**CASCADE
      FINANCIAL CORPORATION SELECTED FINANCIAL DATA**


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


**FOR
                THE YEARS ENDED DECEMBER 31,****2005**
            
            **2004**
            
            **2003**Interest
                income
            
            $
            67,802
            
            $
            55,316
            
            $
            50,363Interest
                expense
            
            
            31,276
            
            
            22,919
            
            
            22,753Net
                interest income
            
            
            36,526
            
            
            32,397
            
            
            27,610Provision
                for loan losses
            
            
            945
            
            
            675
            
            
            1,275Net
                interest income after provision for loan losses
            
            
            35,581
            
            
            31,722
            
            
            26,335Other
                income
            
            
            6,333
            
            
            4,747
            
            
            5,306Other
                expense
            
            
            22,606
            
            
            20,317
            
            
            17,733Income
                before federal income taxes
            
            
            19,308
            
            
            16,152
            
            
            13,908Net
                income
            
            
            13,046
            
            
            10,785
            
            
            9,599Net
                income per common share, basic*(1)*
            
            
            1.36
            
            
            1.20
            
            
            1.17Net
                income per common share, diluted*(1)*
            
            
            1.32
            
            
            1.16
            
            
            1.13Book
                value per share*(1)*
            
            
            10.95
            
            
            10.07
            
            
            7.76





**AT
                DECEMBER 31,****2005**
            
            **2004**
            
            **2003**Assets
            
            $
            1,211,784
            
            $
            1,088,955
            
            $
            885,220Loans,
                net
            
            
            867,049
            
            
            794,466
            
            
            567,094Cash
                and securities
            
            
            278,747
            
            
            228,644
            
            
            290,537Deposits
            
            
            795,768
            
            
            721,908
            
            
            564,314Borrowings
            
            
            66,270
            
            
            36,356
            
            
            50,123FHLB
                advances
            
            
            236,000
            
            
            228,000
            
            
            200,000Stockholders’
                equity
            
            
            105,193
            
            
            96,250
            
            
            63,957Nonperforming
                loans
            
            
            1,987
            
            
            532
            
            
            1,921





**FINANCIAL
                RATIOS FOR THE YEARS ENDED DECEMBER 31,****2005**
            
            **2004**
            
            **2003**Return
                on assets
            
            
            1.13
            %
            
            1.09
            %
            
            1.13
            %Return
                on equity
            
            
            13.13
            
            
            13.22
            
            
            15.81Return
                on tangible equity
            
            
            17.82
            
            
            16.24
            
            
            15.81Net
                interest margin
            
            
            3.35
            
            
            3.44
            
            
            3.35Efficiency
                ratio
            
            
            52.75
            
            
            54.70
            
            
            53.87Average
                stockholders’ equity to average assets
            
            
            8.60
            
            
            8.25
            
            
            7.15Total
                risk based capital to risk weighted assets
            
            
            10.77
            
            
            11.06
            
            
            13.22Tier
                1 capital to adjusted total assets
            
            
            8.15
            
            
            8.04
            
            
            8.34





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




-
          9
          -


**MANAGEMENT
      DISCUSSION AND ANALYSIS**


The
      following discussion is provided for the consolidated operations of Cascade
      Financial Corporation (the “Corporation”)
      as of December 31, 2005. 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 1,263,423 new shares.
      The
      merger enhances Cascade’s commercial banking franchise by expanding Cascade’s
      presence in east King County. Total Issaquah assets on June 3, 2004, were
      approximately $131 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 will be 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, 2005,
      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 7 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, 2005, were $1.2 billion, compared to
      $1.1 billion at December 31, 2004, an increase of 11.3%. The increase in 2005
      is
      due entirely to internal growth. The Corporation’s total assets at December 31,
      2003, were $885.2 million.





**Investment
      Securities**


Securities
      designated as available-for-sale increased to $152.5 million at December 31,
      2005, versus $124.3 million at December 31, 2004. Securities designated as
      held-to-maturity increased to $95.1 million at December 31, 2005, from $91.3
      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, 2005. All investment securities received the highest credit rating
      from at least one of the major rating agencies.





**Loan
      Portfolio**


Net
      loans
      increased to $867.0 million at December 31, 2005, a 9.1% increase over $794.5
      million at December 31, 2004. Net loans were $567.1 million at December 31,
      2003.


Business
      loans increased from $292.1 million at December 31, 2004, to $394.0 million
      at
      December 31, 2005, a 34.9% 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 $166.0 million from $107.4 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 $178.7 million at December 31, 2004, to $141.1 million at December 31,
      2005. Of this decrease, $35.0 million was the result of a reclassification
      of
      loans acquired in the Issaquah Bank acquisition to business loans as the loan
      collateral was owner-occupied real estate. 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 decreased from $106.0 million at December 31,
      2004, to $95.4 million at December 31, 2005. High rates of refinancing activity
      due to low interest rates impacted loan balances in that 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. In addition, Cascade sold $9.3 million of seasoned loans in
      the
      fourth quarter. Multifamily loans outstanding decreased from $92.4 million
      at
      December 31, 2004, to $52.1 million at December 31, 2005. The Corporation sold
      approximately $34.7 million of relatively low yielding loans in 2005 to take
      advantage of investor appetites for multifamily loans. The sales have helped
      us
      grow noninterest income.


Consumer
      loans increased $2.0 million to $32.2 million as of December 31, 2005. 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, 2005**
            
            **DECEMBER
                31, 2004**
            
            **DECEMBER
                31, 2003***(Dollars
                in thousands)*
            
            **AMOUNT**
            
            **PERCENT**
            
            **AMOUNT**
            
            **PERCENT**
            
            **AMOUNT**
            
            **PERCENT**Business
            
            $
            394,034
            
            
            44.75
            %
            $
            292,117
            
            
            36.21
            %
            $
            204,446
            
            
            35.43
            %Commercial
                real estate
            
            
            141,109
            
            
            16.02
            
            
            178,704
            
            
            22.15
            
            
            83,856
            
            
            14.53Total
                business-like loans
            
            
            535,143
            
            
            60.77
            
            
            470,821
            
            
            58.36
            
            
            288,302
            
            
            49.96Single-family
                residential
            
            
            95,429
            
            
            10.83
            
            
            105,975
            
            
            13.14
            
            
            105,565
            
            
            18.30Real
                estate construction
            
            
            165,957
            
            
            18.84
            
            
            107,431
            
            
            13.32
            
            
            62,742
            
            
            10.87Consumer
            
            
            32,160
            
            
            3.65
            
            
            30,125
            
            
            3.73
            
            
            33,163
            
            
            5.75Multifamily
                loans
            
            
            52,057
            
            
            5.91
            
            
            92,372
            
            
            11.45
            
            
            87,212
            
            
            15.12Total
                loans
            
            
            880,746
            
            
            100.00
            %
            
            806,724
            
            
            100.00
            %
            
            576,984
            
            
            100.00
            %Allowance
                for losses on loans
            
            
            (10,254
            )
            
            
            
            
            (9,563
            )
            
            
            
            
            (7,711
            )Deferred
                loan fees and discounts
            
            
            (3,443
            )
            
            
            
            
            (2,695
            )
            
            
            
            
            (2,179
            )Net
                loans receivable
            
            $
            867,049
            
            
            
            
            $
            794,466
            
            
            
            
            $
            567,094




**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, 2005, the allowance for loan losses was $10.3 million (1.16% of
      total loans) compared to $9.6 million (1.19% of total loans) at December 31,
      2004, and $7.7 million (1.34% of total loans) at December 31, 2003. During
      2005,
      the Corporation added $945,000 to the allowance compared to $675,000 in 2004.
      In
      2004, the Corporation assumed $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 $254,000 in 2005 (or 0.03% of average loans outstanding)
      compared to $218,000 in 2004 (or 0.03% of average loans outstanding).
      Charge-offs in business loans accounted for most of the change, decreasing
      from
      $310,000 in the year ended December 31, 2004, to $1,000 in the year ended
      December 31, 2005. Net charge-offs were $436,000 for the year ended December
      31,
      2003. The coverage ratio (the allowance for loan losses to nonperforming loans)
      was 516% at December 31, 2005, 1,798% at December 31, 2004, and 401% at December
      31, 2003.





**Deposit
      Accounts**


Deposit
      accounts totaled $795.8 million at December 31, 2005, an increase of $73.9
      million or 10.2% over $721.9 million at December 31, 2004. The Bank assumed
      $101.8 million in deposits with the acquisition of Issaquah in 2004. Checking
      account balances, primarily through its High Performance Checking program,
      grew
      7.0% to $120.5 million during the year as the Bank continued its sales efforts
      to generate transaction accounts. Money market deposit account balances grew
      by
      16.2% to $181.6 million with rates competitive with those offered by money
      market funds. Certificates of deposit grew 9.6% to $478.5 million. As business
      banking activity increases, management expects to increase its
      noninterest-bearing accounts through the growth of commercial checking
      accounts.


The
      market for deposits has remained very competitive and may intensify as the
      Federal Reserve continues to increase its target Fed funds rate. 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, 2005,
      the Bank had $236.0 million in FHLB advances compared to $228.0 million as
      of
      December 31, 2004. For 2005, FHLB advances averaged 20.8% of assets compared
      to
      21.2% in 2004. 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 short term funding to partially offset
      the
      interest rate sensitivity of its prime-based loans. At December 31, 2005, the
      Bank had executed $51.1 million in repurchase agreements compared to $20.9
      million a year earlier. In 2000 the Corporation issued $10 million in trust
      preferred securities, which are termed “junior subordinated debentures,” which
      mature on March 1, 2030, but are callable at a premium beginning


-
          12
          -


March
      1,
      2010. In December 2004, the Corporation issued an additional $5 million in
      trust
      preferred securities/junior subordinated debentures. 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. Trust preferred securities/junior subordinated debentures 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, 2005, Cascade Bank remained a “well-capitalized” institution (the
      FDIC’s highest rating), under regulatory guidelines, with a core capital to
      asset ratio of 8.15% and a risk-based capital to asset ratio of 10.77%. 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, 2005, the Corporation's
      total
      risk-based capital to risk-weighted assets was 10.86%, compared to 11.18% at
      December 31, 2004, and 13.42% at December 31, 2003. 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 October 2005, the quarterly cash dividend was
      increased from $.08 per share to $.09 per share. For the year, the Corporation
      returned $3.2 million in dividends to its shareholders compared to $2.6 million
      in 2004. The dividend payout ratio (the ratio of dividends paid to net income)
      for 2005 was 24.2%.


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, 2005,
      of
      $13.0 million, an increase of 21.0% over the $10.8 million net income in the
      year ended December 31, 2004. Earnings per fully diluted share (EPS) were $1.32
      in 2005 and $1.16 in 2004. In 2004, the Corporation incurred $356,000 of
      acquisition-related expenses in connection with its acquisition of Issaquah,
      which translated to approximately $.04 a share. Without those expenses, 2004
      diluted EPS would have been $1.20. Higher net interest income due to increased
      earning assets contributed to the improved results. Income was also enhanced
      by
      increased checking fees, which partially offset the decline in gains on the
      sale
      of securities. The Corporation earned net income of $9.6 million or $1.13 per
      fully diluted share for the fiscal year December 31, 2003.





**Return
      on Average Equity**


Return
      on
      average equity for the year ended December 31, 2005, was 13.13% compared to
      13.22% for the same period of 2004. Return on average equity for the fiscal
      year
      ending December 31, 2003, was 15.81%.




**Return
      on Average Tangible Equity**


Return
      on
      average tangible equity (average equity less goodwill) was 17.82% compared
      to
      16.24% in 2004. 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.


A
      summary
      of tangible equity follows:





*(Dollars
                in thousands)*
            
            **2005**
            
            **2004**Net
                income
            
            $
            13,046
            
            $
            10,785Average
                equity
            
            
            99,370
            
            
            81,575Average
                goodwill & intangibles
            
            
            26,166
            
            
            15,167Average
                tangible equity
            
            
            73,204
            
            
            66,408Return
                on average tangible equity
            
            
            17.82
            %
            
            16.24
            %




-
          13
          -




**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, 2005, increased by 12.7%, or
      $4.1 million, to $36.5 million from $32.4 million for the year ended December
      31, 2004. 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, 2003 was $27.6 million.


Average
      earning assets increased 15.5% to $1.1 billion for the year ended December
      31,
      2005, from $942.8 million for the year ended December 31, 2004. Average earning
      assets were $824.4 million for the year ended December 31, 2003.


