CASCADE
      FINANCIAL CORPORATION SELECTED FINANCIAL DATA(Dollars in thousands, except
      per share data)FOR
      THE YEARS ENDED DECEMBER 31,2008
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    2005
                    
                    
                    2004Interest
      income
                    
                    $
                    92,571
                    
                    
                    $
                    93,935
                    
                    
                    $
                    82,658
                    
                    
                    $
                    67,802
                    
                    
                    $
                    55,316Interest
      expense
                    
                    
                    46,686
                    
                    
                    
                    50,540
                    
                    
                    
                    43,268
                    
                    
                    
                    31,276
                    
                    
                    
                    22,919Net
      interest income
                    
                    
                    45,885
                    
                    
                    
                    43,395
                    
                    
                    
                    39,390
                    
                    
                    
                    36,526
                    
                    
                    
                    32,397Provision
      for loan losses
                    
                    
                    7,240
                    
                    
                    
                    1,350
                    
                    
                    
                    1,000
                    
                    
                    
                    945
                    
                    
                    
                    675Net
      interest income after provision for loan losses
                    
                    
                    38,645
                    
                    
                    
                    42,045
                    
                    
                    
                    38,390
                    
                    
                    
                    35,581
                    
                    
                    
                    31,722Other
      income
                    
                    
                    8,884
                    
                    
                    
                    7,566
                    
                    
                    
                    6,026
                    
                    
                    
                    6,333
                    
                    
                    
                    4,747Other
      expense
                    
                    
                    28,540
                    
                    
                    
                    26,682
                    
                    
                    
                    24,586
                    
                    
                    
                    22,606
                    
                    
                    
                    20,317Other
      than temporary impairment (OTTI)
                    
                    
                    17,338
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Income
      before provision for income taxes
                    
                    
                    1,651
                    
                    
                    
                    22,929
                    
                    
                    
                    19,830
                    
                    
                    
                    19,308
                    
                    
                    
                    16,152Net
      income
                    
                    
                    2,090
                    
                    
                    
                    15,546
                    
                    
                    
                    13,355
                    
                    
                    
                    13,046
                    
                    
                    
                    10,785Dividends
      on preferred stock
                    
                    
                    216
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Net
      income available for common stockholders
                    
                    
                    1,874
                    
                    
                    
                    15,546
                    
                    
                    
                    13,355
                    
                    
                    
                    13,046
                    
                    
                    
                    10,785Earnings
      per common share, basic(1)
                    
                    
                    0.16
                    
                    
                    
                    1.29
                    
                    
                    
                    1.11
                    
                    
                    
                    1.09
                    
                    
                    
                    0.96Earnings
      per common share, diluted(1)
                    
                    
                    0.15
                    
                    
                    
                    1.27
                    
                    
                    
                    1.08
                    
                    
                    
                    1.06
                    
                    
                    
                    0.93Book
      value per common share(1)
                    
                    
                    10.23
                    
                    
                    
                    10.15
                    
                    
                    
                    9.53
                    
                    
                    
                    8.76
                    
                    
                    
                    8.06AT
      DECEMBER 31,2008
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    2005
                    
                    
                    2004Assets
                    
                    $
                    1,637,319
                    
                    
                    $
                    1,417,588
                    
                    
                    $
                    1,345,254
                    
                    
                    $
                    1,211,784
                    
                    
                    $
                    1,088,955Loans,
      net
                    
                    
                    1,238,733
                    
                    
                    
                    1,092,776
                    
                    
                    
                    996,015
                    
                    
                    
                    867,049
                    
                    
                    
                    794,466Cash
      and securities
                    
                    
                    309,658
                    
                    
                    
                    246,548
                    
                    
                    
                    282,301
                    
                    
                    
                    278,747
                    
                    
                    
                    228,644Deposits
                    
                    
                    1,006,782
                    
                    
                    
                    904,896
                    
                    
                    
                    855,449
                    
                    
                    
                    795,768
                    
                    
                    
                    721,908Other
      borrowings
                    
                    
                    212,365
                    
                    
                    
                    147,512
                    
                    
                    
                    121,485
                    
                    
                    
                    66,270
                    
                    
                    
                    36,356FHLB
      advances
                    
                    
                    249,000
                    
                    
                    
                    231,000
                    
                    
                    
                    243,000
                    
                    
                    
                    236,000
                    
                    
                    
                    228,000Preferred
      stock
                    
                    
                    36,616
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Common
      stockholders’ equity
                    
                    
                    123,506
                    
                    
                    
                    122,096
                    
                    
                    
                    115,199
                    
                    
                    
                    105,193
                    
                    
                    
                    96,250Total
      stockholders’ equity
                    
                    
                    160,122
                    
                    
                    
                    122,096
                    
                    
                    
                    115,199
                    
                    
                    
                    105,193
                    
                    
                    
                    96,250Nonperforming
      loans
                    
                    
                    40,278
                    
                    
                    
                    1,523
                    
                    
                    
                    851
                    
                    
                    
                    1,987
                    
                    
                    
                    532FINANCIAL
      RATIOSFOR
      THE YEARS ENDED DECEMBER 31,2008
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    2005
                    
                    
                    2004Return
      on average assets
                    
                    
                    0.14
                    %
                    
                    
                    1.13
                    %
                    
                    
                    1.05
                    %
                    
                    
                    1.13
                    %
                    
                    
                    1.09
                    %Return
      on average equity
                    
                    
                    1.62
                    
                    
                    
                    13.23
                    
                    
                    
                    12.24
                    
                    
                    
                    13.13
                    
                    
                    
                    13.22Return
      on average common equity
                    
                    
                    1.49
                    
                    
                    
                    13.23
                    
                    
                    
                    12.24
                    
                    
                    
                    13.13
                    
                    
                    
                    13.22Return
      on average tangible common equity
                    
                    
                    1.87
                    
                    
                    
                    16.88
                    
                    
                    
                    16.08
                    
                    
                    
                    17.82
                    
                    
                    
                    16.24Net
      interest margin
                    
                    
                    3.20
                    
                    
                    
                    3.34
                    
                    
                    
                    3.26
                    
                    
                    
                    3.35
                    
                    
                    
                    3.44Efficiency
      ratio (2)
                    
                    
                    52.11
                    
                    
                    
                    52.36
                    
                    
                    
                    54.14
                    
                    
                    
                    52.75
                    
                    
                    
                    54.70Dividend
      payout ratio
                    
                    
                    175.19
                    
                    
                    
                    25.98
                    
                    
                    
                    28.43
                    
                    
                    
                    25.66
                    
                    
                    
                    25.81Average
      stockholders’ equity to average assets
                    
                    
                    8.41
                    
                    
                    
                    8.58
                    
                    
                    
                    8.55
                    
                    
                    
                    8.60
                    
                    
                    
                    8.25Total
      risk-based capital to risk-weighted assets
                    
                    
                    13.26
                    
                    
                    
                    10.80
                    
                    
                    
                    11.22
                    
                    
                    
                    10.86
                    
                    
                    
                    11.18Tier
      1 capital to average total assets
                    
                    
                    10.30
                    
                    
                    
                    8.90
                    
                    
                    
                    8.99
                    
                    
                    
                    8.23
                    
                    
                    
                    8.14


(1)
            Per
      common share data is retroactively adjusted to reflect all stock splits
      and stock dividends.  December 31, 2008 is calculated using net
      income available for common
stockholders.


(2)
            The
      efficiency ratio calculation excludes the OTTI charge of $17.3 million in
      2008.





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


1


MANAGEMENT
DISCUSSION AND ANALYSIS




The
following discussion is provided for the consolidated operations of Cascade
Financial Corporation (the “Corporation”) as of December 31, 2008. 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.


Certain of the statements contained
herein that are not historical facts are 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
Corporation’s actual results may differ materially from those included in the
forward-looking statements.  Forward-looking statements are typically
identified by words or phrases such as “believe,” “expect,” “intend,” “may
increase,” “may fluctuate,” and similar expressions or future or conditional
verbs such as “will,” “should,” “would,” and “could.”  These
forward-looking statements involve risks and uncertainties including, but not
limited to, economic conditions which have been and continue to be in a
recession, portfolio growth, the credit performance of the portfolios, including
bankruptcies, higher than expected loan delinquency rates, and seasonal factors;
changes in general economic conditions including the performance of financial
markets, prevailing inflation and interest rates, realized gains from sales of
investments, gains from asset sales, and losses on commercial lending
activities; results of various investment activities; the effects of
competitors’ pricing policies, of changes in laws and regulations on competition
and of demographic changes in target market populations’ savings and financial
planning needs; industry changes in information technology systems on which we
are highly dependent; failure of acquisitions to produce revenue enhancements or
cost savings at levels or within the time frames originally anticipated or
unforeseen integration difficulties; the adoption of the Corporation of an FFIEC
policy that provides guidance on the reporting of delinquent consumer loans and
the timing of associated credit charge-offs for financial institution
subsidiaries; and the resolution of legal proceedings and related
matters.  In addition, the banking industry in general is subject to
various monetary and fiscal policies and regulations, which include those
determined by the Federal Reserve Board, the Federal Deposit Insurance
Corporation, and state regulators, whose policies and regulations could affect
the Corporation’s results and are subject to change at any
time.  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 the documents the Corporation files from
time to time with the Securities and Exchange Commission.





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. The
Bank believes 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 collectability of loans; and (2) the impact of a sudden
large loss could significantly reduce the allowance and would require increased
provisions to replenish the allowance, which would negatively affect
earnings.


At December 31, 2008, the Corporation
had $25.1 million in goodwill and other intangible assets as a result of a
business combination. Goodwill and other intangible assets with indefinite lives
are not amortized but instead are periodically tested for
impairment.  Management performs an impairment analysis periodically,
and at least annually. Management determined that there was no impairment as of
December 31, 2008.  The valuation is determined using discounted cash
flows of forecasted earnings, estimated sales price based on recent observable
market transactions and market capitalization based on current stock price. If
impairment was deemed to exist, a write-down of the asset would occur with a
charge to earnings.  The impairment analysis requires management to
make subjective judgments.  Events and factors that may significantly
affect the estimates include, among others, competitive forces, customer
behaviors and attrition, changes in revenue growth trends, cost structures,
technology, changes in discount rates and specific industry and market
conditions.


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 potential losses on adversely
classified loans, 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 probable and will have a material
impact on the Corporation’s consolidated financial statements and results of
operation. 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.


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, 2008, and “Management’s Discussion
and Analysis of Financial Condition and Results of Operation – Provision for
Loan Losses.”


2


Critical
Accounting Policies


The
Corporation’s significant accounting policies are described in Note 1 of the
Notes to Consolidated Financial Statements 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.





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, 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. The Bank also uses Qualitative (“Q”) Factors
to analyze the adequacy of the loan loss allowance and determine an unallocated
portion of the allowance.  Factors such as regional/local economic
trends, the health of the real estate market, loan and collateral
concentrations, size of borrowing relationships, trends in loan delinquencies
and charge-offs and changes in loan classifications are included in the Bank’s
analysis of the allowance for loan losses. Loans losses are charged-off against
the allowance when management confirms the uncollectability of a loan balance or
when the liquidation value of the collateral is less than the amount of the
loan. 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 held-for-trading, available-for-sale, or
held-to-maturity. Held-for-trading securities are marked to market with the
change in value recognized in the income
statement.  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 15 of the
Notes to Consolidated Financial Statements. Held-to-maturity securities are
carried at amortized cost.





Income
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. 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.





Fair
Value


Effective
January 1, 2007, the Corporation adopted Statement of Financial Accounting
Standards (“SFAS”) No. 157, Fair Value Measurements,
which among other things, requires enhanced disclosures about financial
instruments carried at fair value. SFAS No. 157 establishes a hierarchical
disclosure framework associated with the level of pricing observability utilized
in measuring financial instruments at fair value. The degree of judgment
utilized in measuring the fair value of financial instruments generally
correlates to the level of pricing observability. Financial instruments with
readily available active quoted prices or for which fair value can be measured
from actively quoted prices generally will have a higher degree of pricing
observability and a lesser degree of judgment utilized in measuring fair value.
Conversely, financial instruments rarely traded or not quoted will generally
have little or no pricing observability and a higher degree of judgment utilized
in measuring fair value. Pricing observability is impacted by a number of
factors, including the type of financial instrument, whether the financial
instrument is new to the market and not yet established and the characteristics
specific to the transaction. See Note 15 of the Notes to Consolidated
Financial Statements for additional information about the level of pricing
transparency associated with financial instruments carried at fair
value.





FINANCIAL
CONDITION


Total
Assets


The
Corporation’s total assets at December 31, 2008, were $­­­­1.6
billion, compared to $1.4 billion at December 31, 2007, an increase of 15.5%.
The increase in 2008 is due to internal growth. The Corporation’s total assets
at December 31, 2006, were $1.3 billion.





Investment
Securities


Total
securities held increased by $24.2 million to $256.2 million as of December 31,
2008.  Securities designated as available-for-sale increased to $135.6
million at December 31, 2008, versus $94.8 million at December 31, 2007.
Securities designated as available-for-sale include $11.9 million in Federal
Home Loan Bank (“FHLB”) of Seattle stock at December 31, 2008


3


and 2007.
At December 31, 2008, securities available-for-sale also included $454,000 of
Fannie Mae (“FNMA”) and Freddie Mac (“FHLMC”) preferred stock. Securities
designated as held-to-maturity decreased to $120.6 million at December 31, 2008,
from $137.2 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.
There were no investment securities that were backed by subprime loans and all
investments received the highest credit rating from at least one of the major
rating agencies except for the FNMA and FHLMC preferred stock. For a discussion
on the impact of FNMA and FHLMC preferred stock on the Corporation’s results,
see the details of the Other Than Temporary Impairment (OTTI) of these
securities under Results of Operations – Earnings and Other Expense in the
Management Discussion and Analysis and under Investment Securities, Note 3 to
the financial statements.





Loan
Portfolio


Net loans
increased to $1.2 billion at December 31, 2008, a 13.4% increase over $1.1
billion at December 31, 2007. Net loans were $996.0 million at December 31,
2006.


Business banking loans increased from
$468.5 million at December 31, 2007, to $485.1 million at December 31, 2008, a
3.5% increase. Growth in this portfolio was the result of our ability to win new
borrowing customers in a very competitive market. Cascade has slowed new
construction and land development lending but the construction balances have
grown as construction draws were made and exceeded payoffs. Construction loans
(net of loans in process) increased from $381.8 million to $406.5 million during
the year. Commercial real estate loans increased from $120.4 million at December
31, 2007, to $123.0 million at December 31, 2008. The Corporation’s loan focus
remains on small businesses in the Puget Sound Region of Washington State.
Construction lending is directed toward building single-family housing and land
development for single-family housing.


Total single-family residential mortgage
loans increased from $98.4 million at December 31, 2007, to $126.1 million at
December 31, 2008. The Corporation sells the vast majority of its originations
of 30-year fixed-rate loans, its 15-year fixed-rate loans, and many of its
conforming intermediate term hybrid adjustable rate mortgages (“ARMs”) in the
secondary mortgage market. Multifamily loans outstanding increased from $11.4
million at December 31, 2007, to $86.9 million at December 31, 2008. Multifamily
loans increased substantially from a year ago, partly as a result of the
reclassifications from multifamily construction as projects were
completed.


Consumer loans increased from $27.7
million at December 31, 2007, to $30.8 million at December 31, 2008. The
Corporation’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.


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





DECEMBER
      31, 2008
                  
                  
                  DECEMBER
      31, 2007
                  
                  
                  DECEMBER
      31, 2006(Dollars in thousands)
                  
                  AMOUNT
                  
                  
                  PERCENT
                  
                  
                  AMOUNT
                  
                  
                  PERCENT
                  
                  
                  AMOUNT
                  
                  
                  PERCENTBusiness
                  
                  $
                  485,060
                  
                  
                  
                  39
                  %
                  
                  $
                  468,453
                  
                  
                  
                  42
                  %
                  
                  $
                  442,391
                  
                  
                  
                  44
                  %Construction
                  
                  
                  406,505
                  
                  
                  
                  32
                  
                  
                  
                  381,810
                  
                  
                  
                  34
                  
                  
                  
                  295,087
                  
                  
                  
                  29Commercial
      real estate
                  
                  
                  122,951
                  
                  
                  
                  10
                  
                  
                  
                  120,421
                  
                  
                  
                  11
                  
                  
                  
                  119,298
                  
                  
                  
                  12Residential
                  
                  
                  126,089
                  
                  
                  
                  10
                  
                  
                  
                  98,384
                  
                  
                  
                  9
                  
                  
                  
                  91,256
                  
                  
                  
                  10Consumer
                  
                  
                  30,772
                  
                  
                  
                  2
                  
                  
                  
                  27,688
                  
                  
                  
                  3
                  
                  
                  
                  27,686
                  
                  
                  
                  2Multifamily
                  
                  
                  86,864
                  
                  
                  
                  7
                  
                  
                  
                  11,397
                  
                  
                  
                  1
                  
                  
                  
                  34,719
                  
                  
                  
                  3Total
      loans
                  
                  
                  1,258,241
                  
                  
                  
                  100
                  %
                  
                  
                  1,108,153
                  
                  
                  
                  100
                  %
                  
                  
                  1,010,437
                  
                  
                  
                  100
                  %Deferred
      loan fees, net
                  
                  
                  (3,069
                  )
                  
                  
                  
                  
                  
                  
                  (3,724
                  )
                  
                  
                  
                  
                  
                  
                  (3,434
                  )Allowance
      for losses on loans
                  
                  
                  (16,439
                  )
                  
                  
                  
                  
                  
                  
                  (11,653
                  )
                  
                  
                  
                  
                  
                  
                  (10,988
                  )Loans,
      net
                  
                  $
                  1,238,733
                  
                  
                  
                  
                  
                  
                  $
                  1,092,776
                  
                  
                  
                  
                  
                  
                  $
                  996,015
  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. There is no guarantee that management’s estimate
will be sufficient to cover actual loan losses. The allowance for loan losses is
maintained at levels based on management’s assessment of various factors
affecting the loan portfolio, including analysis of adversely classified loans,
delinquencies, trends in credit quality, local economic conditions, growth of
the loan portfolio, past loss experience, and the portfolio’s composition.
Increases in the allowance for loan losses made through provisions primarily
reflect loan growth, loan loss 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 quality 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 over $1.0 million 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, 2008, the allowance for
loan losses was $16.4 million (1.31% of total loans) compared to $11.7 million
(1.05% of total loans) at December 31, 2007, and $11.0 million


4


(1.09% of
total loans) at December 31, 2006. During 2008, the Corporation added $7.2
million to the allowance compared to $1.4 million in 2007 and $1.0 million in
2006.  In 2007, the Bank segregated a valuation reserve against
off-balance sheet commitments, such as loans in process.  As of
December 31, 2008, that valuation reserve account was $93,000 compared to
$142,000 at December 31, 2007.  Total allowance for loan losses, which
includes the allowance for off-balance sheet commitments, was $16.5 million
(1.31% of total loans) as of December 31, 2008 compared to $11.8 million (1.06%
of total loans) as of December 31, 2007.


The allowance for loan losses increased
during the year in terms of dollars and percentage of total loans, due to an
increase in nonperforming loans, an increase in adversely classified loans,
growth in the loan portfolio and a weakening economy with its negative impact on
local real estate, which serves as collateral for a majority of the
Corporation’s loans. The allowance for loan losses is discussed in Note
4.


