment, data processing, and other operations.


Other
      expense increased by $2.0 million to $24.6 million for the year ended December
      31, 2006, from $22.6 million and $20.3 million for 2005 and 2004, respectively.
      The increase in expense was partially due to costs of $381,000 in core processor
      conversion expense and the first year of expensing stock options at a cost
      of
      $287,000. Salaries and employee benefits increased overall by $577,000 to $12.7
      million.


A
      standard measurement used to calculate the overhead costs of financial
      institutions is the efficiency ratio. The efficiency ratio is calculated by
      dividing other expense by total revenue, which generally indicates how much
      an
      institution spends to generate a dollar of revenue. The lower the efficiency
      ratio, the more efficient the institution. For the years ending December 31,
      2006, 2005, and 2004, the Corporation’s efficiency ratio was 54.14%, 52.75%, and
      54.70%, respectively. Management continues to look for ways to improve the
      efficiency ratio by increasing other income and net interest income while
      diligently controlling costs and maintaining high standards of
      service.





**Liquidity
      Management**


Liquidity
      is a term used to define the Corporation's ability to meet its financial
      commitments. The Corporation is required by prudent business practice and its
      regulators to maintain adequate levels of liquidity. The main liquidity
      requirements are funding customer loan requests and deposit outflows of Cascade
      Bank. Primary sources of liquidity are cash and cash equivalents, which include
      highly liquid investments. At December 31, 2006, December 31, 2005, and December
      31, 2004, cash and cash equivalents totaled $42.9 million, $31.1 million, and
      $13.0 million, respectively. Another source of liquidity is the Corporation’s
      investment portfolio, which consists of investment-grade securities. These
      securities are of the highest credit quality and can be sold or used as
      collateral to secure borrowings.


15


The
      primary source of borrowings is Federal Home Loan Bank of Seattle (FHLB-Seattle)
      advances and repurchase agreements. At December 31, 2006, $227.8 million of
      additional borrowing capacity remained under Cascade Bank’s existing credit line
      from the FHLB-Seattle, which is 35% of Cascade’s assets. The use of this Line of
      Credit is subject to the availability of eligible collateral, which includes
      residential mortgages, investment grade securities, and commercial real estate
      mortgages. At December 31, 2006, Cascade had unencumbered eligible collateral
      of
      approximately $70.9 million to pledge against the line. In addition, Cascade
      Bank has the ability to borrow through repurchase agreements. Under these
      agreements, borrowings are collateralized with mortgage-backed securities or
      other investment securities.


The
      Bank
      has Fed funds borrowing lines with three of its correspondent banks. Cascade
      used each of these lines during the year. The Bank also opened a Line of Credit
      with the Federal Reserve Bank of San Francisco. As of December 31, 2006, there
      were no outstanding balances in any of these lines.


Liquidity
      management is of critical importance to Cascade Bank in that it significantly
      relies upon wholesale sources of funds (e.g. FHLB-Seattle advances). While
      these
      sources have proven to be stable and reliable, an interruption in the
      availability of these sources could have an adverse impact on the operations
      of
      the Corporation. Also see the Consolidated Statement of Cash Flows in the
      financial statement section of this filing for further information regarding
      liquidity.





**Interest
      Rate Risk Management**


Management
      considers interest rate risk to be a significant market risk that could have
      a
      material effect on the Corporation’s financial condition and results of
      operations.


The
      Corporation has taken steps to balance its sensitivity to changes in interest
      rates by altering its asset and liability mix. The origination of floating-rate
      loans such as business, construction and other prime based loans is emphasized.
      The vast majority of fixed-rate loans have repricing periods with a maximum
      of
      five years. The mix of floating- and fixed-rates assets is designed to mitigate
      the impact of rate changes on the Corporation’s net interest income. Virtually
      all fixed-rate residential loans with maturities greater than five years are
      sold into the secondary market. However, the Bank has sought to add prepayment
      provisions to its newly originated fixed and adjustable rate loans. Many of
      the
      Bank’s fixed-rate loans do not have such provisions for prepayment fees, and as
      a result, a drop in rates can precipitate a refinancing of the Bank’s
      assets.


Interest
      rate risk is monitored using several methodologies, principally financial
      modeling. The earnings exposure to interest rate changes is evaluated in the
      context of certain upward and downward interest rate changes occurring
      instantaneously. At December 31, 2006, a 200 basis point increase in rates
      would
      decrease forecasted net interest income over a twelve-month period by
      approximately 5.3%. A 200 basis point decrease in rates would decrease interest
      income by 1.6% according to the model.


The
      changes of the fair value of assets and liabilities and the resulting impact
      on
      the fair value of equity are also modeled under different rate scenarios. In
      the
      200 basis point increase scenario, the fair value of equity declines by $26.1
      million or 16.6%, which is within the guideline established by the Bank’s
      Asset/Liability Policy.


The
      Corporation does not maintain a trading account for any class of financial
      instrument. Moreover, the Corporation is not subject to foreign currency
      exchange rate risk or commodity price risk.


The
      individual categories of assets and liabilities that are subject to interest
      rate sensitivity as of December 31, 2006, are shown in the following table.


**INTEREST
                  REPRICING ASSUMPTIONS****<1
                  YEAR**
              
              **1-3**
                **YEARS**
              
              **3-5**
                **YEARS**
              
              **5-10
                  YEARS**
              
              **10
                  YEARS**
                **AND
                  UP**
              
              **TOTAL**
              
              **FAIR
                  VALUE***(Dollars
                  in thousands)***Interest-Sensitive
                  Assets**Total
                  loans
              
              $
              692,582
              
              $
              157,360
              
              $
              153,753
              
              $
              6,613
              
              $
              129
              
              $
              1,010,437
              
              $
              1,016,976Investments
                  and other Interest-earning
                  assets
              
              
              54,170
              
              
              15,621
              
              
              81,443
              
              
              87,735
              
              
              18,851
              
              
              257,820
              
              
              243,364**Interest-Sensitive
                  Liabilities**Checking
                  accounts
              
              $
              11,451
              
              $
              12,492
              
              $
              18,738
              
              $
              8,432
              
              $
              938
              
              $
              52,051
              
              $
              52,051Money
                  market accounts
              
              
              268,964
              
              
              1,945
              
              
              2,918
              
              
              1,313
              
              
              146
              
              
              275,286
              
              
              275,286Savings
                  accounts
              
              
              3,335
              
              
              3,638
              
              
              5,456
              
              
              2,456
              
              
              273
              
              
              15,158
              
              
              15,158Certificates
                  of deposit*(1)*
              
              
              381,305
              
              
              33,379
              
              
              10,115
              
              
              700
              
              
              -
              
              
              425,499
              
              
              424,844Borrowings
              
              
              257,176
              
              
              2,186
              
              
              69,348
              
              
              10,000
              
              
              -
              
              
              338,710
              
              
              338,859Junior
                  subordinated debentures
                  payable
              
              
              -
              
              
              -
              
              
              15,465
              
              
              -
              
              
              10,310
              
              
              25,775
              
              
              27,465
  *(1)
        Net of ($312) mark-to-market on swap*





**Off-Balance
      Sheet Arrangements: Credit Commitments**


Commitments
      to extend credit are agreements to lend to a customer as long as there is no
      violation of any condition established in the contract. Commitments generally
      have fixed expiration dates or other termination clauses and may require payment
      of a fee. Since many of the commitments are expected to expire without being
      drawn upon, the total commitment amounts do not necessarily represent future
      cash requirements.


16


The
      Bank
      underwrites its standby letters of credit using its policies and procedures
      applicable to loans in general. Standby letters of credit are made on an
      unsecured and secured basis. The Bank has not incurred any losses on its
      commitments in 2006 or 2005.


A
      summary
      of the notional amount of the Bank’s financial instruments with off-balance
      sheet risk at December 31, 2006, follows:




*(Dollars
              in thousands)*
            
            
            **TOTAL**Commitments
              to extend credit
            
            $
            215,105Standby
              letters of credit and financial
              guarantees written
            
            
            4,924Unused
              commitments on bankcards
            
            
            12,751Total
            
            $
            232,780





**Contractual
      Obligations and Commitments**


The
      following table sets forth the Corporation’s long-term contractual
      obligations:




**PAYMENTS
                  DUE PER PERIOD***(Dollars
                  in thousands)*
              
              
              **<1
                  YEAR**
              
              
              **1-3
                  YEARS**
              
              
              **3-5
                  YEARS**
              
              
              **THEREAFTER**
              
              
              **TOTAL**Certificates
                  of deposit
              
              $
              381,304
              
              $
              33,379
              
              $
              10,115
              
              $
              700
              
              $
              425,498Federal
                  Home Loan Bank advances
              
              
              32,000
              
              
              41,000
              
              
              55,000
              
              
              115,000
              
              
              243,000Operating
                  lease obligations
              
              
              758
              
              
              1,515
              
              
              1,457
              
              
              7,764
              
              
              11,494Junior
                  subordinated debentures payable
              
              
              -
              
              
              -
              
              
              -
              
              
              25,775
              
              
              25,775Total
              
              $
              414,062
              
              $
              75,894
              
              $
              66,572
              
              $
              149,239
              
              $
              705,767





At
      December 31, 2006, the Corporation’s long-term contractual obligations related
      to debt totaled $ 268.8 million.
      See additional discussion under Notes 7 and 8 to the Consolidated Financial
      Statements for the year ended December 31, 2006.


The
      Corporation also has operating leases comprised of leases for office
      space.





**Summation
      of Factors That May Affect Financial Condition and Future Results**


*Credit
      risk:* The most
      significant risk that may impact Cascade Financial Corporation would be a
      deterioration in the quality of the loan portfolio. Cascade’s loan growth has
      been focused on commercial lending. While it has not been the Corporation’s
      experience, historically for the banking industry, commercial loans have higher
      levels of losses than residential loans. The Corporation’s ability to meet its
      profitability and growth goals would be severely compromised with a large number
      of impaired credits. In addition, the Corporation and its subsidiary, Cascade
      Bank, could face regulatory restrictions on its activities.


*Interest
      rate risk:* While
      the
      Corporation actively manages its exposure to changes in interest rates, volatile
      interest rates and/or changes in the shape of the yield curve could have a
      meaningful impact on Cascade’s net income. Many of the assets and liabilities of
      the Corporation have embedded options, which add another layer of complexity
      in
      its interest rate risk management practices.


*Liquidity:* Disruptions in the capital markets could have a major impact on the
      Corporation’s net income and balance sheet. As a user of Federal Home Loan Bank
      advances, repurchase agreements and brokered CDs, interruption or truncation
      of
      these sources of funds could force the Corporation to liquidate assets at an
      inauspicious time or curtail lending activity, which could adversely affect
      customer relationships.


*Recently
      issued accounting pronouncements:* In
      December 2004, the FASB issued No. 123(R), *Share-Based
      Payment,* which is
      a revision of No. 123, *Accounting
      for Stock-Based Compensation.* Statement 123(R) supersedes APB Opinion No. 25, which the Corporation had used
      to report stock options granted to employees and directors. Statement 123(R)
      requires all share-based payments to employees, including stock options, be
      recognized in the income statement based on their fair values. The adoption
      of
      this accounting standard reduced our earnings per share by $0.02 in 2006.







**Available
      Information**


A
      copy of
      the Corporation’s annual report on Form 10-K, quarterly reports on Form 10-Q,
      current reports on Form 8-K, and all amendments to such reports filed pursuant
      to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are available
      free of charge on or through our website located at www.cascadebank.com as
      soon
      as reasonably practicable after filing with the United States Securities and
      Exchange Commission. These reports are also available to shareholders, at no
      charge, upon written request to the Secretary of Cascade Financial Corporation
      at 2828 Colby Avenue, Everett, Washington 98201.




17


**Report
      of Independent Registered Public Accounting Firm**





The
      Board
      of Directors


Cascade
      Financial Corporation:





We
      have
      audited the accompanying consolidated balance sheets of Cascade Financial
      Corporation and subsidiaries (Corporation) as of December 31, 2006 and 2005,
      and
      the related consolidated statements of income, stockholders' equity and
      comprehensive income, and cash flows for the three years in the period ended
      December 31, 2006. We also have audited management's assessment included in
      the
      accompanying Management’s Report on Internal Control over Financial Reporting
      that the Corporation maintained effective internal control over financial
      reporting as of December 31, 2006, based on criteria established in Internal
      Control - Integrated Framework issued by the Committee of Sponsoring
      Organizations of the Treadway Commission (COSO). The Corporation’s management is
      responsible for these financial statements, for maintaining effective internal
      control over financial reporting, and for its assessment of the effectiveness
      of
      internal control over financial reporting. Our responsibility is to express
      an
      opinion on these financial statements, an opinion on management's assessment,
      and an opinion on the effectiveness of the Corporation's internal control over
      financial reporting based on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audits to obtain reasonable assurance about whether the
      financial statements are free of material misstatement and whether effective
      internal control over financial reporting was maintained in all material
      respects. Our audit of financial statements included examining, on a test basis,
      evidence supporting the amounts and disclosures in the financial statements,
      assessing the accounting principles used and significant estimates made by
      management, and evaluating the overall financial statement presentation. Our
      audit of internal control over financial reporting included obtaining an
      understanding of internal control over financial reporting, evaluating
      management's assessment, testing and evaluating the design and operating
      effectiveness of internal control, and performing such other procedures as
      we
      considered necessary in the circumstances. We believe that our audits provide a
      reasonable basis for our opinion.





The
      company's internal control over financial reporting is a process designed to
      provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with generally accepted accounting principles. A company's internal control
      over
      financial reporting includes those policies and procedures that (1) pertain
      to
      the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company; (2)
      provide reasonable assurance that transactions are recorded as necessary to
      permit preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the company are
      being made only in accordance with authorizations of management and directors
      of
      the company; and (3) provide reasonable assurance regarding prevention or timely
      detection of unauthorized acquisition, use, or disposition of the company's
      assets that could have a material effect on the financial
      statements.





Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the consolidated financial position of Cascade
      Financial Corporation and subsidiaries as of December 31, 2006 and 2005, and
      the
      results of their operations and cash flows for each of the three years in the
      period ended December 31, 2006, in conformity with accounting principles
      generally accepted in the United States of America. Also in our opinion,
      management's assessment that Cascade Financial Corporation and subsidiaries
      maintained effective internal control over financial reporting as of December
      31, 2006, is fairly stated, in all material respects, based on criteria
      established in Internal Control - Integrated Framework issued by the Committee
      of Sponsoring Organizations of the Treadway Commission. Furthermore, in our
      opinion, Cascade Financial Corporation and subsidiaries maintained, in all
      material respects, effective internal control over financial reporting as of
      December 31, 2006, based on criteria established in Internal Control -
      Integrated Framework issued by the Committee of Sponsoring Organizations of
      the
      Treadway Commission.