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, 2005, was 3.35%,
      compared to 3.44% for the year ended December 31, 2004. While yield on assets
      has improved over the last year, liability costs have also increased. The yield
      on earning assets increased 36 basis points to 6.23% in 2005. The cost of
      interest-bearing liabilities increased 50 basis points to 3.22% 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,****2005**
            
            **2004**
            
            **2003****AVERAGE****BALANCE**
            
            **INTEREST
                AND****DIVIDEND**
            
            **YIELD/****COST**
            
            **AVERAGE****BALANCE**
            
            **INTEREST
                AND****DIVIDEND**
            
            **YIELD/****COST**
            
            **AVERAGE****BALANCE**
            
            **INTEREST
                AND****DIVIDEND**
            
            **YIELD/****COST***(Dollars
                in thousands)***ASSETS**Interest-earning
                assets*(1)*Single-family
                loans
            
            $
            104,789
            
            $
            5,882
            
            
            5.61
            %
            $
            106,187
            
            $
            6,219
            
            
            5.86
            %
            $
            112,299
            
            $
            7,450
            
            
            6.63
            %Multifamily
                loans
            
            
            74,650
            
            
            4,910
            
            
            6.58
            
            
            91,410
            
            
            5,839
            
            
            6.39
            
            
            87,028
            
            
            6,293
            
            
            7.23Commercial
                real estate loans
            
            
            166,736
            
            
            10,957
            
            
            6.57
            
            
            122,958
            
            
            7,888
            
            
            6.41
            
            
            74,381
            
            
            5,292
            
            
            7.11Construction
                loans
            
            
            133,975
            
            
            10,199
            
            
            7.61
            
            
            88,635
            
            
            5,579
            
            
            6.29
            
            
            77,717
            
            
            4,499
            
            
            5.79Consumer
                loans
            
            
            31,352
            
            
            2,210
            
            
            7.05
            
            
            32,016
            
            
            2,254
            
            
            7.04
            
            
            39,592
            
            
            2,787
            
            
            7.04Business
                loans
            
            
            343,182
            
            
            23,441
            
            
            6.83
            
            
            250,166
            
            
            16,447
            
            
            6.57
            
            
            174,436
            
            
            11,420
            
            
            6.55Total
                loans
            
            
            854,684
            
            
            57,599
            
            
            6.74
            
            
            691,372
            
            
            44,226
            
            
            6.40
            
            
            565,453
            
            
            37,741
            
            
            6.67Securities
                available-for-sale
            
            
            134,157
            
            
            5,582
            
            
            4.16
            
            
            155,563
            
            
            6,692
            
            
            4.30
            
            
            184,558
            
            
            9,182
            
            
            4.98Securities
                held-to-maturity
            
            
            93,069
            
            
            4,306
            
            
            4.63
            
            
            91,747
            
            
            4,326
            
            
            4.72
            
            
            65,956
            
            
            3,327
            
            
            5.04Daily
                interest-earning deposits
            
            
            6,912
            
            
            315
            
            
            4.56
            
            
            4,123
            
            
            71
            
            
            1.72
            
            
            8,455
            
            
            113
            
            
            1.34Total
                securities and interest earning deposits
            
            
            234,138
            
            
            10,203
            
            
            4.36
            
            
            251,433
            
            
            11,089
            
            
            4.41
            
            
            258,969
            
            
            12,622
            
            
            4.87Total
                interest-earning assets
            
            
            1,088,822
            
            
            67,802
            
            
            6.23
            %
            
            942,805
            
            
            55,315
            
            
            5.87
            %
            
            824,422
            
            
            50,363
            
            
            6.11
            %Noninterest-earning
                assetsOffice
                properties and equipment, net
            
            
            12,741
            
            
            
            
            
            
            
            
            11,117
            
            
            
            
            
            
            
            
            8,806Real
                estate, net
            
            
            328
            
            
            
            
            
            
            
            
            769
            
            
            
            
            
            
            
            
            361Other
                noninterest - earning assets
            
            
            53,847
            
            
            
            
            
            
            
            
            33,976
            
            
            
            
            
            
            
            
            16,189Total
                assets
            
            $
            1,155,738
            
            
            
            
            
            
            
            $
            988,667
            
            
            
            
            
            
            
            $
            849,778




-
          14
          -




**FOR
                    THE YEARS ENDED DECEMBER 31,****2005**
                
                **2004**
                
                **2003****AVERAGE****BALANCE**
                
                **INTEREST
                    AND****DIVIDEND**
                
                **YIELD/****COST**
                
                **AVERAGE****BALANCE**
                
                **INTEREST
                    AND****DIVIDEND**
                
                **YIELD/****COST**
                
                **AVERAGE****BALANCE**
                
                **INTEREST
                    AND****DIVIDEND**
                
                **YIELD/****COST***(Dollars
                    in thousands)***LIABILITIES
                    AND EQUITY**Interest-bearing
                    liabilitiesSavings
                    accounts
                
                $
                15,465
                
                $
                67
                
                
                0.43
                %
                $
                14,895
                
                $
                43
                
                
                0.29
                %
                $
                11,828
                
                $
                55
                
                
                0.46
                %Checking
                    accounts
                
                
                39,618
                
                
                245
                
                
                0.62
                
                
                29,562
                
                
                93
                
                
                0.31
                
                
                21,854
                
                
                105
                
                
                0.48Money
                    market accounts
                
                
                170,641
                
                
                3,255
                
                
                1.91
                
                
                145,626
                
                
                1,872
                
                
                1.29
                
                
                113,263
                
                
                1,499
                
                
                1.32Certificates
                    of deposit
                
                
                467,388
                
                
                14,747
                
                
                3.16
                
                
                401,620
                
                
                9,151
                
                
                2.28
                
                
                357,955
                
                
                9,314
                
                
                2.60Total
                    interest-bearing deposits
                
                
                693,112
                
                
                18,314
                
                
                2.64
                
                
                591,703
                
                
                11,159
                
                
                1.89
                
                
                504,900
                
                
                10,973
                
                
                2.17Other
                    interest-bearing liabilitiesFHLB
                    advances
                
                
                239,896
                
                
                11,031
                
                
                4.60
                
                
                210,023
                
                
                10,601
                
                
                5.05
                
                
                194,229
                
                
                10,308
                
                
                5.31Other
                    interest-bearing liabilities
                
                
                39,495
                
                
                1,931
                
                
                4.89
                
                
                41,511
                
                
                1,159
                
                
                2.79
                
                
                45,360
                
                
                1,472
                
                
                3.25Total
                    interest-bearing liabilities
                
                
                972,503
                
                
                31,276
                
                
                3.22
                %
                
                843,237
                
                
                22,919
                
                
                2.72
                %
                
                744,489
                
                
                22,753
                
                
                3.06
                %Other
                    liabilities
                
                
                83,865
                
                
                
                
                
                
                
                
                63,855
                
                
                
                
                
                
                
                
                44,523Total
                    liabilities
                
                
                1,056,368
                
                
                
                
                
                
                
                
                907,092
                
                
                
                
                
                
                
                
                789,012Stockholders’
                    equity
                
                
                99,370
                
                
                
                
                
                
                
                
                81,575
                
                
                
                
                
                
                
                
                60,766Total
                    liabilities and retained earnings
                
                $
                1,155,738
                
                
                
                
                
                
                
                $
                988,667
                
                
                
                
                
                
                
                $
                849,778Net
                    interest income*(2)*
                
                
                
                
                $
                36,526
                
                
                
                
                
                
                
                $
                32,396
                
                
                
                
                
                
                
                $
                27,610Interest
                    rate spread*(3)*
                
                
                
                
                
                
                
                
                3.01
                %
                
                
                
                
                
                
                
                3.15
                %
                
                
                
                
                
                
                
                3.05
                %Net
                    interest margin*(4)*
                
                
                
                
                
                
                
                
                3.35
                %
                
                
                
                
                
                
                
                3.44
                %
                
                
                
                
                
                
                
                3.35
                %Average
                    interest-earning assets to average interest-bearingliabilities
                
                
                111.96
                %
                
                
                
                
                
                
                
                111.81
                %
                
                
                
                
                
                
                
                110.74
                %




*(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, 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, 2005, was $6.3 million, compared to $4.7 million and $5.3
      million for the same periods in 2004 and 2003, respectively. This increase
      was
      attributable primarily to a $1.1 million increase in checking fees and $212,000
      increase in other services fees. The higher gain on sale of loans primarily
      reflects the sale of $34.7 million of multifamily loans. The decrease in gain
      on
      sale of securities resulted primarily from an interest rate environment that
      was
      stable for longer-dated securities, but saw a dramatic increase in short-term
      rates as the Fed continues to increase its target Fed funds rate.





**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 $2.3 million to $22.6 million for the year ended December
      31, 2005, from $20.3 million and $17.7 million for 2004 and 2003, respectively.
      The increase in expense was due to costs associated with the operations of
      the
      Issaquah Bank Division for a complete year; the costs of running two new
      branches for a full year; and marketing costs associated with the introduction
      of the High Performance Checking program. Salaries and employee benefits
      increased overall by $631,000 to $12.1 million. Cascade also incurred $356,000
      in acquisition-related expenses in 2004 in association with the merger with
      Issaquah.


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,
      2005, 2004, and 2003, the Corporation’s efficiency ratio was 52.75%, 54.70%, and
      53.87%, respectively. Management continues to look for ways to improve the
      efficiency ratio by increasing other income and net interest margin 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


-
          15
          -


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, 2005, December 31, 2004, and December 31, 2003,
      cash and cash equivalents totaled $31.1 million, $13.0 million, and $14.1
      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.


The
      primary source of borrowings is Federal Home Loan Bank of Seattle (FHLB-Seattle)
      advances and repurchase agreements. At December 31, 2005, $188.1 million of
      additional borrowing capacity remained under Cascade Bank’s existing credit line
      from the FHLB-Seattle based upon the total, 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, 2005, Cascade had
      unencumbered eligible collateral of approximately $98.5 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 two of these lines during the year, one of which was to test the
      operational aspects of the facility as part of our liquidity planning process.
      The Bank also opened a line of credit with the Federal Reserve Bank of San
      Francisco. As of December 31, 2005, 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.





**Interest
      Rate Risk Management**


The
      Corporation’s results of operations are largely dependent upon its ability to
      manage interest rate risk. 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. Since most of Cascade Bank’s fixed-rate loans do
      not have provisions for prepayment fees, a drop in rates can precipitate a
      refinancing of Cascade 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, 2005, a 200 basis point increase in rates
      would
      decrease forecasted net interest income over a twelve-month period by
      approximately 1.0%. A 200 basis point decrease in rates would increase interest
      income by 0.4% 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 $26.0
      million or 20.8%, which is within the guideline established by the Bank’s
      Asset/Liability Policy.


The
      Bank
      uses interest rate swaps to manage its interest rate exposure. The first swap
      effectively converts the junior subordinated debentures of Capital Trust I,
      $10
      million notional value, to a LIBOR-based borrowing. The second swap is for
      $10
      million and effectively converts a fixed-rate CD into a LIBOR-based
      liability.


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, 2005, 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
              
              $
              509,232
              
              $
              293,267
              
              $
              72,658
              
              $
              5,385
              
              $
              204
              
              $
              880,746
              
              $
              888,780Investments
                  and other interest-earning assets
              
              
              51,819
              
              
              28,494
              
              
              69,434
              
              
              92,155
              
              
              20,229
              
              
              262,131
              
              
              259,504**Interest-Sensitive
                  Liabilities**Checking
                  accounts
              
              $
              8,814
              
              $
              16,828
              
              $
              7,212
              
              $
              6,491
              
              $
              721
              
              $
              40,066
              
              $
              40,066Money
                  market accounts
              
              
              39,957
              
              
              76,280
              
              
              32,692
              
              
              29,423
              
              
              3,269
              
              
              181,621
              
              
              181,621Savings
                  accounts
              
              
              3,337
              
              
              6,370
              
              
              2,731
              
              
              2,458
              
              
              273
              
              
              15,169
              
              
              15,169Certificates
                  of deposit*(1)*
              
              
              409,970
              
              
              57,544
              
              
              10,294
              
              
              702
              
              
              —
              
              
              478,510
              
              
              477,510Borrowings
              
              
              184,058
              
              
              24,000
              
              
              59,000
              
              
              20,000
              
              
              —
              
              
              287,058
              
              
              288,060Junior
                  subordinateddebentures
                  payable (2*)*
              
              
              10,057
              
              
              —
              
              
              5,155
              
              
              —
              
              
              —
              
              
              15,212
              
              
              15,212





*(1)
      Net of $311 mark-to-market on swap.*


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




-
          16
          -




**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.


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 2005 or 2004.