Net loan charge-offs were $2.5 million
in 2008 (or 0.21% of average loans outstanding) compared to $543,000 in 2007 (or
0.05% of average loans outstanding). Net charge-offs were $266,000 (or 0.03% of
average loans outstanding) for the year ended December 31, 2006. The coverage
ratio (the allowance for loan losses to nonperforming loans) was 41% at December
31, 2008, 765% at December 31, 2007, and 1,291% at December 31, 2006. The
increase in net charge-offs was driven by the decline in real estate values,
especially land held for the development of residential building lots and/or
houses. The decrease in the Corporation’s coverage ratio, from the very high
levels of 2007 and 2006, was due to an increase in nonperforming
loans.





Deposit
Accounts


Deposit
account balances totaled $1.0 billion at December 31, 2008, an increase of
$101.9 million or 11.3% over $904.9 million at December 31, 2007. Deposits
totaled $855.4 million at December 31, 2006. Checking account balances grew
$48.7 million to $186.8 million as of December 31, 2008, compared to $138.2
million in the prior year. Continued marketing and sales management efforts
directed at our High Performance Checking program resulted in dramatic growth in
our checking account balances. Personal checking account balances grew by 76% or
$44.0 million over the course of the year and business checking balances grew 6%
or $4.7 million during the same time period.  Money market deposit
account balances decreased by ­38.8% to $193.4 million. The reductions in
money market account balances were primarily from the public sector and the
termination of a sweep account agreement with a money center bank. Certificates
of deposit increased 40.2% to $616.0 million. As business banking activity
increases, management’s goal is to increase its noninterest-bearing or low
interest accounts through the growth of commercial checking
accounts.


The market for deposits has remained
very competitive. It remains a key objective of the Bank to increase its demand
deposit account balances and other low rate accounts.





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, 2008,
the Bank had $249.0 million in FHLB advances compared to $231.0 million as of
December 31, 2007. For 2008, FHLB advances averaged 16.7% of assets compared to
16.0% in 2007. Subject to its line of credit with the FHLB, the availability of
collateral, and the parameters of liquidity management, the Bank will continue
to use advances as a funding source.


The Bank also uses repurchase agreements
for funding. At December 31, 2008, the Bank had executed $146.4 million in
repurchase agreements compared to $120.6 million a year earlier. The Bank
participates in the Federal Reserve term auction facility (TAF) and had an
outstanding balance of $ 40.0 million at December 31, 2008. In 2000, the
Corporation issued $10.3 million in trust preferred securities, which are termed
“junior subordinated debentures payable.” These junior subordinated debentures
payable have a fixed rate of 11% and mature on March 1, 2030, but are callable
at a premium beginning March 1, 2010. In December 2004, the Corporation issued
an additional $5.2 million in junior subordinated debentures payable. These
debentures have a fixed rate of 5.82% for the first 5 years and then float at
the three-month LIBOR plus 1.90% for the remaining 25 years. The debentures are
callable at par after 5 years. On March 30, 2006, the Corporation issued an
additional $10.3 million in junior subordinated debentures payable. These
debentures have an initial rate of 6.65% set for 5 years and then convert to a
three-month LIBOR plus 1.40% for the remaining 25 years. The debentures are
callable at par after 5 years. Junior subordinated debentures payable are
considered Tier 1 capital by financial institution regulators.





Capital


On
November 21, 2008, Cascade completed its $39 million capital raise as a
participant in the U.S. Treasury Department’s Capital Purchase Program. Under
the terms of the transaction, the Corporation issued 38,970 shares of Series A
Fixed-Rate Cumulative Perpetual Preferred Stock, and a warrant to purchase
863,442 shares of the Corporation’s common stock at an exercise price of $6.77
per share.


Banking regulations require the Bank to
maintain minimum levels of capital. As of December 31, 2008, the Bank remained a
“well-capitalized” institution (the FDIC’s highest rating), under regulatory
guidelines, with a Tier 1 capital-to-asset ratio of 10.34% and a risk-based
capital-to-asset ratio of 13.32%. The Bank’s regulatory capital ratios are
discussed in more detail in Note 12 of the Notes to Consolidated Financial
Statements.


Federal Reserve guidelines require the
Corporation, on a consolidated basis, to maintain minimum levels of capital as
well. At December 31, 2008, the Corporation's total risk-based capital to
risk-weighted assets was 13.26%, compared to 10.80% at December 31, 2007, and
11.22% at December 31, 2006. The Corporation has paid its shareholders a cash
dividend on a


5


quarterly
basis since 2002. Average shares outstanding, stock options, net income per
share and book value per share for all periods presented have been retroactively
adjusted to reflect stock splits. In 2008, the Corporation returned $3.3 million
in dividends to its shareholders compared to $4.1 million in 2007.


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 of $2.1 million for the year ended
December 31, 2008, a decrease of 86.6% from the $15.5 million net income for the
year ended December 31, 2007. After dividends on preferred stock, net income
available for common stockholders for the year ended December 31, 2008, was $1.9
million. Operating results for the year were below the record-setting earnings
from the previous year due to an increase of $5.9 million in the provision for
loan losses and the OTTI charge of $17.3 million during the third
quarter.  Net interest income increased $2.5 million to $45.9 million
in 2008 and other income increased $1.3 million to $8.9 million due mostly to a
$1.0 million increase in checking service fees. The Corporation earned net
income of $13.4 million for the fiscal year ended December 31,
2006.





Return
on Average Equity and Average Common Equity


Return on
average equity for the year ended December 31, 2008, was 1.62% compared to
13.23% for the same period of 2007. Return on average equity for the fiscal year
ending December 31, 2006, was 12.24%. Return on average common equity, which
excludes preferred stock, was 1.49% for the year ended December 31, 2008. The
decline in return on equity from 2007 was driven by the OTTI charge on FNMA and
FHLMC preferred stock and a substantial increase in the Corporation’s provision
for loan losses.




Return
on Average Tangible Common Equity


Return on
average tangible common equity (average equity less average goodwill and
preferred stock), was 1.87% for the year ended December 31, 2008, compared to
16.88% in 2007 and 16.08% in 2006. The June 2004 acquisition of Issaquah
Bancshares, Inc. (“Issaquah”) generated $26.3 million in goodwill and
intangible 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 average tangible common equity follows:


(Dollars in thousands)
                  
                  2008
                  
                  
                  2007Net
      income
                  
                  $
                  2,090
                  
                  
                  $
                  15,546Dividends
      on preferred stock
                  
                  
                  216
                  
                  
                  
                  -Income
      available for common stockholders
                  
                  
                  1,874
                  
                  
                  
                  15,546Average
      total equity
                  
                  $
                  129,083
                  
                  
                  $
                  117,534Average
      preferred stock
                  
                  
                  3,683
                  
                  
                  
                  -Average
      common equity
                  
                  
                  125,400
                  
                  
                  
                  117,534Average
      goodwill & intangibles
                  
                  
                  25,149
                  
                  
                  
                  25,439Average
      tangible common equity
                  
                  $
                  100,251
                  
                  
                  $
                  92,095Return
      on average tangible common equity
                  
                  
                  1.87
                  %
                  
                  
                  16.88
                  %
  Net
Interest Income


The
largest component of the Corporation’s earnings is net interest income. Net
interest income is the difference between interest-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 and government policies. The Corporation’s operations may be sensitive
to changes in interest rates and the resulting impact on net interest
income.


Net interest income for the year ended
December 31, 2008, increased by 5.7%, or $2.5 million, to $45.9 million from
$43.4 million for the year ended December 31, 2007. The improvement in net
interest income was primarily due to the growth in our level of average earning
assets of $137.6 million. Net interest income for the fiscal year ended December
31, 2006, was $39.4 million.


Average earning assets increased 10.6%
to $1.4 billion for the year ended December 31, 2008, from $1.3 billion for the
year ended December 31, 2007. Average earning assets were $1.2 billion for the
year ended December 31, 2006.


6


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, 2008, was 3.20%, compared to 3.34% for the year
ended December 31, 2007. Interest reversals associated with loans placed on
non-accrual during the year and a 400 basis point drop in interest rates were
responsible for the reduction in the net interest margin. The yield on earning
assets decreased 79 basis points to 6.45% in 2008. The cost of
interest-bearing liabilities decreased 81 basis points to 3.57% for the
year.





Average
Balances and an Analysis of Average Rates Earned and Paid


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


FOR THE YEARS ENDED DECEMBER
      31,2008
                                  
                                  
                                  2007
                                  
                                  
                                  2006(Dollars
      in thousands)AVERAGE
                                      BALANCE
                                  
                                  
                                  INTEREST
                                      AND
                                      DIVIDEND
                                  
                                  
                                  YIELD/COST
                                  
                                  
                                  AVERAGEBALANCE
                                  
                                  
                                  INTERESTANDDIVIDEND
                                  
                                  
                                  YIELD/COST
                                  
                                  
                                  AVERAGEBALANCE
                                  
                                  
                                  INTERESTANDDIVIDEND
                                  
                                  
                                  YIELD/COSTASSETSInterest-earning
      assets (1)Residential
      loans
                                  
                                  $
                                  107,912
                                  
                                  
                                  $
                                  6,478
                                  
                                  
                                  
                                  6.00
                                  %
                                  
                                  $
                                  94,608
                                  
                                  
                                  $
                                  5,753
                                  
                                  
                                  
                                  6.08
                                  %
                                  
                                  $
                                  98,476
                                  
                                  
                                  $
                                  5,582
                                  
                                  
                                  
                                  5.67
                                  %Multifamily
      loans
                                  
                                  
                                  48,272
                                  
                                  
                                  
                                  3,367
                                  
                                  
                                  
                                  6.98
                                  
                                  
                                  
                                  18,467
                                  
                                  
                                  
                                  1,416
                                  
                                  
                                  
                                  7.67
                                  
                                  
                                  
                                  42,574
                                  
                                  
                                  
                                  2,863
                                  
                                  
                                  
                                  6.72Commercial
      real estate loans
                                  
                                  
                                  117,510
                                  
                                  
                                  
                                  7,857
                                  
                                  
                                  
                                  6.69
                                  
                                  
                                  
                                  117,952
                                  
                                  
                                  
                                  8,259
                                  
                                  
                                  
                                  7.00
                                  
                                  
                                  
                                  144,094
                                  
                                  
                                  
                                  9,821
                                  
                                  
                                  
                                  6.82Construction
      loans
                                  
                                  
                                  384,410
                                  
                                  
                                  
                                  25,427
                                  
                                  
                                  
                                  6.61
                                  
                                  
                                  
                                  332,467
                                  
                                  
                                  
                                  30,094
                                  
                                  
                                  
                                  9.05
                                  
                                  
                                  
                                  214,290
                                  
                                  
                                  
                                  19,376
                                  
                                  
                                  
                                  9.04Consumer
      loans
                                  
                                  
                                  29,111
                                  
                                  
                                  
                                  1,931
                                  
                                  
                                  
                                  6.63
                                  
                                  
                                  
                                  27,575
                                  
                                  
                                  
                                  2,128
                                  
                                  
                                  
                                  7.72
                                  
                                  
                                  
                                  30,064
                                  
                                  
                                  
                                  2,304
                                  
                                  
                                  
                                  7.66Business
      banking loans
                                  
                                  
                                  475,716
                                  
                                  
                                  
                                  32,881
                                  
                                  
                                  
                                  6.91
                                  
                                  
                                  
                                  455,024
                                  
                                  
                                  
                                  33,908
                                  
                                  
                                  
                                  7.45
                                  
                                  
                                  
                                  426,194
                                  
                                  
                                  
                                  31,158
                                  
                                  
                                  
                                  7.31Total
      loans
                                  
                                  
                                  1,162,931
                                  
                                  
                                  
                                  77,941
                                  
                                  
                                  
                                  6.70
                                  
                                  
                                  
                                  1,046,093
                                  
                                  
                                  
                                  81,558
                                  
                                  
                                  
                                  7.80
                                  
                                  
                                  
                                  955,692
                                  
                                  
                                  
                                  71,104
                                  
                                  
                                  
                                  7.44Securities
      available-for-sale
                                  
                                  
                                  124,875
                                  
                                  
                                  
                                  6,280
                                  
                                  
                                  
                                  5.03
                                  
                                  
                                  
                                  102,613
                                  
                                  
                                  
                                  4,828
                                  
                                  
                                  
                                  4.71
                                  
                                  
                                  
                                  148,917
                                  
                                  
                                  
                                  6,735
                                  
                                  
                                  
                                  4.52Securities
      held-to-maturity
                                  
                                  
                                  140,008
                                  
                                  
                                  
                                  8,213
                                  
                                  
                                  
                                  5.87
                                  
                                  
                                  
                                  88,535
                                  
                                  
                                  
                                  4,527
                                  
                                  
                                  
                                  5.11
                                  
                                  
                                  
                                  96,668
                                  
                                  
                                  
                                  4,563
                                  
                                  
                                  
                                  4.72Securities
      held-for-trading
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  38,614
                                  
                                  
                                  
                                  1,884
                                  
                                  
                                  
                                  4.88
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Daily
      interest-earning deposits
                                  
                                  
                                  8,939
                                  
                                  
                                  
                                  137
                                  
                                  
                                  
                                  1.54
                                  
                                  
                                  
                                  21,607
                                  
                                  
                                  
                                  1,138
                                  
                                  
                                  
                                  5.27
                                  
                                  
                                  
                                  5,356
                                  
                                  
                                  
                                  256
                                  
                                  
                                  
                                  4.78Total
      securities and interest-earning deposits
                                  
                                  
                                  273,822
                                  
                                  
                                  
                                  14,630
                                  
                                  
                                  
                                  5.34
                                  
                                  
                                  
                                  251,369
                                  
                                  
                                  
                                  12,377
                                  
                                  
                                  
                                  4.92
                                  
                                  
                                  
                                  250,941
                                  
                                  
                                  
                                  11,554
                                  
                                  
                                  
                                  4.60Total
      interest-earning assets
                                  
                                  
                                  1,436,753
                                  
                                  
                                  
                                  92,571
                                  
                                  
                                  
                                  6.44
                                  
                                  
                                  
                                  1,297,462
                                  
                                  
                                  
                                  93,935
                                  
                                  
                                  
                                  7.24
                                  
                                  
                                  
                                  1,206,633
                                  
                                  
                                  
                                  82,658
                                  
                                  
                                  
                                  6.85Noninterest-earning
      assetsOffice
      properties and  equipment, net
                                  
                                  
                                  15,420
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  13,744
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  12,093Other
      noninterest-earning assets
                                  
                                  
                                  82,285
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  59,103
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  56,830Total
      assets
                                  
                                  $
                                  1,534,458
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  1,370,309
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  1,275,556LIABILITIES
      AND EQUITYInterest-bearing
      liabilitiesSavings
      accounts
                                  
                                  $
                                  10,888
                                  
                                  
                                  $
                                  53
                                  
                                  
                                  
                                  0.49
                                  %
                                  
                                  $
                                  13,261
                                  
                                  
                                  $
                                  66
                                  
                                  
                                  
                                  0.50
                                  %
                                  
                                  $
                                  14,748
                                  
                                  
                                  $
                                  75
                                  
                                  
                                  
                                  0.51
                                  %Checking
      accounts
                                  
                                  
                                  72,817
                                  
                                  
                                  
                                  1,203
                                  
                                  
                                  
                                  1.65
                                  
                                  
                                  
                                  51,021
                                  
                                  
                                  
                                  747
                                  
                                  
                                  
                                  1.46
                                  
                                  
                                  
                                  45,039
                                  
                                  
                                  
                                  656
                                  
                                  
                                  
                                  1.46Money
      market accounts
                                  
                                  
                                  297,312
                                  
                                  
                                  
                                  7,311
                                  
                                  
                                  
                                  2.46
                                  
                                  
                                  
                                  284,843
                                  
                                  
                                  
                                  12,314
                                  
                                  
                                  
                                  4.32
                                  
                                  
                                  
                                  229,788
                                  
                                  
                                  
                                  8,505
                                  
                                  
                                  
                                  3.70Certificates
      of deposit
                                  
                                  
                                  497,115
                                  
                                  
                                  
                                  18,648
                                  
                                  
                                  
                                  3.75
                                  
                                  
                                  
                                  444,726
                                  
                                  
                                  
                                  22,093
                                  
                                  
                                  
                                  4.97
                                  
                                  
                                  
                                  446,437
                                  
                                  
                                  
                                  19,339
                                  
                                  
                                  
                                  4.33Total
      interest-bearing deposits
                                  
                                  
                                  878,132
                                  
                                  
                                  
                                  27,215
                                  
                                  
                                  
                                  3.10
                                  
                                  
                                  
                                  793,851
                                  
                                  
                                  
                                  35,220
                                  
                                  
                                  
                                  4.44
                                  
                                  
                                  
                                  736,012
                                  
                                  
                                  
                                  28,575
                                  
                                  
                                  
                                  3.88Other
      interest-bearing liabilitiesFHLB
      advances
                                  
                                  
                                  256,898
                                  
                                  
                                  
                                  10,955
                                  
                                  
                                  
                                  4.26
                                  
                                  
                                  
                                  226,124
                                  
                                  
                                  
                                  10,240
                                  
                                  
                                  
                                  4.53
                                  
                                  
                                  
                                  237,888
                                  
                                  
                                  
                                  11,194
                                  
                                  
                                  
                                  4.71Other
      interest-bearing liabilities
                                  
                                  
                                  173,195
                                  
                                  
                                  
                                  8,516
                                  
                                  
                                  
                                  4.92
                                  
                                  
                                  
                                  134,410
                                  
                                  
                                  
                                  5,080
                                  
                                  
                                  
                                  3.78
                                  
                                  
                                  
                                  104,085
                                  
                                  
                                  
                                  3,499
                                  
                                  
                                  
                                  3.36Total
      interest-bearing liabilities
                                  
                                  
                                  1,308,225
                                  
                                  
                                  
                                  46,686
                                  
                                  
                                  
                                  3.57
                                  
                                  
                                  
                                  1,154,385
                                  
                                  
                                  
                                  50,540
                                  
                                  
                                  
                                  4.38
                                  
                                  
                                  
                                  1,077,985
                                  
                                  
                                  
                                  43,268
                                  
                                  
                                  
                                  4.01Other
      liabilities
                                  
                                  
                                  97,150
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  98,390
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  88,468Total
      liabilities
                                  
                                  
                                  1,405,375
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  1,252,775
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  1,166,453Stockholders’
      equity
                                  
                                  
                                  129,083
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  117,534
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  109,103Total
      liabilities and stockholders’equity
                                  
                                  $
                                  1,534,458
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  1,370,309
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  1,275,556Net
      interest income (2)
                                  
                                  
                                  
                                  
                                  
                                  $
                                  45,885
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  43,395
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  39,390Interest rate spread(3)
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  2.87
                                  %
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  2.86
                                  %
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  2.84
                                  %Net
      interest margin (4)
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  3.20
                                  %
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  3.34
                                  %
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  3.26
                                  %Average
      interest-earning assets
                                      to
      average interest-bearing liabilities
                                  
                                  
                                  109.82
                                  %
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  112.39
                                  %
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  111.93
                                  %
  (1)  Does
not include interest on nonaccrual loans 90 days or more past
due.