/s/
      Moss Adams LLP


Everett,
      Washington


March
      14,
      2007


18


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Consolidated
      Balance Sheets***


Years
      ended December 31, 2006, and 2005


**DECEMBER
                  31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005****ASSETS**Cash
                  on hand and in banks
              
              $
              23,707
              
              $
              16,616Interest-bearing
                  deposits in other financial institutions
              
              
              19,172
              
              
              14,493Securities
                  available-for-sale
              
              
              130,656
              
              
              140,596Securities
                  held-to-maturity
              
              
              96,846
              
              
              95,122Federal
                  Home Loan Bank (FHLB) stock
              
              
              11,920
              
              
              11,920Loans,
                  net
              
              
              996,015
              
              
              867,049Goodwill
              
              
              25,195
              
              
              25,195Core
                  deposit intangible, net
              
              
              775
              
              
              916Premises
                  and equipment, net
              
              
              12,003
              
              
              12,270Cash
                  surrender value of bank owned life insurance (BOLI)
              
              
              17,974
              
              
              17,313Accrued
                  interest receivable and other assets
              
              
              10,991
              
              
              10,294Total
                  assets
              
              $
              1,345,254
              
              $
              1,211,784**LIABILITIES
                  AND STOCKHOLDERS’ EQUITY**Liabilities:Deposits
              
              $
              855,449
              
              $
              795,768Federal
                  Home Loan Bank advances
              
              
              243,000
              
              
              236,000Securities
                  sold under agreements to repurchase
              
              
              95,710
              
              
              51,058Junior
                  subordinated debentures payable
              
              
              25,775
              
              
              15,212Advance
                  payments by borrowers for taxes and insurance
              
              
              703
              
              
              689Dividends
                  payable
              
              
              967
              
              
              864Accrued
                  interest payable, expenses, and other liabilities
              
              
              8,451
              
              
              7,000Total
                  liabilities
              
              $
              1,230,055
              
              $
              1,106,591Stockholders’
                  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 outstanding12,093,699shares at December31,
                  2006,and 12,004,734 shares at December 31, 2005
              
              
              121
              
              
              120Additional
                  paid-in capital
              
              
              39,430
              
              
              38,125Retained
                  earnings, substantially restricted
              
              
              77,952
              
              
              68,945Accumulated
                  other comprehensive (loss)
              
              
              (2,304
              )
              
              (1,997
              )Total
                  stockholders’ equity
              
              
              115,199
              
              
              105,193Total
                  liabilities and stockholders’ equity
              
              $
              1,345,254
              
              $
              1,211,784


*(See
      accompanying notes to consolidated financial statements.)*


19


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Consolidated
      Statements of Income***


Years
      ended December 31, 2006, 2005, and 2004




**YEARS
                  ENDED****DECEMBER
                  31,***(Dollars
                  in thousands, except share amounts)*
              
              **2006**
              
              **2005**
              
              **2004**Interest
                  income:Loans
              
              $
              71,104
              
              $
              57,599
              
              $
              44,226Securities
                  held-to-maturity
              
              
              4,563
              
              
              4,306
              
              
              4,292Securities
                  available-for-sale
              
              
              6,723
              
              
              5,534
              
              
              6,291FHLB
                  dividends
              
              
              12
              
              
              48
              
              
              436Interest-bearing
                  deposits
              
              
              256
              
              
              315
              
              
              71Total
                  interest income
              
              
              82,658
              
              
              67,802
              
              
              55,316Interest
                  expense:Deposits
              
              
              28,576
              
              
              18,314
              
              
              11,159FHLB
                  advances
              
              
              11,193
              
              
              11,031
              
              
              10,601Securities
                  sold under agreements to repurchase
              
              
              1,619
              
              
              733
              
              
              436Junior
                  subordinated debentures payable
              
              
              1,880
              
              
              1,198
              
              
              723Total
                  interest expense
              
              
              43,268
              
              
              31,276
              
              
              22,919Net
                  interest income
              
              
              39,390
              
              
              36,526
              
              
              32,397Provision
                  for loan losses
              
              
              1,000
              
              
              945
              
              
              675Net
                  interest income after provision for loan losses
              
              
              38,390
              
              
              35,581
              
              
              31,722Other
                  income:Gain
                  on sale of loans
              
              
              483
              
              
              865
              
              
              228Gain
                  on sale of securities available-for-sale, net
              
              
              -
              
              
              67
              
              
              510(Loss)
                  gain on sale of REO, net
              
              
              (27
              )
              
              33
              
              
              82Checking
                  service fees
              
              
              3,311
              
              
              3,124
              
              
              2,069Other
                  service fees
              
              
              1,156
              
              
              916
              
              
              704BOLI
              
              
              769
              
              
              764
              
              
              566Other
              
              
              334
              
              
              564
              
              
              588Total
                  other income
              
              
              6,026
              
              
              6,333
              
              
              4,747Other
                  expenses:Salaries
                  and employee benefits
              
              
              12,691
              
              
              12,114
              
              
              11,483Occupancy
              
              
              3,450
              
              
              3,323
              
              
              2,745Data
                  processing
              
              
              392
              
              
              646
              
              
              448Marketing
              
              
              1,094
              
              
              810
              
              
              547B&O
                  tax
              
              
              1,027
              
              
              713
              
              
              487Merger
                  expense
              
              
              -
              
              
              -
              
              
              356Other
              
              
              5,932
              
              
              5,000
              
              
              4,251Total
                  other expenses
              
              
              24,586
              
              
              22,606
              
              
              20,317Income
                  before provision for income taxes
              
              
              19,830
              
              
              19,308
              
              
              16,152Provision
                  for income taxes
              
              
              6,475
              
              
              6,262
              
              
              5,367Net
                  income
              
              $
              13,355
              
              $
              13,046
              
              $
              10,785Net
                  income per common share, basic
              
              
              1.11
              
              
              1.09
              
              
              0.96Weighted
                  average number of sharesoutstanding,
                  basic
              
              $
              12,060,191
              
              $
              11,977,824
              
              $
              11,190,616Net
                  income per share, diluted
              
              
              1.08
              
              
              1.06
              
              
              0.93Weighted
                  average number of sharesoutstanding,
                  diluted
              
              $
              12,363,198
              
              $
              12,319,873
              
              $
              11,595,290





*(See
      accompanying notes to consolidated financial statements.)*


20


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Consolidated
      Statements of Stockholders’ Equity and Comprehensive
      Income***


Years
      ended December 31, 2006, 2005, and 2004


**ACCUMULATED****OTHER**
              
              **TOTAL****ADDITIONAL**
              
              
              
              **COMPREHENSIVE**
              
              **STOCK-****COMMON**
              
              **PAID-IN**
              
              **RETAINED**
              
              **INCOME**
              
              **HOLDERS’***(Dollars
                  in thousands, except share amounts)*
              
              **SHARES**
              
              **STOCK**
              
              **CAPITAL**
              
              **EARNINGS**
              
              **(LOSS),
                  NET**
              
              **EQUITY**Balances
                  at December 31, 2003
              
              
              8,241,288
              
              $
              82
              
              $
              11,921
              
              $
              52,109
              
              $
              (155
              )
              $
              63,957Cash
                  dividends
              
              
              -
              
              
              -
              
              
              -
              
              
              (2,777
              )
              
              -
              
              
              (2,777
              )Options
                  exercised, includingrelated
                  tax benefit
              
              
              63,865
              
              
              1
              
              
              634
              
              
              -
              
              
              -
              
              
              635Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              10,785
              
              
              -
              
              
              10,785Shares
                  repurchased
              
              
              (8,754
              )
              
              -
              
              
              (8
              )
              
              (142
              )
              
              -
              
              
              (150
              )Other
                  comprehensive loss,net
                  of tax (benefit) of $(537)
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (992
              )
              
              (992
              )Issaquah
                  Bank merger
              
              
              1,263,423
              
              
              13
              
              
              24,779
              
              
              -
              
              
              -
              
              
              24,792Balances
                  at December 31, 2004
              
              
              9,559,822
              
              
              96
              
              
              37,326
              
              
              59,975
              
              
              (1,147
              )
              
              96,250Cash
                  dividends
              
              
              -
              
              
              -
              
              
              -
              
              
              (3,260
              )
              
              -
              
              
              (3,260
              )Options
                  exercised, including
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              -related
                  tax benefit
              
              
              81,019
              
              
              -
              
              
              803
              
              
              -
              
              
              -
              
              
              803Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              13,046
              
              
              -
              
              
              13,046Shares
                  repurchased
              
              
              (40,953
              )
              
              -
              
              
              (42
              )
              
              (816
              )
              
              -
              
              
              (858
              )Other
                  comprehensive income,net
                  of tax (benefit) of $(457)
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (850
              )
              
              (850
              )Issaquah
                  Bank merger
              
              
              3,899
              
              
              -
              
              
              62
              
              
              -
              
              
              -
              
              
              62Balances
                  at December 31, 2005
              
              
              9,603,787
              
              
              96
              
              
              38,149
              
              
              68,945
              
              
              (1,997
              )
              
              105,193Stock
                  split (5-for-4)
              
              
              2,410,282
              
              
              24
              
              
              (33
              )
              
              -
              
              
              -
              
              
              (9
              )Cash
                  dividends
              
              
              -
              
              
              -
              
              
              -
              
              
              (3,706
              )
              
              -
              
              
              (3,706
              )Options
                  exercised, including
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              -related
                  tax benefit
              
              
              122,920
              
              
              1
              
              
              1,058
              
              
              -
              
              
              -
              
              
              1,059Stock
                  compensation expense
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              -net
                  of tax benefit
              
              
              -
              
              
              -
              
              
              287
              
              
              -
              
              
              -
              
              
              287Net
                  income
              
              
              -
              
              
              -
              
              
              **-**
              
              
              13,355
              
              
              -
              
              
              13,355Shares
                  repurchased
              
              
              (43,290
              )
              
              -
              
              
              (31
              )
              
              (642
              )
              
              -
              
              
              (673
              )Other
                  comprehensive income,net
                  of tax (benefit) of $(165)
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (307
              )
              
              (307
              )Balances
                  at December 31, 2006
              
              
              12,093,699
              
              $
              121
              
              $
              39,430
              
              $
              77,952
              
              $
              (2,304
              )
              $
              115,199





**Comprehensive
                  Income**
              
              
              
              **YEARS
                  ENDED****DECEMBER
                  31,****2006**
              
              **2005**
              
              **2004**Net
                  income
              
              $
              13,355
              
              $
              13,046
              
              $
              10,785Increase
                  in unrealized gain (loss) on securitiesavailable-for-sale,
                  net of tax (benefit)of
                  $(165), $(452) and $(346).
              
              
              (307
              )
              
              (840
              )
              
              (622
              )Increase
                  in unrealized gain on swapsAvailable-for-sale,
                  net of tax expenseof
                  $0, $114 and $119.
              
              
              —
              
              
              213
              
              
              232Less
                  reclassification adjustment for gains onsecurities
                  included in net income, net oftax
                  (benefit) of $0, $(23) and $(173).
              
              
              —
              
              
              (44
              )
              
              (337
              )Less
                  reclassification adjustment for gains onswaps
                  included in net income, net of tax(benefit)
                  of $0, $(96) and $(137).
              
              
              —
              
              
              (179
              )
              
              (265
              )Comprehensive
                  income
              
              $
              13,048
              
              $
              12,196
              
              $
              9,793





*(See
      accompanying notes to consolidated financial statements.)*


21


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Consolidated
      Statements of Cash Flows***


Years
      ended December 31, 2006, 2005, and 2004


**YEARS
                  ENDED****DECEMBER
                  31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**
              
              **2004**Cash
                  flows from operating activities:Net
                  income
              
              $
              13,355
              
              $
              13,046
              
              $
              10,785Adjustments
                  to reconcile net income to netcash
                  provided by (used in) operating activities:Depreciation
                  and amortization of premises and equipment
              
              
              1,917
              
              
              1,874
              
              
              1,553Provision
                  for losses on loans
              
              
              1,000
              
              
              945
              
              
              675Increase
                  in cash surrender value of bank owned life insurance
              
              
              (661
              )
              
              (663
              )
              
              (488
              )Amortization
                  of retained servicing rights
              
              
              6
              
              
              30
              
              
              40Amortization
                  of core deposit intangible
              
              
              141
              
              
              141
              
              
              70Deferred
                  income taxes
              
              
              178
              
              
              (150
              )
              
              (100
              )Deferred
                  loan fees, net
              
              
              (9
              )
              
              748
              
              
              516Gain
                  on sale of loans
              
              
              (483
              )
              
              (865
              )
              
              (228
              )Stock-based
                  compensation
              
              
              287
              
              
              -
              
              
              -Excess
                  tax benefits from stock-based compensation
              
              
              (314
              )
              
              (301
              )
              
              (199
              )Net
                  gain on sales of securities available-for-sale
              
              
              -
              
              
              (67
              )
              
              (510
              )Loss
                  on sales of premises and equipment
              
              
              -
              
              
              -
              
              
              6Net
                  loss (gain) on sale of real estate owned, investment
                  propertyand
                  other repossessed assets
              
              
              27
              
              
              (33
              )
              
              (82
              )Federal
                  Home Loan Bank stock dividend received
              
              
              -
              
              
              (48
              )
              
              (436
              )Net
                  change in accrued interest receivable and other assets
              
              
              (562
              )
              
              (156
              )
              
              6,945Net
                  change in accrued interest payable, expensesand
                  other liabilities
              
              
              1,764
              
              
              2,392
              
              
              227Net
                  cash provided by operating activities
              
              
              16,646
              
              
              16,893
              
              
              18,774Cash
                  flows from investing activities:Loans
                  originated, net of principal repayments
              
              
              (133,462
              )
              
              (71,352
              )
              
              (230,120
              )Purchases
                  of securities held-to-maturity
              
              
              (3,434
              )
              
              (10,054
              )
              
              (35,436
              )Proceeds
                  from sales/calls on securities held-to-maturity
              
              
              -
              
              
              -
              
              
              26,095Principal
                  repayments on securities held-to-maturity
              
              
              2,020
              
              
              6,271
              
              
              4,876Principal
                  repayments on securities available-for-sale
              
              
              15,184
              
              
              22,318
              
              
              31,471Purchases
                  of securities available-for-sale
              
              
              (5,716
              )
              
              (58,289
              )
              
              (93,167
              )Proceeds
                  from sales of securities available-for-sale
              
              
              -
              
              
              6,488
              
              
              127,261Purchases
                  of premises and equipment
              
              
              (1,846
              )
              
              (1,345
              )
              
              (5,802
              )Proceeds
                  from sales/retirements of premises and equipment and REO
              
              
              269
              
              
              25
              
              
              5Proceeds
                  from loan participations sold
              
              
              3,988
              
              
              (1,747
              )
              
              446Cash
                  used for acquisition
              
              
              -
              
              
              -
              
              
              (9,546
              )Purchase
                  of bank owned life insurance
              
              
              -
              
              
              -
              
              
              (5,000
              )Net
                  cash used in investing activities
              
              
              (122,997
              )
              
              (107,685
              )
              
              (188,917
              )Subtotal,
                  carried forward
              
              $
              (106,351
              )
              $
              (90,792
              )
              $
              (170,143
              )




*(See
      accompanying notes to consolidated financial statements.)*


22


***Consolidated
                  Statements of Cash Flows, Continued*****YEARS
                  ENDED****DECEMBER
                  31,***(Dollars
                  in thousands)*
              
              **2006**
              
              **2005**
              
              **2004**Subtotal,
                  brought forward
              
              $
              (106,351
              )
              $
              (90,792
              )
              $
              (170,143
              )Cash
                  flows from financing activities:Proceeds
                  from issuance of common stock
              
              
              736
              
              
              564
              
              
              436Dividends
                  paid
              
              
              (3,603
              )
              
              (3,163
              )
              
              (2,589
              )Repurchase
                  of common stock
              
              
              (673
              )
              
              (858
              )
              
              (150
              )Excess
                  tax benefits from stock-based compensation
              
              
              314
              
              
              301
              
              
              199Net
                  increase in deposits
              
              
              59,681
              
              
              73,860
              
              
              157,594Net
                  increase in Federal Home Loan Bank advances
              
              
              7,000
              
              
              8,000
              
              
              28,000Net
                  increase (decrease) in securities sold under agreementsto
                  repurchase
              
              
              44,652
              
              
              30,156
              
              
              (19,009
              )Net
                  increase (decrease) in advance payments by borrowersfor
                  taxes and insurance
              
              
              14
              
              
              12
              
              
              (380
              )Proceeds
                  from junior subordinated debentures payable
              
              
              10,000
              
              
              -
              
              
              5,000Net
                  cash provided by financing activities
              
              
              118,121
              
              
              108,872
              
              
              169,101Net
                  increase (decrease) in cash and cash equivalents
              
              
              11,770
              
              
              18,080
              
              
              (1,042
              )Cash
                  and cash equivalents at beginning of period
              
              
              31,109
              
              
              13,029
              
              
              14,071Cash
                  and cash equivalents at end of period
              
              $
              42,879
              
              $
              31,109
              
              $
              13,029Supplemental
                  disclosures of cash flow information -Cash
                  paid during the period for:Interest
              
              $
              40,241
              
              $
              30,642
              
              $
              21,326Income
                  taxes
              
              
              6,700
              
              
              4,716
              
              
              5,802Supplemental
                  schedule of non-cash investing activities:Net
                  mortgage loans transferred to real estate owned
              
              
              -
              
              
              -
              
              
              1,339Mark-to-market
                  on securities available-for-sale
              
              
              472
              
              
              1,308
              
              
              1,529Issaquah
                  Bank merger
              
              
              -
              
              
              -
              
              
              24,792


*(See
      accompanying notes to consolidated financial statements
      below.)*





**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)* ****





**(1)
      Summary of Significant Accounting Policies**


The
      accounting and financial reporting policies of Cascade Financial Corporation
      and
      subsidiaries (the “Corporation”) conform to accounting principles generally
      accepted in the United States of America and to general practice within the
      financial institutions industry, where applicable. In preparing the consolidated
      financial statements, management makes estimates and assumptions that affect
      the
      reported amounts of assets and liabilities and disclosure of contingent assets
      and liabilities at the date of the financial statements and the reported amounts
      of income and expense. Actual results could differ from those estimates. A
      material estimate that is particularly susceptible to significant change relates
      to the determination of the allowance for losses on loans and the valuation
      of
      real estate acquired in connection with foreclosures or in satisfaction of
      loans. In connection with the determination of the estimated losses on loans
      and
      foreclosed assets held-for-sale, management obtains independent appraisals
      for
      significant properties.


The
      following is a description of the more significant policies that the Corporation
      follows in preparing and presenting its consolidated financial
      statements.