A
      summary
      of the notional amount of the Bank’s financial instruments with off-balance
      sheet risk at December 31, 2005, follows:


**PAYMENTS
                  DUE PER PERIOD***(Dollars
                  in thousands)*
              
              **<1
                  YEAR**
              
              **1-3
                  YEARS**
              
              **3-5
                  YEARS**
              
              **THEREAFTER**
              
              **TOTAL**Commitments
                  to extend credit
              
              $
              109,470
              
              $
              46,026
              
              $
              1,384
              
              $
              59,435
              
              $
              216,315Standby
                  letters of credit and financial guarantees written
              
              
              1,565
              
              
              3,676
              
              
              —
              
              
              —
              
              
              5,241Unused
                  commitments on bankcards
              
              
              —
              
              
              —
              
              
              —
              
              
              11,873
              
              
              11,873Total
              
              $
              111,035
              
              $
              49,702
              
              $
              1,384
              
              $
              71,308
              
              $
              233,429
 
 **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
              
              $
              409,970
              
              $
              57,544
              
              $
              10,294
              
              $
              702
              
              $
              478,510Federal
                  Home Loan Bank advances
              
              
              23,000
              
              
              24,000
              
              
              99,000
              
              
              90,000
              
              
              236,000Capital
                  lease obligations
              
              
              51
              
              
              —
              
              
              —
              
              
              —
              
              
              51Operating
                  lease obligations
              
              
              608
              
              
              1,216
              
              
              1,190
              
              
              6,258
              
              
              9,272Junior
                  subordinated debentures payable
              
              
              —
              
              
              —
              
              
              —
              
              
              15,212
              
              
              15,212Total
              
              $
              433,629
              
              $
              82,760
              
              $
              110,484
              
              $
              112,172
              
              $
              739,045


At
      December 31, 2005, the Corporation’s long-term contractual obligations related
      to debt totaled $246.2 million. See additional discussion under Note 7 and
      8 to
      the Consolidated Financial Statements for the year ended December 31, 2005.


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 standards:* 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 Corporation
      will adopt Statement 123(R) effective January 1, 2006. Cascade estimates that
      the adoption of this accounting standard will reduce our earnings per share
      by
      $0.015-$0.02 in 2006, and slightly less in subsequent years.





**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, 2005 and 2004,
      and
      the related consolidated statements of income, stockholders' equity and
      comprehensive income, and cash flows for the years ended December 31, 2005
      and
      2004. 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, 2005, 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 opinions.





A
      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, 2005 and 2004, and
      the
      results of their operations and cash flows for each of the years then ended,
      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, 2005, 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, 2005, based on criteria established
      in Internal Control - Integrated Framework issued by the Committee of Sponsoring
      Organizations of the Treadway Commission.








Everett,
      Washington


March
      13,
      2006


-
          18
          -





**KPMG
      LLP**


Suite
      900


801
      Second Avenue


Seattle,
      WA 98104




**Report
      of Independent Registered Public Accounting Firm**




The
      Board
      of Directors


Cascade
      Financial Corporation:




We
      have
      audited the accompanying consolidated statements of operations, stockholders’
equity and comprehensive income, and cash flows of Cascade Financial Corporation
      and subsidiaries (Corporation) for the year ended December 31, 2003. These
      consolidated financial statements are the responsibility of the Corporation’s
      management. Our responsibility is to express an opinion on these consolidated
      financial statements based on our audit.





We
      conducted our audit  in
      accordance with the standards of the Public Company Accounting Oversight Board
      (United States). Those standards require that we plan and perform the audit
      to
      obtain reasonable assurance about whether the financial statements are free
      of
      material misstatement. An audit includes examining, on a test basis, evidence
      supporting the amounts and disclosures in the financial statements. An audit
      also includes assessing the accounting principles used and significant estimates
      made by management, as well as evaluating the overall financial statement
      presentation. We believe that our audit provides a reasonable basis for our
      opinion.





In
      our
      opinion, the consolidated financial statements  referred
      to above present fairly, in all material respects, the results of operations
      and
      cash flows of Cascade Financial Corporation and subsidiaries for the
      year  ended
      December 31, 2003, in conformity with U.S. generally accepted accounting
      principles.









Seattle,
      Washington


February
      20, 2004













***KPMG
      LLP, a limited liability partnership, is the U.S.***


***member
      firm of KPMG International, a Swiss cooperative***


-
          19
          -


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Consolidated
      Balance Sheets***


Years
      ended December 31, 2005, and 2004




**DECEMBER
                  31,***(Dollars
                  in thousands)*
              
              **2005**
              
              **2004****ASSETS**Cash
                  on hand and in banks
              
              $
              16,616
              
              $
              11,692Interest-bearing
                  deposits in other financial institutions
              
              
              14,493
              
              
              1,337Securities
                  available-for-sale
              
              
              140,596
              
              
              112,404Securities
                  held-to-maturity
              
              
              95,122
              
              
              91,339Federal
                  Home Loan Bank (FHLB) stock
              
              
              11,920
              
              
              11,872Loans,
                  net
              
              
              867,049
              
              
              794,466Goodwill
                  and intangibles, net
              
              
              26,121
              
              
              26,292Premises
                  and equipment, net
              
              
              12,270
              
              
              12,824Cash
                  surrender value of bank-owned life insurance
              
              
              17,313
              
              
              16,650Accrued
                  interest receivable and other assets
              
              
              10,284
              
              
              10,079Total
                  assets
              
              $
              1,211,784
              
              $
              1,088,955**LIABILITIES
                  AND STOCKHOLDERS’ EQUITY**Liabilities:Deposits
              
              $
              795,768
              
              $
              721,908Federal
                  Home Loan Bank advances
              
              
              236,000
              
              
              228,000Securities
                  sold under agreements to repurchase
              
              
              51,058
              
              
              20,902Junior
                  subordinated debentures payable
              
              
              15,212
              
              
              15,454Advance
                  payments by borrowers for taxes and insurance
              
              
              689
              
              
              677Dividends
                  payable
              
              
              864
              
              
              765Accrued
                  interest payable, expenses, and other liabilities
              
              
              7,000
              
              
              4,999Total
                  liabilities
              
              
              1,106,591
              
              
              992,705Stockholders’
                  equity:Preferred
                  stock, $.01 par value. Authorized 500,000 shares; no shares issued
                  or
                  outstanding
              
              
              __
              
              
              __Common
                  stock, $.01 par value. Authorized 25,000,000 shares; issued and
                  outstanding 9,603,787 shares at December 31, 2005, and 9,559,822
                  shares at
                  December 31, 2004
              
              
              96
              
              
              96Additional
                  paid-in capital
              
              
              38,149
              
              
              37,326Retained
                  earnings, substantially restricted
              
              
              68,945
              
              
              59,975Accumulated
                  other comprehensive income (loss)
              
              
              (1,997
              )
              
              (1,147
              )Total
                  stockholders’ equity
              
              
              105,193
              
              
              96,250Total
                  liabilities and stockholders’ equity
              
              $
              1,211,784
              
              $
              1,088,955




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


-
          20
          -


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Consolidated
      Statements of Income***


Years
      ended December 31, 2005, 2004, and 2003




**YEARS
                ENDED DECEMBER 31,***(Dollars
                in thousands, except share amounts)*
            
            **2005**
            
            **2004**
            
            **2003**Interest
                income:Loans
            
            $
            57,599
            
            $
            44,226
            
            $
            37,741Securities
                held-to-maturity
            
            
            4,306
            
            
            4,292
            
            
            3,327Securities
                available-for-sale
            
            
            5,534
            
            
            6,291
            
            
            8,391FHLB
                stock dividends
            
            
            48
            
            
            436
            
            
            791Interest-bearing
                deposits
            
            
            315
            
            
            71
            
            
            113Total
                interest income
            
            
            67,802
            
            
            55,316
            
            
            50,363Interest
                expense:Deposits
            
            
            18,314
            
            
            11,159
            
            
            10,973FHLB
                advances
            
            
            11,031
            
            
            10,601
            
            
            10,308Securities
                sold under agreements to repurchase
            
            
            733
            
            
            436
            
            
            438Junior
                subordinated debentures payable
            
            
            1,198
            
            
            723
            
            
            1,034Total
                interest expense
            
            
            31,276
            
            
            22,919
            
            
            22,753Net
                interest income
            
            
            36,526
            
            
            32,397
            
            
            27,610Provision
                for loan losses
            
            
            945
            
            
            675
            
            
            1,275Net
                interest income after provision for loan losses
            
            
            35,581
            
            
            31,722
            
            
            26,335Other
                income:Gain
                on sale of loans
            
            
            865
            
            
            228
            
            
            855Gain
                on sale of securities available-for-sale
            
            
            67
            
            
            510
            
            
            1,790Gain
                on sale of REO
            
            
            33
            
            
            82
            
            
            48Checking
                service fees
            
            
            3,124
            
            
            2,069
            
            
            1,415Other
                service fees
            
            
            916
            
            
            704
            
            
            480BOLI
            
            
            764
            
            
            566
            
            
            598Other
            
            
            564
            
            
            588
            
            
            120Total
                other income
            
            
            6,333
            
            
            4,747
            
            
            5,306Other
                expenses:Salaries
                and employee benefits
            
            
            12,114
            
            
            11,483
            
            
            9,617Occupancy
            
            
            3,323
            
            
            2,745
            
            
            2,551Data
                processing
            
            
            646
            
            
            448
            
            
            284Marketing
            
            
            810
            
            
            547
            
            
            461Prepayment
                penalty FHLB
            
            
            110
            
            
            26
            
            
            863Merger
                expense
            
            
            —
            
            
            356
            
            
            —Other
            
            
            5,603
            
            
            4,712
            
            
            3,957Total
                other expenses
            
            
            22,606
            
            
            20,317
            
            
            17,733Income
                before provision for federal income taxes
            
            
            19,308
            
            
            16,152
            
            
            13,908Provision
                for federal income taxes
            
            
            6,262
            
            
            5,367
            
            
            4,309Net
                income
            
            $
            13,046
            
            $
            10,785
            
            $
            9,599Net
                income per common share, basic
            
            $
            1.36
            
            $
            1.20
            
            $
            1.17Weighted
                average number of shares outstanding, basic
            
            
            9,582,259
            
            
            8,952,493
            
            
            8,184,455Net
                income per share, diluted
            
            $
            1.32
            
            $
            1.16
            
            $
            1.13Weighted
                average number of shares outstanding, diluted
            
            
            9,855,898
            
            
            9,276,232
            
            
            8,461,503





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


-
          21
          -


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


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


Years
      ended December 31, 2005, 2004, and 2003





*(Dollars
                in thousands, except share amounts)*
            
            **SHARES**
            
            **COMMON****STOCK**
            
            **ADDITIONAL
                PAID-IN****CAPITAL**
            
            **RETAINED****EARNINGS**
            
            **ACCUMULATED
                OTHER COMPREHENSIVE INCOME****(LOSS),
                NET**
            
            **TOTAL
                STOCK- HOLDERS’****EQUITY**Balances
                at December 31, 2002
            
            
            8,105,150
            
            $
            81
            
            $
            11,268
            
            $
            44,290
            
            $
            1,001
            
            $
            56,640Cash
                dividends
            
            
            —
            
            
            —
            
            
            —
            
            
            (1,692
            )
            
            —
            
            
            (1,692
            )Options
                exercised, including related tax benefit
            
            
            144,051
            
            
            1
            
            
            661
            
            
            —
            
            
            —
            
            
            662Net
                income
            
            
            —
            
            
            —
            
            
            —
            
            
            9,599
            
            
            —
            
            
            9,599Shares
                repurchased
            
            
            (7,913
            )
            
            —
            
            
            (8
            )
            
            (88
            )
            
            —
            
            
            (96
            )Other
                comprehensive loss, net of tax of $(596)
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            (1,156
            )
            
            (1,156
            )Balances
                at December 31, 2003
            
            
            8,241,288
            
            
            82
            
            
            11,921
            
            
            52,109
            
            
            (155
            )
            
            63,957Cash
                dividends
            
            
            —
            
            
            —
            
            
            —
            
            
            (2,777
            )
            
            —
            
            
            (2,777
            )Options
                exercised, including related tax benefit
            
            
            63,865
            
            
            1
            
            
            634
            
            
            —
            
            
            —
            
            
            635Net
                income
            
            
            —
            
            
            —
            
            
            —
            
            
            10,785
            
            
            —
            
            
            10,785Shares
                repurchased
            
            
            (8,754
            )
            
            —
            
            
            (8
            )
            
            (142
            )
            
            —
            
            
            (150
            )Other
                comprehensive loss, net of tax 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 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
            )
            $
            105,193





**Comprehensive
                Income**
            
            **YEARS
                ENDED****DECEMBER
                31,****2005**
            
            **2004**
            
            **2003**Net
                income
            
            $
            13,046
            
            $
            10,785
            
            $
            9,599Increase
                in unrealized gain (loss) on securities available-for-sale, net of
                tax
                (benefit) expense of $(452), $(346) and $13.
            