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


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


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





Other
Income


Other
income is derived from sources other than interest and fees on earning assets.
The Corporation’s primary sources of other income are service charge fees on
deposit accounts, other service fees, the accretion of cash surrender value of
bank owned life insurance (“BOLI”), gains on the sale of single-family
residential and other loans, gains on the sale of securities, and rental income,
primarily on space at the building that formerly served as the headquarters of
Issaquah Bank. Other income for the year ended December 31, 2008, was $8.9


7


million
compared to $7.6 million for the year ended December 31, 2007.  The
increase is largely due to the increase in checking fees, which were up $1.0
million to $4.8 million in 2008.  Other income for the year ended
December 31, 2006, was $6.0 million.  The net gain on the fair value
of financial instruments, related to the implementation of SFAS No. 159 was $912
and $1.1 million for the years ended December 31, 2008, and 2007,
respectively.  There were no corresponding gains in 2006.





Other
Expense


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


Other expense increased by $19.2 million
to $45.9 million for the year ended December 31, 2008, from $26.7 million and
$24.6 million for 2007 and 2006, respectively. The Corporation owns preferred
shares issued by FNMA ($10.2 million of original book value) and FHLMC ($8.4
million of original book value) with a combined original book value of
approximately $18.6 million.  Following the placement of these two
Government Sponsored Enterprises into conservatorship, and the decline in the
market value of these securities, the Corporation recorded a pre-tax OTTI charge
of $17.3 million in the third quarter of 2008.  This accounted for
most of the increase in other expense in the year ended December 31, 2008.
Salaries and employee benefits increased overall by $727,000 to $14.5 million
during 2008 compared to the prior year. Other expenses increased $1.1 million to
$14.0 million during 2008, largely due to FDIC insurance premiums of $633,000
and costs associated with opening the new Burlington branch in May of 2008,
compared to $12.9 million and $11.9 million for the years ended December 31,
2007, and 2006, respectively.


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, 2008, 2007, and 2006, the Corporation’s efficiency
ratio was 52.11%, 52.36%, and 54.14%, respectively. The efficiency ratio
calculation for the year ended December 31, 2008, excludes the OTTI charge of
$17.3 million. Management continues to look for ways to improve the efficiency
ratio by increasing other income and net interest income while diligently
controlling costs and maintaining high standards of service.





Liquidity
Management


Liquidity
is a term used to define the Corporation's ability to meet its financial
commitments. The Corporation is required by prudent business practice and its
regulators to maintain adequate levels of liquidity. The main liquidity
requirements are funding customer loan requests and deposit outflows of the
Bank. Primary sources of liquidity are cash and cash equivalents, which include
highly liquid investments. At December 31, 2008, 2007 and 2006, cash and cash
equivalents totaled $53.5 million, $14.5 million, and $42.9 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 are
Federal Home Loan Bank of Seattle (“FHLB-Seattle”) advances, repurchase
agreements and starting in 2008, the Term Auction Facility (“TAF”) from the
Federal Reserve Bank (“FRB”). At December 31, 2008, $323.9 million of additional
borrowing capacity remained under the Bank’s existing credit line from the
FHLB-Seattle, which is 35% of the Bank’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, 2008, the Bank had unencumbered eligible collateral
of approximately $136.2 million to pledge against the line. In addition, the
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. The Bank tested each of these lines
during the year. The Bank also has a $172.4 million line of credit with the
Federal Reserve Bank of San Francisco collateralized with commercial and
construction loans. As of December 31, 2008, $40.0 million in TAF borrowings
were outstanding against this line.


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





Interest
Rate Risk Management


Management
considers interest rate risk to be a 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 vast majority of fixed-rate loans have repricing periods with
a maximum of five years. The mix of floating- and fixed-rate assets is designed
to mitigate the impact of rate changes on the Corporation’s net interest income.
Virtually all fixed-rate residential loans are sold into the secondary market.
However, the Bank has sought to add prepayment provisions to its newly
originated loans with five year fixed and adjustable rates. The Bank has also
instituted a required floor on many floating and adjustable rate loans. At the
end of December 31, 2008, over one-third of the loans in the floating rate
portfolio were at or near their floors.


8


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, 2008, a 200
basis point increase in rates would increase forecasted net interest income over
a 12 month period by approximately 2.2%. A 200 basis point decrease in rates
would decrease interest income by 17.3% 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 $5.5 million or 2.8%, a 200 basis
point decrease in rates would decrease the fair value of equity by $55.4 million
or 28.1%. Both are within the guideline established by the Bank’s
Asset/Liability Policy.


The Corporation has maintained a trading
account for financial instruments in the past, however there was no
activity during 2008. 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,
2008, are shown in the following table.





INTEREST REPRICING
      ASSUMPTIONS(Dollars
      in thousands)
                        
                        <1
      YEAR
                        
                        
                        1-3
                          YEARS
                        
                        
                        3-5
                          YEARS
                        
                        
                        5-10
      YEARS
                        
                        
                        10
      YEARS
                          AND
      UP
                        
                        
                        TOTAL
                        
                        
                        FAIR
      VALUEInterest-Sensitive
      AssetsTotal
      loans
                        
                        $
                        830,759
                        
                        
                        $
                        144,649
                        
                        
                        $
                        225,302
                        
                        
                        $
                        15,876
                        
                        
                        $
                        1,377
                        
                        
                        $
                        1,217,963
                        
                        
                        $
                        1,239,685Investments
      and otherinterest-earning
      assets
                        
                        
                        267,406
                        
                        
                        
                        13,907
                        
                        
                        
                        4,413
                        
                        
                        
                        12,028
                        
                        
                        
                        44
                        
                        
                        
                        297,798
                        
                        
                        
                        297,894Interest-Sensitive
      LiabilitiesChecking
      accounts
                        
                        $
                        22,618
                        
                        
                        $
                        24,674
                        
                        
                        $
                        37,011
                        
                        
                        $
                        16,655
                        
                        
                        $
                        1,851
                        
                        
                        $
                        102,809
                        
                        
                        $
                        102,810Money
      market accounts
                        
                        
                        189,597
                        
                        
                        
                        1,185
                        
                        
                        
                        1,777
                        
                        
                        
                        800
                        
                        
                        
                        89
                        
                        
                        
                        193,448
                        
                        
                        
                        193,448Savings
      accounts
                        
                        
                        2,329
                        
                        
                        
                        2,541
                        
                        
                        
                        3,811
                        
                        
                        
                        1,715
                        
                        
                        
                        191
                        
                        
                        
                        10,587
                        
                        
                        
                        10,587Certificates
      of deposit
                        
                        
                        587,094
                        
                        
                        
                        10,332
                        
                        
                        
                        8,307
                        
                        
                        
                        10,171
                        
                        
                        
                        -
                        
                        
                        
                        615,904
                        
                        
                        
                        618,044Borrowings
                        
                        
                        101,390
                        
                        
                        
                        -
                        
                        
                        
                        80,000
                        
                        
                        
                        229,000
                        
                        
                        
                        25,000
                        
                        
                        
                        435,390
                        
                        
                        
                        458,911Junior
      subordinateddebentures
      payable
                        
                        
                        -
                        
                        
                        
                        15,975
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        10,000
                        
                        
                        
                        25,975
                        
                        
                        
                        22,079





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
had not incurred any losses on its commitments in 2008 or 2007.





A summary
of the notional amount of the Bank’s financial instruments with off-balance
sheet risk at December 31, 2008 follows:


(Dollars
      in thousands)
                      
                      TOTALCommitments
      to extend credit
                      
                      $
                      173,680Standby
      letters of credit and financial guarantees written
                      
                      
                      5,116Unused
      commitments on bankcards
                      
                      
                      13,868Total
                      
                      $
                      192,664
  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
                  
                  
                  TOTALCertificates
      of deposit
                  
                  $
                  587,094
                  
                  
                  $
                  13,571
                  
                  
                  $
                  5,068
                  
                  
                  $
                  10,171
                  
                  
                  $
                  615,904Federal
      Home Loan Bank advances
                  
                  
                  10,000
                  
                  
                  
                  10,000
                  
                  
                  
                  70,000
                  
                  
                  
                  159,000
                  
                  
                  
                  249,000Operating
      lease obligations
                  
                  
                  820
                  
                  
                  
                  1,557
                  
                  
                  
                  1,515
                  
                  
                  
                  8,314
                  
                  
                  
                  12,206Junior
      subordinated debentures payable
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  25,975
                  
                  
                  
                  25,975Total
                  
                  
                  
                  
                  
                  
                  $
                  597,914
                  
                  
                  
                  
                  
                  
                  $
                  25,128
  At
December 31, 2008, the Corporation’s long-term contractual obligations related
to debt totaled $275.0 million. See additional discussion under Notes 7 and 8 to
the Consolidated Financial Statements for the year ended December 31, 2008. The
Corporation also has operating leases comprised of leases for office
space.


9





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
deterioration in the quality of the loan portfolio. The Corporation’s loan
growth has been focused on commercial lending. 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 their 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 the Corporation’s net income. Many of
the assets and liabilities of the Corporation have embedded options, which add
another layer of complexity in its interest rate risk management
practices.


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


Recently issued accounting
pronouncements: In October 2008, the FASB issued FASB Staff
Position (FSP) FAS No. 157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active. The FSP
clarifies the application of FAS No. 157, Fair Value Measurements, when
the market for a financial asset is not active. The FSP was effective upon
issuance, including reporting for prior periods for which financial statements
have not been issued. The adoption of the FSP for reporting as of
December 31, 2008, did not have a material impact on our consolidated
financial statements.





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. In addition, the 2008 Proxy Statement and Annual Report
are available at http://bnymellon.mobular.net/bnymellon/CASB. 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.


10


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 (the Corporation) as of December 31, 2008, and
2007, and the related consolidated statements of income, stockholders' equity
and comprehensive income, and cash flows for each of the years in the three-year
period ended December 31, 2008. We also have audited the Corporation’s internal
control over financial reporting as of December 31, 2008, 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 included in the
accompanying Report of Management on Internal Control over Financial Reporting.
Our responsibility is to express an opinion on these financial statements 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 auditing 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 audits of the 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, as well as evaluating the overall financial statement
presentation.  Our audit of internal control over financial reporting
included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, and testing and
evaluating the design and operating effectiveness of internal control based on
the assessed risks.  Our audits also included 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, 2008 and 2007, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2008, in conformity with accounting
principles generally accepted in the United States of America. Also in our
opinion, Cascade Financial Corporation maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2008,
based on criteria established in Internal Control - Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).





/s/ Moss Adams
LLP


Everett,
Washington


March 12,
2009


11


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Consolidated
Balance Sheets


December
31, 2008, and 2007


DECEMBER
      31,(Dollars in thousands, except share
      amounts)
                              
                              2008
                              
                              
                              2007ASSETSCash
      on hand and in banks
                              
                              $
                              11,859
                              
                              
                              $
                              12,911Interest-bearing
      deposits in other financial institutions
                              
                              
                              10,907
                              
                              
                              
                              1,619Fed
      funds sold
                              
                              
                              30,700
                              
                              
                              
                              —Securities
      available-for-sale, fair value
                              
                              
                              123,678
                              
                              
                              
                              82,860Securities
      held-to-maturity, amortized cost
                              
                              
                              120,594
                              
                              
                              
                              137,238Federal
      Home Loan Bank (FHLB) stock
                              
                              
                              11,920
                              
                              
                              
                              11,920Loans,
      net
                              
                              
                              1,238,733
                              
                              
                              
                              1,092,776Goodwill
                              
                              
                              24,585
                              
                              
                              
                              24,585Core
      deposit intangible, net
                              
                              
                              493
                              
                              
                              
                              634Premises
      and equipment, net
                              
                              
                              15,463
                              
                              
                              
                              14,160Cash
      surrender value of bank owned life insurance (BOLI)
                              
                              
                              23,638
                              
                              
                              
                              22,658Real
      estate owned (REO) and other repossessed assets
                              
                              
                              1,446
                              
                              
                              
                              —Deferred
      tax asset
                              
                              
                              9,828
                              
                              
                              
                              1,574Accrued
      interest receivable and other assets
                              
                              
                              13,475
                              
                              
                              
                              14,653Total
      assets
                              
                              $
                              1,637,319
                              
                              
                              $
                              1,417,588LIABILITIES
      AND STOCKHOLDERS’ EQUITYLiabilities:Deposits
                              
                              $
                              1,006,782
                              
                              
                              $
                              904,896FHLB
      advances
                              
                              
                              249,000
                              
                              
                              
                              231,000Federal
      Reserve Bank (FRB) TAF borrowings
                              
                              
                              40,000
                              
                              
                              
                              —Securities
      sold under agreements to repurchase
                              
                              
                              146,390
                              
                              
                              
                              120,625Junior
      subordinated debentures payable
                              
                              
                              15,465
                              
                              
                              
                              15,465Junior
      subordinated debentures payable, fair value
                              
                              
                              10,510
                              
                              
                              
                              11,422Accrued
      interest payable, expenses, and other liabilities
                              
                              
                              9,050
                              
                              
                              
                              12,084Total
      liabilities
                              
                              
                              1,477,197
                              
                              
                              
                              1,295,492Stockholders’
      equity:Preferred
      stock, no par value. Authorized 38,970 shares; Series A (liquidation
      preference $1,000 per share); issued and Outstanding 38,970shares
      at December 31, 2008, and none at December 31, 2007
                              
                              
                              36,616
                              
                              
                              
                              —Preferred
      stock, $.01 par value. Authorized 500,000 shares; no shares issued or
      outstanding
                              
                              
                              —
                              
                              
                              
                              —Common
      stock, $.01 par value. Authorized 25,000,000 shares; issued and
      outstanding 12,071,032 shares at December 31, 2008, and 12,023,685 shares
      at December 31, 2007
                              
                              
                              121
                              
                              
                              
                              120Additional
      paid-in capital
                              
                              
                              40,781
                              
                              
                              
                              40,322Retained
      earnings, substantially restricted
                              
                              
                              80,875
                              
                              
                              
                              82,169Warrants
      issued to US Treasury
                              
                              
                              2,389
                              
                              
                              
                              —Accumulated
      other comprehensive loss
                              
                              
                              (660
                              )
                              
                              
                              (515
                              )Total
      stockholders’ equity
                              
                              
                              160,122
                              
                              
                              
                              122,096Total
      liabilities and stockholders’ equity
                              
                              $
                              1,637,319
                              
                              
                              $
                              1,417,588
  (See
accompanying notes to consolidated financial statements.)


12


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Consolidated
Statements of Income


Years
ended December 31, 2008, 2007, and 2006


YEARS
      ENDED DECEMBER 31,(Dollars in thousands, except share
      amounts)
                  
                  2008
                  
                  
                  2007
                  
                  
                  2006Interest
      income:Loans
                  
                  $
                  77,941
                  
                  
                  $
                  81,558
                  
                  
                  $
                  71,104Securities
      held-for-trading
                  
                  
                  —
                  
                  
                  
                  1,884
                  
                  
                  
                  —Securities
      available-for-sale
                  
                  
                  5,258
                  
                  
                  
                  4,756
                  
                  
                  
                  6,723Securities
      held-to-maturity
                  
                  
                  8,213
                  
                  
                  
                  4,527
                  
                  
                  
                  4,563FHLB
      dividends
                  
                  
                  113
                  
                  
                  
                  72
                  
                  
                  
                  12Preferred
      stock
                  
                  
                  909
                  
                  
                  
                  —
                  
                  
                  
                  —Interest-bearing
      deposits
                  
                  
                  137
                  
                  
                  
                  1,138
                  
                  
                  
                  256Total
      interest income
                  
                  
                  92,571
                  
                  
                  
                  93,935
                  
                  
                  
                  82,658Interest
      expense:Deposits
                  
                  
                  27,215
                  
                  
                  
                  35,220
                  
                  
                  
                  28,576FHLB
      advances
                  
                  
                  10,955
                  
                  
                  
                  10,240
                  
                  
                  
                  11,193FRB
      TAF borrowings
                  
                  
                  375
                  
                  
                  
                  —
                  
                  
                  
                  —Securities
      sold under agreements to repurchase
                  
                  
                  6,021
                  
                  
                  
                  2,960
                  
                  
                  
                  1,619Junior
      subordinated debentures payable
                  
                  
                  2,120
                  
                  
                  
                  2,120
                  
                  
                  
                  1,880Total
      interest expense
                  
                  
                  46,686
                  
                  
                  
                  50,540
                  
                  
                  
                  43,268Net
      interest income
                  
                  
                  45,885
                  
                  
                  
                  43,395
                  
                  
                  
                  39,390Provision
      for loan losses
                  
                  
                  7,240
                  
                  
                  
                  1,350
                  
                  
                  
                  1,000Net
      interest income after provision for loan losses
                  
                  
                  38,645
                  
                  
                  
                  42,045
                  
                  
                  
                  38,390Other
      income:Checking
      service fees
                  
                  
                  4,848
                  
                  
                  
                  3,820
                  
                  
                  
                  3,311Other
      service fees
                  
                  
                  1,092
                  
                  
                  
                  1,059
                  
                  
                  
                  1,156BOLI
                  
                  
                  1,056
                  
                  
                  
                  803
                  
                  
                  
                  769Gain
      (loss) on sale of securities available-for-sale, net
                  
                  
                  285
                  
                  
                  
                  (435
                  )
                  
                  
                  —Gain
      on calls of securities held-to-maturity, net
                  
                  
                  113
                  
                  
                  
                  —
                  
                  
                  
                  —Gain
      on sale of loans
                  
                  
                  128
                  
                  
                  
                  199
                  
                  
                  
                  483Gain
      on fair value of financial instruments, net
                  
                  
                  912
                  
                  
                  
                  1,081
                  
                  
                  
                  —Gain
      on FHLB advances, net
                  
                  
                  —
                  
                  
                  
                  569
                  
                  
                  
                  —Loss
      on sale of REO and other repossessed assets, net
                  
                  
                  (3
                  )
                  
                  
                  —
                  
                  
                  
                  (27
                  )Other
                  
                  
                  453
                  
                  
                  
                  470
                  
                  
                  
                  334Total
      other income
                  
                  
                  8,884
                  
                  
                  
                  7,566
                  
                  
                  
                  6,026Other
      expenses:Salaries
      and employee benefits
                  
                  
                  14,544
                  
                  
                  
                  13,817
                  
                  
                  
                  12,691Occupancy
                  
                  
                  3,986
                  
                  
                  
                  3,576
                  
                  
                  
                  3,450Marketing
                  
                  
                  1,096
                  
                  
                  
                  1,182
                  
                  
                  
                  1,094B&O
      tax
                  
                  
                  1,277
                  
                  
                  
                  1,373
                  
                  
                  
                  1,027Other
                  
                  
                  7,637
                  
                  
                  
                  6,734
                  
                  
                  
                  6,324Other
      than temporary impairment (OTTI)
                  
                  
                  17,338
                  
                  
                  
                  —
                  
                  
                  
                  —Total
      other expenses
                  
                  
                  45,878
                  
                  
                  
                  26,682
                  
                  
                  
                  24,586Income
      before (benefit) provision for income taxes
                  
                  
                  1,651
                  
                  
                  
                  22,929
                  
                  
                  
                  19,830(Benefit)
      provision for income taxes
                  
                  
                  (439
                  )
                  
                  
                  7,383
                  
                  
                  
                  6,475Net
      income
                  
                  
                  2,090
                  
                  
                  
                  15,546
                  
                  
                  
                  13,355Dividends
      on preferred stock
                  
                  
                  216
                  
                  
                  
                  —
                  
                  
                  
                  —Net
      income available for common stockholders
                  
                  $
                  1,874
                  
                  
                  $
                  15,546
                  
                  
                  $
                  13,355Earnings
      per common share (EPS), basic
                  
                  $
                  0.16
                  
                  
                  $
                  1.29
                  
                  
                  $
                  1.11Weighted
      average number of common shares outstanding, basic
                  
                  
                  12,053,084
                  
                  
                  
                  12,047,792
                  
                  
                  
                  12,060,191Earnings
      per common share, diluted
                  
                  $
                  0.15
                  
                  
                  $
                  1.27
                  
                  
                  $
                  1.08Weighted
      average number of common shares outstanding, diluted
                  
                  
                  12,159,174
                  
                  
                  
                  12,284,854
                  
                  
                  
                  12,363,198
  (See
accompanying notes to consolidated financial statements.)