23


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)* ****





**(a)
      Basis of Presentation**


The
      consolidated financial statements include the accounts of the Corporation,
      its
      subsidiaries, Cascade Bank (the “Bank”) and the Bank’s subsidiary, Cascade
      Investment Services, Inc. All significant intercompany balances and transactions
      have been eliminated in the consolidation. In January 2003, the Financial
      Accounting Standards Board (FASB) issued Interpretation No. 46 (FIN 46), *Consolidation
      of Variable Interest Entities* and, in
      December 2003, issued Revised Interpretation No. 46 (FIN 46R), *Consolidation
      of Variable Interest Entities* ,
      which
      replaced FIN 46. Historically, issuer trusts that issued trust preferred
      securities (junior subordinated debentures payable) have been consolidated
      by
      their parent companies and trust preferred securities have been treated as
      eligible for Tier 1 capital treatment by bank holding companies under Federal
      Reserve Board (FRB) rules and regulations relating to minority interests in
      equity accounts of consolidated subsidiaries.


In
      a
      Supervisory Letter dated July 2, 2003, the FRB stated that trust preferred
      securities continue to qualify as Tier 1 capital until notice is given to the
      contrary. The FRB will review the regulatory implications of any accounting
      treatment changes and will provide further guidance if necessary or
      warranted .




**(b)
      Cash Equivalents**


The
      Corporation considers all interest-bearing deposits and short-term highly liquid
      investment securities with an original maturity of three months or less to
      be
      cash equivalents.




**(c)
      Interest-Bearing Deposits with Financial Institutions**


Interest-bearing
      deposits with other financial institutions are carried at cost and include
      interest-bearing deposits at the Federal Home Loan Bank. At times throughout
      the
      year, the Bank has balances that exceed FDIC insurance limits.




**(d)
      Federal Home Loan Bank (FHLB) Stock**


As
      a
      member of the FHLB system, the Bank is required to maintain a minimum level
      of
      investment in FHLB stock based on specified percentages of its outstanding
      FHLB
      advances. The Bank's investment in FHLB stock is carried at par value ($100
      per
      share), which reasonably approximates its fair value. The Bank may request
      redemption at par value of any stock in excess of the amount the Bank is
      required to hold. Stock redemptions are at the discretion of the FHLB. During
      2002, the FHLB revised its capital structure from the issuance of one class
      of
      stock to two, B (1) and B (2) stock. Class B (1) stock can be sold back to
      the
      FHLB at cost, but is restricted as to purchase, sale and redemption. Class
      B (2)
      is not a required investment for institutions and is not restricted to purchase
      and sale, but has the same redemption restrictions as Class B (1) stock.
      Included in the balance sheet as of December 31, 2006, and 2005, the Bank has
      $11,920 and $0 of Class B (1) and B (2) stock.





**(e)
      Transfer of Financial Assets**


Transfers
      of financial assets are accounted for as sales when control over the assets
      has
      been surrendered. Control over transferred assets is deemed to be surrendered
      when (1) the assets have been isolated from the Bank, (2) the transferee obtains
      the right (free of conditions that constrain it from taking advantage of that
      right) to pledge or exchange the transferred assets, and (3) the Bank does
      not
      maintain effective control over the transferred assets through an agreement
      to
      repurchase them before their maturity.





**(f)
      Mortgage Servicing Rights**


Servicing
      assets are recognized when rights are acquired through the sale of mortgage
      loans or when the Bank originates and sells mortgage loans and retains the
      servicing. Loans serviced for others are not included in the accompanying
      consolidated balance sheets. In 2006, the Bank sold $34.1 million of commercial
      real estate and multifamily loans and retained the servicing. In the two
      previous years the Bank had not retained the servicing on any loans sold.
      Capitalized servicing rights are reported in other assets. Mortgage loans
      serviced for others include whole loans sold. Loans being serviced totaled
      $39.0
      million and $15.6 million at December 31, 2006, and 2005, respectively. Included
      in the 2005 total is $9.2 million of loans serviced on a short-term interim
      servicing agreement.


Servicing
      fee income is recorded for fees earned for servicing loans. The fees are based
      on a contractual percentage of the outstanding principal; or a fixed amount
      per
      loan and are recorded as income when earned. The amortization of mortgage
      servicing rights is netted against loan servicing fee income.





**(g)
      Marketing Costs**


The
      Bank
      expenses most marketing costs as they are incurred but some marketing costs
      are
      capitalized and amortized over the useful life of the expenditure. Marketing
      expense was $1.1 million, $810, and $547 for the years ended December 31, 2006,
      2005, and 2004, respectively.


24


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*




**(h)
      Comprehensive Income**


Comprehensive
      income is comprised of net income and other comprehensive income. Other
      comprehensive income includes items previously recorded directly to equity,
      such
      as unrealized gains and losses on securities available-for-


sale
      and
      certain derivative instruments. Comprehensive income is presented with the
      consolidated statement of shareholders’ equity.





**(i)
      Segment Reporting**


The
      Corporation’s sole operating subsidiary is Cascade Bank, which is managed along
      four major lines of business: business banking, retail banking, construction
      lending and income property lending. The financial performance of these business
      lines is measured by the Corporation’s profitability reporting processes, which
      utilize various management accounting techniques to ensure that each business
      line’s financial results reflect the underlying performance of that business.
      The Bank’s operations are solely in the financial services industry and include
      providing to its customers traditional banking and other financial services.
      The
      administrative group, although not considered a line of business, is responsible
      for the management of investments, interest rate risk, marketing, data
      processing, as well as regulatory and stockholder reporting. The Bank operates
      primarily in the Puget Sound geographical region of Washington state.





**(j)
      Earnings Per Share (EPS) Data**


The
      Corporation displays basic and diluted EPS in the consolidated statement of
      income. Basic EPS is computed by dividing net income by the weighted average
      number of shares outstanding during the year. Diluted EPS is computed by
      dividing net income by diluted weighted average shares outstanding, which
      includes common stock equivalent shares outstanding using the treasury stock
      method, unless such shares are anti-dilutive. Common stock equivalents include
      stock options.




**(k)
      Goodwill and Other Intangible Assets**


Net
      assets of companies acquired in purchase transactions are recorded at fair
      value
      at the date of acquisition. Identified intangibles are amortized on an
      accelerated basis over the period benefited. Goodwill is not amortized but
      is
      reviewed for potential impairment on a quarterly basis at the reporting unit
      level. The impairment test is performed in two phases. The first step of the
      goodwill impairment test compares the fair value of the reporting unit with
      its
      carrying amount, including goodwill. If the fair value of the reporting unit
      exceeds its carrying amount, goodwill of the reporting unit is considered not
      impaired; however, if the carrying amount of the reporting unit exceeds its
      fair
      value, an additional procedure must be performed. That additional procedure
      compares the implied fair value of the reporting unit’s goodwill (as defined in
      SFAS No. 142, *“Goodwill
      and Other Intangible Assets”,* (SFAS
      142)) with the carrying amount of that goodwill. An impairment loss is recorded
      to the extent that the carrying amount of goodwill exceeds its implied fair
      value. The excess cost over fair value of net assets acquired consists mainly
      of
      goodwill and core deposit premiums. Core deposit intangibles are amortized
      on a
      straight-line basis over 8 years. Intangibles are evaluated periodically, and
      at
      least annually, for impairment.




Goodwill
      and other intangible assets consisted of the following at December 31, 2006
      and
      2005:





**GROSS
                CARRYING AMOUNT**Intangible
                assets carrying value
            
            
            **2006**
            
            
            **2005**Core
                deposit intangible, net
            
            $
            775
            
            $
            916Goodwill
            
            
            25,195
            
            
            25,195Total
            
            $
            25,970
            
            $
            26,111







Amortization
      and write-downs of intangible assets for 2006 and 2005, was as follows:





**AMORTIZATION
                AND WRITE-DOWN**
              **YEARS
                ENDED DECEMBER 31**Intangible
                assets amortization and impairment
            
            
            **2006**
            
            
            **2005**Core
                deposit intangible
            
            $
            141
            
            $
            141Mortgage
                servicing rights
            
            
            6
            
            
            30Total
            
            $
            147
            
            $
            171




25


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





Estimated
      existing intangible asset amortization for the next five years is as follows:





Estimated
                amortization expenseFor
                year ended 12/31/07
            
            $
            199For
                year ended 12/31/08
            
            
            178For
                year ended 12/31/09
            
            
            167For
                year ended 12/31/10
            
            
            160For
                year ended 12/31/11
            
            
            154





**(l)
      Loans**


Almost
      all of the Corporation's loans are located in Washington state, primarily in
      the
      Puget Sound Region. At December 31, 2006, the Corporation's loans were
      classified as one-to-four-family residences (9%), multifamily residences (3%),
      real estate construction (29%), business assets (44%), consumer assets (3%),
      and
      non-owner occupied commercial real estate properties (12%). Accordingly, the
      ultimate collectibility of the Corporation's loan portfolio is susceptible
      to
      changes in the economic and real estate market conditions in the Puget Sound
      Region.


Business
      banking loans comprise 44% of the total loan portfolio. Most of the business
      banking loans are secured with collateral such as commercial property, business
      inventories, accounts receivable, equipment and personal property of the
      borrowers and/or guarantors. At December 31, 2006, $22.3 million in commercial
      real estate loans were unsecured. Home equity loans and Lines of Credit account
      for the majority of the consumer loan portfolio.


Real
      estate loans originated by the Corporation are generally secured by no less
      than
      80% of the lesser of the appraised value or purchase price of the underlying
      property. The Corporation currently requires first mortgage, residential
      customers to obtain private mortgage insurance on all loans above an 80%
      loan-to-value ratio.


Loans
      are
      stated at principal amounts outstanding, net of deferred loan fees and
      costs.


Loans
      that management has the intent and ability to hold for the foreseeable future
      or
      until maturity or pay-off generally are reported at their outstanding unpaid
      principal balances adjusted for charge-offs, the allowance for loan losses,
      and
      any deferred fees or costs on originated loans. Interest income is accrued
      on
      the unpaid principal balance.




*Interest
      Income*


Interest
      is accrued only if deemed collectible. Accrual of interest income is generally
      discontinued when a loan becomes 90 days past due and accrued interest amounts
      are reversed. Once interest has been paid to date or management considers the
      loan to be fully collectible, it is returned to accrual status.


Loan
      origination fees and certain direct origination costs are deferred and amortized
      as an adjustment of the loans' yield over the contractual life of the loan
      using
      the interest method. In the event loans are sold, the remaining net deferred
      loan origination fees or costs are recognized as a component of the gains or
      losses on the sale of loans. When portfolio loans pay off before their
      contractual maturity, the remaining deferred fees or costs are recognized as
      interest income or expense.


Loan
      commitment fees are deferred until loans are funded, at which time they are
      amortized into interest income using the effective interest method. If the
      commitment period expires, the fees are recognized as service
      charges.




*Impairment
      of Loans and Allowance for Loan Losses*


The
      allowance for loan losses is established as losses are estimated to have
      occurred through a provision for loan losses charged to earnings. Loan losses
      are charged against the allowance when management believes the uncollectibility
      of a loan balance is confirmed. Subsequent recoveries, if any, are credited
      to
      the allowance.


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


The
      allowance consists of specific, general and unallocated components. The specific
      component relates to loans that are classified as either doubtful, substandard
      or special mention. For such loans that are also classified as


impaired,
      an allowance is established when the discounted cash flows (or collateral value
      or observable market price) of the impaired loan is lower than the carrying
      value of that loan. The general component covers nonclassified loans and is
      based on historical loss experience adjusted for qualitative factors. An
      unallocated component is maintained to cover uncertainties that could affect
      management’s estimate of probable losses. The unallocated component of the
      allowance reflects the margin of imprecision inherent in the underlying
      assumptions used in the methodologies for estimating specific and general losses
      in the portfolio.


A
      loan is
      considered impaired when, based on current information and events, it is
      probable that the Corporation will be unable to collect the scheduled payments
      of principal or interest when due according to the contractual terms of the
      loan
      agreement. Factors considered by management in determining impairment include
      payment status, collateral value, and the probability of collecting scheduled
      principal and interest payments when due. Loans that experience insignificant
      payment delays and payment shortfalls generally are not classified as impaired.
      Management determines the significance of payment delays and payment shortfalls
      on a case-by-case basis, taking into consideration all of the


26


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





circumstances
      surrounding the loan and the borrower, including the length of the delay, the
      reasons for the delay, the borrower’s prior payment record, and the amount of
      the shortfall in relation to the principal and interest owed. Impairment is
      measured on a loan-by-loan basis for commercial and construction loans by either
      the present value of expected future cash flows discounted at the loan’s
      effective interest rate, the loan’s obtainable market price, or the fair value
      of the collateral if the loan is collateral dependent.


Large
      groups of smaller balance homogeneous loans are collectively evaluated for
      impairment. Accordingly, the Corporation does not separately identify individual
      consumer and residential loans for impairment disclosures, unless such loans
      are
      the subject of a restructuring agreement.


Management
      believes the allowance for losses on loans is adequate. While management uses
      available information to recognize losses on these assets, future additions
      to
      the allowances will be necessary based on


changes
      in economic conditions, particularly in the western Washington region. In
      addition, various regulatory agencies, as an integral part of their examination
      process, periodically review the Corporation’s allowances for losses on loans.
      Such agencies may require the Corporation to recognize additions to the
      allowances, or change valuations, based on their judgments about information
      available to them at the time of their examinations.





**(m)
      Sales of Loans**


Any
      loan
      that management determines will not be held-to-maturity is classified as
      held-for-sale at the time of origination. Loans
      originated and designated as held-for-sale are intended for sale in the
      secondary market and are carried at the lower of cost or estimated fair value
      in
      the aggregate. Gains or losses on the sale of such loans are based on the
      specific identification method. Net unrealized losses, if any, are recognized
      through a valuation allowance by charges to income. The Bank held $311 in loans
      held for sale at December 31, 2006, and $539 loans held for sale at December
      31,
      2005. L oans
      are
      sold without recourse on a best efforts, servicing released basis. In December
      2006, the Bank sold $34.1 million in commercial and multifamily loans in which
      the servicing was retained.





**(n)
      Securities**


Debt
      and
      equity securities, including MBS, may be classified as trading,
      available-for-sale, or held-to-maturity. Securities classified as trading are
      carried at fair value with unrealized gains and losses reported in earnings.
      Securities available-for-sale are carried at fair value, with unrealized gains
      and losses reported as a component of other comprehensive income. Investment
      securities held-to-maturity are carried at amortized cost or principal balance,
      adjusted for amortization of premiums and accretion of discounts. Amortization
      of premiums and accretion of discounts are calculated using a method that
      approximates the level yield method. The Corporation has the ability, and it
      is
      management’s intention, to hold held-to-maturity securities until maturity. Investments
      with fair values that are less than the amortized cost are considered impaired.
      Impairment may result from either a decline in the financial condition of the
      issuing entity or, in the case of fixed interest rate investments, from rising
      interest rates. At
      each
      financial statement date, management
      assesses each investment to determine if impaired investments are temporarily
      impaired or if the impairment is other-than-temporary based upon the positive
      and negative evidence available. Evidence evaluated includes, but is not limited
      to, industry analyst reports, credit market conditions, interest rate trends,
      and the intent and ability of the Corporation to retain its investment in the
      issuer for a period of time sufficient to allow for any anticipated recovery
      of
      fair value. If negative evidence outweighs positive evidence that the carrying
      amount is recoverable within a
      reasonable period of time, the impairment is deemed to be other-than-temporary
      and the security is written down in earnings as a realized loss in the period
      in
      which such determination is made. Gains and losses on the sale of securities
      are
      recorded on the settlement date and are determined based on the specific
      identification method.





**(o)
      Real Estate Owned**


Real
      estate owned includes real estate acquired in settlement of loans. Real estate
      owned is recorded at the lower of cost or fair value, based upon the most recent
      appraisal, less estimated costs to sell. Development, improvement and direct
      holding costs related to the property are capitalized. Any loss recorded at
      the
      time a foreclosure occurs is classified as a charge-off against the allowance
      for loan losses. Losses that result from the ongoing periodic valuation of
      these
      properties are charged to operations in the period in which they are identified.
      Real estate owned at December 31, 2006, and December 31, 2005, was $0, and
      $0,
      respectively.





**(p)
      Premises and Equipment**


Land
      is
      carried at cost. Buildings and equipment are stated at cost less accumulated
      depreciation. Straight-line depreciation is provided over the estimated useful
      lives of the respective assets. Leasehold improvements are amortized
      over the estimated useful lives of the improvements, or terms of the related
      leases, whichever is shorter.