            
            (840
            )
            
            (622
            )
            
            25Increase
                in unrealized gain (loss) on swaps available-for-sale, net of tax
                expense
                of $114, $119, and $0.
            
            
            213
            
            
            232
            
            
            —Less
                reclassification adjustment for gains on securities included in net
                income, net of tax (benefit) of $(23), $(173), and $(609).
            
            
            (44
            )
            
            (337
            )
            
            (1,181
            )Less
                reclassification adjustment for gains on swaps included in net income,
                net
                of tax (benefit) of $(96), $(137), and $0.
            
            
            (179
            )
            
            (265
            )
            
            —Comprehensive
                income
            
            $
            12,196
            
            $
            9,793
            
            $
            8,443


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


-
          22
          -


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Consolidated
      Statements of Cash Flows***


Years
      ended December 31, 2005, 2004, and 2003




**YEARS
                ENDED DECEMBER 31,***(Dollars
                in thousands)*
            
            **2005**
            
            **2004**
            
            **2003**Cash
                flows from operating activities:Net
                income
            
            $
            13,046
            
            $
            10,785
            
            $
            9,599Adjustments
                to reconcile net income to net cash provided by (used in) operating
                activities:Depreciation
                and amortization of premises and equipment
            
            
            1,874
            
            
            1,553
            
            
            1,454Provision
                for losses on loans
            
            
            945
            
            
            675
            
            
            1,275Increase
                in cash surrender value of bank owned life insurance
            
            
            (663
            )
            
            (488
            )
            
            (542
            )Amortization
                of retained servicing rights
            
            
            30
            
            
            40
            
            
            230Amortization
                of core deposit intangible
            
            
            141
            
            
            70
            
            
            —Deferred
                federal income taxes
            
            
            (150
            )
            
            (100
            )
            
            (236
            )Deferred
                loan fees, net of amortization
            
            
            748
            
            
            516
            
            
            (19
            )Net
                gain on sales of securities available-for-sale
            
            
            (67
            )
            
            (510
            )
            
            (1,790
            )Loss
                on sales of premises and equipment
            
            
            —
            
            
            6
            
            
            —Net
                gain on sale of real estate owned, investment property and other
                repossessed assets
            
            
            (33
            )
            
            (82
            )
            
            (48
            )Federal
                Home Loan Bank stock dividend received
            
            
            (48
            )
            
            (436
            )
            
            (791
            )Net
                change in accrued interest receivable and other assets
            
            
            (156
            )
            
            6,945
            
            
            1,729Net
                change in accrued interest payable, expenses and other
                liabilities
            
            
            2,392
            
            
            227
            
            
            (2,883
            )Net
                cash provided by operating activities
            
            
            18,059
            
            
            19,201
            
            
            7,978Cash
                flows from investing activities:Loans
                originated, net of principal repayments
            
            
            (72,217
            )
            
            (230,348
            )
            
            (22,239
            )Purchases
                of securities held-to-maturity
            
            
            (10,054
            )
            
            (35,436
            )
            
            (105,085
            )Proceeds
                from sales/calls on securities held-to-maturity
            
            
            —
            
            
            26,095
            
            
            54,913Principal
                repayments on securities held-to-maturity
            
            
            6,271
            
            
            4,876
            
            
            12,841Principal
                repayments on securities available-for-sale
            
            
            22,318
            
            
            31,471
            
            
            96,515Purchases
                of securities available-for-sale
            
            
            (58,289
            )
            
            (93,167
            )
            
            (337,004
            )Proceeds
                from sales of securities available-for-sale
            
            
            6,488
            
            
            127,261
            
            
            211,470Purchases
                of premises and equipment
            
            
            (1,345
            )
            
            (5,802
            )
            
            (799
            )Proceeds
                from sales/retirements of premises and equipment
            
            
            25
            
            
            5
            
            
            19Proceeds
                from loan participations sold
            
            
            (1,747
            )
            
            446
            
            
            —Cash
                used for acquisition
            
            
            —
            
            
            (9,546
            )
            
            —Purchase
                of bank owned life insurance
            
            
            —
            
            
            (5,000
            )
            
            —Net
                cash used in investing activities
            
            
            (108,550
            )
            
            (189,145
            )
            
            (89,369
            )Subtotal,
                carried forward
            
            $
            (90,491
            )
            $
            (169,944
            )
            $
            (81,391
            )





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




-
          23
          -


***Consolidated
      Statements of Cash Flows, Continued***





**YEARS
                ENDED DECEMBER 31,***(Dollars
                in thousands)*
            
            **2005**
            
            **2004**
            
            **2003**Subtotal,
                brought forward
            
            $
            (90,491
            )
            $
            (169,944
            )
            $
            (81,391
            )Cash
                flows from financing activities:Proceeds
                from issuance of common stock
            
            
            564
            
            
            436
            
            
            547Dividends
                paid
            
            
            (3,163
            )
            
            (2,589
            )
            
            (1,440
            )Repurchase
                of common stock
            
            
            (858
            )
            
            (150
            )
            
            (96
            )Net
                increase in deposits
            
            
            73,860
            
            
            157,594
            
            
            54,464Net
                increase (decrease) in Federal Home Loan Bank advances
            
            
            8,000
            
            
            28,000
            
            
            2,500Net
                increase (decrease) in securities sold under agreements to
                repurchase
            
            
            30,156
            
            
            (19,009
            )
            
            19,342Net
                increase (decrease) in advance payments by borrowers for taxes and
                insurance
            
            
            12
            
            
            (380
            )
            
            (450
            )Proceeds
                from junior subordinated debentures payable
            
            
            —
            
            
            5,000
            
            
            —Net
                cash provided by financing activities
            
            
            108,571
            
            
            168,902
            
            
            74,867Net
                increase (decrease) in cash and cash equivalents
            
            
            18,080
            
            
            (1,042
            )
            
            (6,524
            )Cash
                and cash equivalents at beginning of period
            
            
            13,029
            
            
            14,071
            
            
            20,595Cash
                and cash equivalents at end of period
            
            $
            31,109
            
            $
            13,029
            
            $
            14,071Supplemental
                disclosures of cash flow information -Cash
                paid during the period for:Interest
            
            $
            31,909
            
            $
            24,511
            
            $
            23,238Federal
                income taxes
            
            
            4,716
            
            
            5,802
            
            
            4,350Supplemental
                schedule of non-cash operating activities:Retirement
                of treasury stock in retained earnings
            
            
            —
            
            
            —
            
            
            (1,237
            )Supplemental
                schedule of non-cash investing activities:Net
                mortgage loans transferred to real estate owned
            
            
            —
            
            
            1,339
            
            
            566Mark-to-market
                on securities available-for-sale
            
            
            1,308
            
            
            1,529
            
            
            1,752Tax
                benefit of non-qualified options exercised
            
            
            301
            
            
            199
            
            
            115Issaquah
                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.




-
          24
          -


**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 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.


Applying
      the provisions of FIN 46R, we deconsolidated our issuer trust as of December
      31,
      2003, and all periods in the consolidated financial statements have been
      restated to reflect this change. 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 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, 2005, and 2004, the Bank has
      $11,920 and $0 of Class B (1) and B (2) stock, and $11,872 and $0 of Class
      B (1)
      and B (2) stock, respectively.





**(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. During the last three years, the Bank has 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 $15.6 million and $9.0 million at December 31, 2005, and 2004,
      respectively. Included in the 2005 total is $9.2 million of loans serviced
      on a
      short-term interim servicing agreement.





**(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 $810, $547 and $461 for the years ended December 31, 2005, 2004,
      and
      2003, respectively.




**(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.


-
          25
          -





**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*




**(i)
      Segment Reporting**


The
      Corporation’s sole operating subsidiary is Cascade Bank, which is managed along
      five major lines of business: business banking, retail banking, construction
      lending, income property lending and residential lending. 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,
      and
      regulatory and stockholder reporting. The Bank operates primarily in the Puget
      Sound geographical region of Washington State. 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.





**(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, 2005
      and
      2004:





**GROSS
                CARRYING AMOUNT**Intangible
                assets carrying value
            
            **2005**
            
            **2004**Core
                deposit intangible, net
            
            $
            916
            
            $
            1,057Goodwill
            
            
            25,195
            
            
            25,195Mortgage
                servicing rights, net
            
            
            10
            
            
            40Total
            
            $
            26,121
            
            $
            26,292




Amortization
      and write-downs of intangible assets for 2005 and 2004, was as follows:





**AMORTIZATION
                AND WRITE-DOWN YEARS ENDED DECEMBER 31**Intangible
                assets amortization and impairment
            
            **2005**
            
            **2004**Core
                deposit intangible
            
            $
            141
            
            $
            70Mortgage
                servicing rights
            
            
            30
            
            
            40Total
            
            $
            171
            
            $
            110




-
          26
          -


**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 12/31/06
            
            $
            151For
                year ended 12/31/07
            
            
            141For
                year ended 12/31/08
            
            
            141For
                year ended 12/31/09
            
            
            141For
                year ended 12/31/10
            
            
            141





**(l)
      Loans**


All
      of
      the Corporation's loans are located in Washington State, primarily in the Puget
      Sound region. At December 31, 2005, the Corporation's loans were classified
      as
      one-to-four-family residences (11%), multifamily residences (6%), real estate
      construction (19%), business assets (45%), consumer assets (3%), and non-owner
      occupied commercial real estate properties (16%). 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
      loans comprise 45% of the total loan portfolio. Most of the business 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, 2005, $13.2 million in commercial 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 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 non-classified 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


-
          27
          -


**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 carried at cost. Gains or losses
      on the sale of such loans are based on the specific identification method.
      The
      Bank held $539 in loans for sale at December 31, 2005, and no loans held for
      sale at December 31, 2004. All
      loans
      are sold without recourse on a best efforts, servicing released
      basis.





**(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, and interest rate
      trends. 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 trade 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, 2005, and December 31, 2004, was $0, and
      $868,
      respectively, which is included in other assets.





**(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.





**(q)
      Federal Income Taxes**


Deferred
      tax assets and liabilities are recognized for the future tax consequences
      attributable to differences between the financial statement carrying amounts
      of
      existing assets and liabilities and their respective tax bases using the asset
      and liability method. Deferred tax assets and liabilities are measured using
      enacted tax rates expected to apply to taxable income in the years in which
      those temporary differences are expected to be recovered or settled. The effect
      on the deferred tax assets and liabilities of a change in tax rates is
      recognized in income in the period that includes the enactment
      date.


-
          28
          -





**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


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





**(r)
      Stock-Based Compensation**


The
      Corporation measures its employee stock-based compensation arrangements using
      the provisions outlined in Accounting Principles Board (APB) Opinion No. 25, *Accounting
      for Stock Issued to Employees* ,
      which
      is an intrinsic value-based method of recognizing compensation costs. As none
      of
      the Corporation’s stock options have an intrinsic value at grant date, no
      compensation cost has been recognized for its stock option plans.


The
      Corporation applies Accounting Principles Board (APB) Opinion No. 25, *Accounting
      for Stock Issued to Employees* ,
      in
      accounting for its stock option plans. Had compensation cost on the fair value
      at the grant dates for the Corporation's stock option plan been determined
      consistent with the Statement of Financial Accounting Standards (SFAS) No.
      123, *Accounting
      for Stock-Based Compensation* ,
      as
      amended, the Corporation's net income and earnings per share would have been
      reduced to the pro forma amounts indicated below:





**YEARS
                ENDED DECEMBER 31,****2005**
            
            **2004**
            
            **2003**Net
                incomeAs
                reported
            
            $
            13,046
            
            $
            10,785
            
            $
            9,599Less:
                SFAS 123 compensation costs, net of tax
            
            
            167
            
            
            183
            
            
            140Pro
                forma
            
            $
            12,879
            
            $
            10,602
            
            $
            9,459Net
                income per common shareBasicAs
                reported
            
            $
            1.36
            
            $
            1.20
            
            $
            1.17Pro
                forma
            
            
            1.34
            
            
            1.18
            
            
            1.16DilutedAs
                reported
            
            $
            1.32
            
            $
            1.16
            
            $
            1.13Pro
                forma
            
            
            1.31
            
            
            1.14
            
            
            1.12





The
      weighted average fair value of options granted under the Corporation's stock
      option plan was $4.82, $5.36, and $4.22, respectively for the years ended
      December 31, 2005, December 31, 2004, and December 31, 2003. The fair value
      is
      estimated on the date of grant using the Black-Scholes Model. The following
      weighted average assumptions were used for December 31, 2005, December 31,
      2004,
      and December 31, 2003: risk-free interest rate of 3.00%, 2.25%, and 1.00%,
      an
      expected life of eight years, cash dividends of $0.36 in 2005, cash dividends
      of
      $0.32 in 2004, and cash dividends of $0.28 in 2003, and a volatility factor
      of
      24%.