13


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Consolidated
Statements of Stockholders’ Equity and Comprehensive Income


Years
ended December 31, 2008, 2007, and 2006





Consolidated Statement of Stockholders’
      Equity(Dollars
      in thousands, except share amounts)
                  
                  
                  
                  
                  
                  
                  
                  
                  ACCUMULATED
                  
                  
                  TOTALADDITIONAL
                  
                  
                  
                  
                  
                  OTHER
                  
                  
                  STOCK-PREFERRED
                  
                  
                  COMMON
                  
                  
                  PAID-IN
                  
                  
                  RETAINED
                  
                  
                  COMPREHENSIVE
                  
                  
                  HOLDERS’STOCK
                  
                  
                  SHARES
                  
                  
                  AMOUNT
                  
                  
                  CAPITAL
                  
                  
                  EARNINGS
                  
                  
                  LOSS,
      NET
                  
                  
                  EQUITYBalances at December 31, 2005
                  
                  $
                  -
                  
                  
                  
                  9,603,787
                  
                  
                  $
                  96
                  
                  
                  $
                  38,149
                  
                  
                  $
                  68,945
                  
                  
                  $
                  (1,997
                  )
                  
                  $
                  105,193Stock
      split (5-for-4)
                  
                  
                  -
                  
                  
                  
                  2,410,282
                  
                  
                  
                  24
                  
                  
                  
                  (33
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (9
                  )Cash
      dividends declared
                  
                  
                  
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (3,706
                  )
                  
                  
                  -
                  
                  
                  
                  (3,706
                  )Options
      exercised, including related tax benefit
                  
                  
                  -
                  
                  
                  
                  122,920
                  
                  
                  
                  1
                  
                  
                  
                  1,058
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,059Stock
      compensation expense, net of tax benefit
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  287
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  287Net
      income
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  13,355
                  
                  
                  
                  -
                  
                  
                  
                  13,355Shares
      repurchased
                  
                  
                  -
                  
                  
                  
                  (43,290
                  )
                  
                  
                  -
                  
                  
                  
                  (31
                  )
                  
                  
                  (642
                  )
                  
                  
                  -
                  
                  
                  
                  (673
                  )Other
      comprehensive loss, net of tax benefit of $(165)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (307
                  )
                  
                  
                  (307
                  )Balances
      at December 31, 2006
                  
                  
                  -
                  
                  
                  
                  12,093,699
                  
                  
                  
                  121
                  
                  
                  
                  39,430
                  
                  
                  
                  77,952
                  
                  
                  
                  (2,304
                  )
                  
                  
                  115,199Adoption
      of fair value option
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (4,532
                  )
                  
                  
                  -
                  
                  
                  
                  (4,532
                  )Cash
      dividends declared
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (4,094
                  )
                  
                  
                  -
                  
                  
                  
                  (4,094
                  )Options
      exercised, including related tax benefit
                  
                  
                  -
                  
                  
                  
                  108,818
                  
                  
                  
                  -
                  
                  
                  
                  813
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  813Stock
      compensation expense, net of tax benefit
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  213
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  213Net
      income
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  15,546
                  
                  
                  
                  -
                  
                  
                  
                  15,546Shares
      repurchased
                  
                  
                  -
                  
                  
                  
                  (178,832
                  )
                  
                  
                  (1
                  )
                  
                  
                  (134
                  )
                  
                  
                  (2,703
                  )
                  
                  
                  -
                  
                  
                  
                  (2,838
                  )Other
      comprehensive income, net of tax provision of $963
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,789
                  
                  
                  
                  1,789Balances
      at December 31, 2007
                  
                  
                  -
                  
                  
                  
                  12,023,685
                  
                  
                  
                  120
                  
                  
                  
                  40,322
                  
                  
                  
                  82,169
                  
                  
                  
                  (515
                  )
                  
                  
                  122,096Cash
      dividends declaredCommon
      stock
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (3,256
                  )
                  
                  
                  -
                  
                  
                  
                  (3,256
                  )Preferred
      stock
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (216
                  )
                  
                  
                  -
                  
                  
                  
                  (216
                  )Options
      exercised, including related tax benefit
                  
                  
                  -
                  
                  
                  
                  47,347
                  
                  
                  
                  1
                  
                  
                  
                  263
                  
                  
                  
                  123
                  
                  
                  
                  -
                  
                  
                  
                  387Stock
      compensation expense, net of tax benefit
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  196
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  196Net
      income
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,090
                  
                  
                  
                  -
                  
                  
                  
                  2,090Issuance
      of preferred stock
                  
                  
                  36,581
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  36,581Warrants
      on issuance of preferred stock
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,389
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,389Accretion
      of discount on preferred stock
                  
                  
                  35
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (35
                  )
                  
                  
                  -
                  
                  
                  
                  -Other
      comprehensive loss, net of tax benefit of $(79)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (145
                  )
                  
                  
                  (145
                  )Balances
      at December 31, 2008
                  
                  $
                  36,616
                  
                  
                  
                  12,071,032
                  
                  
                  $
                  121
                  
                  
                  $
                  43,170
                  
                  
                  $
                  80,875
                  
                  
                  $
                  (660
                  )
                  
                  $
                  160,122







Consolidated
      Statement of Comprehensive Income(Dollars
      in thousands, except share amounts)
                        
                        YEARS
      ENDED DECEMBER 31,2008
                        
                        
                        2007
                        
                        
                        2006Net
      income
                        
                        $
                        2,090
                        
                        
                        $
                        15,546
                        
                        
                        $
                        13,355Unrealized
      gain (loss) on securities available-for-sale, netof tax provision
      (benefit) of $(178), $953, and $(165)
                        
                        
                        (330
                        )
                        
                        
                        1,771
                        
                        
                        
                        (307
                        )Reclassification
      adjustment for gains on securitiesincluded in net income, net of
      tax provision of $100, $10, and $0
                        
                        
                        185
                        
                        
                        
                        18
                        
                        
                        
                        —Comprehensive
      income
                        
                        $
                        1,945
                        
                        
                        $
                        17,335
                        
                        
                        $
                        13,048


(See
accompanying notes to consolidated financial statements.)


14


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Consolidated
Statements of Cash Flows


Years
ended December 31, 2008, 2007, and 2006


YEARS
      ENDEDDECEMBER
      31,(Dollars in thousands)
                        
                        2008
                        
                        
                        2007
                        
                        
                        2006Cash
      flows from operating activities:Net
      income
                        
                        $
                        2,090
                        
                        
                        $
                        15,546
                        
                        
                        $
                        13,355Adjustments
      to reconcile net income to netcash provided by (used in) operating
      activities:Depreciation
      and amortization of premises and equipment
                        
                        
                        2,136
                        
                        
                        
                        1,875
                        
                        
                        
                        1,917Provision
      for losses on loans
                        
                        
                        7,240
                        
                        
                        
                        1,350
                        
                        
                        
                        1,000Increase
      in cash surrender value of bank owned life insurance
                        
                        
                        (980
                        )
                        
                        
                        (684
                        )
                        
                        
                        (661
                        )Amortization
      of retained servicing rights
                        
                        
                        39
                        
                        
                        
                        44
                        
                        
                        
                        6Amortization
      of core deposit intangible
                        
                        
                        141
                        
                        
                        
                        141
                        
                        
                        
                        141Deferred
      income taxes
                        
                        
                        (8,176
                        )
                        
                        
                        (1,982
                        )
                        
                        
                        178Deferred
      loan fees, net
                        
                        
                        (654
                        )
                        
                        
                        290
                        
                        
                        
                        (9
                        )Gain
      on sale of loans
                        
                        
                        (128
                        )
                        
                        
                        (199
                        )
                        
                        
                        (483
                        )Stock-based
      compensation
                        
                        
                        196
                        
                        
                        
                        213
                        
                        
                        
                        287Excess
      tax benefits from stock-based compensation
                        
                        
                        (30
                        )
                        
                        
                        (231
                        )
                        
                        
                        (314
                        )Net
      change in fair value of financial instruments
                        
                        
                        (912
                        )
                        
                        
                        (1,081
                        )
                        
                        
                        —Purchase
      of securities held-for-trading
                        
                        
                        —
                        
                        
                        
                        (46,413
                        )
                        
                        
                        —Proceeds
      from sales/calls on securities held-for-trading
                        
                        
                        —
                        
                        
                        
                        112,162
                        
                        
                        
                        —Net
      (gain) loss on sales of securities available-for-sale
                        
                        
                        (285
                        )
                        
                        
                        435
                        
                        
                        
                        —Net
      (gain) on calls of securities held-to-maturity
                        
                        
                        (113
                        )
                        
                        
                        —
                        
                        
                        
                        —Net
      (gain) on FHLB advances
                        
                        
                        —
                        
                        
                        
                        (569
                        )
                        
                        
                        —Net
      (gain) on sales of premises and equipment
                        
                        
                        (4
                        )
                        
                        
                        —
                        
                        
                        
                        —Net
      loss (gain) on sale of real estate owned, investment propertyand
      other repossessed assets
                        
                        
                        3
                        
                        
                        
                        —
                        
                        
                        
                        27Net
      change in accrued interest receivable and other assets
                        
                        
                        1,308
                        
                        
                        
                        3,732
                        
                        
                        
                        (562
                        )Net
      change in accrued interest payable, expensesand other
      liabilities
                        
                        
                        (797
                        )
                        
                        
                        (733
                        )
                        
                        
                        1,764Impairment
      on securities available-for-sale (OTTI)
                        
                        
                        17,338
                        
                        
                        
                        —
                        
                        
                        
                        —Net
      cash provided by operating activities
                        
                        
                        18,412
                        
                        
                        
                        83,896
                        
                        
                        
                        16,646Cash
      flows from investing activities:Loans
      originated, net of principal repayments
                        
                        
                        (154,195
                        )
                        
                        
                        (91,242
                        )
                        
                        
                        (133,462
                        )Purchases
      of securities held-to-maturity
                        
                        
                        (81,866
                        )
                        
                        
                        (64,034
                        )
                        
                        
                        (3,434
                        )Proceeds
      from sales/calls on securities held-to-maturity
                        
                        
                        96,550
                        
                        
                        
                        5,000
                        
                        
                        
                        —Principal
      repayments on securities held-to-maturity
                        
                        
                        2,074
                        
                        
                        
                        2,658
                        
                        
                        
                        2,020Purchases
      of securities available-for-sale
                        
                        
                        (149,022
                        )
                        
                        
                        (76,198
                        )
                        
                        
                        (5,716
                        )Proceeds
      from sales of securities available-for-sale
                        
                        
                        88,184
                        
                        
                        
                        66,220
                        
                        
                        
                        —Principal
      repayments on securities available-for-sale
                        
                        
                        2,743
                        
                        
                        
                        5,677
                        
                        
                        
                        15,184Net
      purchases of premises and equipment
                        
                        
                        (3,440
                        )
                        
                        
                        (4,047
                        )
                        
                        
                        (1,846
                        )Proceeds
      from sales/retirements of premises and equipment
                        
                        
                        6
                        
                        
                        
                        15
                        
                        
                        
                        195Proceeds
      from sales/retirements of REO
                        
                        
                        4,434
                        
                        
                        
                        —
                        
                        
                        
                        74Proceeds
      from loan participations sold
                        
                        
                        (4,269
                        )
                        
                        
                        (6,818
                        )
                        
                        
                        3,988Change
      in CRA investment
                        
                        
                        (1,902
                        )
                        
                        
                        (1,890
                        )
                        
                        
                        —Purchase
      of bank owned life insurance
                        
                        
                        —
                        
                        
                        
                        (4,000
                        )
                        
                        
                        —Net
      cash used in investing activities
                        
                        
                        (200,703
                        )
                        
                        
                        (168,659
                        )
                        
                        
                        (122,997
                        )Subtotal,
      carried forward
                        
                        $
                        (182,291
                        )
                        
                        $
                        (84,763
                        )
                        
                        $
                        (106,351
                        )
  (See
accompanying notes to consolidated financial statements.)


15


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Consolidated
Statements of Cash Flows,Continued


Years
ended December 31, 2008, 2007, and 2006


YEARS
      ENDEDDECEMBER
      31,(Dollars in thousands)
                      
                      2008
                      
                      
                      2007
                      
                      
                      2006Subtotal,
      brought forward
                      
                      $
                      (182,291
                      )
                      
                      $
                      (84,763
                      )
                      
                      $
                      (106,351
                      )Cash
      flows from financing activities:Proceeds
      from issuance of common stock
                      
                      
                      357
                      
                      
                      
                      582
                      
                      
                      
                      736Proceeds
      from issuance of preferred stock/warrants
                      
                      
                      38,970
                      
                      
                      
                      —
                      
                      
                      
                      —Dividends
      paid
                      
                      
                      (3,794
                      )
                      
                      
                      (3,978
                      )
                      
                      
                      (3,603
                      )Repurchase
      of common stock
                      
                      
                      —
                      
                      
                      
                      (2,838
                      )
                      
                      
                      (673
                      )Excess
      tax benefits from stock-based compensation
                      
                      
                      30
                      
                      
                      
                      231
                      
                      
                      
                      314Net
      increase in deposits
                      
                      
                      101,886
                      
                      
                      
                      49,134
                      
                      
                      
                      59,681Net
      increase (decrease) in FHLB advances
                      
                      
                      18,000
                      
                      
                      
                      (11,431
                      )
                      
                      
                      7,000Net
      increase (decrease) in securities sold under agreements to
      repurchase
                      
                      
                      25,765
                      
                      
                      
                      24,915
                      
                      
                      
                      44,652Net
      proceeds from FRB borrowing
                      
                      
                      40,000
                      
                      
                      
                      —
                      
                      
                      
                      —Net
      increase (decrease) in advance payments by borrowers for taxes and
      insuranceProceeds
      from junior subordinated debentures payable
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      10,000Net
      cash provided by financing activities
                      
                      
                      221,227
                      
                      
                      
                      56,414
                      
                      
                      
                      118,121Net
      increase (decrease) in cash and cash equivalents
                      
                      
                      38,936
                      
                      
                      
                      (28,349
                      )
                      
                      
                      11,770Cash
      and cash equivalents at beginning of period
                      
                      
                      14,530
                      
                      
                      
                      42,879
                      
                      
                      
                      31,109Cash
      and cash equivalents at end of period
                      
                      
                      53,466
                      
                      
                      
                      14,530
                      
                      
                      
                      42,879Supplemental
      disclosures of cash flow information –Cash
      paid during the period for:Interest
                      
                      $
                      47,494
                      
                      
                      $
                      51,457
                      
                      
                      $
                      40,241Income
      taxes
                      
                      
                      7,150
                      
                      
                      
                      5,600
                      
                      
                      
                      6,700Supplemental
      schedule of non-cash investing activities:Mark-to-market
      on securities available-for-sale
                      
                      
                      223
                      
                      
                      
                      (2,752
                      )
                      
                      
                      472Retirement
      of common stock in retained earnings
                      
                      
                      —
                      
                      
                      
                      171
                      
                      
                      
                      142Dividends
      declared on common and preferred stock
                      
                      
                      3,471
                      
                      
                      
                      4,094
                      
                      
                      
                      3,706Cumulative
      adjustment to equity for SFAS No.159
                      
                      
                      —
                      
                      
                      
                      (3,162
                      )
                      
                      
                      —Transfer
      of loans to REO and other repossessed assets
                      
                      
                      6,000
                      
                      
                      
                      —
                      
                      
                      
                      —
  (See
accompanying notes to consolidated financial statements below.)


16


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
(the “Corporation”) and its sole subsidiary, Cascade Bank (the “Bank”) 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. Material estimates that are
particularly susceptible to significant change relates to the determination of
the allowance for losses on loans, valuation of real estate acquired in
connection with foreclosures or in satisfaction of loans and goodwill. In
connection with the determination of the estimated losses on loans and
foreclosed assets held-for-sale, management obtains independent appraisals for
significant properties. Goodwill and other intangible assets with indefinite
lives are not amortized but instead are periodically tested for impairment.
Management performs an impairment analysis periodically, and at least annually.
Management determined that there was no impairment as of December 31,
2008.  The valuation is determined using discounted cash flows of
forecasted earnings, estimated sales price based on recent observable market
transactions and market capitalization based on current stock price. If
impairment was deemed to exist, a write-down of the asset would occur with a
charge to earnings.  The impairment analysis requires management to
make subjective judgments.  Events and factors that may significantly
affect the estimates include, among others, competitive forces, customer
behaviors and attrition, changes in revenue growth trends, cost structures,
technology, changes in discount rates, and specific industry and market
conditions.


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





(a)
Basis of Presentation




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


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, Fed funds sold and
short-term highly liquid investment securities with an original maturity of
three months or less to be cash equivalents.




(c)
Interest-Bearing Deposits with Financial Institutions


Interest-bearing
deposits with other financial institutions are carried at cost and include
interest-bearing deposits at the Federal Home Loan Bank.




(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, 2008, and 2007, the Bank has
$11.9 million and $0 of Class B (1) and B (2) stock.





(e)
Transfer of Financial Assets


Transfers
of financial assets are accounted for as sales when control over the assets has
been surrendered. Control


over
transferred assets is deemed to be surrendered when (1) the assets have been
isolated from the Bank, (2) the transferee obtains the right (free of conditions
that constrain it from taking advantage of that right) to pledge
or


17


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars
in thousands, except share amounts)





exchange
the transferred assets, and (3) the Bank does not maintain effective control
over the transferred assets through an agreement to repurchase them before their
maturity.





(f)
Mortgage Servicing Rights


Servicing
assets are recognized when rights are acquired through the sale of mortgage
loans or when the Bank originates and sells mortgage loans and retains the
servicing. Loans serviced for others are not included in the accompanying
consolidated balance sheets. In 2006, the Bank sold $34.1 million of commercial
real estate and multifamily loans and retained the servicing. In the two
previous years, the Bank had not retained the servicing on any loans sold.
Capitalized servicing rights are reported in other assets. Mortgage loans
serviced for others include whole loans sold. Loans being serviced totaled $23.1
million and $32.0 million at December 31, 2008, and 2007,
respectively.


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





(g)
Marketing Costs


The Bank
expenses most marketing costs as they are incurred, but some marketing costs are
capitalized and amortized over the useful life of the expenditure. Marketing
expense was $1.1 million, $1.2 million, and $1.1 million for the years ended
December 31, 2008, 2007, and 2006, 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 stockholders’ equity.





(i)
Earnings per Common Share (EPS) Data


The
Corporation displays basic and diluted EPS in the consolidated statement of
income. Basic EPS is computed by dividing net income available for common
stockholders, which is net income less dividends on preferred stock, by the
weighted average number of shares outstanding during the year. Diluted EPS is
computed by dividing net income available for common stockholders 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 and
warrants.