27


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)* ****





**(q)
      Income Taxes**


We
      account for income taxes in accordance with SFAS No. 109 “Accounting
      for Income Taxes” (“SFAS 109”), under the liability method which requires
      recognition of deferred tax assets and liabilities for the expected future
      income tax consequences of transactions that have been included in the
      Consolidated Financial Statements. Under this method, deferred tax assets and
      liabilities are determined based on the difference between the financial
      statement and tax basis of assets and liabilities using enacted tax rates in
      effect for the year in which the differences are expected to reverse. When
      circumstances warrant, we assess the likelihood that our net deferred tax assets
      will more likely than not be recovered from future projected taxable
      income.





**(r)
      Stock-Based Compensation**


The
      Corporation previously accounted for its stock option plan in accordance with
      the provisions of Accounting


Principles
      Board (APB) Opinion No. 25, *Accounting
      for Stock Issued to Employees* .
      Effective January 1, 2006, the Corporation adopted Statement of Financial
      Accounting Standards No. 123 (revised 2004), *“Share-Based
      Payment,”* (“SFAS
      123(R)”) using the modified prospective method. Statement 123(R) requires all share-based payments to employees, including
      grants of employee stock options, to be recognized in the income statement
      based
      on their fair values. See Note 15 to the Consolidated Financial Statements
      for a
      further discussion on stock-based compensation.





**(s)
      Interest Rate Swap Agreements**


For
      asset/liability management purposes, the Corporation uses interest rate swap
      agreements to hedge various exposures or to modify interest rate characteristics
      of various instruments. Interest rate swaps are contracts in which a series
      of
      interest rate flows are exchanged over a prescribed period. The notional amount
      on which the interest payments are based is not exchanged. Such derivatives
      are
      linked to specific assets or liabilities, and have high correlation between
      the
      contract and the underlying item being hedged, both at inception and throughout
      the hedge period.


Interest
      rate swap agreements are utilized to convert a portion of variable-rate debt
      to
      a fixed-rate (cash flow hedge), or to convert a portion of fixed-rate assets
      to
      a variable-rate (fair value hedge).


Under
      SFAS No. 133, as amended, the gain or loss on a swap designated and qualifying
      as a fair value hedging instrument, as well as the offsetting gain or loss
      on
      the hedged item attributable to the risk being hedged, is recognized currently
      in earnings in the same accounting period. The effective portion of the gain
      or
      loss on a swap designated and


qualifying
      as a cash flow hedging instrument is reported as a component of other
      comprehensive income. The ineffective portion of the gain or loss on the swap
      instrument, if any, is recognized in current earnings.


Interest
      rate derivative financial instruments receive hedge accounting treatment only
      if
      they are designated as a hedge and are expected to be, and are, effective in
      substantially reducing interest rate risk arising from the assets and
      liabilities. Those swaps that do not meet the hedging criteria discussed below
      would be recorded at fair value with changes in fair value recorded in current
      income. Swaps must meet specific effectiveness tests (e.g., over time the change
      in their fair values due to the designated hedge risk must be within 80 to
      125
      percent of the opposite change in the fair values of the hedged assets or
      liabilities). If periodic assessment indicates derivatives no longer provide
      an
      effective hedge, the derivatives contracts would be closed out and settled
      or
      mark-to-market through income.


Beginning
      January 1, 2001, in accordance with SFAS No. 133, hedges of variable-rate debt
      are accounted for as cash flow hedges, with changes in fair value recorded
      in
      derivative assets or liabilities and other comprehensive income. The net
      settlement (upon close out or termination) that offsets changes in the value
      of
      the hedged debt is deferred and amortized into net interest income over the
      life
      of the hedged debt. Hedges of fixed-rate assets are accounted for as fair value
      hedges, with changes in fair value recorded in derivative assets or liabilities
      and interest income. The net settlement (upon close out or termination) that
      offsets changes in the value of the assets adjusts the basis of the assets
      and
      is deferred and amortized to interest income over the life of the assets. The
      portion, if any, of the net settlement amount that did not offset changes in
      the
      value of the hedged asset or liability is recognized immediately in noninterest
      income.


Cash
      flows resulting from the derivative financial instruments that are accounted
      for
      as hedges of assets and liabilities are classified in the cash flow statement
      in
      the same category as the cash flows of the items being hedged.


Derivative
      financial instruments are recognized as assets and liabilities on the
      consolidated balance sheet and measured at fair value.





**(t)
      Off-Balance Sheet Credit Related Financial Instruments**


In
      the
      ordinary course of business, the Corporation enters into commitments to extend
      credit, including commitments under lines of credit, bank cards, letters of
      credit, and standby letters of credit and guarantees. Such financial instruments
      are recorded when they are funded.





**(u)
      Bank Owned Life Insurance (BOLI)**


The
      carrying amount of BOLI approximates its fair value, net of any surrender
      charges. Fair value of BOLI is estimated using the cash surrender
      value.


28


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





**(v)
      Reclassifications**


Certain
      balances have been reclassified to conform to the 2005
      presentation.





**(w)
      Earnings Per Share**


Basic
      earnings per share represents income available to common stockholders divided
      by
      the weighted-average number of common shares outstanding during the period.
      Diluted earnings per share reflects additional common shares that would have
      been outstanding if dilutive potential common shares had been issued, as well
      as
      any adjustment to income that would result from the assumed issuance. Potential
      common shares that may be issued by the Corporation relate solely to outstanding
      stock options, and are determined using the treasury stock method.





**(x)
      Recent Accounting Pronouncements**


In
      September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined
      Benefit Pension and other Post-retirement Plans —
An
      A mendment
      of FASB Statements No. 87, 88, 106, and 132(R)." This Statement improves
      financial reporting by requiring an employer to recognize the overfunded or
      underfunded status of a defined benefit post-retirement plan as an asset or
      liability in its statement of financial position and to recognize changes in
      that funded status in the year in which the changes occur through comprehensive
      income of a business entity or changes in unrestricted net assets of a
      not-for-profit organization. This Statement also improves financial reporting
      by
      requiring an employer to measure the funded status of a plan as of the date
      of
      its year-end statement of financial position, with limited exceptions. An
      employer with publicly traded equity securities is required to initially
      recognize the funded status of a defined benefit post-retirement plan and to
      provide the required disclosures as of the end of the fiscal year ending after
      December 15, 2006. The requirement to measure plan assets and benefit
      obligations as of the date of the employer's fiscal year-end statement of
      financial position is effective for fiscal years ending after December 15,
      2008.
      SFAS No. 158 is not expected to have a material impact on the
      Company.


In
      September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." This
      Statement defines fair value, establishes a framework for measuring fair value
      in generally accepted accounting principles, and expands disclosures about
      fair
      value measurements. This Statement applies under other accounting pronouncements
      that require or permit fair value measurements. Accordingly, this Statement
      does
      not require any new fair value measurements. This Statement is effective for
      financial statements issued for fiscal years beginning after November 15, 2007,
      and interim periods within those fiscal years. SFAS No. 157 is not expected
      to
      have a material impact on the Company.


In
      June
      2006, the FASB issued Interpretation No. 48 “Accounting for Uncertainty in
      Income Taxes — An Interpretation of FASB Statement No. 109”
(“FIN 48”). FIN 48 is effective as of the beginning of the first
      annual period beginning after December 15, 2006. FIN 48 defines the
      threshold for recognizing the tax benefits of a tax return filing position
      in
      the financial statements as “more-likely-than-not” to be sustained by the taxing
      authority. This is different than the accounting practice currently followed
      by
      the Company, which is to recognize the best estimate of the impact of a tax
      position only when the position is “probable” of being sustained on audit based
      solely on the technical merits of the position. The term “probable” is
      consistent with the use of the term in SFAS No. 5 “Accounting for
      Contingencies,” to mean that “the future event or events are likely to occur.”
Cascade has analyzed its tax positions and does not believe that any tax
      positions would not rise to the level of more likely than not and therefore
      FIN
      48 is not expected to have a material impact on the Company.





**(2)
      Restricted Assets**


Federal
      Reserve Board regulations require that the Bank maintain certain minimum reserve
      balances as either cash on hand, in the vault or on deposit with the Federal
      Reserve Bank. The minimum reserve balance as of December 31,


2006,
      and
      2005, was approximately $5,629 and $3,494, respectively.





**(3)
      Securities**


A
      summary
      of securities at December 31, 2006, and December 31, 2005, follows:




**DECEMBER
                31, 2006****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**
              **VALUE**Securities
                available-for-saleMBS
            
            $
            38,428
            
            $
            47
            
            $
            3
            
            $
            (18
            )
            $
            (713
            )
            $
            37,747Agency
                notes
            
            
            95,772
            
            
            -
            
            
            -
            
            
            -
            
            
            (2,863
            )
            
            92,909$
            134,200
            
            $
            47
            
            $
            3
            
            $
            (18
            )
            $
            (3,576
            )
            $
            130,656





29


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*




**DECEMBER
                  31, 2006****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**
                **VALUE**Securities
                  held-to-maturityMBS
              
              $
              25,218
              
              $
              7
              
              $
              -
              
              $
              (14
              )
              $
              (873
              )
              $
              24,338Agency
                  notes
              
              
              70,853
              
              
              -
              
              
              -
              
              
              (24
              )
              
              (2,406
              )
              
              68,423Corporate/other
              
              
              775
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              775$
              96,846
              
              $
              7
              
              $
              -
              
              $
              (38
              )
              $
              (3,279
              )
              $
              93,536






**DECEMBER
                31, 2005****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**
              **VALUE**Securities
                available-for-saleMBS
            
            $
            47,847
            
            $
            16
            
            $
            14
            
            $
            (71
            )
            $
            (383
            )
            $
            47,423Agency
                notes
            
            
            95,822
            
            
            -
            
            
            -
            
            
            (2,258
            )
            
            (391
            )
            
            93,173$
            143,669
            
            $
            16
            
            $
            14
            
            $
            (2,329
            )
            $
            (774
            )
            $
            140,596





**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**
              **VALUE**Securities
                held-to-maturityMBS
            
            $
            23,830
            
            $
            -
            
            $
            8
            
            $
            (188
            )
            $
            (601
            )
            $
            23,049Agency
                notes
            
            
            70,827
            
            
            -
            
            
            -
            
            
            (376
            )
            
            (1,845
            )
            
            68,606Corporate/other
            
            
            465
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            465$
            95,122
            
            $
            -
            
            $
            8
            
            $
            (564
            )
            $
            (2,446
            )
            $
            92,120





At
      December 31, 2006, Cascade had 31 securities with a gross unrealized loss
      totaling $3.6 million in our available-for-sale portfolio with a fair value
      of
      $113.0 million that had an unrealized loss for greater than one year and 21
      held-to-maturity securities with a gross unrealized loss totaling $3.3 million
      with a fair value of $87.0 million that have had an unrealized loss for more
      than one year. The majority of the impairment on available-for-sale securities
      was in the Agency Notes category, which accounted for 81% of the total
      impairment. As of December 31, 2006, the Bank had 35 available-for-sale and
      23
      held-to-maturity securities included in the temporarily impaired report,
      compared to 5 available-for-sale and 3 held-to-maturity with unrealized gains.
      The temporary impairment was less than 3% of the total book value of
      investments. Temporarily impaired securities are a result of an increase in
      interest rates and are expected to regain their value as the securities near
      maturity and/or market rates decline; other-than-temporarily impaired securities
      are a result of contractual failure by the issuer and are not expected to
      rebound and are considered not collectable. At December 31, 2006, the Bank
      had
      no securities with other-than-temporary impairments.


Certain
      investment securities shown above currently have fair values less than amortized
      cost and therefore contain unrealized losses. The Corporation has evaluated
      these securities and has determined that the decline in value is temporary
      and
      is related to the change in market interest rates since purchase. All are rated
      AAA for credit quality by at least one major rating agency. The decline in
      value
      is not related to any company or industry specific event. The Corporation
      anticipates full recovery of amortized cost with respect to these securities
      at
      maturity or sooner in the event of a more favorable market interest rate
      environment.


As
      of
      December 31, 2006, and 2005, the Corporation was required to maintain 79,050
      and
      100,122 shares, respectively, of $100 par value FHLB stock.


Accrued
      interest receivable on securities and interest-bearing deposits was $2,318
      and
      $2,214 at December
      31, 2006, and 2005, respectively.


Proceeds
      from the sale of securities available-for-sale including calls on securities
      held-to-maturity and gross realized gains and losses are summarized as follows
      for the year ended December 31, 2006, 2005, and 2004.


30


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)* ****




**PROCEEDS**
              
              **GAINS**
              
              **LOSSES**Year
                  ended December 31, 2006
              
              $
              -
              
              $
              -
              
              $
              -Year
                  ended December 31, 2005
              
              
              6,488
              
              
              68
              
              
              (1
              )Year
                  ended December 31, 2004
              
              
              153,356
              
              
              510
              
              
              -





The
      following table shows the contractual or expected maturities of the
      Corporation’s securities available-for-sale at December 31, 2006:




**WITHIN
                  ONE**
              
              **ONE
                  TO**
              
              **OVER
                  FIVE TO**
              
              **OVER
                  TEN****YEAR**
              
              **FIVE
                  YEARS**
              
              **TEN
                  YEARS**
              
              **YEARS**
              
              **TOTAL**Amortized
                  CostMBS
              
              $
              1,464
              
              $
              28,991
              
              $
              6,010
              
              $
              1,963
              
              $
              38,428Agency
                  notes
              
              $
              -
              
              $
              47,970
              
              $
              47,747
              
              $
              55
              
              $
              95,772Total
                  amortized cost
              
              $
              1,464
              
              $
              76,961
              
              $
              53,757
              
              $
              2,018
              
              $
              134,200Fair
                  ValueMBS
              
              $
              1,462
              
              $
              28,630
              
              $
              5,841
              
              $
              1,814
              
              $
              37,747Agency
                  notes
              
              $
              -
              
              $
              47,125
              
              $
              45,729
              
              $
              55
              
              $
              92,909Total
                  fair value
              
              $
              1,462
              
              $
              75,755
              
              $
              51,570
              
              $
              1,869
              
              $
              130,656




The
      following table shows the contractual or expected maturities of the
      Corporation’s securities held-to-maturity at December 31, 2006:




**WITHIN
                  ONE**
              
              **ONE
                  TO**
              
              **OVER
                  FIVE TO**
              
              **OVER
                  TEN****YEAR**
              
              **FIVE
                  YEARS**
              
              **TEN
                  YEARS**
              
              **YEARS**
              
              **TOTAL**Amortized
                  CostMBS
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              25,218
              
              $
              25,218Agency
                  notes
              
              
              -
              
              
              16,000
              
              
              17,898
              
              
              36,955
              
              
              70,853Corporate/other
              
              
              -
              
              
              -
              
              
              -
              
              
              775
              
              
              775Total
                  amortized cost
              
              $
              -
              
              $
              16,000
              
              $
              17,898
              
              $
              62,948
              
              $
              96,846Fair
                  ValueMBS
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              24,338
              
              $
              24,338Agency
                  notes
              
              
              -
              
              
              15,717
              
              
              17,390
              
              
              35,316
              
              
              68,423Corporate/other
              
              
              -
              
              
              -
              
              
              -
              
              
              775
              
              
              775Total
                  fair value
              
              $
              -
              
              $
              15,717
              
              $
              17,390
              
              $
              60,429
              
              $
              93,536




Securities
      are classified based upon contractual maturity dates. Actual maturities may
      differ from contractual maturities because the borrowers have the right to
      prepay their obligations. The fair value of securities pledged as collateral
      to
      secure public deposits were $54.2 million at December 31, 2006, and $17.0
      million at December 31, 2005. The fair value of securities of $41.0 million
      were
      pledged to the FHLB at December 31, 2006, and $99.6 million at December 31,
      2005. The fair value of securities pledged to fund repurchase agreements were
      $109.1 million at December 31, 2006, and $57.2 million at December 31, 2005.
      The
      fair value of securities of $956 was also pledged to third parties as collateral
      for derivative contracts at December 31, 2006.





**(4)
      Loans and Allowance for Loan Losses**


A
      summary
      of loans at December 31, 2006, and 2005, follows:




**DECEMBER
                  31,**
              
              **DECEMBER
                  31,****2006**
              
              **2005**Residential
              
              $
              96,350
              
              $
              95,429Multifamily
              
              
              34,719
              
              
              52,057Commercial
                  real estate
              
              
              119,298
              
              
              141,109Construction(1)
              
              
              289,993
              
              
              165,957Business
                  banking
              
              
              442,391
              
              
              394,034Consumer
              
              
              27,686
              
              
              32,160Total
                  loans
              
              
              1,010,437
              
              
              880,746Deferred
                  loan fees, net
              
              
              (3,434
              )
              
              (3,443
              )Allowance
                  for loan losses
              
              
              (10,988
              )
              
              (10,254
              )Loans
              
              $
              996,015
              
              $
              867,049Loans
                  serviced for others
              
              $
              39,032
              
              $
              15,598




*(1)
      Construction loans are net of loans in process*





31


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)* ****





The
      increase in loans serviced for others was due to a $34.1 million sale of
      multifamily and commercial loans in December.