Beginning
      January 1, 2006, the Corporation shall begin accounting for stock options as
      required by SFAS 123(R). The fair value of the options and all other
      equity-based compensation shall be considered a compensation expense over the
      vesting period.





**(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 balance sheet accounts. 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.


The
      Corporation utilizes interest rate swap agreements to convert a portion of
      its
      variable-rate debt to a fixed-rate (cash flow hedge), or to convert a portion
      of
      its 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 currently in 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 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




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          29
          -




**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





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.





**(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 stand by 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.





**(v)
      Reclassifications**


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





**(w)
      Recent Accounting Pronouncements**


On
      December 16, 2004, FASB issued Statement No. 123 (revised 2004), *Share-Based
      Payment* ,
      which
      is a revision of FASB Statement No. 123, *Accounting
      for Stock-Based Compensation* .
      Statement 123(R) supersedes APB Opinion No. 25, *Accounting
      for Stock Issued to Employees* ,
      and
      amends FASB Statement No. 95, *Statement
      of Cash Flows* .
      Generally, the approach in Statement 123(R) is similar to the approach described
      in Statement No. 123. However, 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. Pro forma
      disclosure is no longer an alternative.


Statement
      123(R) must be adopted no later than January 1, 2006, and we expect to adopt
      the
      Statement on that date. As permitted by Statement 123, the Corporation currently
      accounts for share-based payments to employees using the intrinsic value method
      as detailed in Opinion No. 25 and, as such, generally recognizes no compensation
      cost for employee stock options. Accordingly, the adoption of Statement 123(R)’s
      fair value method will have an impact on our results of operations, although
      it
      will have no impact on our overall financial position. The impact of adoption
      of
      Statement 123(R) cannot be predicted at this time because it will depend on
      levels of share-based payments granted in the future. However, had we adopted
      Statement 123(R) in prior periods, the impact of the standard would have
      approximated the impact of Statement 123 as described in the disclosure of
      pro
      forma net income and earnings per share discussed above.





**(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,


2005,
      and
      2004, was approximately $3,494 and $2,821, respectively.





**(3)
      Securities**


A
      summary
      of securities at December 31, 2005, and December 31, 2004, follows:




**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


-
          30
          -


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


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




**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
                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







**DECEMBER
                31, 2004****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
            
            $
            43,208
            
            $
            50
            
            $
            20
            
            $
            544
            
            $
            212
            
            $
            42,522Agency
                notes
            
            
            70,910
            
            
            18
            
            
            —
            
            
            652
            
            
            394
            
            
            69,882$
            114,118
            
            $
            68
            
            $
            20
            
            $
            1,196
            
            $
            606
            
            $
            112,404




**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
            
            $
            25,083
            
            $
            —
            
            $
            30
            
            $
            345
            
            $
            184
            
            $
            24,584Agency
                notes
            
            
            65,791
            
            
            21
            
            
            —
            
            
            367
            
            
            939
            
            
            64,506Corporate/other
            
            
            465
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            465$
            91,339
            
            $
            21
            
            $
            30
            
            $
            712
            
            $
            1,123
            
            $
            89,555





At
      December 31, 2005, Cascade had nine securities with a gross unrealized loss
      totaling $774 in our available-for-sale portfolio with a fair value of $31.0
      million that had an unrealized loss for greater than one year and thirteen
      held-to- ****


maturity
      securities with a gross unrealized loss totaling $2.4 million with a fair value
      of $61.7 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 85% of the total impairment. As of December
      31, 2005, the Bank had thirty three available-for-sale and twenty two
      held-to-maturity securities included in the temporarily impaired report,
      compared to six available-for-sale and three 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 market value changes and are expected to regain the lost value with
      market shifts; 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. 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 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, 2005, and 2004, the Corporation was required to maintain 100,122
      and 97,501 shares, respectively, of $100 par value FHLB stock.


Accrued
      interest receivable on securities and interest-bearing deposits was $2,214
      and
      $1,728 at


December
      31, 2005, and 2004, respectively.




-
          31
          -




**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


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





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, 2005, 2004, and 2003.




**PROCEEDS**
            
            **GAINS**
            
            **LOSSES**Year
                ended December 31, 2005
            
            $
            6,488
            
            $
            68
            
            $
            (1)Year
                ended December 31, 2004
            
            
            153,356
            
            
            510
            
            
            —Year
                ended December 31, 2003
            
            
            266,383
            
            
            1,790
            
            
            —




The
      following table shows the contractual or expected maturities of the
      Corporation’s securities available-for-sale at December 31, 2005:




**WITHIN
                ONE****YEAR**
            
            **OVER
                ONE TO****FIVE
                YEARS**
            
            **OVER
                FIVE TO****TEN
                YEARS**
            
            **OVER
                TEN****YEARS**
            
            **TOTAL**Amortized
                CostMBS
            
            $
            —
            
            $
            40,871
            
            $
            6,976
            
            $
            —
            
            $
            47,847Agency
                notes
            
            
            87
            
            
            47,959
            
            
            31,894
            
            
            15,882
            
            
            95,822Total
                amortized cost
            
            $
            87
            
            $
            88,830
            
            $
            38,870
            
            $
            15,882
            
            $
            143,669Fair
                ValueMBS
            
            $
            —
            
            $
            40,620
            
            $
            6,803
            
            $
            —
            
            $
            47,423Agency
                notes
            
            
            87
            
            
            47,111
            
            
            30,523
            
            
            15,452
            
            
            93,173Total
                fair value
            
            $
            87
            
            $
            87,731
            
            $
            37,326
            
            $
            15,452
            
            $
            140,596




The
      following table shows the contractual or expected maturities of the
      Corporation’s securities held-to-maturity at December 31, 2005:




**WITHIN
                ONE****YEAR**
            
            **OVER
                ONE TO****FIVE
                YEARS**
            
            **OVER
                FIVE TO****TEN
                YEARS**
            
            **OVER
                TEN****YEARS**
            
            **TOTAL**Amortized
                CostMBS
            
            $
            —
            
            $
            15,558
            
            $
            8,272
            
            $
            —
            
            $
            23,830Agency
                notes
            
            
            —
            
            
            16,000
            
            
            17,893
            
            
            36,934
            
            
            70,827Corporate/other
            
            
            —
            
            
            —
            
            
            —
            
            
            465
            
            
            465Total
                amortized cost
            
            $
            —
            
            $
            31,558
            
            $
            26,165
            
            $
            37,399
            
            $
            95,122Fair
                ValueMBS
            
            $
            —
            
            $
            15,065
            
            $
            7,984
            
            $
            —
            
            $
            23,049Agency
                notes
            
            
            —
            
            
            15,712
            
            
            17,422
            
            
            35,472
            
            
            68,606Corporate/other
            
            
            —
            
            
            —
            
            
            —
            
            
            465
            
            
            465Total
                fair value
            
            $
            —
            
            $
            30,777
            
            $
            25,406
            
            $
            35,937
            
            $
            92,120




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 available-for-sale securities
      pledged as collateral to secure public deposits were $17.0 million at December
      31, 2005, and $17.6 million at December 31, 2004. The fair value of
      available-for-sale securities of $99.6 million were pledged to the FHLB at
      December 31, 2005, and $103.1 million at December 31, 2004. The fair value
      of
      available-for-sale securities of $4.0 million was also pledged to third parties
      as collateral for derivative contracts at December 31, 2005.





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


A
      summary
      of loans at December 31, 2005, and 2004, follows:




**DECEMBER
                31,****2005**
            
            **DECEMBER
                31,****2004**Residential
                real estate
            
            $
            95,429
            
            $
            105,975Multifamily
                real estate
            
            
            52,057
            
            
            92,372Commercial
                real estate
            
            
            141,109
            
            
            178,704Real
                estate construction(1)
            
            
            165,957
            
            
            107,431Business
            
            
            394,034
            
            
            292,117Consumer
            
            
            32,160
            
            
            30,125Total
                loans
            
            
            880,746
            
            
            806,724Deferred
                loan fees, net
            
            
            (3,443
            )
            
            (2,695
            )Loans
            
            $
            877,303
            
            $
            804,029Loans
                serviced for others
            
            $
            15,598
            
            $
            9,038




*____________________________*


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


-
          32
          -


**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 $9.2 million sale of
      single-family loans in December that were being serviced under a thirty day
      interim servicing agreement.


Accrued
      interest on loans was $4,078 and $3,340 at December 31, 2005, and December
      31,
      2004, respectively. Loans to officers and directors totaled $2.6 million at
      December 31, 2005, $2.7 million at December 31, 2004, and $3.3 million at
      December 31, 2003. Repayments totaling $39, $502, and $1,439 were received
      and
      additional advances of $17, $0, and $2,893 were made for the years ended
      December 31, 2005, 2004, and 2003, respectively. Additionally, in 2004, $121,000
      in loans were excluded since the officer previously included in the 2003 total
      terminated employment with the Bank.


At
      December 31, 2005, the composition of the loan portfolio was as
      follows:





**FIXED
                RATE**
            
            **ADJUSTABLE
                RATE**Term
                to maturityLess
                than one year
            
            $
            17,787
            
            $
            121,3001-3
                years
            
            
            69,905
            
            
            99,8303-5
                years
            
            
            54,236
            
            
            14,9955-10
                years
            
            
            77,048
            
            
            152,18910-20
                years
            
            
            13,950
            
            
            30,095Over
                20 years
            
            
            13,337
            
            
            216,074Total
            
            $
            246,263
            
            $
            634,483




Nonaccrual
      loans totaled $1,987, $532, and $1,921, respectively, at December 31, 2005,
      December 31, 2004, and December 31, 2003. If interest on these loans had been
      recognized, such income would have been $82, $2, and $90 respectively, for
      the
      periods ended December 31, 2005, 2004, and 2003. The Corporation has no
      commitments to extend additional credit on loans that are nonaccrual. At
      December 31, 2005, 2004, and 2003, loans totaling $17,485, $9,319, and $11,969,
      were adversely classified, for which there were no allocated allowances. These
      loans had no allowances allocated to them because the value of the underlying
      collateral of the adversely classified loans was equal to or exceeded the
      recorded investment. Of the adversely classified loans, $1,511, $166, and $1,758
      were under foreclosure. The average balance of adversely classified loans for
      the year ended December 31, 2005, and December 31, 2004, respectively, was
      $13,130, and $7,152 and the Corporation recognized $760, and $534 of related
      interest income on such loans during the time such loans were
      impaired.


At
      December 31, 2005, and December 31, 2004, the Bank had no loans that were 90
      days or more past due and still accruing.


At
      December 31, 2005, the Corporation had outstanding commitments of $197 to fund
      loans with fixed interest rates and $10,814 for loans with adjustable
      rates.


The
      Corporation had non-mandatory forward commitments totaling $157 and $784 to
      sell
      loans into the secondary market at December 31, 2005, and December 31, 2004,
      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 2005 or 2004.