(j)
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, 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 intangible assets consisted of the following at December 31, 2008, and
2007:





GROSS
      CARRYING AMOUNTIntangible
      assets carrying amount
                
                2008
                
                
                2007Goodwill
                
                $
                24,585
                
                
                $
                24,585Core
      deposit intangible, net
                
                
                493
                
                
                
                634Total
                
                $
                25,078
                
                
                $
                25,219




18


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars
in thousands, except share amounts)





Carrying
amount of the core deposit intangible asset at December 31, 2008 and 2007 was as
follows:





YEARS
      ENDED DECEMBER 31Core
      deposit intangible asset
                  
                  2008
                  
                  
                  2007Gross
      carrying amount
                  
                  $
                  1,127
                  
                  
                  $
                  1,127Accumulated
      amortization
                  
                  
                  (634
                  )
                  
                  
                  (493
                  )Net
      carrying amount
                  
                  $
                  493
                  
                  
                  $
                  634





Amortization
expense for each of the years ended December 31, 2008, 2007, and 2006 was $141.
Estimated existing intangible asset amortization for the next five years is as
follows:





Estimated
      amortization expenseFor
      year ended 12/31/09
                    
                    $
                    141For
      year ended 12/31/10
                    
                    
                    141For
      year ended 12/31/11
                    
                    
                    141For
      year ended 12/31/12
                    
                    
                    70For
      year ended 12/31/13
                    
                    
                    —





(k)
Loans


Almost
all of the Corporation's loans are located in Washington State, primarily in the
Puget Sound Region. At December 31, 2008, the Corporation's loans were
classified as one-to-four-family residences (10%), multifamily residences (7%),
real estate construction (32%), business (39%), consumer (2%), and commercial
real estate (10%). Accordingly, the ultimate collectability of the Corporation's
loan portfolio is susceptible to changes in the economic and real estate market
conditions in the Puget Sound Region.


Business banking loans comprise 39% of
the total loan portfolio. Most of the business banking loans are secured with
collateral such as commercial property, business inventories, accounts
receivable, equipment and personal property of the borrowers and/or guarantors.
At December 31, 2008, $29.8 million in commercial and industrial 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 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 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.
Approximately 84% of Cascade’s loan portfolio is secured by real estate and a
significant decline in real estate market values may require an increase in the
provision for loan losses.  Over the last two years, there has been
deterioration in the residential development market which has led to an increase
in nonperforming loans and the allowance for loan losses.  A continued
deterioration in this market, or deterioration in other segments of the loan
portfolio, may lead to additional charges to the allowance for loan
losses.




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 loan’s
yield over the contractual life of the loan using the interest or straight-line
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.




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 uncollectability
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 collectability of the loans in light of historical
experience, the nature and volume of the loan portfolio, adverse situations that
may affect the borrowers’ 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.


19


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars
in thousands, except share amounts)





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


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


The allowance for losses on loans is
management’s best estimate of potential losses. 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.





(l)
Loans Held for Sale


Loans
held for sale includes mortgage loans and are reported at the lower of cost or
market value.  Cost generally approximates market value, given the
short duration of these assets. Gains or losses on the sale of loans that are
held for sale are recognized at the time of the sale and determined by the
difference between net sale proceeds and the net book value of the loans less
the estimated fair value of any retained mortgage servicing rights. The Bank
held $1.2 million in loans held for sale at December 31, 2008, and $129 in loans
held for sale at December 31, 2007. Loans are sold without recourse on a best
effort, servicing released basis.





(m)
Securities


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





(n)
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


20


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars in
thousands, except share amounts)





charge-offagainst
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. There was $1.4 million of real estate owned at December 31,
2008, and no real estate owned at December 31, 2007.





(o)
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.





(p)
Income Taxes


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





(q)
Stock-Based Compensation


The
Corporation previously accounted for its stock option plan in accordance with
the provisions of APB Opinion No. 25, Accounting for Stock Issued to
Employees. Effective January 1, 2006, the Corporation adopted SFAS No.
123 (revised 2004), Share-Based Payment, (“SFAS
No. 123(R)”) using the modified prospective method. SFAS No. 123(R)
requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the income statement based on their fair
values. See Note 14 to the Consolidated Financial Statements for a further
discussion on stock-based compensation.





(r)
Interest Rate Swap Agreements


For
asset/liability management purposes, the Corporation has used interest rate swap
agreements to hedge various exposures or to modify interest rate characteristics
of various instruments. Interest rate swaps are contracts in which a series of
interest rate flows are exchanged over a prescribed period. The notional amount
on which the interest payments are based is not exchanged. Such derivatives are
linked to specific assets or liabilities, and have a high correlation between
the contract and the underlying item being hedged, both at inception and
throughout the hedge period.  The Corporation had no interest rate
swap agreements at December 31, 2008 or December 31, 2007.


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


Under SFAS No. 133, as amended, the gain
or loss on a swap designated and qualifying as a fair value hedging instrument,
as well as the offsetting gain or loss on the hedged item attributable to the
risk being hedged, is recognized currently in earnings in the same accounting
period. The effective portion of the gain or loss on a swap designated and
qualifying as a cash flow hedging instrument is reported as a component of other
comprehensive income. The ineffective portion of the gain or loss on the swap
instrument, if any, is recognized in current earnings.


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


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


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


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


21


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars
in thousands, except share amounts)





(s)  Off-Balance
Sheet Credit Related Financial Instruments


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





(t)  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.





(u)
Reclassifications


Certain
balances have been reclassified to conform to the 2008
presentation.





(v)
Recent Accounting Pronouncements


In
November 2007, the SEC issued Staff Accounting Bulletin
No. 109, Written Loan
Commitments Recorded at Fair Value through Earnings (“SAB 109”). SAB 109
provides guidance on the accounting for written loan commitments recorded at
fair value under GAAP. Specifically, the SAB revises the Staff’s views on
incorporating expected net future cash flows related to loan servicing
activities in the fair value measurement of a written loan commitment.  SAB
109, which supersedes SAB 105, Application of
Accounting Principles to Loan Commitments, requires the
expected net future cash flows related to the associated servicing of the
loan be included in the measurement of all written loan commitments that are
accounted for at fair value through earnings. SAB 109 is effective on January 1,
2008, for the Corporation. Adoption of SAB 109 is not expected to have a
material impact on the Corporation’s financial statements.


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


In December 2007, the FASB issued SFAS
No. 160, Noncontrolling
Interests in Consolidated Financial Statements, an amendment of ARB
No. 51.  SFAS 160 establishes accounting and
reporting standards that require that the ownership interests in subsidiaries
held by parties other than the parent be clearly identified, labeled, and
presented in the consolidated statement of financial position within equity, but
separate from the parent’s equity; the amount of consolidated net income
attributable to the parent and to the noncontrolling interest be clearly
identified and presented on the face of the consolidated statement of income;
and changes in a parent’s ownership interest while the parent retains its
controlling financial interest in its subsidiary be accounted for consistently.
SFAS 160 also requires that any retained noncontrolling equity investment
in the former subsidiary be initially measured at fair value when a subsidiary
is deconsolidated. SFAS 160 also sets forth the disclosure requirements to
identify and distinguish between the interests of the parent and the interests
of the noncontrolling owners. SFAS 160 applies to all entities that prepare
consolidated financial statements, except not-for-profit organizations, but will
affect only those entities that have an outstanding noncontrolling interest in
one or more subsidiaries or that deconsolidate a subsidiary. SFAS 160 is
effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008. Earlier adoption is prohibited.
SFAS 160 must be applied prospectively as of the beginning of the fiscal
year in which SFAS 160 is initially applied, except for the presentation
and disclosure requirements. The presentation and disclosure requirements are
applied retrospectively for all periods presented.  The Corporation
does not have a noncontrolling interest in one or more subsidiaries.
Accordingly, the Corporation does not anticipate that the initial application of
SFAS 160 will have an impact on our financial statements.


In October 2008, the FASB issued
FASB Staff Position (“FSP”) FAS No. 157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active. The FSP
clarifies the application of FAS No. 157, Fair Value Measurements, when
the market for a financial asset is not active. The FSP was effective upon
issuance, including reporting for prior periods for which financial statements
have not been issued. The adoption of the FSP for reporting as of
December 31, 2008, did not have a material impact on the Corporation’s
consolidated financial statements.


On January 12, 2009, FASB issued
FSP Emerging Issues Task Force (“EITF”) 99-20-1, Amendments to the Impairment
Guidance of EITF Issue No. 99-20. FSP EITF 99-20-1 addresses certain
practice issues in EITF No. 99-20, Recognition of Interest Income and
Impairment on Purchased Beneficial Interests and Beneficial Interests That
Continue to Be Held by a Transferor in Securitized Financial Assets, by
making its other-than-temporary impairment assessment guidance consistent with
SFAS No. 115, Accounting for
Certain Investments in Debt and Equity Securities. FSP EITF 99-20-1
removes the reference to the consideration of a market participant's estimates
of cash flows in EITF 99-20, and instead requires an assessment of whether it is
probable, based on current information and events, that the holder of the
security will be unable to collect all amounts due according to the contractual
terms.  If it is probable that there has been an adverse change in
estimated cash flows, an other-than-temporary impairment is deemed to exist, and
a corresponding loss shall be


22


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars in
thousands, except share amounts)





recognized
in earnings equal to the entire difference between the investment’s carrying
value and its fair value


at the
balance sheet date of the reporting period for which the assessment is
made.  This FSP is effective for interim and annual reporting periods
ending after December 15, 2008, and shall be applied prospectively. The impact
of adoption did not have a material impact on the Corporation’s consolidated
financial statements.





(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. No deposit was required to be held at the Federal Reserve as of
December 31, 2008, and December 31, 2007, due to a reclassification of
deposits.





(3)
Securities


A summary
of securities at December 31, 2008 and December 31, 2007, follows:




DECEMBER
      31, 2008AMORTIZED
                  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
                  VALUESecurities
      available-for-saleMBS
                
                $
                42,250
                
                
                $
                288
                
                
                $
                -
                
                
                $
                (281
                )
                
                $
                (405
                )
                
                $
                41,852Agency
      notes
                
                
                81,149
                
                
                
                368
                
                
                
                -
                
                
                
                (145
                )
                
                
                -
                
                
                
                81,372Corporate/other
                
                
                1,294
                
                
                
                -
                
                
                
                -
                
                
                
                (840
                )
                
                
                -
                
                
                
                454Total
                
                $
                124,693
                
                
                $
                656
                
                
                $
                -
                
                
                $
                (1,266
                )
                
                $
                (405
                )
                
                $
                123,678







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
                  VALUESecurities
      held-to-maturityMBS
                
                $
                20,484
                
                
                $
                195
                
                
                $
                14
                
                
                $
                (139
                )
                
                $
                (9
                )
                
                $
                20,545Agency
      notes
                
                
                99,335
                
                
                
                442
                
                
                
                -
                
                
                
                (396
                )
                
                
                -
                
                
                
                99,381Corporate/other
                
                
                775
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                775Total
                
                $
                120,594
                
                
                $
                637
                
                
                $
                14
                
                
                $
                (535
                )
                
                $
                (9
                )
                
                $
                120,701







DECEMBER
      31, 2007AMORTIZED
                  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
                  VALUESecurities
      available-for-saleMBS
                
                $
                26,286
                
                
                $
                2
                
                
                $
                5
                
                
                $
                (71
                )
                
                $
                (795
                )
                
                $
                25,427Agency
      notes
                
                
                57,366
                
                
                
                67
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                57,433Total
                
                $
                83,652
                
                
                $
                69
                
                
                $
                5
                
                
                $
                (71
                )
                
                $
                (795
                )
                
                $
                82,860





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
                  VALUESecurities
      held-to-maturityMBS
                
                $
                22,556
                
                
                $
                28
                
                
                $
                -
                
                
                $
                -
                
                
                $
                (643
                )
                
                $
                21,941Agency
      notes
                
                
                113,907
                
                
                
                67
                
                
                
                -
                
                
                
                (246
                )
                
                
                (149
                )
                
                
                113,579Corporate/other
                
                
                775
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                775Total
                
                $
                137,238
                
                
                $
                95
                
                
                $
                -
                
                
                $
                (246
                )
                
                $
                (792
                )
                
                $
                136,295





23


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars in
thousands, except share amounts)





At
December 31, 2008, the Bank had five securities with a gross unrealized loss
totaling $405 in our available-for-sale portfolio with a fair value of $10.0
million that had an unrealized loss for greater than one year and two
held-to-maturity securities with a gross unrealized loss totaling $9 with a fair
value of $2.0 million that have had an unrealized loss for


more than
one year. The only impairment on available-for-sale securities was in the MBS
category, which accounted for 100% of the total impairment. As of December 31,
2008, the Bank had sixteen available-for-sale and eight held-to-maturity
securities included in the temporarily impaired report, compared to fourteen
available-for-sale and twenty held-to-maturity with unrealized gains. The
temporary impairment was less than 3% of the total book value of investments.
Temporarily impaired securities are a result of an increase in credit spreads
and are expected to regain their value as the securities near maturity and/or
market rates decline; other-than-temporarily impaired securities are a result of
contractual failure by the issuer and are not expected to rebound and are
considered not collectable.


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


On September 7, 2008, the U.S. Treasury,
the Federal Reserve and the Federal Housing Finance Agency (“FHFA”) announced
that FHFA was placing Fannie Mae and Freddie Mac under conservatorship and would
eliminate dividends on FNMA and FHLMC common and preferred stock. On
September 9, 2008, Cascade reported that as of June 30, 2008, the Bank owned
preferred shares issued by FNMA ($10.2 million book value) and FHLMC ($8.4
million book value) with a combined adjusted book value of approximately $18.6
million.  As of September 30, 2008, the fair market value of these
securities was $1.3 million.  With an amortized cost basis for the
securities of $18.6 million, Cascade recorded a pre-tax OTTI charge of $17.3
million, resulting in a charge net of taxes of $11.3 million to third quarter
2008 earnings.  As of September 30, 2008, the adjusted book value of
these securities was $1.3 million. The fair value as of December 31, 2008, was
$454.


As of December 31, 2008, and 2007, the
Corporation was required to maintain 89,350 and 81,050 shares, respectively, of
$100 par value FHLB stock.


Accrued interest receivable on
securities and interest-bearing deposits was $2.7 million and $2.2 million at


December
31, 2008, and 2007, respectively.





Proceeds
from the sales of securities available-for-sale and gross realized gains and
losses are summarized as follows for the year ended December 31, 2008, 2007, and
2006:


PROCEEDS
                  
                  
                  GAINS
                  
                  
                  LOSSESYear
      ended December 31, 2008
                  
                  $
                  88,184
                  
                  
                  $
                  374
                  
                  
                  $
                  (89
                  )Year
      ended December 31, 2007
                  
                  
                  66,220
                  
                  
                  
                  55
                  
                  
                  
                  (490
                  )Year
      ended December 31, 2006
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
  The
following table shows the contractual or expected maturities of the
Corporation’s securities available-for-sale at December 31, 2008:


WITHIN
      ONEYEAR
                  
                  
                  ONE
      TOFIVE YEARS
                  
                  
                  OVER
      FIVE TOTEN YEARS
                  
                  
                  OVER
      TENYEARS
                  
                  
                  TOTALAmortized
      CostMBS
                  
                  $
                  22,517
                  
                  
                  $
                  19,733
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  42,250Agency
      notes
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  71,100
                  
                  
                  
                  10,049
                  
                  
                  
                  81,149Corporate/other
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,294
                  
                  
                  
                  1,294Total
      amortized cost
                  
                  $
                  22,517
                  
                  
                  $
                  19,733
                  
                  
                  $
                  71,100
                  
                  
                  $
                  11,343
                  
                  
                  $
                  124,693Fair
      ValueMBS
                  
                  $
                  22,345
                  
                  
                  $
                  19,507
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  41,852Agency
      notes
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  71,458
                  
                  
                  
                  9,914
                  
                  
                  
                  81,372Corporate/other
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  454
                  
                  
                  
                  454Total
      fair value
                  
                  $
                  22,345
                  
                  
                  $
                  19,507
                  
                  
                  $
                  71,458
                  
                  
                  $
                  10,368
                  
                  
                  $
                  123,678
  24
 CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars in
thousands, except share amounts)





The
following table shows the contractual or expected maturities of the
Corporation’s securities held-to-maturity at December 31, 2008:


WITHIN
      ONEYEAR
                    
                    
                    ONE
      TOFIVE YEARS
                    
                    
                    OVER
      FIVE TOTEN YEARS
                    
                    
                    OVER
      TENYEARS
                    
                    
                    TOTALAmortized
      CostMBS
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    8,660
                    
                    
                    $
                    11,824
                    
                    
                    $
                    20,484Agency
      notes
                    
                    
                    -
                    
                    
                    
                    5,000
                    
                    
                    
                    46,958
                    
                    
                    
                    47,377
                    
                    
                    
                    99,335Corporate/other
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    775
                    
                    
                    
                    775Total
      amortized cost
                    
                    $
                    -
                    
                    
                    $
                    5,000
                    
                    
                    $
                    55,618
                    
                    
                    $
                    59,976
                    
                    
                    $
                    120,594Fair
      ValueMBS
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    8,552
                    
                    
                    $
                    11,993
                    
                    
                    $
                    20,545Agency
      notes
                    
                    
                    -
                    
                    
                    
                    5,059
                    
                    
                    
                    46,944
                    
                    
                    
                    47,378
                    
                    
                    
                    99,381Corporate/other
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    775
                    
                    
                    
                    775Total
      fair value
                    
                    $
                    -
                    
                    
                    $
                    5,059
                    
                    
                    $
                    55,496
                    
                    
                    $
                    60,146
                    
                    
                    $
                    120,701
  Securities
are classified based upon contractual maturity dates. Actual maturities may
differ from contractual maturities because the borrowers have the right to
prepay their obligations. The fair value of securities pledged as collateral to
secure public deposits was $23.8 million at December 31, 2008, and $36.0 million
at December 31, 2007. The fair


value of
securities pledged to the FHLB at December 31, 2008, was $23.5 million and $29.1
million at December 31, 2007. The fair value of securities pledged to fund
repurchase agreements was $193.8 million at December 31, 2008, and $139.7
million at December 31, 2007.  The fair value of securities pledged at
the Federal Reserve Bank for treasury tax and loan was $1.5 million at December
31, 2008 and $1.2 million at December 31, 2007. The Bank also had securities
pledged with a fair value of $442 at the Federal Reserve Bank at December 31,
2008.





(4)
Loans and Allowance for Loan Losses


A summary
of loans at December 31, 2008, and 2007, follows:


DECEMBER
      31,
                  
                  
                  DECEMBER
      31,2008
                  
                  
                  2007Residential
                  
                  $
                  126,089
                  
                  
                  $
                  98,384Multifamily
                  
                  
                  86,864
                  
                  
                  
                  11,397Commercial
      real estate
                  
                  
                  122,951
                  
                  
                  
                  120,421Construction
      (1)
                  
                  
                  406,505
                  
                  
                  
                  381,810Business
      banking
                  
                  
                  485,060
                  
                  
                  
                  468,453Consumer
                  
                  
                  30,772
                  
                  
                  
                  27,688Total
      loans
                  
                  
                  1,258,241
                  
                  
                  
                  1,108,153Deferred
      loan fees, net
                  
                  
                  (3,069
                  )
                  
                  
                  (3,724
                  )Allowance
      for loan losses
                  
                  
                  (16,439
                  )
                  
                  
                  (11,653
                  )Net
      loans
                  
                  $
                  1,238,733
                  
                  
                  $
                  1,092,776Loans
      serviced for others
                  
                  $
                  23,131
                  
                  
                  $
                  31,965
  (1)
Construction loans are net of loans in process.