Accrued
      interest on loans was $5,281 and $4,078 at December 31, 2006, and December
      31,
      2005, respectively. Loans to officers and directors totaled $311 at December
      31,
      2006, $300 at December 31, 2005, and $2.7 million at December 31, 2004.
      Repayments totaling $6, $39, and $502 were received and additional advances
      of
      $17, $17, and $0 were made for the years ended December 31, 2006, 2005, and
      2004, respectively. Additionally, in 2006, $2.3 million in loans were excluded
      since the director previously included was no longer affiliated with the
      Bank.


At
      December 31, 2006, the composition of the loan portfolio was as
      follows:




**FIXED**
              
              **VARIABLE**
              
              **ADJUSTABLE****RATE**
              
              **RATE*****(1)***
              
              **RATE**Term
                  to maturityLess
                  than one year
              
              $
              22,809
              
              $
              209,602
              
              $
              7,8741-3
                  years
              
              
              74,309
              
              
              98,842
              
              
              11,3633-5
                  years
              
              
              41,101
              
              
              834
              
              
              13,6235-10
                  years
              
              
              111,120
              
              
              19,121
              
              
              234,70210-20
                  years
              
              
              6,740
              
              
              4,041
              
              
              25,053Over
                  20 years
              
              
              5,684
              
              
              13,338
              
              
              110,281Total
              
              $
              261,763
              
              $
              345,778
              
              $
              402,896




*(1)*
            *Variable
                includes all Prime, LIBOR, or Treasury indexed loans with a repricing
                frequency of three months or
                less*





Nonaccrual
      loans totaled $851, $1,987, and $532, respectively, at December 31, 2006,
      December 31, 2005, and December 31, 2004. If interest on these loans had been
      recognized, such income would have been $27, $82, and $2 respectively, for
      the
      periods ended December 31, 2006, 2005, and 2004. The Corporation has no
      commitments to extend additional credit on loans that are nonaccrual. At
      December 31, 2006, 2005, and 2004, loans totaling $9,396, $17,485, and $9,319,
      were adversely classified loans, for which there were $46 in allocated
      allowances. The $46 allocated allowance was on one loan with a principal balance
      of $105. Of the adversely classified loans, $223, $1,511, and $166 were under
      foreclosure. The average balance of adversely classified loans for the year
      ended December 31, 2006, and December 31, 2005, respectively, was $13,826,
      and
      $13,130 and the Corporation recognized $759, and $760 of related interest income
      on such loans during the time such loans were adversely classified.


At
      December 31, 2006, 2005, and 2004, impaired loans totaled $859, $1,987, and
      $644, respectively. The average balance during the years ended December 31,
      2006, 2005 and 2004 were $796, $1,226, and $1,089, respectively. The allowance
      for loan losses related to these loans was approximately $401 in 2006, $801
      in
      2005, and $269 in 2004. Interest collected on these loans in cash and included
      in income was not considered significant for 2006, 2005, and 2004. If interest
      on these loans had been accrued, the additional amount of such income would
      not
      have been significant for 2006, 2005, and 2004. At December 31, 2006, there
      were
      no commitments to lend additional funds to borrowers whose loans were classified
      as impaired.


At
      December 31, 2006, and December 31, 2005, the Bank had no loans that were 90
      days or more past due and still accruing.


At
      December 31, 2006, the Corporation had outstanding commitments of $4,541 to
      fund
      loans with fixed interest rates and $16,871 for loans with adjustable
      rates.


The
      Corporation had non-mandatory forward commitments totaling $364 and $157 to
      sell
      loans into the secondary market at December 31, 2006, and December 31, 2005,
      respectively.


Commitments
      to extend credit are agreements to lend to a customer as long as there is no
      violation of any condition established in the contract. Commitments generally
      have fixed expiration dates or other termination clauses and may require payment
      of a fee. Since many of the commitments are expected to expire without being
      drawn upon, the total commitment amounts do not necessarily represent future
      cash requirements. While approximately 100% of commercial letters of credit
      are
      utilized, a significant portion of such utilization is on an immediate payment
      basis. The Bank evaluates each customer's creditworthiness on a case-by-case
      basis. The amount of collateral obtained, if it is deemed necessary by the
      Bank
      upon extension of credit, is based on management's credit evaluation of the
      borrower. Collateral held varies but may include accounts receivable, inventory,
      property, plant and equipment, and income-producing commercial
      properties.


Unfunded
      commitments under commercial Lines of Credit, revolving credit lines and loans
      in process are commitments for possible future extensions of credit to existing
      customers.


Standby
      letters of credit and financial guarantees written are conditional commitments
      issued by the Bank to guarantee the performance of a customer to a third party.
      Those guarantees are primarily issued to support public and private borrowing
      arrangements, bond financing, and similar transactions. The Bank underwrites
      its
      standby letters of credit using its policies and procedures applicable to loans
      in general. Standby letters of credit are made on an unsecured and secured
      basis. The Bank has not been required to perform on any financial guarantees
      during the past two years. The Bank did not incur any significant losses on
      its
      commitments in 2006 or 2005.


32


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





At
      December 31, 2006, and 2005, the following financial instruments with
      off-balance sheet risk were outstanding:


**2006**
              
              **2005**Commitments
                  to grant loans(1)
              
              $
              18,203
              
              $
              26,742Unfunded
                  commitments under lines of credit/loans in process
              
              
              196,902
              
              
              189,573Standby
                  letters of credit and financial guarantees written
              
              
              4,924
              
              
              5,241Unused
                  commitments on bankcards
              
              
              12,751
              
              
              11,873Total
              
              $
              232,780
              
              $
              233,429




*(1)*
            *Excludes
                $3.2 million in commitments to originate/sell loans into the secondary
                market as of December 31, 2006, and $197 as of December 31,
                2005*





A
      summary
      of the allowance for losses on loans follows:




**YEARS
                  ENDED DECEMBER 31,****2006**
              
              **2005**
              
              **2004**Balances
                  at beginning of year
              
              $
              10,254
              
              $
              9,563
              
              $
              7,711Issaquah
                  Bank allowance assumed
              
              
              -
              
              
              -
              
              
              1,395Provision
                  for loss
              
              
              1,000
              
              
              945
              
              
              675Recoveries
              
              
              148
              
              
              266
              
              
              223Charge-offs
              
              
              (414
              )
              
              (520
              )
              
              (441
              )Balances
                  at end of year
              
              $
              10,988
              
              $
              10,254
              
              $
              9,563




**(5)
      Premises and Equipment**


A
      summary
      of premises and equipment follows:




**ESTIMATED**
              
              **DECEMBER
                  31,**
              
              **DECEMBER
                  31,****USEFUL
                  LIVES**
              
              **2006**
              
              **2005**Land
              
              
              
              
              $
              2,577
              
              $
              2,577Buildings
              
              
              40
                  years
              
              
              10,936
              
              
              10,703Leasehold
                  improvements
              
              
              Lease
                  term
              
              
              2,229
              
              
              2,186Furniture
                  and equipment
              
              
              2-10
                  years
              
              
              14,679
              
              
              13,30530,421
              
              
              28,771Accumulated
                  depreciation and amortization
              
              
              
              
              
              (18,418
              )
              
              (16,501
              )$
              12,003
              
              $
              12,270




Total
      depreciation and amortization expense was $1,917, $1,874, and $1,553 for the
      years ended December 31, 2006, 2005, and 2004, respectively.


The
      Bank
      leases space for various branches. These leases run for a period ranging from
      2
      to 12 years and allow for established rent increases each year. Generally these
      leases require the Bank to pay all taxes, maintenance and utility costs, as
      well
      as maintain certain types of insurance. The annual lease commitments at December
      31, 2006, are as follows:




Years
                ending December 31,
            
            
            2007
            
            $
            6932008
            
            
            6932009
            
            
            6932010
            
            
            6642011
            
            
            664Thereafter
            
            
            6,796$
            10,203





Rental
      expense charged to operations was approximately $693, $642, and $482 for the
      years ended December 31, 2006, 2005, and 2004, respectively.





**(6)
      Deposits**


Deposits
      at December 31, 2006, and 2005, are summarized as follows:




**DECEMBER
                  31,**
              
              **DECEMBER
                  31,****2006**
              
              **2005**Noninterest-bearing
                  checking accounts
              
              $
              87,456
              
              $
              80,402Interest-bearing
                  checking accounts
              
              
              52,051
              
              
              40,066Money
                  market deposit accounts
              
              
              275,286
              
              
              181,621Savings
                  accounts
              
              
              15,158
              
              
              15,169Certificates
                  of deposit
              
              
              425,498
              
              
              478,510$
              855,449
              
              $
              795,768





33


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





Time
      deposit accounts in amounts of $100 thousand or more totaled $257.0 million
      and
      $294.2 million at December 31, 2006, and December 31, 2005,
      respectively. **** Deposits
      by executive officers and directors totaled $2.3 million at December 31, 2006,
      and $4.0 million at December 31, 2005.


**DEPOSIT
                  ACCOUNTS****WEIGHTED
                  AVERAGE**
              
              **WITH
                  BALANCES**
              
              **ACCRUED
                  INTEREST****INTEREST
                  RATE**
              
              **IN
                  EXCESS**
              
              **PAYABLE
                  ON****ON
                  DEPOSITS**
              
              **OF
                  $100,000**
              
              **DEPOSITS**December
                  31, 2006
              
              
              3.86
              %
              $
              552,522
              
              $
              5,176December
                  31, 2005
              
              
              2.89
              
              
              479,480
              
              
              1,952





A
      summary
      of interest expense on deposits follows:


**YEARS
                  ENDED DECEMBER 31,****2006**
              
              **2005**
              
              **2004**Checking
                  and money market accounts
              
              $
              9,160
              
              $
              3,500
              
              $
              1,965Savings
                  accounts and time deposits
              
              
              19,416
              
              
              14,814
              
              
              9,194$
              28,576
              
              $
              18,314
              
              $
              11,159


Maturities
      of time deposits at December 31, 2006, are as follows:


Years
                  ending December 31,
              
              
              2007
              
              $
              381,3052008
              
              
              33,3782009
              
              
              5,0982010
              
              
              3,8452011
              
              
              1,172Thereafter
              
              
              700$
              425,498





**(7)
      Junior Subordinated Debentures Payable (Trust Preferred
      Securities)**


On
      March
      1, 2000, $10.3 million of 11% junior subordinated debentures payable due March
      1, 2030, were issued by a wholly owned business Trust whose common equity is
      100% owned by Cascade Financial Corporation, Cascade Capital Trust I. The Trust
      exists for the exclusive purposes of issuing and selling the junior subordinated
      debentures payable, using the proceeds from the sale of the capital securities
      to acquire junior subordinated debentures payable, issued by Cascade Financial
      Corporation, and engaging in only those other activities necessary, advisable
      or
      incidental to the above. The Corporation used the proceeds for general corporate
      purposes including stock repurchases and investment in its subsidiary bank.
      As a
      result of the adoption of FIN 46R, we deconsolidated the Trust and all periods
      in the consolidated financial statements have been restated to reflect this
      change. The $10.3 million of junior subordinated debentures payable issued
      by
      the Corporation to the Trust were reflected as junior subordinated debentures
      payable in the consolidated balance sheet at December 31, 2005, and 2004. The
      junior subordinated debentures payable will mature on March 1, 2030 unless
      redeemed prior to such date if certain conditions are met. The Trust will redeem
      the trust preferred securities when we pay the junior subordinated debentures
      payable at maturity or upon any earlier redemption of the junior subordinated
      debentures payable.


In
      October 2003, Cascade entered into an interest rate swap agreement with a third
      party as a hedge of the interest rate on the Corporation’s junior subordinated
      debentures payable. Under the terms of the agreement, Cascade received an 11%
      fixed-rate and paid a floating-rate of USD-six month LIBOR-BBA plus 520 basis
      points. The unrealized loss on the interest rate swap was $253 as of December
      31, 2005. The swap was terminated in December 2006 at a loss of
      $150.


On
      December 15, 2004, the Corporation issued $5.2 million in junior subordinated
      debentures payable, Cascade Capital Trust II. These securities have a fixed
      coupon of 5.82% for the first 5 years and then float at 3-month LIBOR plus
      1.90%
      for the remaining 25 years. The securities are callable at par after 5 years.
      These securities are considered Tier 1 capital by financial institution
      regulators.


On
      March
      30, 2006, the Corporation issued an additional $10.3 million in junior
      subordinated debentures payable, Cascade Capital Trust III. These securities
      have a fixed coupon of 6.50% for the first 5 years and then float, if not
      called, at 3-month LIBOR plus 1.40% for the remaining 25 years. These debentures
      are also considered Tier 1 capital for regulatory purposes.


The
      junior subordinated debentures payable issued under Cascade Capital Trust II
      and
      III incorporate the same structure for the same purposes as Cascade Capital
      Trust I.


34


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





**(8)
      FHLB Advances**


FHLB
      advances are summarized as follows:


**DECEMBER
                  31,**
              
              **DECEMBER
                  31,****2006**
              
              **2005****WEIGHTED**
              
              
              
              **WEIGHTED****AVERAGE**
              
              
              
              **AVERAGE****INTEREST**
              
              
              
              **INTEREST****MATURITY
                  DATE**
              
              **AMOUNT**
              
              **RATE**
              
              **AMOUNT**
              
              **RATE**At
                  December 31,2006
              
              $
              -
              
              
              -
              %
              $
              23,000
              
              
              4.65
              %2007*(1)*
              
              
              32,000
              
              
              5.87
              
              
              22,000
              
              
              6.062008
              
              
              2,000
              
              
              3.51
              
              
              2,000
              
              
              3.512009*(2)*
              
              
              39,000
              
              
              5.00
              
              
              39,000
              
              
              4.312010
              
              
              45,000
              
              
              5.83
              
              
              60,000
              
              
              5.322011
              
              
              10,000
              
              
              3.88
              
              
              10,000
              
              
              3.88Thereafter*(3)*
              
              
              115,000
              
              
              4.04
              
              
              80,000
              
              
              3.38$
              243,000
              
              
              4.76
              %
              $
              236,000
              
              
              4.42
              %


*(1)*
            *Includes
                $10,000 tied to 1 month LIBOR*


*(2)*
            *Includes
                $25,000 tied to 3 month LIBOR*


*(3)*
            *Includes
                $65,000 tied to 3 month LIBOR*




**YEARS
                  ENDED DECEMBER 31,****2006**
              
              **2005**Maximum
                  amount of outstanding FHLB advances at any month-end
              
              $
              256,000
              
              $
              251,000Average
                  amount of outstanding FHLB advances during the year
              
              
              237,888
              
              
              239,896


The
      Corporation had $143.0 million in fixed-rate advances as of December 31, 2006,
      where the FHLB has the option to convert these advances to variable-rate
      advances after a specified period.


At
      December 31, 2006, the Bank had an unused Line of Credit from the FHLB-Seattle
      of $231.0 million subject to the availability of eligible collateral. The Bank’s
      credit line with the FHLB-Seattle is 35% of total assets, or up to approximately
      $474.0 million and is subject to certain collateral requirements.


FHLB
      advances are collateralized by otherwise unencumbered permanent residential
      mortgages, investment grade securities, and other eligible real estate
      mortgages. Federal statute requires all members of the FHLB to maintain
      collateral on FHLB borrowings and advances equivalent to the amount borrowed
      on
      a daily basis.





**(9)
      Securities Sold Under Agreements to Repurchase and Lines of
      Credit**


The
      Corporation enters into sales of securities under agreements to repurchase
      (reverse repurchase agreements) that are treated as financing arrangements.
      Accordingly, the obligations to repurchase securities sold are reflected as
      a
      liability in the consolidated balance sheets, and the securities underlying
      the
      agreements remain in the asset accounts. The securities underlying the
      agreements are under the Corporation’s control and are held by nationally known
      government security dealers who are recognized as primary dealers by the Federal
      Reserve Board, or other investment banking firms approved by the Corporation’s
      Board of Directors.