At
      December 31, 2005, and 2004, the following financial instruments with
      off-balance sheet risk were outstanding:




**2005**
            
            **2004**Commitments
                to grant loans
            
            $
            26,742
            
            $
            45,972Unfunded
                commitments under lines of credit/loans in process
            
            
            189,573
            
            
            144,875Standby
                letters of credit and financial guarantees written
            
            
            5,241
            
            
            5,602Unused
                commitments on bankcards
            
            
            11,873
            
            
            11,103Total
            
            $
            233,429
            
            $
            207,552


-
          33
          -


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





A
      summary
      of the allowance for losses on loans follows:


**YEARS
                ENDED DECEMBER 31,****2005**
            
            **2004**
            
            **2003**Balances
                at beginning of year
            
            $
            9,563
            
            $
            7,711
            
            $
            6,872Issaquah
                Bank allowance assumed
            
            
            —
            
            
            1,395
            
            
            —Provision
                for loss
            
            
            945
            
            
            675
            
            
            1,275Recoveries
            
            
            266
            
            
            223
            
            
            315Charge-offs
            
            
            (520
            )
            
            (441
            )
            
            (751
            )Balances
                at end of year
            
            $
            10,254
            
            $
            9,563
            
            $
            7,711







**(5)
      Premises and Equipment**


A
      summary
      of premises and equipment follows:




**ESTIMATED****USEFUL
                LIVES**
            
            **DECEMBER
                31, 2005**
            
            **DECEMBER
                31,****2004**Land
            
            
            
            
            $
            2,577
            
            $
            2,577Buildings
            
            
            40
                years
            
            
            10,703
            
            
            10,527Leasehold
                improvements
            
            
            Lease
                term
            
            
            2,186
            
            
            1,985Furniture
                and equipment
            
            
            2-10
                years
            
            
            13,305
            
            
            12,36228,771
            
            
            27,451Accumulated
                depreciation and amortization
            
            
            
            
            
            (16,501
            )
            
            (14,627
            )$
            12,270
            
            $
            12,824




Total
      depreciation and amortization expense was $1,874, $1,553, and $1,454 for the
      years ended December 31, 2005, 2004, and 2003, 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, 2005, are as follows:




Years
                  ending December 31,
              
              
              2006
              
              $
              6082007
              
              
              6082008
              
              
              6082009
              
              
              5952010
              
              
              595Thereafter
              
              
              6,258$
              9,272


Rental
      expense charged to operations was approximately $642, $482, and $415 for the
      years ended December 31, 2005, 2004, and 2003, respectively.





**(6)
      Deposits**


Deposits
      at December 31, 2005, and 2004, are summarized as follows:


**DECEMBER
                31,****2005**
            
            **DECEMBER
                31,****2004**Noninterest-bearing
                checking accounts
            
            $
            80,402
            
            $
            74,865Interest-bearing
                checking accounts
            
            
            40,066
            
            
            37,699Money
                market deposit accounts
            
            
            181,621
            
            
            156,347Savings
                accounts
            
            
            15,169
            
            
            16,237Certificates
                of deposit
            
            
            478,510
            
            
            436,760$
            795,768
            
            $
            721,908




-
          34
          -


**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 $294.2 million
      and
      $277.3 million at December 31, 2005, and December 31, 2004, respectively.
      Deposits by officers and directors totaled $4.0 million at December 31, 2005,
      and $3.8 million at December 31, 2004.




**WEIGHTED
                  AVERAGE INTEREST RATE****ON
                  DEPOSITS**
              
              **DEPOSIT
                  ACCOUNTS WITH BALANCES IN EXCESS****OF
                  $100,000**
              
              **ACCRUED
                  INTEREST PAYABLE ON****DEPOSITS**December
                  31, 2005
              
              
              2.89
              %
              $
              479,480
              
              $
              1,952December
                  31, 2004
              
              
              1.87
              
              
              428,293
              
              
              906





A
      summary
      of interest expense on deposits follows:




**YEARS
                ENDED DECEMBER 31,****2005**
            
            **2004**
            
            **2003**Checking
                and money market accounts
            
            $
            3,500
            
            $
            1,965
            
            $
            1,604Savings
                accounts and time deposits
            
            
            14,814
            
            
            9,194
            
            
            9,369$
            18,314
            
            $
            11,159
            
            $
            10,973








Maturities
      of time deposits at December 31, 2005, are as follows:





Years
                ending December 31,
            
            
            2006
            
            $
            409,9702007
            
            
            39,8112008
            
            
            17,7332009
            
            
            5,3902010
            
            
            4,904Thereafter
            
            
            702$
            478,510





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


On
      March
      1, 2000, $10.3 million of 11% Capital Securities due March 1, 2030, were issued
      by a wholly owned business Trust whose common equity is 100% owned by Cascade
      Financial Corporation. The Trust exists for the exclusive purposes of issuing
      and selling the capital securities, 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 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
      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 at maturity or upon any earlier
      redemption of the junior subordinated debentures.


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. Under the terms of the agreement, Cascade will receive an 11%
      fixed-rate and pay a floating-rate of USD-six month LIBOR-BBA plus 520 basis
      points. The rate paid at December 31, 2005 is 9.28%. The floating-rate will
      reprice the first calendar day of each March and September. The unrealized gain
      on
      the interest rate swap w as $253 as of December 31, 2005. Unrealized gains
      or
      losses on the interest rate swap are recorded as other assets or liabilities
      with the corresponding change in the amount of liability for the junior
      subordinated debentures. The change in unrealized gains or losses on the
      interest rate swap is offset by the


corresponding
      changes in the unrealized gains or losses on junior subordinated debentures
      in
      the accompanying Consolidated Statements of Income.


On
      December 15, 2004, the Corporation issued an additional $5 million in trust
      preferred securities/junior subordinated debentures. 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. The junior subordinated debentures issued under Capital Trust II
      incorporates the same structure for the same purposes as Capital Trust
      I.


-
          35
          -


**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,**2005
            
            **2004****MATURITY
                DATE**
            
            **AMOUNT**
            
            **WEIGHTED
                AVERAGE INTEREST****RATE**
            
            **AMOUNT**
            
            **WEIGHTED
                AVERAGE INTEREST****RATE**At
                December 31,2005
            
            $
            -
            
            
            -
            %
            $
            77,000
            
            
            4.55
            %2006
            
            
            23,000
            
            
            4.65
            
            
            23,000
            
            
            4.572007
            
            
            22,000
            
            
            6.06
            
            
            22,000
            
            
            6.062008
            
            
            2,000
            
            
            3.51
            
            
            2,000
            
            
            3.512009*(*)*
            
            
            39,000
            
            
            4.31
            
            
            39,000
            
            
            2.972010
            
            
            60,000
            
            
            5.32
            
            
            45,000
            
            
            5.83Thereafter
            
            
            90,000
            
            
            3.44
            
            
            20,000
            
            
            3.58$
            236,000
            
            
            4.42
            %
            $
            228,000
            
            
            4.59
            %




**includes
      $25,000 tied to 3 month LIBOR*





**YEARS
                  ENDED DECEMBER 31,****2005**
              
              **2004**Maximum
                  amount of outstanding FHLB advances at any month-end
              
              $
              251,000
              
              $
              237,500Average
                  amount of outstanding FHLB advances during the year
              
              
              239,896
              
              
              210,023


The
      Corporation had $200 million in fixed-rate advances as of December 31, 2005,
      where the FHLB has the option to convert these advances to variable-rate
      advances after a specified period.


At
      December 31, 2005, the Bank had an unused line of credit from the FHLB-Seattle
      of $188.1 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
      $424.1 million.


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****BALANCE****OUTSTANDING**
            
            **WEIGHTED
                AVERAGE INTEREST****RATE**
            
            **BOOK
                VALUE, INCLUDING ACCRUED****INTEREST**
            
            **MARKET****VALUE**December
                31, 2005
            
            $
            51,058
            
            
            1.68
            %
            $
            58,950
            
            $
            57,200December
                31, 2004
            
            
            20,902
            
            
            2.38
            
            
            20,358
            
            
            19,758




Financial
      data pertaining to repurchase agreements follows:




**DECEMBER
                31,**
            
            **DECEMBER
                31,****2005**
            
            **2004**Maximum
                amount of outstanding agreements at any month-end
            
            $
            51,058
            
            $
            40,251Average
                amount of outstanding agreements during the year
            
            
            24,051
            
            
            30,125





The
      Corporation used $50 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 (4.25%) in both cases for the remainder of the agreement
      unless the lender terminates the agreement.


-
          36
          -


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





The
      Bank
      has Fed funds borrowing lines with three of its correspondent banks. One line
      is
      for $13.0 million and matures July 1, 2006. The other two facilities are for
      $10.0 million; one matures June 30, 2006, and the other has no maturity date.
      Interest rates for both lines are quoted at the time of borrowing. The Bank
      used
      two of these lines during the year, one of which was to test the operational
      aspects of the facility as part of our liquidity planning process. 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, 2005, there were no
      outstanding balances on any of these lines.





**(10)
      Federal Income Taxes**


Federal
      income tax expense (benefits) includes the following components:





**YEARS
                ENDED DECEMBER 31,****2005**
            
            **2004**
            
            **2003**Current
            
            $
            6,412
            
            $
            5,467
            
            $
            4,545Deferred
            
            
            (150
            )
            
            (100
            )
            
            (236
            )$
            6,262
            
            $
            5,367
            
            $
            4,309





For
      the
      year ended December 31, 2005, the Corporation's effective tax rate was 32.4%
      compared to 33.2% for the year ended December 31, 2004. Increased tax benefits
      related to interest on tax exempt loans and increases in cash


surrender
      value of bank owned life insurance accounted for 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:




**2005**
            
            **2004**
            
            **2003**Computed
                “expected” tax expense
            
            $
            6,758
            
            $
            5,588
            
            $
            4,729Bank
                owned life insurance
            
            
            (232
            )
            
            (169
            )
            
            (184
            )Tax
                exempt interest
            
            
            (284
            )
            
            (69
            )
            
            (89
            )Non-deductible
                acquisition cost
            
            
            —
            
            
            122
            
            
            —Other,
                net
            
            
            20
            
            
            (105
            )
            
            (147
            )$
            6,262
            
            $
            5,367
            
            $
            4,309





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.


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, 2005, and December 31, 2004:





**DECEMBER
                31,****2005**
            
            **DECEMBER
                31,****2004**Deferred
                tax assets:Securities
                available-for-sale
            
            $
            1,075
            
            $
            617Loans
            
            
            3,087
            
            
            2,788Gross
                deferred tax assets
            
            
            4,162
            
            
            3,405Deferred
                tax liabilities:Deferred
                loan fees
            
            
            (1,221
            )
            
            (1,031
            )Core
                deposit intangible
            
            
            (317
            )
            
            (395
            )Premises
                and equipment
            
            
            (204
            )
            
            (205
            )FHLB
                stock
            
            
            (1,732
            )
            
            (1,732
            )Other
            
            
            (120
            )
            
            (82
            )Gross
                deferred tax liabilities
            
            
            (3,594
            )
            
            (3,445
            )Net
                deferred tax asset (liability)
            
            $
            568
            
            $
            (40
            )


-
          37
          -


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*




A
      valuation allowance for deferred tax assets was not considered necessary at
      December 31, 2005 or 2004. Management believes the Corporation will fully
      realize its total deferred income tax assets as of December 31, 2005, and 2004,
      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
            
            $
            1.21
            
            $
            1.18Diluted
                earnings per share
            
            $
            1.17
            
            $
            1.15





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




-
          38
          -


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





**(12)
      Earnings Per Share**


The
      following table presents EPS information:




**YEARS
                ENDED DECEMBER 31,****2005**
            
            **2004**
            
            **2003**Net
                income
            
            $
            13,046
            
            $
            10,785
            
            $
            9,599Common
                shares outstanding (basic)
            
            
            9,582,259
            
            
            8,952,493
            
            
            8,184,455Effect
                of dilutive stock options
            
            
            273,639
            
            
            323,739
            
            
            277,048Common
                shares outstanding (diluted)
            
            
            9,855,898
            
            
            9,276,232
            
            
            8,461,503EPS,
                basic
            
            $
            1.36
            
            $
            1.20
            
            $
            1.17EPS,
                diluted
            
            
            1.32
            
            
            1.16
            
            
            1.13





For
      purposes of calculating basic and diluted earnings per share, the numerator
      of
      net income is the same. There were outstanding options to purchase 143,939,
      136,544, and 69,199 shares of common stock at December 31, 2005, December 31,
      2004, and December 31, 2003, respectively, that are considered nondilutive
      and
      have been excluded from the above calculation. Nondilutive 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.


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, 2005,
      and
      2004, that the Corporation and the Bank meet all capital adequacy requirements
      to which they are subject. As of
      December 31, 2005, the most recent notification from the Federal Deposit
      Insurance Corporation categorized the Bank as well-capitalized under the
      regulatory framework for prompt corrective action. 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, 2005, 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, 2005, the Bank was in compliance with the regulatory requirements
      for well-capitalized institutions.


As
      of
      December 31, 2005, the most recent notification from the FDIC categorized the
      Bank as well-capitalized under the regulatory framework. There are no conditions
      or events since the notification that management believes have changed the
      Bank's category.