Accrued
interest on loans was $4.9 million and $5.9 million at December 31, 2008, and
December 31, 2007, respectively. Loans to officers and directors totaled $1.4
million at December 31, 2008, $301 at December 31, 2007, and $311 at December
31, 2006. Repayments totaling $6, $10, and $6 were received and additional
advances of $1.1 million, $0, and $17 were made for the years ended December 31,
2008, 2007, and 2006, respectively.


At December 31, 2008, the composition of
the loan portfolio was as follows:


FIXED
                  
                  
                  VARIABLE
                  
                  
                  ADJUSTABLETerm to maturity
                  
                  RATE
                  
                  
                  RATE(1)
                  
                  
                  RATELess
      than one year
                  
                  $
                  43,907
                  
                  
                  $
                  319,832
                  
                  
                  $
                  5,0881-3
      years
                  
                  
                  80,915
                  
                  
                  
                  104,257
                  
                  
                  
                  4,1793-5
      years
                  
                  
                  96,231
                  
                  
                  
                  22,438
                  
                  
                  
                  100,5095-10
      years
                  
                  
                  71,095
                  
                  
                  
                  11,676
                  
                  
                  
                  241,15210-20
      years
                  
                  
                  4,954
                  
                  
                  
                  4,571
                  
                  
                  
                  28,227Over
      20 years
                  
                  
                  6,660
                  
                  
                  
                  13,881
                  
                  
                  
                  98,669Total
                  
                  $
                  303,762
                  
                  
                  $
                  476,655
                  
                  
                  $
                  477,824


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




25


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars in
thousands, except share amounts)





Nonaccrual loans totaled $40.3 million,
$1.5 million, and $851, respectively, at December 31, 2008, December 31, 2007,
and December 31, 2006. If interest on these loans had been recognized, such
income would have been $871, $111, and $27, respectively, for the periods ended
December 31, 2008, 2007, and 2006. The Corporation has no commitments to extend
additional credit on loans that are nonaccrual. At December 31, 2008, 2007, and
2006, loans totaling $87.3 million, $29.1 million, and $9.4 million, were
adversely classified loans. Of the adversely classified loans, $3.5 million,
$451, and $223 were in foreclosure at December 31, 2008, 2007, and 2006,
respectively. The average balances of adversely classified loans for the years
ended December 31, 2008, and December 31, 2007, respectively, were $54.5 million
and $9.2 million and the Corporation recognized $2.2 million and $561 of related
interest income on such loans during the time they were adversely
classified.


At December 31, 2008, 2007, and 2006,
impaired loans totaled $83.4 million, $26.2 million, and $7.0 million,
respectively. The Corporation conducts an impairment analysis on any loan
exceeding $1.0 million when their ability to make all contractual payments
in a timely basis is in question. At December 31, 2008, $83.4 million were
subjected to impairment analysis. No impairment charges were taken and/or
reserves established for $48.5 million of the analyzed loans. However, according
to FAS114, the Bank is still required to report these loans as impaired since an
impairment analysis was performed. The average balances during the years
ended December 31, 2008, 2007, and 2006, were $47.8 million, $6.5 million and
$10.0 million, respectively. The allowance for loan losses related to these
loans was approximately $2.9 million, $1.2 million, and $932, at December 31,
2008, 2007, and 2006, respectively. Interest collected on impaired loans in cash
and included in income was $4.5 million for 2008, $1.8 million for 2007, and
$545 for 2006. If interest on these loans had been accrued, the additional
amount of such income would have been $871, $111, and $23 at December 31, 2008,
2007, and 2006, respectively.


The Bank had no loans that were 90 days
or more past due and still accruing at December 31, 2008. The Bank had three
loans that were 90 days or more past due and still accruing totaling $11.6
million at December 31, 2007. These loans were secured by real estate and
supported by then current appraised values.


At December 31, 2008, and 2007,
respectively, loans of $171.3 million and $29.2 million represent real estate
secured loans that have loan-to-value ratios above supervisory
guidelines.


At December 31, 2008, the Corporation
had outstanding commitments to grant loans of $3.9 million with fixed interest
rates and $2.4 million with adjustable rates.


The Corporation had non-mandatory
forward commitments totaling $127 and $0 to sell loans into the secondary market
at December 31, 2008, and December 31, 2007, 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 losses on its commitments in 2008 or 2007.





At
December 31, 2008, and 2007, the following financial instruments with
off-balance sheet risk were outstanding:


2008
                  
                  
                  2007Commitments
      to grant loans
                  
                  $
                  6,327
                  
                  
                  $
                  45,118Unfunded
      commitments under lines of credit/loans in process
                  
                  
                  167,353
                  
                  
                  
                  265,118Standby
      letters of credit and financial guarantees written
                  
                  
                  5,116
                  
                  
                  
                  5,171Unused
      commitments on bankcards
                  
                  
                  13,868
                  
                  
                  
                  12,840Total
                  
                  $
                  192,664
                  
                  
                  $
                  328,247
  26
 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 31,2008
                  
                  
                  2007
                  
                  
                  2006Balances
      at beginning of year
                  
                  $
                  11,653
                  
                  
                  $
                  10,988
                  
                  
                  $
                  10,254Off-balance
      sheet commitments
                  
                  
                  49
                  
                  
                  
                  (142
                  )
                  
                  
                  —Provision
      for loss
                  
                  
                  7,240
                  
                  
                  
                  1,350
                  
                  
                  
                  1,000Recoveries
                  
                  
                  1,282
                  
                  
                  
                  135
                  
                  
                  
                  148Charge-offs
                  
                  
                  (3,785
                  )
                  
                  
                  (678
                  )
                  
                  
                  (414
                  )Balances
      at end of year
                  
                  $
                  16,439
                  
                  
                  $
                  11,653
                  
                  
                  $
                  10,988
  (5)
Premises and Equipment


A summary
of premises and equipment follows:


ESTIMATED
                          
                          DECEMBER
      31,
                          
                          
                          DECEMBER
      31,USEFUL LIVES
                          
                          2008
                          
                          
                          2007Land
                          40
      years
                            Lease
      term
                            2-10
      years
                          
                          $
                          4,291
                          
                          
                          $
                          4,277Buildings
                          
                          
                          13,106
                          
                          
                          
                          11,394Leasehold
      improvements
                          
                          
                          2,420
                          
                          
                          
                          2,498Furniture
      and equipment
                          
                          
                          13,293
                          
                          
                          
                          14,06633,110
                          
                          
                          
                          32,235Accumulated
      depreciation and amortization
                          
                          
                          
                          (17,647
                          )
                          
                          
                          (18,075
                          )Total
                          
                          
                          $
                          15,463
                          
                          
                          $
                          14,160
  Total
depreciation and amortization expense was $2.1 million for the year ended
December 31, 2008, and $1.9 million for each of the years ended December 31,
2007, and 2006, respectively.


The Bank leases space for various
branches. These leases run for a period ranging from 20 months to 10 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, 2008,
are as follows:




Years ending December
      31,
                  2009
                  
                  $
                  8212010
                  
                  
                  7862011
                  
                  
                  7712012
                  
                  
                  7572013
                  
                  
                  757Thereafter
                  
                  
                  8,315Total
                  
                  $
                  12,207





Rental
expenses charged to operations were approximately $825, $763, and $693 for the
years ended December 31, 2008, 2007, and 2006, respectively.





(6)
Deposits


Deposits
at December 31, 2008, and 2007, are summarized as follows:


DECEMBER
      31,
                  
                  
                  DECEMBER
      31,2008
                  
                  
                  2007Noninterest-bearing
      checking accounts
                  
                  $
                  84,033
                  
                  
                  $
                  87,350Interest-bearing
      checking accounts
                  
                  
                  102,810
                  
                  
                  
                  50,840Money
      market deposit accounts
                  
                  
                  193,448
                  
                  
                  
                  315,967Savings
      accounts
                  
                  
                  10,587
                  
                  
                  
                  11,297Certificates
      of deposit
                  
                  
                  615,904
                  
                  
                  
                  439,442Total
                  
                  
                  1,006,782
                  
                  
                  
                  904,896
  Time
deposit accounts in amounts of $100 thousand or more totaled $462.3 million and
$271.5 million at December 31, 2008, and December 31, 2007, respectively.Deposits held by
executive officers and directors totaled $3.8 million at December 31, 2008, and
$4.2 million at December 31, 2007. Included in these totals were $1.6 million
and $2.6 million held in business accounts on which six directors have signing
authority, at December 31, 2008, and December 31 2007,
respectively.


27


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars in
thousands, except share amounts)





WEIGHTED
      AVERAGE INTEREST RATEON
      DEPOSITS
                
                
                DEPOSIT
      ACCOUNTS WITH BALANCES IN EXCESS OF $100
      THOUSAND
                
                
                ACCRUED
      INTEREST PAYABLE ONDEPOSITSDecember
      31, 2008
                
                
                2.24
                %
                
                $
                710,863
                
                
                $
                2,925December
      31, 2007
                
                
                3.78
                
                
                
                606,579
                
                
                
                4,285


A summary
of interest expense on deposits follows:


YEARS
      ENDED DECEMBER 31,2008
                  
                  
                  2007
                  
                  
                  2006Checking
      and money market accounts
                  
                  $
                  8,514
                  
                  
                  $
                  13,061
                  
                  
                  $
                  9,160Savings
      accounts and time deposits
                  
                  
                  18,701
                  
                  
                  
                  22,159
                  
                  
                  
                  19,416Total
                  
                  $
                  27,215
                  
                  
                  $
                  35,220
                  
                  
                  $
                  28,576




Maturities
of time deposits at December 31, 2008, are as follows:


Years
      ending December 31,
                      2009
                      
                      $
                      587,0942010
                      
                      
                      10,3322011
                      
                      
                      3,2392012
                      
                      
                      2,1532013
                      
                      
                      2,915Thereafter
                      
                      
                      10,171Total
                      
                      
                      615,904
  (7)
Junior Subordinated Debentures Payable (Trust Preferred Securities)


On March
1, 2000, $10.3 million of 11% junior subordinated debentures payable due March
1, 2030, were issued by a wholly owned business trust whose common equity is
100% owned by Cascade Financial Corporation, Cascade Capital Trust I. The Trust
exists for the exclusive purposes of issuing and selling the junior subordinated
debentures


payable,
using the proceeds from the sale of the capital securities to acquire junior
subordinated debentures payable, issued by Cascade Financial Corporation, and
engaging in only those other activities necessary, advisable or incidental to
the above. The Corporation used the proceeds for general corporate purposes
including stock


repurchases
and investment in its subsidiary bank.


The junior subordinated debentures
payable will mature on March 1, 2030, unless redeemed prior to such date if
certain conditions are met.


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


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


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


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


Effective January 1, 2007, the
Corporation elected early adoption of SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities,and SFAS No. 157, Fair Value Measurements, both
of which were issued in February 2007. The Corporation applied fair value
accounting to Cascade Capital Trust I. Upon adoption of SFAS No. 159 and No.
157, the Corporation determined a fair value for Cascade Capital Trust I of
approximately 117 or $11.17 million for the $10.0 million in trust preferred
securities (junior subordinated debentures). This resulted in charging off the
unamortized issuance costs to retained earnings of $654 as required under SFAS
No. 159. The $1.17 million fair value premium is the result of the 11% coupon
and the 5.5% call premium. This fair value premium should be effectively written
down to the $550 premium to call the security on March 1, 2010, which is
embedded in its fair value. The fair value option was not selected for variable
rate junior subordinated debentures totaling $15.0 million. See Note 15 of the
Notes to Consolidated Financial Statements for additional information on SFAS
No. 157.


28


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 31,2008
                      
                      
                      2007WEIGHTED
                      
                      
                      
                      
                      
                      WEIGHTEDAVERAGE
                      
                      
                      
                      
                      
                      AVERAGEINTEREST
                      
                      
                      
                      
                      
                      INTERESTMATURITY DATE
                      
                      
                      AMOUNT
                      
                      
                      RATE
                      
                      
                      AMOUNT
                      
                      
                      RATEAt
      December 31,
                      2008
                      
                      $
                      —
                      
                      
                      
                      —
                      %
                      
                      $
                      2,000
                      
                      
                      
                      3.51
                      %2009
                      
                      
                      10,000
                      
                      
                      
                      3.62
                      
                      
                      
                      10,000
                      
                      
                      
                      3.622010
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -2011
                      
                      
                      10,000
                      
                      
                      
                      3.88
                      
                      
                      
                      10,000
                      
                      
                      
                      3.882012
                      
                      
                      40,000
                      
                      
                      
                      4.33
                      
                      
                      
                      40,000
                      
                      
                      
                      4.332013
                      
                      
                      30,000
                      
                      
                      
                      3.61
                      
                      
                      
                      10,000
                      
                      
                      
                      5.30Thereafter
      (1)
                      
                      
                      159,000
                      
                      
                      
                      4.44
                      
                      
                      
                      159,000
                      
                      
                      
                      4.26$
                      249,000
                      
                      
                      
                      4.27
                      %
                      
                      $
                      231,000
                      
                      
                      
                      4.27
                      %


(1)
            December
      31, 2007 includes $30,000 tied to the three-month
  Libor.




YEARS
      ENDED DECEMBER 31,2008
                  
                  
                  2007Maximum
      amount of outstanding FHLB advances at any month-end
                  
                  $
                  287,500
                  
                  
                  $
                  264,790Average
      amount of outstanding FHLB advances during the year
                  
                  
                  256,898
                  
                  
                  
                  226,124
  The Bank
had $249.0 million in fixed-rate advances as of December 31, 2008, and the FHLB
has the option to convert these advances to variable-rate advances after a
specified period.


At December 31, 2008, the Bank had an
unused line of credit from the FHLB-Seattle of $323.9 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 $572.9 million, and
is subject to certain collateral requirements.


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





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


The
Corporation enters into sales of securities under agreements to repurchase
(reverse repurchase agreements) that are treated as financing arrangements.
Accordingly, the obligations to repurchase securities sold are reflected as a
liability in the consolidated balance sheets, and the securities and cash
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. At December 31, 2008, $10.5 million in
cash was held as collateral as securities were called at the end of the year and
not yet replaced.


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





UNDERLYING SECURITIES/CASHWEIGHTED
                
                
                BOOK
      VALUE,AVERAGE
                
                
                INCLUDINGBALANCE
                
                
                INTEREST
                
                
                ACCRUED
                
                
                MARKETOUTSTANDING
                
                
                RATE
                
                
                INTEREST
                
                
                VALUEDecember
      31, 2008
                
                $
                146,390
                
                
                
                5.19
                %
                
                $
                193,832
                
                
                $
                193,846December
      31, 2007
                
                
                120,625
                
                
                
                3.23
                
                
                
                140,523
                
                
                
                139,722


Financial
data pertaining to repurchase agreements follows:


YEARS
      ENDED DECEMBER 31,2008
                  
                  
                  2007Maximum
      amount of outstanding agreements at any month-end
                  
                  $
                  147,740
                  
                  
                  $
                  120,625Average
      amount of outstanding agreements during the year
                  
                  
                  124,211
                  
                  
                  
                  107,516
  The
Corporation had $75.0 million of repurchase agreements that adjust to a spread
based on a calculation using the three-month LIBOR every three months to
maturity and $70 million that are fixed for the remainder of the agreement
unless the lender terminates the agreement.
 29


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 $15.0 million
and


the other
two facilities are for $10.0 million each. All three have no maturity dates.
Interest rates for these lines are quoted at the time of borrowing and are
subject to certain collateral requirements. The Bank used each of these
lines


during
the year. The Bank also has the ability to borrow from the Federal Reserve Bank
of San Francisco based on the amount of collateral pledged.


The Bank had an outstanding balance of
$40.0 million in TAF borrowings at the Federal Reserve Bank at December 31,
2008, as detailed in the following table:





AMOUNT
                  
                  
                  INTEREST
      RATE
                  
                  ORIGINATION
      DATE
                  MATURITY
      DATE$
                  10,000
                  
                  
                  
                  1.39
                  %
                  10/09/08
                  1/02/0920,000
                  
                  
                  
                  0.60
                  
                  11/06/08
                  1/29/0910,000
                  
                  
                  
                  0.28
                  
                  12/18/08
                  1/15/09$
                  40,000





(10)
Income Taxes


Income
tax expense (benefits) includes the following components:


YEARS
      ENDEDDECEMBER
      31,2008
                  
                  
                  2007
                  
                  
                  2006Current
                  
                  $
                  7,737
                  
                  
                  $
                  9,365
                  
                  
                  $
                  6,297Deferred
                  
                  
                  (8,176
                  )
                  
                  
                  (1,982
                  )
                  
                  
                  178Total
                  
                  $
                  (439
                  )
                  
                  $
                  7,383
                  
                  
                  $
                  6,475
  As
required by SFAS No. 109, the Corporation continually reviews the
likelihood that deferred tax assets will be realized in future tax periods under
the “more-likely-than-not” criteria. In making this judgment, SFAS No. 109
requires that all available evidence, both positive and negative, should be
considered to determine whether, based on the


weight of
that evidence, a valuation allowance is required. As of December 31, 2008,
the Corporation had $13.1 million of deferred tax assets and net deferred
tax assets (after deferred tax liabilities) of $9.8 million related to the U.S.
tax jurisdictions whose recoverability is dependent upon future
profitability.


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


For the year ended December 31, 2008,
the Corporation's effective tax rate was -26.6% compared to 32.2% and 32.7% for
the years ended December 31, 2007 and 2006. A decrease in earnings, combined
with decreased tax benefits related to interest on tax exempt loans and
increases in cash surrender value of bank owned life insurance comprised the
significant portion of the differences in the effective tax rates between 2008
and 2007.


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, 2008, 2007 and 2006, as a result of the
following:


2008
                    
                    
                    2007
                    
                    
                    2006Computed
      “expected” tax expense
                    
                    $
                    578
                    
                    
                    $
                    8,025
                    
                    
                    $
                    6,941Bank
      owned life insurance (BOLI)
                    
                    
                    (343
                    )
                    
                    
                    (239
                    )
                    
                    
                    (231
                    )Tax
      exempt interest
                    
                    
                    (111
                    )
                    
                    
                    (218
                    )
                    
                    
                    (341
                    )Nondeductible
      stock-basedcompensation cost
                    
                    
                    65
                    
                    
                    
                    68
                    
                    
                    
                    101Dividend
      on preferred stock
                    
                    
                    (223
                    )
                    
                    
                    -
                    
                    
                    
                    -Other,
      net
                    
                    
                    (405
                    )
                    
                    
                    (253
                    )
                    
                    
                    5Total
                    
                    $
                    (439
                    )
                    
                    $
                    7,383
                    
                    
                    $
                    6,475
  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.