Securities
      sold under agreements to repurchase the same securities consist of agency notes
      and/or mortgage-backed securities summarized as follows:


**UNDERLYING
                  SECURITIES****WEIGHTED**
              
              **BOOK
                  VALUE,****AVERAGE**
              
              **INCLUDING****BALANCE**
              
              **INTEREST**
              
              **ACCRUED**
              
              **MARKET****OUTSTANDING**
              
              **RATE**
              
              **INTEREST**
              
              **VALUE**December
                  31, 2006
              
              $
              95,710
              
              
              1.42
              %
              $
              113,026
              
              $
              109,145December
                  31, 2005
              
              
              51,058
              
              
              1.68
              
              
              58,950
              
              
              57,200




Financial
      data pertaining to repurchase agreements follows:


**YEARS
                  ENDED DECEMBER 31,****2006**
              
              **2005**Maximum
                  amount of outstanding agreements at any month-end
              
              $
              96,007
              
              $
              51,058Average
                  amount of outstanding agreements during the year
              
              
              81,284
              
              
              24,051




35


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





The
      Corporation used $95.0 million of repurchase agreements that adjust to a spread
      under three-month LIBOR for periods ranging from six months to one year and
      then
      adjust to a fixed-rate for the remainder of the agreement unless the lender
      terminates the agreement.


The
      Bank
      has Fed funds borrowing lines with three of its correspondent banks. One line
      is
      for $15.0 million and matures July 1, 2007. The other two facilities are for
      $10.0 million; one matures June 30, 2007, and the other has no maturity date.
      Interest rates for these lines are quoted at the time of borrowing and are
      subject to certain collateral requirements. The Bank used each of these lines
      during the year. The Bank also has the ability to borrow from the Federal
      Reserve Bank of San Francisco based on the amount of collateral pledged. As
      of
      December 31, 2006, there were no outstanding balances on any of these
      lines.




**(10)
      Income Taxes**


Income
      tax expense (benefits) includes the following components:


**YEARS
                  ENDED****DECEMBER
                  31,****2006**
              
              **2005**
              
              **2004**Current
              
              $
              6,297
              
              $
              6,412
              
              $
              5,467Deferred
              
              
              178
              
              
              (150
              )
              
              (100
              )$
              6,475
              
              $
              6,262
              
              $
              5,367





As
      required by SFAS 109, we continually review the likelihood that deferred
      tax assets will be realized in future tax periods under the more likely than
      not
      criteria. In making this judgment SFAS 109 requires that all available
      evidence, both positive and negative, should be considered to determine whether,
      based on the weight of that evidence, a valuation allowance is required. As
      of
      December 31, 2006, we had $4.6 million of deferred tax assets and net
      deferred tax assets (after deferred tax liabilities) of $555 related to the
      U.S.
      tax jurisdictions whose recoverability is dependent upon future profitability.


In
      the
      future, our effective tax rate could be adversely affected by several factors,
      many of which are outside of our control. Our effective tax rate is affected
      by
      the proportion of revenues and income before taxes in the various domestic
      and
      international jurisdictions in which we operate. Further, we are subject to
      changing tax laws, regulations and interpretations in multiple jurisdictions
      in
      which we operate, as well as the requirements, pronouncements and rulings of
      certain tax, regulatory and accounting organizations. We estimate our annual
      effective tax rate each quarter based on a combination of actual and forecasted
      results of subsequent quarters. Consequently, significant changes in our actual
      quarterly or forecasted results may impact the effective tax rate for the
      current or future periods.


For
      the
      year ended December 31, 2006, the Corporation's effective tax rate was 32.7%
      compared to 32.4% for the year ended December 31, 2005. Decreased tax benefits
      related to interest on tax exempt loans and increases in cash surrender value
      of
      bank owned life insurance comprised the significant portion of the differences
      in the effective tax rates between the two years.


Income
      tax expense differs from that computed by applying the U.S. federal income
      tax
      rate of 35% to pretax income for the years ended December 31 st as a
      result of the following:


**2006**
              
              **2005**
              
              **2004**Computed
                  “expected” tax expense
              
              $
              6,941
              
              $
              6,758
              
              $
              5,588Bank
                  owned life insurance (BOLI)
              
              
              (231
              )
              
              (232
              )
              
              (169
              )Tax
                  exempt interest
              
              
              (341
              )
              
              (284
              )
              
              (69
              )Nondeductible
                  acquisition cost
              
              
              -
              
              
              -
              
              
              122Nondeductible
                  option cost
              
              
              101
              
              
              -
              
              
              -Other,
                  net
              
              
              5
              
              
              20
              
              
              (105
              )$
              6,475
              
              $
              6,262
              
              $
              5,367





Under
      certain provisions of the Internal Revenue Code, the Corporation was allowed
      a
      statutory bad debt deduction (based
      upon a percentage of taxable income before such deduction) for additions to
      tax
      bad debt reserves established for the purpose of absorbing losses on loans
      or
      property acquired through foreclosure. This amount represents allocations of
      income to bad debt deductions for tax reporting purposes only. Reduction of
      amounts so allocated for purposes
      other than tax bad debt losses will create income for tax reporting purposes
      only, which will be subject to the then-current corporate income tax
      rate.


36


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





The
      following table presents major components of the net deferred tax asset
      (liability) resulting from differences between financial reporting and tax
      bases
      at December 31, 2006, and December 31, 2005:


**DECEMBER
                  31,**
              
              **DECEMBER
                  31,****2006**
              
              **2005**Deferred
                  tax assets:Securities
                  available-for-sale
              
              $
              1,240
              
              $
              1,075Loans
              
              
              3,316
              
              
              3,087Gross
                  deferred tax assets
              
              
              4,556
              
              
              4,162Deferred
                  tax liabilities:Deferred
                  loan fees
              
              
              (1,660
              )
              
              (1,221
              )Core
                  deposit intangible
              
              
              (267
              )
              
              (317
              )Premises
                  and equipment
              
              
              (203
              )
              
              (204
              )FHLB
                  stock
              
              
              (1,732
              )
              
              (1,732
              )Other
              
              
              (139
              )
              
              (120
              )Gross
                  deferred tax liabilities
              
              
              (4,001
              )
              
              (3,594
              )Net
                  deferred tax asset
              
              $
              555
              
              $
              568





A
      valuation allowance for deferred tax assets was not considered necessary at
      December 31, 2006 or 2005. Management believes the Corporation will fully
      realize its total deferred income tax assets as of December 31, 2006, and 2005,
      based upon its total deferred income tax liabilities, previous taxes paid and
      its current and expected future levels of taxable income.





**(11)
      Acquisition**


On
      June
      3, 2004, the Corporation acquired Issaquah Bancshares, Inc. (“Issaquah”). The
      acquisition was accounted for using the purchase method of accounting and
      accordingly, the assets and liabilities were recorded based on their fair values
      at the acquisition date. Shares of Issaquah were exchanged for cash or cash
      and
      shares of the Corporation. The merger enhances the Corporation’s commercial
      banking franchise by expanding its presence in east King County. Total Issaquah
      assets on June 3, 2004, were approximately $131.0 million and the total value
      of
      the transaction, both cash and stock, was approximately $34.3 million as
      measured under the provisions of FAS 141. The Corporation issued approximately
      1.3 million shares and paid cash of $9.5 million in connection with the merger.
      The Bank booked $26.3 million in intangible assets associated with the
      transaction including $25.2 million in goodwill and a $1.1 million core deposit
      intangible that is amortized under the straight-line method over an eight year
      period of time.


The
      following information presents unaudited pro forma results of operations for
      the
      years ended December 31, 2004 and 2003, as though the Issaquah acquisition
      had
      occurred on January 1, 2003. The pro forma results do not necessarily indicate
      the results that would have been obtained had the acquisition actually occurred
      on January 1, 2003.





**YEARS
                ENDED DECEMBER 31,**
              *(unaudited)*2004
            
            2003Net
                interest income
            
            $
            34,736
            
            $
            32,736Provision
                for credit losses
            
            
            700
            
            
            1,465Noninterest
                income
            
            
            4,983
            
            
            6,030Noninterest
                expense
            
            
            22,818
            
            
            21,075Income
                before provision for income taxes
            
            
            16,201
            
            
            16,226Provision
                for income taxes
            
            
            5,379
            
            
            5,088Net
                income
            
            $
            10,822
            
            $
            11,138Basic
                earnings per share
            
            $
            0.97
            
            $
            0.94Diluted
                earnings per share
            
            $
            0.94
            
            $
            0.92




37


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





The
      fair
      values of the Issaquah assets acquired and liabilities assumed as of June 3,
      2004, were initially recorded as follows:





Investment
                securities
            
            $
            23,087Loans
                and leases, net
            
            
            94,556Premises
            
            
            3,866Goodwill
            
            
            25,195Core
                deposit intangibles
            
            
            1,127Other
                assets
            
            
            825$
            148,656Deposits
            
            $
            101,759Other
                borrowings
            
            
            15,200Other
                liabilities
            
            
            960Acquisition
                cost, net of cash acquired
            
            
            30,737$
            148,656





As
      a
      result of the merger and merger-related activities, the Corporation incurred
      expenses that were classified as merger-related. The components of these charges
      for the year ended December 31, 2004, were as follows:





Professional
                fees
            
            $
            354Other
            
            
            2$
            356





**(12)
      Earnings Per Share**


The
      following table presents EPS information:


**YEARS
                  ENDED****DECEMBER
                  31,****2006**
              
              **2005**
              
              **2004**Net
                  income
              
              $
              13,355
              
              $
              13,046
              
              $
              10,785Common
                  shares outstanding (basic)
              
              
              12,060,191
              
              
              11,977,824
              
              
              11,190,616Effect
                  of dilutive stock options
              
              
              303,007
              
              
              342,049
              
              
              404,674Common
                  shares outstanding (diluted)
              
              
              12,363,198
              
              
              12,319,873
              
              
              11,595,290EPS,
                  basic
              
              $
              1.11
              
              $
              1.09
              
              $
              0.96EPS,
                  diluted
              
              
              1.08
              
              
              1.06
              
              
              0.93





For
      purposes of calculating basic and diluted earnings per share, the numerator
      of
      net income is the same. There were outstanding options to purchase 196,554,
      143,939, and 136,544 shares of common stock at December 31, 2006, December
      31,
      2005, and December 31, 2004, respectively, that are considered non-dilutive
      and
      have been excluded from the above calculation. Non-dilutive options have an
      exercise price that is greater than the current market price of the stock.





**(13)
      Stockholders’ Equity**


**(a)
      Restrictions on Dividends**


Current
      regulations allow the Bank to pay dividends on its stock if its regulatory
      capital would not thereby be reduced below the amount required for the statutory
      capital requirements set by the Federal Deposit Insurance Corporation
      (FDIC).




**(b)
      Regulatory Capital**


The
      Corporation (on a consolidated basis) and the Bank are subject to various
      regulatory capital requirements administered by the federal banking agencies.
      Failure to meet minimum capital requirements can initiate certain mandatory
      and
      possibly additional discretionary actions by regulators that, if undertaken,
      could have a direct material effect on the Corporation's and Bank's financial
      statements. Under capital adequacy guidelines and the regulatory framework
      for
      prompt corrective action, the Corporation and the Bank must meet specific
      capital guidelines that involve quantitative measures of their assets,
      liabilities and certain off-balance-sheet items as calculated under regulatory
      accounting practices. The capital amounts and classification are also subject
      to
      qualitative judgments by the regulators
      about components, risk weightings, and other factors. Prompt corrective action
      provisions are not applicable to bank holding companies.


38


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





Quantitative
      measures established by regulation to ensure capital adequacy require the
      Corporation and the Bank to maintain minimum amounts and ratios (set forth
      in
      the following table) of total and Tier 1 capital (as defined in the


regulations)
      to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to
      average assets (as defined). Management believes, as of December 31, 2006,
      and
      2005, that the Corporation and the Bank met all capital adequacy requirements
      to
      which they are subject. To be
      categorized as well-capitalized, an institution must maintain minimum total
      risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the
      following tables. There are no conditions or events since the notification
      that
      management believes have changed the Bank's category.


At
      December 31, 2006, banking regulations required institutions to have a minimum
      total risk-based capital to risk-weighted assets ratio of 8% and a Tier 1 (core)
      capital to adjusted total assets ratio of 4%.


At
      December 31, 2006, the Bank was in compliance with the regulatory requirements
      for well-capitalized institutions.


As
      of
      December 31, 2006, the most recent notification from the FDIC categorized the
      Bank as well-capitalized under the regulatory framework for prompt corrective
      action. There are no conditions or events since the notification that management
      believes have changed the Bank's category.


**MINIMUM****REQUIREMENTS****FOR
                  CAPITAL**
              
              **WELL-CAPITALIZED****ACTUAL**
              
              **ADEQUACY**
              
              **REQUIREMENTS****CASCADE
                  BANK**
              
              **AMOUNT**
              
              **RATIO**
              
              **AMOUNT**
              
              **RATIO**
              
              **AMOUNT**
              
              **RATIO**December
                  31, 2006:Total
                  risk-based capital to risk-weighted assets(1)
              
              $
              127,132
              
              
              11.20
              %
              $
              90,816
              
              
              8.00
              %
              $
              113,521
              
              
              10.00
              %Tier
                  I (core) capital to risk-weighted assets
              
              
              116,144
              
              
              10.23
              
              
              45,408
              
              
              4.00
              
              
              68,112
              
              
              6.00Tier
                  I (core) capital to average total assets
              
              
              116,144
              
              
              8.96
              
              
              51,850
              
              
              4.00
              
              
              64,813
              
              
              5.00December
                  31, 2005:Total
                  risk-based capital to risk-weighted assets(1)
              
              $
              105,401
              
              
              10.77
              %
              
              78,277
              
              
              8.00
              %
              
              97,846
              
              
              10.00
              %Tier
                  I (core) capital to risk-weighted assets
              
              
              95,147
              
              
              9.72
              
              
              39,138
              
              
              4.00
              
              
              58,707
              
              
              6.00Tier
                  I (core) capital to average total assets
              
              
              95,147
              
              
              8.15
              
              $
              46,718
              
              
              4.00
              
              $
              58,397
              
              
              5.00





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.


**MINIMUM****REQUIREMENTS****FOR
                  CAPITAL**
              
              **WELL-CAPITALIZED****ACTUAL**
              
              **ADEQUACY**
              
              **REQUIREMENTS****CASCADE
                  FINANCIAL CORP**
              
              **AMOUNT**
              
              **RATIO**
              
              **AMOUNT**
              
              **RATIO**
              
              **AMOUNT**
              
              **RATIO**December
                  31, 2006:Total
                  risk-based capital to risk-weighted assets(1)
              
              $
              127,504
              
              
              11.22
              %
              $
              90,935
              
              
              8.00
              %
              $
              113,668
              
              
              10.00
              %Tier
                  I (core) capital to risk-weighted assets
              
              
              116,516
              
              
              10.25
              
              
              45,467
              
              
              4.00
              
              
              68,201
              
              
              6.00Tier
                  I (core) capital to average total assets
              
              
              116,516
              
              
              8.99
              
              
              51,850
              
              
              4.00
              
              
              64,813
              
              
              5.00December
                  31, 2005:Total
                  risk-based capital to risk-weighted assets(1)
              
              $
              106,332
              
              
              10.86
              %
              $
              78,326
              
              
              8.00
              %
              
              97,907
              
              
              10.00
              %Tier
                  I (core) capital to risk-weighted assets
              
              
              96,078
              
              
              9.81
              
              
              39,163
              
              
              4.00
              
              
              58,744
              
              
              6.00Tier
                  I (core) capital to average total assets
              
              
              96,078
              
              
              8.23
              
              
              46,718
              
              
              4.00
              
              $
              58,397
              
              
              5.00


*(1)*  *The
      FDIC and the Federal Reserve require institutions to maintain Tier I capital
      of
      not less than one-half of total capital*




**(14)
      Mortgage Servicing Rights**


The
      increase in mortgage servicing rights is the result of the $34.1 million loan
      sale, servicing retained, in December 2006. A summary of capitalized mortgage
      servicing rights, included in other assets, at December 31, 2006, and December
      31, 2005, follows:


**DECEMBER
                  31,**
              
              **DECEMBER
                  31,****2006**
              
              **2005**Balance
                  at beginning of year
              
              
              10
              
              
              40Additions
              
              
              170
              
              
              -Amortization
              
              
              (6
              )
              
              (30
              )Allowance
                  for losses
              
              
              -
              
              
              -Balance
                  at end of year
              
              
              174
              
              
              10




The
      fair
      value of servicing rights was determined using a discount rate of 12% and a
      prepayment speed of 400%.


39


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





**(15)
      Employee Benefit Plans**


**(a)
      Savings Plan**


The
      Corporation maintains a savings plan under section 401(k) of the Internal
      Revenue Code, covering substantially


all
      full-time employees. Under the plan, employee contributions are matched by
      the
      Corporation at a rate of 50% of the first $12 contributed. Such matching becomes
      vested over a period of five years of credited service. Employees may make
      investments in various stock, fixed income or money market plans, or may
      purchase stock in the Corporation.


The
      Corporation contributed $313, $287, and $290 to the plan for the years ended
      December 31, 2006, 2005, and 2004, respectively.