**ACTUAL**
            
            **MINIMUM
                REQUIREMENTS FOR CAPITAL****ADEQUACY**
            
            **WELL-CAPITALIZE****REQUIREMENTS****CASCADE
                BANK**
            
            **AMOUNT**
            
            **RATIO**
            
            **AMOUNT**
            
            **RATIO**
            
            **AMOUNT**
            
            **RATIO**December
                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
            
            
            5.00December
                31, 2004:Total
                risk-based capital to risk-weighted assets(1)
            
            $
            94,574
            
            
            11.06
            %
            $
            68,380
            
            
            8.00
            %
            $
            85,476
            
            
            10.00
            %Tier
                I (core) capital to risk-weighted assets
            
            
            85,011
            
            
            9.95
            
            
            34,190
            
            
            4.00
            
            
            51,285
            
            
            6.00Tier
                I (core) capital to average total assets
            
            
            85,011
            
            
            8.04
            
            
            42,307
            
            
            4.00
            
            
            52,884
            
            
            5.00


-
          39
          -




**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





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.




**ACTUAL**
            
            **MINIMUM
                REQUIREMENTS FOR CAPITAL****ADEQUACY**
            
            **WELL-CAPITALIZED****REQUIREMENTS****CASCADE
                FINANCIAL CORP**
            
            **AMOUNT**
            
            **RATIO**
            
            **AMOUNT**
            
            **RATIO**
            
            **AMOUNT**
            
            **RATIO**December
                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
            
            
            58,707
            
            
            6.00Tier
                I (core) capital to average total assets
            
            
            96,078
            
            
            8.23
            
            
            46,718
            
            
            4.00
            
            
            58,397
            
            
            5.00December
                31, 2004:Total
                risk-based capital to risk-weighted assets(1)
            
            $
            95,704
            
            
            11.18
            %
            $
            68,496
            
            
            8.00
            %
            $
            85,620
            
            
            10.00
            %Tier
                I (core) capital to risk-weighted assets
            
            
            86,141
            
            
            10.06
            
            
            34,248
            
            
            4.00
            
            
            51,372
            
            
            6.00Tier
                I (core) capital to average total assets
            
            
            86,141
            
            
            8.14
            
            
            42,307
            
            
            4.00
            
            
            52,884
            
            
            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**


A
      summary
      of capitalized mortgage servicing rights, included in other assets, at December
      31, 2005, and December 31, 2004, follows:





**DECEMBER
                31,**
            
            **DECEMBER
                31,****2005**
            
            **2004**Balance
                at beginning of year
            
            $
            40
            
            $
            80Additions
            
            
            —
            
            
            —Amortization
            
            
            (30
            )
            
            (40
            )Allowance
                for losses
            
            
            —
            
            
            —Balance
                at end of year
            
            $
            10
            
            $
            40





**(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 $287, $290,
      and
      $188 to the plan for the years ended December 31, 2005, 2004, and 2003,
      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, 2005, 2004,
      and 2003, the Corporation contributed $0, $14, and $54, respectively, to the
      ESOP, which is invested in Cascade Financial Corporation stock. Allocated and
      unallocated shares at December 31, 2005, were 161,109 and 7,757, respectively.
      The Corporation has the right of first refusal to purchase the allocated shares
      of separated employees.




**(c)
      Employee Stock Purchase Plan**


The
      Corporation maintains an employee stock purchase plan, under the terms of which
      182,353 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.




-
          40
          -





**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





**(d)
      Stock Options**


The
      Corporation maintains stock option plans pursuant to which shares of Common
      Stock have been authorized for issuance to certain key employees and directors
      of the Corporation and its subsidiaries. The options granted under these plans
      are, in general, exercisable under a vesting schedule whereby all options become
      exercisable over seven years, and expire not more than ten years after the
      date
      of grant.


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, 2005, and December 31, 2004,
      308,718 and 281,256 shares, respectively, were fully exercisable. The
      Corporation had 552,286 and 551,275 shares available for grant at December
      31,
      2005, and 2004, respectively.


Changes
      in total options outstanding for the year ended December 31, are as follows:




**SHARES****UNDER
                  OPTION**
              
              **WEIGHTED
                  AVERAGE EXERCISE PRICE OF OPTION SHARES****YEAR
                  ENDED DECEMBER 31, 2005**Outstanding
                  at beginning of year
              
              
              669,570
              
              $
              9.13Granted
                  during year
              
              
              39,239
              
              
              17.80Exercised
                  during year
              
              
              (80,652
              )
              
              5.49Forfeited
                  during year
              
              
              (41,000
              )
              
              16.85Outstanding
                  at end of year
              
              
              587,157
              
              $
              9.67Exercisable
                  at end of year
              
              
              243,842
              
              $
              7.36**YEAR
                  ENDED DECEMBER 31, 2004**Outstanding
                  at beginning of year
              
              
              654,827
              
              $
              7.24Granted
                  during year
              
              
              123,592
              
              
              18.56Exercised
                  during year
              
              
              (57,766
              )
              
              6.02Forfeited
                  during year
              
              
              (51,083
              )
              
              11.53Outstanding
                  at end of year
              
              
              669,570
              
              $
              9.13Exercisable
                  at end of year
              
              
              281,256
              
              $
              6.52**YEAR
                  ENDED DECEMBER 31, 2003**Outstanding
                  at beginning of year
              
              
              576,100
              
              $
              7.23Granted
                  during year
              
              
              96,100
              
              
              12.34Exercised
                  during year
              
              
              (115,619
              )
              
              3.77Forfeited
                  during year
              
              
              (16,739
              )
              
              6.855-for-4
                  stock split
              
              
              114,985
              
              
              —Outstanding
                  at end of year
              
              
              654,827
              
              $
              7.24Exercisable
                  at end of year
              
              
              308,718
              
              $
              6.28




Financial
      data pertaining to outstanding stock options were as follows at December 31,
      2005:




**RANGES
                OF EXERCISEPRICES**
            
            **NUMBER
                OF OPTION SHARES**
            
            **WEIGHTED
                AVERAGE REMAINING CONTRACTUAL LIFE**
            
            **WEIGHTED
                AVERAGE EXERCISE PRICE OF OPTION SHARES**
            
            **NUMBER
                OF****EXERCISABLE****OPTION
                SHARES**
            
            **WEIGHTED
                AVERAGE EXERCISE PRICE OF****EXERCISABLE****OPTION
                SHARES**$
            4.91
            
            -
            5.45
            
            
            17,175
            
            
            4.52
            
            $
            5.03
            
            
            9,750
            
            $
            5.025.55
            
            -
            5.55
            
            
            152,780
            
            
            5.07
            
            
            5.55
            
            
            105,718
            
            
            5.555.64
            
            -
            7.76
            
            
            147,311
            
            
            5.14
            
            
            6.61
            
            
            88,776
            
            
            6.377.85
            
            -
            12.50
            
            
            145,553
            
            
            5.31
            
            
            10.35
            
            
            92,332
            
            
            9.3412.50
            
            -
            19.90
            
            
            124,338
            
            
            8.51
            
            
            18.22
            
            
            12,142
            
            
            17.27$
            4.91
            
            -
            19.90
            
            
            587,157
            
            
            5.86
            
            $
            9.67
            
            
            308,718
            
            $
            7.36


-
          41
          -


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





**(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, 2005**
            
            **DECEMBER
                31, 2004****CARRYING**
            
            **ESTIMATED**
            
            **CARRYING**
            
            **ESTIMATED****VALUE**
            
            **FAIR
                VALUE**
            
            **VALUE**
            
            **FAIR
                VALUE**Financial
                assets:Cash
                and cash******equivalents
            
            $
            31,109
            
            $
            31,109
            
            $
            13,029
            
            $
            13,029Securities
                available-for-sale
            
            
            140,596
            
            
            140,596
            
            
            112,404
            
            
            112,404Securities
                held-to-maturity
            
            
            95,122
            
            
            92,120
            
            
            91,339
            
            
            89,555FHLB
                Stock
            
            
            11,920
            
            
            11,920
            
            
            11,872
            
            
            11,872Loans,
                net
            
            
            867,049
            
            
            875,083
            
            
            794,466
            
            
            805,971Mark-to-market
                on swaps
            
            $
            311
            
            $
            311
            
            $
            533
            
            $
            533Financial
                liabilities:Deposit
                accounts(1)
            
            
            795,768
            
            
            794,759
            
            
            721,908
            
            
            722,550Borrowings
            
            
            287,058
            
            
            288,060
            
            
            248,902
            
            
            256,901Junior
                subordinated debentures payable(2)
            
            
            15,212
            
            
            15,212
            
            
            15,454
            
            
            15,454Mark-to-market
                on swaps
            
            $
            253
            
            $
            253
            
            $
            11
            
            $
            11


___________________________


*(1)
      Net of $311 mark-to-market on swap*


*(2)
      Net of $(253) mark-to-market on swap (see note 17)*





*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.




*Junior
      Subordinated Debentures Payable (Trust Preferred Securities)*


The
      fair
      value is calculated based on the discounted cash flow method, 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.




-
          42
          -


**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





**(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.




**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 - Cash Flow Hedging Instruments**


The
      Corporation periodically uses long-term variable-rate debt as a source of funds
      for use in the Corporation's lending and investment activities and other general
      business purposes. These debt obligations expose the Corporation to variability
      in interest payments due to changes in interest rates. Management believes
      it
      may be prudent to limit the variability of a portion of its interest payments
      and, therefore, may hedge a portion of its variable-rate interest payments.
      To
      meet this objective, management enters into interest rate swap agreements
      whereby the Corporation receives variable interest rate payments and makes
      fixed
      interest rate payments during the contract period.


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


The
      information pertaining to an outstanding interest rate swap agreement used
      to
      hedge FHLB Advances is as follows:




**DECEMBER
                31, 2004**Notional
                amount
            
            $
            25,000Fixed
                pay rate
            
            
            4.02
            %Weighted
                average receive rate
            
            
            1.83
            %Maturity
                in years
            
            
            4.6Unrealized
                (loss) relating to interest rate swap
            
            $
            (50
            )





At
      December 31, 2004, the unrealized loss relating to use of the interest rate
      swap
      was recorded in derivative liabilities in accordance with SFAS No. 133. This
      swap was terminated in March 2005 as the Corporation opted for other strategies
      to mitigate its interest rate risk.


Risk
      management results for the year ended December 31, 2004, related to the balance
      sheet hedging of long-term debt 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.




**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 an outstanding interest rate swap agreement used
      to
      hedge junior subordinated debentures (trust preferred securities) is as
      follows:


**DECEMBER
                  31,****2005**
              
              **2004**Notional
                  amount
              
              $
              10,000
              
              $
              10,000Weighted
                  average pay rate
              
              
              8.60
              %
              
              6.76
              %Fixed
                  receive rate
              
              
              11.00
              %
              
              11.00
              %Maturity
                  in years
              
              
              25.2
              
              
              26.2Unrealized
                  gain relating to interest rate swap
              
              $
              253
              
              $
              11





This
      agreement provides 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.




-
          43
          -




**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





Risk
      management results for the years ended December 31, 2005, and 2004, related
      to
      the balance sheet hedging of junior subordinated debentures 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,****2005**
              
              **2004**Notional
                  amount
              
              $
              10,000
              
              $
              10,000Weighted
                  average pay rate
              
              
              3.30
              %
              
              2.38
              %Fixed
                  receive rate
              
              
              5.00
              %
              
              5.00
              %Maturity
                  in years
              
              
              8.4
              
              
              9.4Unrealized
                  (loss) relating to interest rate swap
              
              $
              (311
              )
              $
              (131
              )




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, 2005, and 2004, 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 terminated an interest rate swap agreement in March 2005 that was
      originally designated to hedge available-for-sale securities. This agreement
      provided for the Corporation to make payments at a fixed-rate in exchange for
      receiving payments at a variable-rate determined by a three-month LIBOR. Due
      to
      a narrowing of swap spreads that the hedge was no longer “highly effective” in
      that the change in the fair value of the swap did not sufficiently correlate
      with the change in the fair value of the designated securities. As of December
      31, 2004, the unrealized loss relating to the use of this swap was recorded
      in
      derivative liabilities and other expense in the income statement, in accordance
      with SFAS No. 133.


The
      information pertaining to an outstanding interest rate swap agreement that
      was
      originally designated to hedge fixed-rate available-for-sale securities is
      as
      follows:




**DECEMBER
                31, 2004**Notional
                amount
            
            $
            25,000Fixed
                pay rate
            
            
            4.79
            %Weighted
                average receive rate
            
            
            1.83
            %Maturity
                in years
            
            
            9.6Unrealized
                (loss) relating to interest rate swap
            
            $
            (352
            )





This
      swap
      was terminated in March 2005 as the Corporation opted for other strategies
      to
      mitigate its interest rate risk.


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 $157 and $784 to
      sell
      loans into the secondary market at December 31, 2005, and December 31, 2004,
      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.