30


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars
in thousands, except share amounts)





The following table presents major
components of the net deferred tax asset (liability) resulting from differences
between financial reporting and tax bases at December 31, 2008, and December 31,
2007:


DECEMBER
      31,
                  
                  
                  DECEMBER
      31,2008
                  
                  
                  2007Deferred
      tax assets:Securities
      available-for-sale
                  
                  $
                  355
                  
                  
                  $
                  277Junior
      subordinated debentures
                  
                  
                  279
                  
                  
                  
                  607Premises
      and equipment
                  
                  
                  788
                  
                  
                  
                  274Loans
                  
                  
                  5,603
                  
                  
                  
                  3,640OTTI
                  
                  
                  6,068
                  
                  
                  
                  -Gross
      deferred tax assets
                  
                  
                  13,093
                  
                  
                  
                  4,798Deferred
      tax liabilities:Deferred
      loan fees
                  
                  
                  (1,305
                  )
                  
                  
                  (1,184
                  )Core
      deposit intangible
                  
                  
                  (173
                  )
                  
                  
                  (222
                  )Premises
      and equipment
                  
                  
                  —
                  
                  
                  
                  —FHLB
      stock
                  
                  
                  (1,732
                  )
                  
                  
                  (1,732
                  )Other
                  
                  
                  (55
                  )
                  
                  
                  (86
                  )Gross
      deferred tax liabilities
                  
                  
                  (3,265
                  )
                  
                  
                  (3,224
                  )Net
      deferred tax asset
                  
                  $
                  9,828
                  
                  
                  $
                  1,574
  A
valuation allowance for deferred tax assets was not considered necessary at
December 31, 2008, or 2007. Management believes the Corporation will fully
realize its total deferred income tax assets as of December 31, 2008, and 2007,
based upon its total deferred income tax liabilities, previous taxes paid and
its current and expected future levels of taxable income.


The Corporation adopted the provisions
of FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxes, on January 1, 2007. The Corporation had no unrecognized tax
benefits which would require an adjustment to the January 1, 2007 beginning
balance of retained earnings. The Corporation had no unrecognized tax benefits
at December 31, 2007, or December 31, 2008.


The Corporation recognizes interest
accrued and penalties related to unrecognized tax benefits in tax expense.
During the years ended December 31, 2008, and 2007, the Corporation recognized
no interest and penalties.


The Corporation and its subsidiaries
file income tax returns in the U.S. Federal jurisdiction. With few exceptions,
the Corporation is no longer subject to U.S. federal or state/local income tax
examinations by tax authorities for years before 2005.





(11)
Earnings per Common Share


The
following table presents EPS information:


YEARS
      ENDED DECEMBER 31,2008
                
                
                2007
                
                
                2006Net
      income
                
                $
                2,090
                
                
                $
                15,546
                
                
                $
                13,355Dividends
      on preferred stock
                
                
                216
                
                
                
                -
                
                
                
                -Net
      income available for common stockholders
                
                
                1,874
                
                
                
                15,546
                
                
                
                13,355Weighted
      average number of common shares outstanding, basic
                
                
                12,053,084
                
                
                
                12,047,792
                
                
                
                12,060,191Effect
      of dilutive stock options
                
                
                106,090
                
                
                
                237,062
                
                
                
                303,007Weighted
      average number of common shares outstanding, diluted
                
                
                12,159,174
                
                
                
                12,284,854
                
                
                
                12,363,198EPS,
      basic
                
                $
                0.16
                
                
                $
                1.29
                
                
                $
                1.11EPS,
      diluted
                
                
                0.15
                
                
                
                1.27
                
                
                
                1.08







For
purposes of calculating basic and diluted earnings per common share, the
numerator of net income available for common stockholders is the same. There
were outstanding options to purchase 399,385; 174,810; and 196,554 shares of
common stock at December 31, 2008, December 31, 2007, and December 31, 2006,
respectively that are considered non-dilutive and have been excluded from the
above calculation. Non-dilutive options have an exercise price that is greater
than the current market price of the stock. Also as of December 31, 2008, the
warrant issued to the U.S. Treasury to purchase up to 863,442 shares of common
stock in the fourth quarter of 2008 was not included in the computation of
diluted EPS because the warrant’s exercise price was greater than the average
market price of common shares.


31


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars
in thousands, except share amounts)





(12)
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). In
November 2008, the Corporation issued preferred stock to the U.S. Treasury. As a
provision of that issuance, the Corporation cannot increase its current cash
dividend, currently 0.045 per quarter, without prior approval of the U.S.
Treasury for three years or until November 2011.




(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, 2008, and 2007, that the Corporation and
the Bank met all capital adequacy requirements to which they are subject. To be
categorized as well-capitalized, an institution must maintain minimum total
risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the
following tables.


At December 31, 2008, 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, 2008, the Bank was in
compliance with the regulatory requirements for well-capitalized
institutions.


As of
December 31, 2008, the most recent notification from the FDIC categorized the
Bank as well-capitalized under the regulatory framework for prompt corrective
action. There are no conditions or events since the notification that management
believes have changed the Bank's category.




ACTUAL
                  
                  
                  MINIMUM
      REQUIREMENTS FOR CAPITALADEQUACY
                  
                  
                  WELL-CAPITALIZEDREQUIREMENTSCASCADE BANK
                  
                  AMOUNT
                  
                  
                  RATIO
                  
                  
                  AMOUNT
                  
                  
                  RATIO
                  
                  
                  AMOUNT
                  
                  
                  RATIODecember
      31, 2008:Total
      risk-based capital to risk-weighted assets (1)
                  
                  $
                  177,318
                  
                  
                  
                  13.32
                  %
                  
                  $
                  106,493
                  
                  
                  
                  8.00
                  %
                  
                  $
                  133,116
                  
                  
                  
                  10.00
                  %Tier
      I (core) capital to risk-weighted assets
                  
                  
                  160,786
                  
                  
                  
                  12.08
                  
                  
                  
                  53,247
                  
                  
                  
                  4.00
                  
                  
                  
                  79,870
                  
                  
                  
                  6.00Tier
      I (core) capital to average total assets
                  
                  
                  160,786
                  
                  
                  
                  10.34
                  
                  
                  
                  62,215
                  
                  
                  
                  4.00
                  
                  
                  
                  77,769
                  
                  
                  
                  5.00December
      31, 2007:Total
      risk-based capital to risk-weighted assets (1)
                  
                  $
                  135,345
                  
                  
                  
                  10.91
                  %
                  
                  $
                  99,248
                  
                  
                  
                  8.00
                  %
                  
                  $
                  124,059
                  
                  
                  
                  10.00
                  %Tier
      I (core) capital to risk-weighted assets
                  
                  
                  123,550
                  
                  
                  
                  9.96
                  
                  
                  
                  49,624
                  
                  
                  
                  4.00
                  
                  
                  
                  74,436
                  
                  
                  
                  6.00Tier
      I (core) capital to average total assets
                  
                  
                  123,550
                  
                  
                  
                  9.00
                  
                  
                  
                  54,901
                  
                  
                  
                  4.00
                  
                  
                  
                  68,626
                  
                  
                  
                  5.00
  The
Corporation, as a bank holding company regulated by the Federal Reserve, is also
subject to capital requirements that are similar to those for Cascade
Bank.


ACTUAL
                  
                  
                  MINIMUM
      REQUIREMENTS FOR CAPITALADEQUACY
                  
                  
                  WELL-CAPITALIZEDREQUIREMENTSCASCADE FINANCIAL CORP
                  
                  AMOUNT
                  
                  
                  RATIO
                  
                  
                  AMOUNT
                  
                  
                  RATIO
                  
                  
                  AMOUNT
                  
                  
                  RATIODecember
      31, 2008:Total
      risk-based capital to risk-weighted assets (1)
                  
                  $
                  176,681
                  
                  
                  
                  13.26
                  %
                  
                  $
                  106,579
                  
                  
                  
                  8.00
                  %
                  
                  $
                  133,224
                  
                  
                  
                  10.00
                  %Tier
      I (core) capital to risk-weighted assets
                  
                  
                  160,149
                  
                  
                  
                  12.02
                  
                  
                  
                  53,290
                  
                  
                  
                  4.00
                  
                  
                  
                  79,934
                  
                  
                  
                  6.00Tier
      I (core) capital to average total assets
                  
                  
                  160,149
                  
                  
                  
                  10.30
                  
                  
                  
                  62,208
                  
                  
                  
                  4.00
                  
                  
                  
                  77,760
                  
                  
                  
                  5.00December
      31, 2007:Total
      risk-based capital to risk-weighted assets (1)
                  
                  
                  134,174
                  
                  
                  
                  10.80
                  %
                  
                  $
                  99,361
                  
                  
                  
                  8.00
                  %
                  
                  $
                  124,201
                  
                  
                  
                  10.00
                  %Tier
      I (core) capital to risk-weighted assets
                  
                  
                  122,379
                  
                  
                  
                  9.85
                  
                  
                  
                  49,681
                  
                  
                  
                  4.00
                  
                  
                  
                  74,521
                  
                  
                  
                  6.00Tier
      I (core) capital to average total assets
                  
                  
                  122,379
                  
                  
                  
                  8.90
                  
                  
                  
                  55,032
                  
                  
                  
                  4.00
                  
                  
                  
                  68,790
                  
                  
                  
                  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.


32




CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars
in thousands, except share amounts)





(13)
Mortgage Servicing Rights


A summary
of capitalized mortgage servicing rights, included in other assets at December
31, 2008, and December 31, 2007, follows:


DECEMBER
      31,2008
                  
                  
                  2007Balance
      at beginning of year
                  
                  
                  130
                  
                  
                  $
                  174Additions
                  
                  
                  —
                  
                  
                  
                  —Amortization
                  
                  
                  (39
                  )
                  
                  
                  (44
                  )Balance
      at end of year
                  
                  $
                  91
                  
                  
                  $
                  130
  The
fair value of servicing rights was determined using a discount rate of 12% and a
prepayment speed of 400%.





(14)
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 $382, $336, and $313 to the plan for the years ended
December 31, 2008, 2007, and 2006, respectively.




(b)
Employee Stock Purchase Plan


The
Corporation maintains an employee stock purchase plan, under the terms of which
213,212 shares of common stock have been authorized for issuance. The plan
allows employees of the Corporation with three months of service the opportunity
to purchase common stock through accumulated salary deductions during each
offering period. On the first day of each six-month offering period (January 1
and July 1 of each year), eligible employees who elect to participate are
granted options to purchase a limited number of shares and unless the
participant withdraws from the plan, the option is effectively 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.





(c)
Stock Options


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


Options are granted to certain employees
and directors at prices equal to the market value of the stock on the dates the
options were granted. The options granted have a term of 10 years from the grant
date. Incentive stock options granted to employees vest over a five-year period.
Non-qualified options granted to directors vest over a four-year


period.
Compensation expense is recorded as if each vesting portion of the award is a
separate award. The maximum number of options that may be issued under the plan
is 937,500 (as adjusted for stock splits and dividends). The Corporation had
504,559 and 597,566 shares available for grant at December 31, 2008, and 2007,
respectively.




Accounting
for Stock Options


On
January 1, 2006, the Corporation adopted SFAS No.123(R), applying the
modified prospective method. SFAS No. 123(R) requires all equity-based
payments to employees, including grants of employee stock options, to be
recognized in the Consolidated Statements of Income at the fair value of the
award over the requisite service period. Under the modified prospective method,
the Corporation is required to record equity-based compensation expense for all
awards granted after the date of adoption and for the unvested portion of
previously granted awards outstanding as of the date of adoption.


Net compensation cost charged against
income for stock-based compensation expense was $196 for 2008, and $213 for
2007. The total income tax benefit recognized in the income statement for stock
based compensation arrangements was $30 for 2008, and $231 for
2007.


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


33


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars
in thousands, except share amounts)





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





YEARS ENDED
      DECEMBER 31,2008
                
                
                2007
                
                
                2006Risk-free
      interest rate
                
                
                2.50
                %
                
                
                4.75
                %
                
                
                4.50
                %Expected
      life in years
                
                
                6
                
                
                
                5
                
                
                
                5Expected
      volatility
                
                
                24
                %
                
                
                24
                %
                
                
                24
                %Dividend
      yield
                
                
                2.90
                %
                
                
                2.00
                %
                
                
                2.03
                %





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


A summary
of option activity as of, and for the year ended, December 31, 2008 is as
follows:


OPTIONS
                
                
                WEIGHTED-
                  AVERAGE
                  EXERCISE
                  PRICE
      PER
                  SHARE
                
                
                WEIGHTED-
                  AVERAGE
                  REMAINING
                  CONTRACTUAL
                  TERM
                  (IN
      YEARS)
                
                
                AGGREGATE
                  INTRINSIC
                  VALUEOutstanding
      as of December 31, 2007
                
                
                595,567
                
                
                $
                9.87
                
                
                
                5.13
                
                
                $
                2,580,240Granted
                
                
                97,382
                
                
                
                12.61Exercised
                
                
                (25,677
                )
                
                
                6.13Forfeited/Cancelled
                
                
                (10,389
                )
                
                
                10.37Outstanding
      as of December 31, 2008
                
                
                656,883
                
                
                $
                10.41
                
                
                
                5.07
                
                
                $
                153,385Exercisable
      as of December 31, 2008
                
                
                441,658
                
                
                $
                8.70
                
                
                
                3.72
                
                
                $
                153,385




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


All options granted have limited rights
that enable a holder upon a change in control of the Corporation to elect to
receive cash equal to the difference between the exercise price of the option
and the fair market value of the common stock on the date of exercise. At
December 31, 2008, and December 31, 2007, 441,658 and 384,696 shares,
respectively, were fully exercisable.


The weighted average fair values of
options granted under the Corporation's stock option plan were $2.59, $4.04, and
$3.77, respectively for the years ended December 31, 2008, December 31, 2007,
and December 31, 2006. The total intrinsic value of options exercised were $133,
$1.1 million and $1.3 million, respectively, during the years ended December 31,
2008, 2007, and 2006. Total unrecognized compensation cost related to stock
options was $233 as of December 31, 2008, $210 as of December 31, 2007, and $466
as of December 31, 2006. That cost is expected to be recognized over a weighted
average period of 1.8 years. Cash received from options exercised under all
share-based payment arrangements were $157, $576, and $670 for the years ended
December 31, 2008, 2007 and 2006, respectively.





Deferred
Compensation Plan


In
December 2004, the Board adopted the Cascade Bank Deferred Compensation Plan.
The purpose of this Plan is to provide specified benefits to a select group of
management or highly compensated employees who contribute materially to the
continued growth, development and business success of the Bank.  The
Plan was inactive in 2007 and has been replaced with a new plan effective
February 1, 2008.


On January 16, 2008, the Cascade Bank
Non-Qualified Deferred Compensation Plan was adopted. During 2007, one of the
major projects of the Compensation Committee was to develop and recommend a plan
to the Board of Directors that would provide specified benefits to a select
group of management and highly compensated employees. Participants may
contribute up to 50 percent of salary and 100 percent of their incentive to the
Plan. In addition, the Compensation Committee has the authority to authorize an
employer contribution to the Plan for these same employees. There were no
employer contributions made for the year ended December 31, 2008. The
contribution will be based upon the performance of the Bank as well as the
individual performance of each employee. The Non-Qualified Deferred Compensation
Plan will also be available to Directors. Each Director may contribute up to 100
percent of their director compensation to the Plan. No Corporation contributions
will be made for Directors.


34


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars
in thousands, except share amounts)





Employment
Agreement


The Bank
entered into an employment agreement with Carol K. Nelson dated November 27,
2007, which replaced a previous agreement dated July 12, 2005. This agreement
replaced a prior agreement dated March 26, 2002, and extended on January 27,
2004. The current agreement may be terminated upon 90 days written
notice.





(15)
Fair Value of Financial Instruments


The fair
value estimates presented below are subjective in nature, involve uncertainties
and matters of significant judgment and, therefore, are not necessarily
indicative of the amounts the Corporation could realize in a
current


market
exchange. The Corporation has not included certain material items in its
disclosure, such as the value of the long-term relationships with the
Corporation’s lending and deposit customers, since this is an intangible and not
a financial instrument. Additionally, the estimates do not include any tax
ramifications. There may be inherent


weaknesses
in any calculation technique, and changes in the underlying assumptions used,
including discount rates


and
estimates of future cash flows, that could materially affect the results. For
all of these reasons, the aggregation of the fair value calculations presented
herein do not represent, and should not be construed to represent, the
underlying value of the Corporation.


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


DECEMBER 31,
                  
                  
                  DECEMBER 31,2008
                  
                  
                  2007CARRYING
                  
                  
                  ESTIMATED
                  
                  
                  CARRYING
                  
                  
                  ESTIMATEDVALUE
                  
                  
                  FAIR VALUE
                  
                  
                  VALUE
                  
                  
                  FAIR VALUEFinancial
      assets:Cash
      and cashequivalents
                  
                  $
                  53,466
                  
                  
                  $
                  53,466
                  
                  
                  $
                  14,530
                  
                  
                  $
                  14,530Securities
      available-for-sale
                  
                  
                  123,678
                  
                  
                  
                  123,678
                  
                  
                  
                  82,860
                  
                  
                  
                  82,860Securities
      held-to-maturity
                  
                  
                  120,594
                  
                  
                  
                  120,701
                  
                  
                  
                  137,238
                  
                  
                  
                  136,295FHLB
      stock
                  
                  
                  11,920
                  
                  
                  
                  11,920
                  
                  
                  
                  11,920
                  
                  
                  
                  11,920Loans,
      net
                  
                  
                  1,238,733
                  
                  
                  
                  1,260,455
                  
                  
                  
                  1,092,776
                  
                  
                  
                  1,110,897Financial
      liabilities:Deposit
      accounts
                  
                  $
                  1,006,782
                  
                  
                  $
                  997,826
                  
                  
                  $
                  904,896
                  
                  
                  $
                  895,449Borrowings
                  
                  
                  435,390
                  
                  
                  
                  458,911
                  
                  
                  
                  351,625
                  
                  
                  
                  364,499Junior
      subordinated debentures payable
                  
                  
                  15,465
                  
                  
                  
                  11,569
                  
                  
                  
                  15,465
                  
                  
                  
                  14,649Junior
      subordinated debentures payable, at fair value
                  
                  
                  10,510
                  
                  
                  
                  10,510
                  
                  
                  
                  11,422
                  
                  
                  
                  11,422
  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 when available or
through the use of alternate approaches, such as matrix or model pricing, when
market quotes are not readily available.




Loans


Fair
values are estimated using current market interest rates to discount future cash
flows for each of the 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
(FHLB advances and securities sold under agreements to repurchase)


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 amounts required to settle the contracts,
adjusted for market interest rates and terms to maturity.




Swaps


The fair
value is calculated based on the discounted cash flow method, adjusted for
changes in swap spreads to the underlying treasury securities. There were no
swaps as of December 31, 2008 or 2007.


35


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars
in thousands, except share amounts)





Off-balance-sheet
financial instruments


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




Fair
Value Accounting


SFAS No.
159 generally permits the measurement of selected eligible financial
instruments at fair value at specified election dates. Upon adoption of SFAS No.
159, the Corporation selected fair value measurement for certain
available-for-sale and held-to-maturity investment securities, FHLB advances and
Cascade Capital Trust I (junior subordinated debentures payable), which had fair
values of approximately $68.1 million, $46.7 million and $12.1 million,
respectively, on January 1, 2007. The Corporation also selected fair value
measurement for an interest rate swap on a certificate of deposit with a
notional value of $10.0 million and a fair value loss of $312 on January 1,
2007. SFAS No. 157 defines fair value, establishes a framework for
measuring fair value under GAAP, and expands disclosures about fair value
measurement.


Upon adoption of SFAS No. 157, there was
no cumulative effect adjustment to beginning retained earnings and no impact on
the financial statements, other than in conjunction with the adoption of SFAS
No. 159, in the year ended December 31, 2007.