**(b)
      Employee Stock Ownership Plan**


The
      Corporation established an employee stock ownership plan (ESOP) which became
      effective on July 1, 1992, for employees of the Corporation and the Bank, who
      have at least one year of continuous service. The Corporation pays all ESOP
      expenses. The shares of Cascade Financial Corporation stock purchased by the
      ESOP are held in a suspense account for allocation among the participants.
      Benefits become 20% vested after the first year of service with an additional
      20% vesting each year thereafter until 100% vesting after five years.
      Allocations to individual participant’s accounts are based on total compensation
      during the year. Forfeitures are reallocated annually


among
      remaining participating employees. For the years ended December 31, 2006, 2005,
      and 2004, the Corporation contributed $0, $0, and $14, respectively, to the
      ESOP, which is invested in Cascade Financial Corporation stock. During the
      year
      the Corporation terminated the Employee Stock Ownership Plan and all shares
      were
      transferred into the individual 401(k) savings plans of participating
      employees.




**(c)
      Employee Stock Purchase Plan**


The
      Corporation maintains an employee stock purchase plan, under the terms of which
      213,212 shares of common stock have been authorized for issuance. The plan
      allows employees of the Corporation with three months of service the opportunity
      to purchase common stock through accumulated salary deductions during each
      offering period. On the first day of each six-month offering period (January
      1
      and July 1 of each year), eligible employees who elect to participate are
      granted options to purchase a limited number of shares and unless the
      participant withdraws from the plan, the option is automatically exercised
      on
      the last day of each offering period. The aggregate number of shares to be
      purchased in any given offering is determined by dividing the accumulated salary
      deduction for the period by the lower of 85% of the market price of a common
      share at the beginning or end of an offering period.





**(d)
      Stock Options**


The
      shareholders of the Corporation approved two stock option plans to promote
      the
      best interest of the Corporation and its shareholders by providing an incentive
      to employees and directors. The plans permit the grant of incentive stock
      options and non-qualified stock options.


Options
      are granted to certain employees and directors at prices equal to the market
      value of the stock on the dates the options were 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. The maximum number of
      options that may be issued under the plan is 937,500 (as adjusted for stock
      splits and dividends). The Corporation had 592,200 and 552,286 shares available
      for grant at December 31, 2006, and 2005, respectively.




*Accounting
      for Stock Options*


On
      January 1, 2006, the Corporation adopted Statement 123(R), applying
      the modified prospective method. Statement 123(R) requires all equity-based
      payments to employees, including grants of employee stock options, to be
      recognized in the Consolidated Statements of Income at the fair value of the
      award over the requisite service period. Under the modified prospective method,
      the Corporation is required to record equity-based compensation expense for
      all
      awards granted after the date of adoption and for the unvested portion of
      previously granted awards outstanding as of the date of adoption.


Compensation
      cost charged against income for stock option expense was $287 for 2006. The
      total income tax benefit recognized in the income statement for stock based
      compensation arrangements was $314 for 2006.


The
      fair
      values of the options granted to the Corporation’s employees were estimated on
      the date of grant using the Black-Scholes valuation model. The application
      of
      this valuation model involves assumptions that are judgmental and sensitive
      in
      the determination of compensation expense.


The
      following table provides the range of assumptions used for stock options
      granted:


**Years
                  Ended December 31,****2006**
              
              **2005**
              
              **2004**Risk-free
                  interest rate
              
              
              4.50
              %
              
              3.00
              %
              
              2.25
              %Expected
                  life in years
              
              
              5
              
              
              8
              
              
              8Expected
                  volatility
              
              
              24
              %
              
              24
              %
              
              24
              %Dividend
                  yield
              
              
              2.03
              %
              
              2.02
              %
              
              1.77
              %




40


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





Historical
      information was the primary basis for the selection of the expected volatility,
      expected dividend yield and the expected lives of the options. The Corporation
      has collected a long history of option activity and feels 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.


A
      summary
      of option activity as of and for the year ended December 31, 2006 is as
      follows:




Options
            
            Weighted-
              Average
              Exercise
              Price
                per
              Share
            
            Weighted-
              Average
              Remaining
              Contractual
              Term
              (in
                years)
            
            Aggregate
              Intrinsic
              ValueOutstanding
                as of December 31, 2005
            
            
            732,252
            
            $
            7.72Granted
            
            
            106,038
            
            
            15.11Exercised
            
            
            (127,313
            )
            
            5.25Forfeited/Canceled
            
            
            (7,371
            )
            
            9.79Outstanding
                as of December 31, 2006
            
            
            703,606
            
            $
            9.26
            
            
            5.76
            
            $
            5,511,642Exercisable
                as of December 31, 2006
            
            
            383,916
            
            $
            6.70
            
            
            4.38
            
            $
            3,988,346





All
      amounts have been
      adjusted retroactively to reflect the 5-for-4 stock split paid in May
      2006.


All
      options granted have limited rights that enable a holder upon a change in
      control of the Corporation to elect to receive cash equal to the difference
      between the exercise price of the option and the fair market value of the common
      stock on the date of exercise. At December 31, 2006, and December 31, 2005,
      383,916 and 308,718 shares, respectively, were fully exercisable.


The
      weighted average fair value of options granted under the Corporation's stock
      option plan was $3.77, $3.86, and $4.29, respectively for the years ended
      December 31, 2006, December 31, 2005, and December 31, 2004. The total intrinsic
      value of options exercised was $1,292, $1,051 and $656, respectively, during
      the
      years ended December 31, 2006, 2005, and 2004. As of December 31, 2006, there
      was $466 of total unrecognized compensation cost related to stock options.
      That
      cost is expected to be recognized over a weighted average period of 1.6 years.
      Cash received from option exercises under all share-based payment arrangements
      was $670, $443, and $348 for the years ended December 31, 2006, 2005 and 2004,
      respectively.


As
      a
      result of adopting Statement 123(R) on January 1, 2006, the Corporation’s income
      before income taxes and net income for the year ended December 31, 2006 are
      $287
      and $283 lower, respectively than if it had continued to account for share-based
      compensation under Opinion No. 25. Basic and diluted earnings per share for
      the
      year ended December 31, 2006 would have been $1.13 and $1.10, respectively,
      if
      the Corporation had not adopted Statement 123(R), compared to reported basic
      and
      diluted earnings per share of $1.11 and $1.08, respectively.


Prior
      to
      the adoption of Statement 123(R), the Corporation presented all tax benefits
      of
      deductions resulting the exercise of stock options as operating cash flows
      in
      the Statement of Cash Flows. Statement 123(R) requires the cash flow resulting
      from the tax benefits resulting from tax deductions in excess of the
      compensation cost recognized for those options (excess tax benefits) to be
      classified as financing cash flows. The $314 excess tax benefit classified
      as a
      financing cash inflow would have been classified as an operating cash inflow
      if
      the Corporation had not adopted Statement 123(R).


The
      following table illustrates the effect on net income and earnings per share
      for
      the years ended December 31, 2005 and 2004, if the Corporation had applied
      the fair value recognition provisions of SFAS 123(R) to stock-based
      employee compensation:


**YEARS
                  ENDED****DECEMBER
                  31,****2005**
              
              **2004**Net
                  Income, as reported
              
              $
              13,046
              
              $
              10,785Add:
                  Stock-based employee compensation expense included in reportednet
                  income, net of related tax effects
              
              
              -
              
              
              -Deduct:
                  Total stock-based employee compensation expense determinedunder
                  fair value based method for all awards, net of related tax
                  effects
              
              
              167
              
              
              183Pro
                  Forma Net Income
              
              $
              12,879
              
              $
              10,602


41


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*




**YEARS
                  ENDED****DECEMBER
                  31,****2005**
              
              **2004**Net
                  income per common share - BasicAs
                  reported
              
              $
              1.09
              
              $
              0.96Pro
                  forma
              
              
              1.07
              
              
              0.94Net
                  income per common share - DilutedAs
                  reported
              
              $
              1.06
              
              $
              0.93Pro
                  forma
              
              
              1.05
              
              
              0.91
  **(16)
      Fair Value of Financial Instruments**


The
      fair
      value estimates presented below are subjective in nature, involve uncertainties
      and matters of significant judgment and, therefore, are not necessarily
      indicative of the amounts the Corporation could realize in a current market
      exchange. The Corporation has not included certain material items in its
      disclosure, such as the value of the long-term relationships with the
      Corporation’s lending and deposit customers, since this is an intangible and not
      a financial instrument. Additionally, the estimates do not include any tax
      ramifications. There may be inherent weaknesses in any calculation technique,
      and changes in the underlying assumptions used, including discount rates and
      estimates of future cash flows, that could materially affect the results. For
      all of these reasons, the aggregation of the fair value calculations presented
      herein do not represent, and should not be construed to represent, the
      underlying value of the Corporation.


The
      following table presents a summary of the fair value of the Corporation’s
      financial instruments:


**DECEMBER
                  31,**
              
              **DECEMBER
                  31,****2006**
              
              **2005****CARRYING**
              
              **ESTIMATED**
              
              **CARRYING**
              
              **ESTIMATED****VALUE**
              
              **FAIR
                  VALUE**
              
              **VALUE**
              
              **FAIR
                  VALUE**Financial
                  assets:Cash
                  and cash******equivalents
              
              $
              42,879
              
              $
              42,879
              
              $
              31,109
              
              $
              31,109Securities
                  available-for-sale
              
              
              130,656
              
              
              130,656
              
              
              140,596
              
              
              140,596Securities
                  held-to-maturity
              
              
              96,846
              
              
              93,536
              
              
              95,122
              
              
              92,120FHLB
                  Stock
              
              
              11,920
              
              
              11,920
              
              
              11,920
              
              
              11,920Loans,
                  net
              
              
              996,015
              
              
              1,002,554
              
              
              867,049
              
              
              875,083Financial
                  liabilities:Deposit
                  accounts(1)
              
              
              855,449
              
              
              854,795
              
              
              795,768
              
              
              794,759Borrowings
              
              
              338,710
              
              
              338,859
              
              
              287,058
              
              
              288,060Junior
                  subordinated debentures payable(2)
              
              
              25,775
              
              
              27,465
              
              
              15,212
              
              
              15,212Mark-to-market
                  on swaps
              
              $
              312
              
              $
              312
              
              $
              564
              
              $
              564




*(1)*
            *Net
                of ($312) mark-to-market on swap for 2006 and ($311) for
                2005*


*(2)*
            *Net
                of ($253) mark-to-market on swap for 2005 (see note 17 to the Consolidated
                Financial Statements for the year ended December 31,
                2006)*




*Cash
      and Cash Equivalents*


The
      carrying amount represents fair value.




*Securities
      including mortgage backed securities and FHLB stock*


Fair
      values are based on quoted market prices or dealer quotations.




*Loans*


Fair
      values are estimated using current market interest rates to discount future
      cash
      flows for each of the six different loan types. Interest rates used to discount
      the cash flows are based on U.S. Treasury yields or other market interest rates
      with appropriate spreads for each segment. The spread over the Treasury yields
      or other market rates is used to account for liquidity, credit quality and
      higher servicing costs. Prepayment rates are based on expected future prepayment
      rates, or, where appropriate and available, market prepayment
      rates.




*Deposit
      Accounts*


The
      fair
      value of deposits with no stated maturity, such as checking accounts, money
      market deposit accounts and savings accounts, equals the amount payable on
      demand. The fair value of certificates of deposits is calculated based on the
      discounted value of contractual cash flows. The discount rate is equal to the
      rate currently offered on similar products.




*Borrowings*


The
      fair
      value is calculated based on the discounted cash flow method, adjusted for
      market interest rates and terms to maturity.


42


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





*Junior
      Subordinated Debentures Payable (Trust Preferred Securities)*


The
      fair
      value is calculated based on the amounts required to settle the contracts,
      adjusted for market interest rates and terms to maturity.




*Swaps*


The
      fair
      value is calculated based on the discounted cash flow method, adjusted for
      changes in swap spreads to the underlying treasury securities.





**(17)
      On-Balance Sheet Derivative Instruments and Hedging Activities**


**Derivative
      Financial Instruments**


The
      Corporation has derivative financial instruments in the form of interest rate
      swap agreements, which derive their value from underlying interest rates. These
      transactions involve both credit and market risk. Direct credit exposure is


limited
      to the net difference between the calculated amounts to be received and paid,
      and any change in fair value of


the
      contract in which the counterparty would owe the Corporation if the contract
      were terminated. Such difference, which represents the fair value of the
      derivative instruments, is reflected on the Corporation's balance sheet as
      derivative assets and derivative liabilities. The Corporation controls the
      credit risk of its financial contracts through credit approvals, limits and
      monitoring procedures, and does not expect any counterparties to fail to meet
      their obligations.


Off-balance-sheet
      financial instruments - commitments to extend credit, standby letters of credit
      and financial guarantees represent the principal categories of off-balance
      instruments (Note 4).  The fair value of these commitments is not
      considered material because they are for a short period of time and subject
      to
      customary credit terms.




**Risk
      Management Policies - Hedging Instruments**


The
      primary focus of the Corporation’s asset/liability management program is to
      monitor the sensitivity of the Corporation’s net income and fair value of equity
      under varying interest rate scenarios to take steps to control its risks (see
      Management Discussion and Analysis - Interest Rate Risk
      Management).




**Interest
      Rate Risk Management - Fair Value Hedging Instruments**


The
      Corporation holds fixed- and variable-rate assets and liabilities. Fixed-rates
      may expose the Corporation to variability in their fair value due to changes
      in
      the level of interest rates. The Corporation may utilize interest rate swaps
      as
      an asset/liability management strategy to hedge the change in value of the
      assets due to changes in interest rate assumptions.


The
      information pertaining to a terminated interest rate swap agreement used to
      hedge junior subordinated debentures payable (trust preferred securities) is
      as
      follows:




**DECEMBER
                  31,****2005**Notional
                  amount
              
              $
              10,000Weighted
                  average pay rate
              
              
              8.60
              %Fixed
                  receive rate
              
              
              11.00
              %Maturity
                  in years
              
              
              25.2Unrealized
                  loss relating to interest rate swap
              
              $
              (253
              )




This
      agreement provided for the Corporation to make payments at a variable rate
      determined by a six-month LIBOR in exchange for receiving payments at a fixed
      rate. The swap was terminated in December 2006 at a loss of $150.


Risk
      management results for the years ended December 31, 2006, and 2005, related
      to
      the balance sheet hedging of junior subordinated debentures payable indicate
      that the hedge was 100% effective and that there was no component of the
      derivative instrument’s gain or loss which was excluded from the assessment of
      hedge effectiveness.


The
      information pertaining to an outstanding interest rate swap agreement used
      to
      hedge certificates of deposit is as follows:


**DECEMBER
                  31,****2006**
              
              **2005**Notional
                  amount
              
              $
              10,000
              
              $
              10,000Weighted
                  average pay rate
              
              
              5.14
              %
              
              3.30
              %Fixed
                  receive rate
              
              
              5.00
              %
              
              5.00
              %Maturity
                  in years
              
              
              7.4
              
              
              8.4Unrealized
                  loss relating to interest rate swap
              
              $
              (312
              )
              $
              (311
              )




43


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





This
      agreement provides for the Corporation to make payments at a variable-rate
      determined by a three-month LIBOR in exchange for receiving payments at a fixed
      rate.


Risk
      management results for the years ended December 31, 2006, and 2005, related
      to
      the balance sheet hedging of certificates of deposit indicate that the hedge
      was
      100% effective and that there was no component of the derivative instrument’s
      gain or loss during which was excluded from the assessment of hedge
      effectiveness.


The
      Corporation enters into rate lock commitments to extend credit to borrowers
      for
      generally a 30-day or 60-day period for the origination of loans.


On
      March
      13, 2002, the Financial Accounting Standards Board determined that loan
      commitments related to the origination or acquisition of mortgage loans that
      will be held-for-sale must be accounted for as derivative instruments.
      Accordingly, the Corporation adopted such accounting on July 1, 2002, and such
      commitments, along with any related fees received from potential borrowers,
      are
      recorded at fair value in derivative assets or liabilities, with changes in
      fair
      value recorded in the net gain or loss on sale of mortgage loans. Since the
      Corporation originates its saleable loans on a “best effort” basis and delivers
      those loans to the purchaser within 10 days at the committed price, there will
      generally be no gain or loss recorded on those commitments.


The
      Corporation had non-mandatory forward commitments totaling $364 and $157 to
      sell
      loans into the secondary market at December 31, 2006, and December 31, 2005,
      respectively.




**(18)
      Contingencies**


The
      Corporation is a defendant in various legal proceedings arising in connection
      with its business. It is the opinion of management that the financial position
      and the results of operations of the Corporation will not be materially
      adversely affected by the final outcome of these legal proceedings and that
      adequate provision has been made in the accompanying consolidated financial
      statements.