-
          44
          -




**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





**(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, 2005**
            
            **DECEMBER
                31, 2004**Assets:Cash
            
            $
            637
            
            $
            410Investment
                in subsidiary
            
            
            119,262
            
            
            110,120Other
                assets
            
            
            2,390
            
            
            2,585$
            122,289
            
            $
            113,115Liabilities
                and stockholders’ equity:Other
                liabilities
            
            
            1,884
            
            
            1,411Junior
                subordinated debentures payable
            
            
            15,212
            
            
            15,454Stockholders’
                equity
            
            
            105,193
            
            
            96,250$
            122,289
            
            $
            113,115




**INCOME
                STATEMENT**
            
            **FOR
                THE YEARS ENDED DECEMBER 31,****2005**
            
            **2004**
            
            **2003**Equity
                in undistributed net income of the subsidiary
            
            $
            13,992
            
            $
            11,833
            
            $
            10,542Interest
                income - junior subordinated debentures payable
            
            
            46
            
            
            35
            
            
            34Operating
                expenses
            
            
            (299
            )
            
            (704
            )
            
            (429
            )Interest
                expense - junior subordinated debentures payable
            
            
            (1,198
            )
            
            (723
            )
            
            (1,034
            )Income
                before provision for federal income taxes
            
            
            12,541
            
            
            10,441
            
            
            9,113Provision
                for federal income taxes
            
            
            505
            
            
            344
            
            
            486Net
                income
            
            $
            13,046
            
            $
            10,785
            
            $
            9,599




**STATEMENT
                OF CASH FLOWS**
            
            **FOR
                THE YEARS ENDED DECEMBER 31,****2005**
            
            **2004**
            
            **2003**Cash
                flows from operating activities:Net
                income
            
            $
            13,046
            
            $
            10,785
            
            $
            9,599Adjustments
                to reconcile net income to net cash (used in) operating
                activities:Equity
                in net income of subsidiaries
            
            
            (13,992
            )
            
            (11,833
            )
            
            (10,542
            )Increase
                (decrease) in other assets
            
            
            195
            
            
            (1,303
            )
            
            38(Decrease)
                increase in other liabilities
            
            
            134
            
            
            257
            
            
            (13
            )Net
                cash used in operating activities
            
            
            (617
            )
            
            (2,094
            )
            
            (918
            )Cash
                flows from investing activities:Dividends
                received from subsidiaries
            
            
            4,000
            
            
            12,882
            
            
            2,100Investment
                in subsidiary
            
            
            —
            
            
            (5,000
            )
            
            —Cash
                used for acquisition
            
            
            —
            
            
            (9,546
            )
            
            —Net
                cash provided (used) by investing activities
            
            
            4,000
            
            
            (1,664
            )
            
            2,100Cash
                flows from financing activities:Repurchase
                of common stock
            
            
            (858
            )
            
            (150
            )
            
            (96
            )Proceeds
                from exercise of stock options
            
            
            865
            
            
            635
            
            
            662Dividends
                paid
            
            
            (3,163
            )
            
            (2,589
            )
            
            (1,440
            )Proceeds
                from junior subordinated debentures payable
            
            
            —
            
            
            5,000
            
            
            —Net
                cash (used) provided by financing activities
            
            
            (3,156
            )
            
            2,896
            
            
            (874
            )Net
                increase (decrease) in cash and cash equivalents
            
            
            227
            
            
            (862
            )
            
            308Cash
                and cash equivalents:Beginning
                of year
            
            
            410
            
            
            1,272
            
            
            964End
                of year
            
            $
            637
            
            $
            410
            
            $
            1,272Supplemental
                schedule of non-cash investing activities:Issaquah
                Bank merger
            
            
            62
            
            
            24,792
            
            
            —





**(20)
      Lines of Business**


The
      Corporation’s sole operating subsidiary is Cascade Bank, which is managed along
      five major lines of business: business banking, retail banking, construction
      lending, income property lending and residential lending. 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


-
          45
          -





**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





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 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 residential unit’s activities are the origination of
      single-family loans and the associated loan servicing activities.


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.


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, 2005****BUSINESS**
            
            **RESI****DENTIAL**
            
            **CONS****TRUCTION**
            
            **INCOME****PROPERTY**
            
            **RETAIL**
            
            **ADMIN****ISTRATION**
            
            **TOTAL**Condensed
                Income StatementNet
                interest income afterprovision
                for loan losses
            
            $
            15,110
            
            $
            828
            
            $
            8,544
            
            $
            7,331
            
            $
            955
            
            $
            2,813
            
            $
            35,581Other
                income
            
            
            76
            
            
            397
            
            
            23
            
            
            623
            
            
            3,738
            
            
            1,476
            
            
            6,333Other
                expense
            
            
            1,496
            
            
            422
            
            
            423
            
            
            870
            
            
            1,801
            
            
            17,594
            
            
            22,606Contribution
                before overhead
            
            
            13,690
            
            
            803
            
            
            8,144
            
            
            7,084
            
            
            2,892
            
            
            (13,305
            )
            
            19,308Support
                transfer
            
            
            5,408
            
            
            1,620
            
            
            2,075
            
            
            3,717
            
            
            485
            
            
            (13,305
            )
            
            —Income
                before provision for income tax
            
            
            8,282
            
            
            (817
            )
            
            6,069
            
            
            3,367
            
            
            2,407
            
            
            —
            
            
            19,308Provision
                for federalincome
                taxes
            
            
            2,688
            
            
            (272
            )
            
            1,964
            
            
            1,101
            
            
            781
            
            
            —
            
            
            6,262Net
                income (loss)
            
            $
            5,594
            
            $
            (545
            )
            $
            4,105
            
            $
            2,266
            
            $
            1,626
            
            $
            —
            
            $
            13,046**At
                December 31, 2005**Total
                Assets
            
            $
            394,034
            
            $
            95,429
            
            $
            165,957
            
            $
            193,166
            
            $
            32,160
            
            $
            331,038
            
            $
            1,211,784




**YEAR
                ENDED DECEMBER 31, 2004****BUSINESS**
            
            **RESI****DENTIAL**
            
            **CONS****TRUCTION**
            
            **INCOME****PROPERTY**
            
            **RETAIL**
            
            **ADMIN****ISTRATION**
            
            **TOTAL**Condensed
                Income StatementNet
                interest income afterprovision
                for loan losses
            
            $
            12,497
            
            $
            912
            
            $
            4,996
            
            $
            8,219
            
            $
            1,573
            
            $
            3,525
            
            $
            31,722Other
                income
            
            
            75
            
            
            326
            
            
            7
            
            
            —
            
            
            2,545
            
            
            1,794
            
            
            4,747Other
                expense
            
            
            1,446
            
            
            658
            
            
            435
            
            
            738
            
            
            1,550
            
            
            15,490
            
            
            20,317Contribution
                before overhead
            
            
            11,126
            
            
            580
            
            
            4,568
            
            
            7,481
            
            
            2,568
            
            
            (10,171
            )
            
            16,152Support
                transfer
            
            
            3,544
            
            
            1,492
            
            
            1,266
            
            
            3,063
            
            
            450
            
            
            (9,815
            )
            
            —Income
                before provision for income tax
            
            
            7,582
            
            
            (912
            )
            
            3,302
            
            
            4,418
            
            
            2,118
            
            
            (356
            )
            
            16,152Provision
                for federal income taxes
            
            
            2,465
            
            
            (297
            )
            
            1,072
            
            
            1,431
            
            
            688
            
            
            8
            
            
            5,367Net
                income (loss)
            
            $
            5,117
            
            $
            (615
            )
            $
            2,230
            
            $
            2,987
            
            $
            1,430
            
            $
            (364
            )
            $
            10,785**At
                December 31, 2004**Total
                Assets
            
            $
            292,117
            
            $
            105,975
            
            $
            107,431
            
            $
            271,076
            
            $
            30,125
            
            $
            282,231
            
            $
            1,088,955




-
          46
          -





**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*





**YEAR
                ENDED DECEMBER 31, 2003****BUSINESS**
            
            **RESI****DENTIAL**
            
            **CONS****TRUCTION**
            
            **INCOME****PROPERTY**
            
            **RETAIL**
            
            **ADMIN****ISTRATION**
            
            **TOTAL**Condensed
                Income StatementNet
                interest income afterprovision for loan losses
            
            $
            7,723
            
            $
            1,334
            
            $
            3,683
            
            $
            6,331
            
            $
            1,521
            
            $
            5,743
            
            $
            26,335Other
                income
            
            
            50
            
            
            872
            
            
            8
            
            
            3
            
            
            1,744
            
            
            2,629
            
            
            5,306Other
                expense
            
            
            1,243
            
            
            602
            
            
            334
            
            
            111
            
            
            1,311
            
            
            14,132
            
            
            17,733Contribution
                before overhead
            
            
            6,530
            
            
            1,604
            
            
            3,357
            
            
            6,223
            
            
            1,954
            
            
            (5,760
            )
            
            13,908Support
                transfer
            
            
            1,807
            
            
            1,134
            
            
            778
            
            
            1,645
            
            
            396
            
            
            (5,760
            )
            
            —Income
                before provision for income tax
            
            
            4,723
            
            
            470
            
            
            2,579
            
            
            4,578
            
            
            1,558
            
            
            —
            
            
            13,908Provision
                for federal income taxes
            
            
            1,457
            
            
            159
            
            
            801
            
            
            1,414
            
            
            478
            
            
            —
            
            
            4,309Net
                income (loss)
            
            $
            3,266
            
            $
            311
            
            $
            1,778
            
            $
            3,164
            
            $
            1,080
            
            $
            —
            
            $
            9,599**At
                December 31, 2003**Total
                Assets
            
            $
            204,446
            
            $
            105,565
            
            $
            62,742
            
            $
            171,068
            
            $
            33,163
            
            $
            308,236
            
            $
            885,220





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





**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 federal income taxes
            
            
            4,576
            
            
            4,792
            
            
            4,978
            
            
            4,962Provision
                for federal income taxes
            
            
            1,505
            
            
            1,577
            
            
            1,634
            
            
            1,546Net
                income
            
            $
            3,071
            
            $
            3,215
            
            $
            3,344
            
            $
            3,416Earnings
                per share, basic
            
            $
            0.32
            
            $
            0.34
            
            $
            0.35
            
            $
            0.36Earnings
                per share, diluted
            
            
            0.31
            
            
            0.33
            
            
            0.34
            
            
            0.35




**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 federal income taxes
            
            
            3,763
            
            
            3,584
            
            
            4,634
            
            
            4,171Provision
                for federal income taxes
            
            
            1,189
            
            
            1,300
            
            
            1,531
            
            
            1,347Net
                income
            
            $
            2,574
            
            $
            2,284
            
            $
            3,103
            
            $
            2,824Earnings
                per share, basic
            
            $
            .31
            
            $
            .27
            
            $
            .33
            
            $
            .30Earnings
                per share, diluted
            
            
            .30
            
            
            .26
            
            
            .32
            
            
            .29




-
          47
          -




**CASCADE
      FINANCIAL CORPORATION AND SUBSIDIARIES**


***Notes
      to Consolidated Financial Statements***


*(Dollars
      in thousands, except share amounts)*




**QUARTER
                ENDED****MAR
                31,**
            
            **JUNE
                30,**
            
            **SEPT
                30,**
            
            **DEC
                31,****2003**
            
            **2003**
            
            **2003**
            
            **2003**Interest
                income
            
            $
            12,748
            
            $
            12,532
            
            $
            12,506
            
            $
            12,577Interest
                expense
            
            
            6,018
            
            
            5,821
            
            
            5,660
            
            
            5,254Net
                interest income
            
            
            6,730
            
            
            6,711
            
            
            6,846
            
            
            7,323Provision
                for loan losses
            
            
            375
            
            
            300
            
            
            300
            
            
            300Other
                income
            
            
            1,615
            
            
            1,451
            
            
            1,353
            
            
            887Other
                expense
            
            
            4,594
            
            
            4,398
            
            
            4,333
            
            
            4,409Income
                before provision for federal income taxes
            
            
            3,376
            
            
            3,464
            
            
            3,566
            
            
            3,501Provision
                for federal income taxes
            
            
            1,072
            
            
            1,105
            
            
            1,133
            
            
            999Net
                income
            
            $
            2,304
            
            $
            2,359
            
            $
            2,433
            
            $
            2,502Earnings
                per share, basic
            
            $
            .28
            
            $
            .29
            
            $
            .30
            
            $
            .30Earnings
                per share, diluted
            
            
            .28
            
            
            .28
            
            
            .29
            
            
            .29









**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 25, 2006 at 6:30 p.m. Pacific
      time. ****






48
      -