Initial
      Fair Value Adjustment on Adoption of SFAS 159JANUARY
      1, 2007AMORTIZED
      COST
                
                
                FAIR
      MARKET VALUATION ADJUSTMENT
                
                
                BASIS
      AT FMV
                
                
                RELATED
      DEFERRED TAXES
                
                
                CUMULATIVE
      EFFECT OF ADOPTIONAssetsSecurities
      available-for-sale (AFS) reclassified to fair value
                
                $
                54,721
                
                
                $
                (2,056
                )
                
                $
                52,665
                
                
                $
                720
                
                
                $
                (1,336
                )Securities
      held-to-maturity (HTM) reclassified to fair value
                
                
                15,984
                
                
                
                (554
                )
                
                
                15,430
                
                
                
                194
                
                
                
                (360
                )Deferred
      origination costs on junior subordinated
                  debentures
                
                
                654
                
                
                
                (654
                )
                
                
                -
                
                
                
                227
                
                
                
                (427
                )$
                71,359
                
                
                $
                (3,264
                )
                
                $
                68,095
                
                
                $
                1,141
                
                
                $
                (2,123
                )LiabilitiesFHLB
      advances
                
                $
                45,000
                
                
                $
                1,654
                
                
                $
                46,654
                
                
                $
                (579
                )
                
                $
                1,075Junior
      subordinated debentures payable
                
                
                10,310
                
                
                
                1,740
                
                
                
                12,050
                
                
                
                (609
                )
                
                
                1,131Interest
      rate swap on CD
                
                
                -
                
                
                
                312
                
                
                
                312
                
                
                
                (109
                )
                
                
                203$
                55,310
                
                
                $
                3,706
                
                
                $
                59,016
                
                
                $
                (1,297
                )
                
                $
                2,409Total
      adjustment
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                2,438
                
                
                $
                (4,532
                )Less
      transfer from other comprehensive loss to
                  retained
      earnings
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (738
                )
                
                $
                1,370Cumulative
      adjustment of deferred tax asset and
                  equity
      on adoption of  SFAS 159
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                1,700
                
                
                $
                (3,162
                )





Following
the initial election, changes in the value of financial instruments recorded at
fair value are recognized as gains or losses in subsequent financial reporting
periods. As a result of the adoption of SFAS No. 159 and changes in the fair
value measurement of the financial assets and liabilities noted above, the
Corporation recorded a cumulative net gain of $1.1 million ($703 after tax) for
the year ended December 31, 2007.


Fair
      Value Gains (Losses)PAR
      VALUE
                            
                            
                            TOTAL
                              NET
      INCOME$
                            10,000
                            
                            Interest
      rate swap
                            $
                            5745,000
                            
                            FHLB
      advances
                            
                            (70
                            )70,000
                            
                            Investment
      securities HFT
                            
                            51810,000
                            
                            Junior
      subordinated debentures
                            
                            576Total
                            $
                            1,081Adjusted
      for taxes
                            $
                            703


Fair values determined by Level 1 inputs
utilize quoted prices (unadjusted) in active markets for identical assets or
liabilities that the Corporation has the ability to access. Fair values
determined by Level 2 inputs utilize inputs other


36


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars
in thousands, except share amounts)





than
quoted prices included in Level 1 that are observable for the asset or
liability, either directly or indirectly. Level 2 inputs include quoted prices
for similar assets and liabilities in active markets, and inputs other than
quoted prices that are observable for the asset or liability, such as interest
rates and yield curves that are observable at commonly quoted intervals. Level 3
inputs are unobservable inputs for the asset or liability, and include
situations where there is little, if any, market activity for the asset or
liability.


Available-for-sale securities are priced
using quoted prices (unadjusted) for identical assets in active
markets


(Level 1)
or through matrix pricing based on securities’ relationship to other benchmark
quoted prices (Level 2).


Junior subordinated debentures payable
are priced using discounted cash flows to the next available redemption date on
the date of valuation based on recent issuances or quotations for comparable
bank holding companies and are considered a Level 3 input method.At December 31, 2008, the
Corporation had $10.5 million in junior subordinated debentures measured at fair
value on a recurring basis.


Fair value adjustments to impaired
collateral dependent loans are sometimes recorded to reflect partial write-downs
based on the current appraised value of the collateral or internally developed
models which contain management’s assumptions.


Fair value adjustments to real estate
owned (REO) and other repossessed assets are recorded at the lower of carrying
amount of the loan or fair value less selling costs.  Any write-downs
based on the asset’s fair value at the date of acquisition are charged to the
allowance for loan losses.  After foreclosure, management periodically
performs valuations such that the real estate is carried at the lower of its new
cost basis or fair value, net of estimated costs to sell.


The following table presents the
balances of assets and liabilities measured at fair value on a recurring basis
at December 31, 2008, and the total gains from these fair value adjustments for
the year ended December 31, 2008.


Fair
      Value at December 31, 2008
              
              
              Year
      Ended December 31, 2008Assets
              
              Level 1
              
              
              Level 2
              
              
              Level 3
              
              
              Total
              
              
              Total
      GainsAvailable-for-sale
      securities
              
              $
              454
              
              
              $
              123,224
              
              
              $
              -
              
              
              $
              123,678
              
              
              $
              285Total
              
              $
              454
              
              
              $
              123,224
              
              
              $
              -
              
              
              $
              123,678
              
              
              $
              285LiabilitiesJunior
      subordinated debentures payable
              
              $
              -
              
              
              $
              -
              
              
              $
              10,510
              
              
              $
              10,510
              
              
              $
              912Total
              
              $
              -
              
              
              $
              -
              
              
              $
              10,510
              
              
              $
              10,510
              
              
              $
              912





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





The following table presents the balance
of assets measured at fair value on a nonrecurring basis at December 31, 2008,
and the total impairment resulting from these fair value adjustments for the
year ended December 31, 2008.


Fair
      Value at December 31, 2008
                
                
                Year
      Ended
                  December
      31, 2008Description
                
                Level 1
                
                
                Level 2
                
                
                Level 3
                
                
                Total
                
                
                Total
      ImpairmentImpaired
      loans
                
                $
                -
                
                
                $
                -
                
                
                $
                83,368
                
                
                $
                83,368
                
                
                $
                2,874REO
      and other repossessed assets
                
                
                -
                
                
                
                -
                
                
                
                1,446
                
                
                
                1,446
                
                
                
                -Total
                
                $
                -
                
                
                $
                -
                
                
                $
                84,814
                
                
                $
                84,814
                
                
                $
                2,874





(16)
On-Balance Sheet Derivative Instruments and Hedging Activities


Derivative
Financial Instruments




Risk
Management Policies - Hedging Instruments


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




Interest
Rate Risk Management - Fair Value Hedging Instruments


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


An interest rate swap agreement used to
hedge junior subordinated debentures payable (trust preferred securities), with
a notional amount of $10.0 million was terminated in December 2006 at a loss of
$150.


37


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars
in thousands, except share amounts)





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


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





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. The unrealized (loss)
relating to the interest rate swap of $(312) was marked to market as an
adjustment to equity with the implementation of SFAS No. 159 effective January
1, 2007. The swap was terminated in April 2007 at a net loss of $4.


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


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


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


The Corporation had non-mandatory
forward commitments totaling $127 and $0 to sell loans into the secondary market
at December 31, 2008, and December 31, 2007, respectively.





(17)
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.





(18)
Subsequent Event


In
January 2009, Cascade was informed by the Washington Public Deposit Protection
Commission (WPDPC) that the failure of a bank in Washington State had resulted
in a $15.1 million shortfall in deposits held by Washington State
municipalities. To prevent losses to public entities, Washington State requires
that all financial institutions that receive public deposits must pledge
collateral to the WPDPC and participate in a collateral pool established to
protect public deposits that are not covered by FDIC insurance or the assets of
the failed bank.  In February, Cascade was informed by the WPDPC that its
share of the shortfall would be $368.


Subsequent to year end the FDIC voted to
amend the restoration plan for the Deposit Insurance Fund (DIF).  The FDIC
took action to ensure the continued strength of the insurance fund by imposing a
special assessment on insured institutions of 20 basis points, implementing
changes to the risk-based assessment system and setting rates beginning the
second quarter of 2009.  The Company has not completed a full evaluation of
the impact but believes its deposit insurance premium assessments will increase
substantially from current levels.


38


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, 2008
                  
                  
                  DECEMBER 31, 2007Assets:Cash
                  
                  $
                  287
                  
                  
                  $
                  267Investment
      in subsidiary
                  
                  
                  185,759
                  
                  
                  
                  148,267Other
      assets
                  
                  
                  1,292
                  
                  
                  
                  2,011$
                  187,338
                  
                  
                  $
                  150,545Liabilities
      and stockholders’ equity:Other
      liabilities
                  
                  $
                  1,241
                  
                  
                  $
                  1,562Junior
      subordinated debentures payable
                  
                  
                  25,975
                  
                  
                  
                  26,887Preferred
      stock
                  
                  
                  36,616
                  
                  
                  
                  —Common
      stockholders’ equity
                  
                  
                  123,506
                  
                  
                  
                  122,096$
                  187,338
                  
                  
                  $
                  150,545





INCOME
      STATEMENT
                    
                    FOR
      THE YEARS ENDED DECEMBER 31,2008
                    
                    
                    2007
                    
                    
                    2006Equity
      in undistributed net income of the subsidiary
                    
                    $
                    3,071
                    
                    
                    $
                    16,745
                    
                    
                    $
                    14,836Interest
      income – junior subordinated debentures payable
                    
                    
                    64
                    
                    
                    
                    64
                    
                    
                    
                    58Net
      gain on fair value of junior subordinateddebentures
      payable
                    
                    
                    912
                    
                    
                    
                    576
                    
                    
                    
                    —Operating
      expenses
                    
                    
                    (366
                    )
                    
                    
                    (364
                    )
                    
                    
                    (460
                    )Interest
      expense – junior subordinated debentures payable
                    
                    
                    (2,120
                    )
                    
                    
                    (2,120
                    )
                    
                    
                    (1,880
                    )Income
      before benefit from income taxes
                    
                    
                    1,561
                    
                    
                    
                    14,901
                    
                    
                    
                    12,554Benefit
      from income taxes
                    
                    
                    529
                    
                    
                    
                    645
                    
                    
                    
                    801Net
      income
                    
                    $
                    2,090
                    
                    
                    $
                    15,546
                    
                    
                    $
                    13,355





STATEMENT
      OF CASH FLOWS
                      
                      FOR
      THE YEARS ENDED DECEMBER 31,2008
                      
                      
                      2007
                      
                      
                      2006Cash
      flows from operating activities:Net
      income
                      
                      $
                      2,090
                      
                      
                      $
                      15,546
                      
                      
                      $
                      13,355Adjustments
      to reconcile net income to net cash used in operating
      activities:Equity
      in net income of subsidiaries
                      
                      
                      (3,071
                      )
                      
                      
                      (16,745
                      )
                      
                      
                      (14,836
                      )Increase
      (decrease) in other assets
                      
                      
                      719
                      
                      
                      
                      (31
                      )
                      
                      
                      936Decrease
      in other liabilities
                      
                      
                      (911
                      )
                      
                      
                      (629
                      )
                      
                      
                      (287
                      )Net
      cash used in operating activities
                      
                      
                      (1,173
                      )
                      
                      
                      (1,859
                      )
                      
                      
                      (832
                      )Cash
      flows from investing activities:Dividends
      received from subsidiaries
                      
                      
                      4,600
                      
                      
                      
                      7,300
                      
                      
                      
                      4,250Investment
      in subsidiary
                      
                      
                      (38,970
                      )
                      
                      
                      —
                      
                      
                      
                      (10,000
                      )Net
      cash (used in) provided by investingactivities
                      
                      
                      (34,370
                      )
                      
                      
                      7,300
                      
                      
                      
                      (5,750
                      )Cash
      flows from financing activities:Repurchase
      of common stock
                      
                      
                      —
                      
                      
                      
                      (2,838
                      )
                      
                      
                      (673
                      )Proceeds
      from exercise of stock options
                      
                      
                      387
                      
                      
                      
                      813
                      
                      
                      
                      1,050Dividends
      paid
                      
                      
                      (3,794
                      )
                      
                      
                      (3,978
                      )
                      
                      
                      (3,603
                      )Proceeds
      from preferred stock/warrants
                      
                      
                      38,970
                      
                      
                      
                      —
                      
                      
                      
                      —Proceeds
      from junior subordinated debentures payable
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      10,000Net
      cash provided by (used in) financing activities
                      
                      
                      35,563
                      
                      
                      
                      (6,003
                      )
                      
                      
                      6,774Net
      increase (decrease) in cash and cash equivalents
                      
                      
                      20
                      
                      
                      
                      (562
                      )
                      
                      
                      192Cash
      and cash equivalents:Beginning
      of year
                      
                      
                      267
                      
                      
                      
                      829
                      
                      
                      
                      637End
      of year
                      
                      $
                      287
                      
                      
                      $
                      267
                      
                      
                      $
                      829




39


CASCADE
FINANCIAL CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements


(Dollars
in thousands, except share amounts)





(20)
Lines of Business


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


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





(21) Selected
Quarterly Financial Data(Unaudited)


QUARTER ENDEDMAR
      31,
                      
                      
                      JUNE
      30,
                      
                      
                      SEPT
      30,
                      
                      
                      DEC
      31,2008
                      
                      
                      2008
                      
                      
                      2008
                      
                      
                      2008Interest
      income
                      
                      $
                      23,014
                      
                      
                      $
                      22,793
                      
                      
                      $
                      24,345
                      
                      
                      $
                      22,419Interest
      expense
                      
                      
                      12,539
                      
                      
                      
                      11,348
                      
                      
                      
                      11,508
                      
                      
                      
                      11,291Net
      interest income
                      
                      
                      10,475
                      
                      
                      
                      11,445
                      
                      
                      
                      12,837
                      
                      
                      
                      11,128Provision
      for loan losses
                      
                      
                      2,390
                      
                      
                      
                      1,200
                      
                      
                      
                      1,250
                      
                      
                      
                      2,400Other
      income
                      
                      
                      2,454
                      
                      
                      
                      2,217
                      
                      
                      
                      2,323
                      
                      
                      
                      1,890Other
      expense
                      
                      
                      6,935
                      
                      
                      
                      7,251
                      
                      
                      
                      24,500
                      
                      
                      
                      7,193Income
      (loss) before provision for income taxes
                      
                      
                      3,604
                      
                      
                      
                      5,211
                      
                      
                      
                      (10,590
                      )
                      
                      
                      3,425Provision
      (benefit) for income taxes
                      
                      
                      990
                      
                      
                      
                      1,577
                      
                      
                      
                      (3,971
                      )
                      
                      
                      964Net
      income (loss)
                      
                      $
                      2,614
                      
                      
                      $
                      3,634
                      
                      
                      $
                      (6,619
                      )
                      
                      $
                      2,461Dividends
      on preferred stock
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      216Income
      available for common stock holders
                      
                      $
                      2,614
                      
                      
                      $
                      3,634
                      
                      
                      $
                      (6,619
                      )
                      
                      $
                      2,245Earnings
      (loss) per common share, basic
                      
                      $
                      0.22
                      
                      
                      $
                      0.30
                      
                      
                      $
                      (0.55
                      )
                      
                      $
                      0.19Earnings
      (loss) per common share, diluted
                      
                      
                      0.21
                      
                      
                      
                      0.30
                      
                      
                      
                      (0.55
                      )
                      
                      
                      0.19QUARTER ENDEDMAR
      31,
                      
                      
                      JUNE
      30,
                      
                      
                      SEPT
      30,
                      
                      
                      DEC
      31,2007
                      
                      
                      2007
                      
                      
                      2007
                      
                      
                      2007Interest
      income
                      
                      $
                      22,631
                      
                      
                      $
                      23,789
                      
                      
                      $
                      23,378
                      
                      
                      $
                      24,137Interest
      expense
                      
                      
                      12,354
                      
                      
                      
                      12,798
                      
                      
                      
                      12,568
                      
                      
                      
                      12,820Net
      interest income
                      
                      
                      10,277
                      
                      
                      
                      10,991
                      
                      
                      
                      10,810
                      
                      
                      
                      11,317Provision
      for loan losses
                      
                      
                      250
                      
                      
                      
                      250
                      
                      
                      
                      350
                      
                      
                      
                      500Other
      income
                      
                      
                      2,051
                      
                      
                      
                      1,834
                      
                      
                      
                      1,942
                      
                      
                      
                      1,739Other
      expense
                      
                      
                      6,423
                      
                      
                      
                      6,548
                      
                      
                      
                      6,724
                      
                      
                      
                      6,987Income
      before provision for income taxes
                      
                      
                      5,655
                      
                      
                      
                      6,027
                      
                      
                      
                      5,678
                      
                      
                      
                      5,569Provision
      for income taxes
                      
                      
                      1,890
                      
                      
                      
                      2,044
                      
                      
                      
                      1,892
                      
                      
                      
                      1,557Net
      income
                      
                      $
                      3,765
                      
                      
                      $
                      3,983
                      
                      
                      $
                      3,786
                      
                      
                      $
                      4,012Earnings
      per share, basic
                      
                      $
                      0.31
                      
                      
                      $
                      0.33
                      
                      
                      $
                      0.32
                      
                      
                      $
                      0.33Earnings
      per share, diluted
                      
                      
                      0.30
                      
                      
                      
                      0.32
                      
                      
                      
                      0.31
                      
                      
                      
                      0.33QUARTER ENDEDMAR
      31,
                      
                      
                      JUNE
      30,
                      
                      
                      SEPT
      30,
                      
                      
                      DEC
      31,2006
                      
                      
                      2006
                      
                      
                      2006
                      
                      
                      2006Interest
      income
                      
                      $
                      18,787
                      
                      
                      $
                      20,249
                      
                      
                      $
                      21,396
                      
                      
                      $
                      22,226Interest
      expense
                      
                      
                      9,267
                      
                      
                      
                      10,561
                      
                      
                      
                      11,440
                      
                      
                      
                      12,000Net
      interest income
                      
                      
                      9,520
                      
                      
                      
                      9,688
                      
                      
                      
                      9,956
                      
                      
                      
                      10,226Provision
      for loan losses
                      
                      
                      250
                      
                      
                      
                      300
                      
                      
                      
                      300
                      
                      
                      
                      150Other
      income
                      
                      
                      1,325
                      
                      
                      
                      1,573
                      
                      
                      
                      1,616
                      
                      
                      
                      1,512Other
      expense
                      
                      
                      5,875
                      
                      
                      
                      6,036
                      
                      
                      
                      6,349
                      
                      
                      
                      6,326Income
      before provision for income taxes
                      
                      
                      4,720
                      
                      
                      
                      4,925
                      
                      
                      
                      4,923
                      
                      
                      
                      5,262Provision
      for income taxes
                      
                      
                      1,548
                      
                      
                      
                      1,598
                      
                      
                      
                      1,609
                      
                      
                      
                      1,720Net
      income
                      
                      $
                      3,172
                      
                      
                      $
                      3,327
                      
                      
                      $
                      3,314
                      
                      
                      $
                      3,542Earnings
      per share, basic
                      
                      $
                      0.26
                      
                      
                      $
                      0.28
                      
                      
                      $
                      0.27
                      
                      
                      $
                      0.29Earnings
      per share, diluted
                      
                      
                      0.26
                      
                      
                      
                      0.27
                      
                      
                      
                      0.27
                      
                      
                      
                      0.29


ANNUAL
SHAREHOLDERS’ MEETING


The
Annual Shareholders’ Meeting will be held at the Everett Golf & Country
Club, 1500 52nd Street
SE, Everett, Washington, on Tuesday, April 28, 2009, at 6:30 p.m. Pacific
Time.


40