At
      periodic intervals, the Washington State Department of Financial Institutions
      and the Federal Deposit Insurance Corporation routinely examine the
      Corporation’s financial statements as part of their legally prescribed oversight
      of the banking industry. Based on these examinations, the regulators can direct
      that the Corporation’s financial statements be adjusted in accordance with their
      findings.





**(19)
      Condensed Financial Information of Cascade Financial
      Corporation**


Following
      are the condensed financial statements of Cascade Financial Corporation (parent
      only) for the period indicated:


**BALANCE
                  SHEET**
              
              **December
                  31, 2006**
              
              **December
                  31, 2005**Assets:Cash
              
              $
              829
              
              $
              637Investment
                  in subsidiary
              
              
              139,827
              
              
              119,262Other
                  assets
              
              
              1,765
              
              
              2,390$
              142,421
              
              $
              122,289Liabilities
                  and stockholders’ equity:Other
                  liabilities
              
              $
              1,447
              
              $
              1,884Junior
                  subordinated debentures payable
              
              
              25,775
              
              
              15,212Stockholders’
                  equity
              
              
              115,199
              
              
              105,193$
              142,421
              
              $
              122,289




**INCOME
                  STATEMENT**
              
              **FOR
                  THE YEARS ENDED DECEMBER 31,****2006**
              
              **2005**
              
              **2004**Equity
                  in undistributed net income of the subsidiary
              
              $
              14,836
              
              $
              13,992
              
              $
              11,833Interest
                  income - junior subordinated debentures payable
              
              
              58
              
              
              46
              
              
              35Operating
                  expenses
              
              
              (460
              )
              
              (299
              )
              
              (704
              )Interest
                  expense - junior subordinated debentures payable
              
              
              (1,880
              )
              
              (1,198
              )
              
              (723
              )Income
                  before benefit for income taxes
              
              
              12,554
              
              
              12,541
              
              
              10,441Benefit
                  for income taxes
              
              
              801
              
              
              505
              
              
              344Net
                  income
              
              $
              13,355
              
              $
              13,046
              
              $
              10,785


44


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





**STATEMENT
                  OF CASH FLOWS**
              
              **FOR
                  THE YEARS ENDED DECEMBER 31,****2006**
              
              **2005**
              
              **2004**Cash
                  flows from operating activities:Net
                  income
              
              $
              13,355
              
              $
              13,046
              
              $
              10,785Adjustments
                  to reconcile net income to net cash(used
                  in) operating activities:Equity
                  in net income of subsidiaries
              
              
              (14,836
              )
              
              (13,992
              )
              
              (11,833
              )Increase
                  (decrease) in other assets
              
              
              938
              
              
              195
              
              
              (1,303
              )(Decrease)
                  increase in other liabilities
              
              
              (287
              )
              
              134
              
              
              257Net
                  cash used in operating activities
              
              
              (830
              )
              
              (617
              )
              
              (2,094
              )Cash
                  flows from investing activities:Dividends
                  received from subsidiaries
              
              
              4,250
              
              
              4,000
              
              
              12,882Investment
                  in subsidiary
              
              
              (10,000
              )
              
              -
              
              
              (5,000
              )Cash
                  used for acquisition
              
              
              -
              
              
              -
              
              
              (9,546
              )Net
                  cash provided (used) by investing activities
              
              
              (5,750
              )
              
              4,000
              
              
              (1,664
              )Cash
                  flows from financing activities:Repurchase
                  of common stock
              
              
              (673
              )
              
              (858
              )
              
              (150
              )Proceeds
                  from exercise of stock options
              
              
              1,050
              
              
              865
              
              
              635Dividends
                  paid
              
              
              (3,605
              )
              
              (3,163
              )
              
              (2,589
              )Proceeds
                  from junior subordinated debentures payable
              
              
              10,000
              
              
              -
              
              
              5,000Net
                  cash (used) provided by financing activities
              
              
              6,772
              
              
              (3,156
              )
              
              2,896Net
                  increase (decrease) in cash and cash equivalents
              
              
              192
              
              
              227
              
              
              (862
              )Cash
                  and cash equivalents:Beginning
                  of year
              
              
              637
              
              
              410
              
              
              1,272End
                  of year
              
              $
              829
              
              $
              637
              
              $
              410Supplemental
                  schedule of non-cash investing activities:Issaquah
                  Bank merger
              
              
              -
              
              
              -
              
              
              24,792
  **(20)
      Lines of Business**


The
      Corporation’s sole operating subsidiary is Cascade Bank, which is managed along
      four major lines of business: business banking, construction lending, income
      property lending and retail banking. The administrative group, although not
      considered a line of business, is responsible for the management of investments,
      interest rate risk, marketing, data processing and regulatory and stockholder
      reporting. The financial performance of these business lines is measured by
      the
      Corporation’s profitability reporting processes, which utilize various
      management accounting techniques to ensure that each business line’s financial
      results reflect the underlying performance of that business.


Each
      line
      of business segment is managed by a senior executive. Back office support is
      provided to each segment through executives responsible for information systems,
      finance and administration.


The
      principal activities conducted by business banking are the origination and
      servicing of commercial business loans and associated merchant services. Retail
      banking includes all deposit products, with their related fee income, and all
      consumer loan products such as home equity and installment loans, single-family
      loans and credit card products. The construction unit provides financing to
      builders and developers for residential construction and land acquisition and
      development. The income property unit originates loans secured by multifamily
      properties and commercial real estate.


The
      Bank’s reportable business segments are the strategic lines of business noted
      above, which are managed by the Management Committee, under the direction of
      the
      President and Chief Executive Officer. The Management Committee, which is the
      senior decision making group of the Bank, is comprised of seven members
      including the President and Chief Executive Officer. To better assess the
      contribution of its various business lines, the Bank generates segment results
      that include balances directly attributable to business line activities.
      Expenses or activities not directly controlled by business unit managers are
      allocated to the administrative unit. In this way, management can assess the
      performance of a particular business line. The Bank is constantly analyzing
      its
      lines of business performance and developing better ways to measure
      profitability.


The
      accounting policies of the segments are the same as those described in “Note 1:
      Summary of Significant Accounting Policies.” Direct revenues and expenses are
      allocated to business segments in determining their net income. Corporate
      overhead, centralized support costs and other costs are assigned to the
      administrative unit. The Corporation evaluates performance based on net income
      of the respective business segments. Depreciation is allocated to the segments
      based upon the utilization of the assets by the segments. All depreciating
      assets are included in administrative unit’s total assets.


45


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





The
      organizational structure of the Bank and the allocated methodologies it employs
      result in business line financial results that are not necessarily comparable
      across companies. As such, the Bank’s business line performance may not be
      directly comparable with similar information from other financial
      institutions.




**YEAR
                  ENDED DECEMBER 31, 2006****BUSINESS**
              
              **CONS-
                  TRUCTION**
              
              **INCOME
                  PROPERTY**
              
              **RETAIL**
              
              **ADMIN-
                  ISTRATION**
              
              **TOTAL**Condensed
                  Income StatementNet
                  interest income afterprovision
                  for loan losses
              
              $
              14,872
              
              $
              14,597
              
              $
              4,702
              
              $
              1,702
              
              $
              2,517
              
              $
              38,390Other
                  income
              
              
              310
              
              
              321
              
              
              -
              
              
              4,283
              
              
              1,112
              
              
              6,026Other
                  expense
              
              
              1,340
              
              
              332
              
              
              332
              
              
              2,291
              
              
              20,291
              
              
              24,586Contribution
                  before overhead
              
              
              13,842
              
              
              14,586
              
              
              4,370
              
              
              3,694
              
              
              (16,662
              )
              
              19,830Support
                  transfer
              
              
              7,079
              
              
              4,105
              
              
              3,243
              
              
              2,235
              
              
              (16,662
              )
              
              -Income
                  before provision forincome
                  tax
              
              
              6,763
              
              
              10,481
              
              
              1,127
              
              
              1,459
              
              
              -
              
              
              19,830Provision
                  forincome
                  taxes
              
              
              2,208
              
              
              3,423
              
              
              367
              
              
              477
              
              
              -
              
              
              6,475Net
                  income
              
              $
              4,555
              
              $
              7,058
              
              $
              760
              
              $
              982
              
              $
              -
              
              $
              13,355**At
                  December 31, 2006**Total
                  assets
              
              $
              442,391
              
              $
              289,993
              
              $
              34,719
              
              $
              124,036
              
              $
              454,115
              
              $
              1,345,254**YEAR
                  ENDED DECEMBER 31, 2005****BUSINESS**
              
              
              **CONS-
                  TRUCTION**
              
              
              **INCOME
                  PROPERTY**
              
              
              **RETAIL**
              
              
              **ADMIN-
                  ISTRATION**
              
              
              **TOTAL**Condensed
                  Income StatementNet
                  interest income afterprovision
                  for loan losses
              
              $
              15,110
              
              $
              8,544
              
              $
              7,331
              
              $
              1,783
              
              $
              2,813
              
              $
              35,581Other
                  income
              
              
              76
              
              
              23
              
              
              623
              
              
              4,135
              
              
              1,476
              
              
              6,333Other
                  expense
              
              
              1,496
              
              
              423
              
              
              870
              
              
              2,223
              
              
              17,594
              
              
              22,606Contribution
                  before overhead
              
              
              13,690
              
              
              8,144
              
              
              7,084
              
              
              3,695
              
              
              (13,305
              )
              
              19,308Support
                  transfer
              
              
              5,408
              
              
              2,075
              
              
              3,717
              
              
              2,105
              
              
              (13,305
              )
              
              -Income
                  before provision forincome
                  tax
              
              
              8,282
              
              
              6,069
              
              
              3,367
              
              
              1,590
              
              
              -
              
              
              19,308Provision
                  forincome
                  taxes
              
              
              2,688
              
              
              1,964
              
              
              1,101
              
              
              509
              
              
              -
              
              
              6,262Net
                  income
              
              $
              5,594
              
              $
              4,105
              
              $
              2,266
              
              $
              1,081
              
              $
              -
              
              $
              13,046**At
                  December 31, 2005**Total
                  assets
              
              $
              394,034
              
              $
              165,957
              
              $
              193,166
              
              $
              127,589
              
              $
              331,038
              
              $
              1,211,784**YEAR
                  ENDED DECEMBER 31, 2004****BUSINESS**
              
              
              **CONS-
                  TRUCTION**
              
              
              **INCOME
                  PROPERTY**
              
              
              **RETAIL**
              
              
              **ADMIN-
                  ISTRATION**
              
              
              **TOTAL**Condensed
                  Income StatementNet
                  interest income afterprovision
                  for loan losses
              
              $
              12,497
              
              $
              4,996
              
              $
              8,219
              
              $
              2,485
              
              $
              3,525
              
              $
              31,722Other
                  income
              
              
              75
              
              
              7
              
              
              -
              
              
              2,871
              
              
              1,794
              
              
              4,747Other
                  expense
              
              
              1,446
              
              
              435
              
              
              738
              
              
              2,208
              
              
              15,490
              
              
              20,317Contribution
                  before overhead
              
              
              11,126
              
              
              4,568
              
              
              7,481
              
              
              3,148
              
              
              (10,171
              )
              
              16,152Support
                  transfer
              
              
              3,544
              
              
              1,266
              
              
              3,063
              
              
              1,942
              
              
              (9,815
              )
              
              -Income
                  before provision forincome
                  tax
              
              
              7,582
              
              
              3,302
              
              
              4,418
              
              
              1,206
              
              
              (356
              )
              
              16,152Provision
                  forincome
                  taxes
              
              
              2,465
              
              
              1,072
              
              
              1,431
              
              
              391
              
              
              8
              
              
              5,367Net
                  income
              
              $
              5,117
              
              $
              2,230
              
              $
              2,987
              
              $
              815
              
              $
              (364
              )
              $
              10,785**At
                  December 31, 2004**Total
                  assets
              
              $
              292,117
              
              $
              107,431
              
              $
              271,076
              
              $
              136,100
              
              $
              282,231
              
              $
              1,088,955





46


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





**(21)
      Selected Quarterly Financial Data** *(Unaudited)*




**QUARTER
                  ENDED****MAR
                  31,**
              
              **JUNE
                  30,**
              
              **SEPT
                  30,**
              
              **DEC
                  31,****2006**
              
              **2006**
              
              **2006**
              
              **2006**Interest
                  income
              
              $
              18,787
              
              $
              20,249
              
              $
              21,396
              
              $
              22,226Interest
                  expense
              
              
              9,267
              
              
              10,561
              
              
              11,440
              
              
              12,000Net
                  interest income
              
              
              9,520
              
              
              9,688
              
              
              9,956
              
              
              10,226Provision
                  for loan losses
              
              
              250
              
              
              300
              
              
              300
              
              
              150Other
                  income
              
              
              1,325
              
              
              1,573
              
              
              1,616
              
              
              1,512Other
                  expense
              
              
              5,875
              
              
              6,036
              
              
              6,349
              
              
              6,326Income
                  before provision for income taxes
              
              
              4,720
              
              
              4,925
              
              
              4,923
              
              
              5,262Provision
                  for income taxes
              
              
              1,548
              
              
              1,598
              
              
              1,609
              
              
              1,720Net
                  income
              
              $
              3,172
              
              $
              3,327
              
              $
              3,314
              
              $
              3,542Earnings
                  per share, basic
              
              $
              0.26
              
              $
              0.28
              
              $
              0.27
              
              $
              0.29Earnings
                  per share, diluted
              
              
              0.26
              
              
              0.27
              
              
              0.27
              
              
              0.29**QUARTER
                  ENDED****MAR
                  31,**
              
              
              **JUNE
                  30,**
              
              
              **SEPT
                  30,**
              
              
              **DEC
                  31,****2005**
              
              
              **2005**
              
              
              **2005**
              
              
              **2005**Interest
                  income
              
              $
              15,600
              
              $
              16,666
              
              $
              17,391
              
              $
              18,145Interest
                  expense
              
              
              6,826
              
              
              7,515
              
              
              8,055
              
              
              8,880Net
                  interest income
              
              
              8,774
              
              
              9,151
              
              
              9,336
              
              
              9,265Provision
                  for loan losses
              
              
              245
              
              
              250
              
              
              250
              
              
              200Other
                  income
              
              
              1,600
              
              
              1,667
              
              
              1,564
              
              
              1,502Other
                  expense
              
              
              5,553
              
              
              5,776
              
              
              5,672
              
              
              5,605Income
                  before provision for income taxes
              
              
              4,576
              
              
              4,792
              
              
              4,978
              
              
              4,962Provision
                  for income taxes
              
              
              1,505
              
              
              1,577
              
              
              1,634
              
              
              1,546Net
                  income
              
              $
              3,071
              
              $
              3,215
              
              $
              3,344
              
              $
              3,416Earnings
                  per share, basic
              
              $
              0.26
              
              $
              0.27
              
              $
              0.28
              
              $
              0.29Earnings
                  per share, diluted
              
              
              0.25
              
              
              0.26
              
              
              0.27
              
              
              0.28**QUARTER
                  ENDED****MAR
                  31,**
              
              
              **JUNE
                  30,**
              
              
              **SEPT
                  30,**
              
              
              **DEC
                  31,****2004**
              
              
              **2004**
              
              
              **2004**
              
              
              **2004**Interest
                  income
              
              $
              12,609
              
              $
              13,096
              
              $
              14,518
              
              $
              15,093Interest
                  expense
              
              
              5,307
              
              
              5,250
              
              
              5,967
              
              
              6,395Net
                  interest income
              
              
              7,302
              
              
              7,846
              
              
              8,551
              
              
              8,698Provision
                  for loan losses
              
              
              225
              
              
              150
              
              
              150
              
              
              150Other
                  income
              
              
              1,153
              
              
              1,188
              
              
              1,238
              
              
              1,168Other
                  expense
              
              
              4,467
              
              
              5,300
              
              
              5,005
              
              
              5,545Income
                  before provision for income taxes
              
              
              3,763
              
              
              3,584
              
              
              4,634
              
              
              4,171Provision
                  for income taxes
              
              
              1,189
              
              
              1,300
              
              
              1,531
              
              
              1,347Net
                  income
              
              $
              2,574
              
              $
              2,284
              
              $
              3,103
              
              $
              2,824Earnings
                  per share, basic
              
              $
              0.25
              
              $
              0.22
              
              $
              0.26
              
              $
              0.24Earnings
                  per share, diluted
              
              
              0.24
              
              
              0.21
              
              
              0.26
              
              
              0.23




47




**ANNUAL
      SHAREHOLDERS’ MEETING**


The
      Annual Shareholders’ meeting will be held at the Everett Golf & Country
      Club, 1500 52 nd Street
      SE, Everett, Washington, on Tuesday, April 24, 2007 at 6:30 p.m. Pacific
      time. ****





48