UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549








FORM
10-K





þ           ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934





For the fiscal year ended December 31,
2008.





OR





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








Commission
file number 0-25286





CASCADE FINANCIAL
CORPORATION


(Exact
name of registrant as specified in its charter)





Washington
            
            91-1661954(State
      or other jurisdiction of incorporation or organization)
            
            (I.R.S.
      Employer I.D. Number)2828
      Colby Avenue, Everett, Washington
            
            98201(Address
      of principal executive offices)
            
            (Zip
      Code)Registrant’s
      telephone number, including area code:
            
            (425)
      339-5500Securities
      registered pursuant to Section 12(b) of the Act:
            
            NoneSecurities
      registered pursuant to Section 12(g) of the Act:
            
            Common
      Stock, par value $0.01 per share








Indicate
by check mark if the registrant is a well-known seasoned issuer as defined in
Rule 405 of the Securities Act.


YES  ̈NO þ




Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.YES  ̈  NO
þ




Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding twelve months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.  YES þ  NO
 ̈




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.      ̈




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Act. (Check
one):




Large
Accelerated Filer  ̈                                                Accelerated
Filer þ                                           Non-Accelerated
Filer  ̈




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


YES   ̈     NO
þ





The aggregate
market value of Common Stock held by non-affiliates of registrant at February
28, 2009 was $28.8 million (based on the last reported sale on such date). The
number of shares of registrant’s Common Stock outstanding at February 28, 2009,
was 12,110,434.




DOCUMENTS
INCORPORATED BY REFERENCE





1.
            Portions
      of Annual Report to Stockholders for the year ended December 31, 2008,
      including the Selected Financial Data and the Management Discussion and
      Analysis attached as Exhibit 13 (the “Annual Report”) (Part I, II &
      IV).




2.
            Portions
      of registrant’s Definitive Proxy Statement for the Annual Meeting of
      Stockholders (the “Proxy Statement”) (Part
III).




2


Cascade
      Financial Corporation


FORM
      10-K


December
      31, 2008





TABLE
      OF CONTENTS








PART
      I
            PageItem
      1.
            Business
            4Item
      1A.
            Risk
      Factors
            26Item
      1B.
            Unresolved
      Staff Comments
            27Item
      2.
            Properties
            28Item
      3.
            Legal
      Proceedings
            28Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            28PART
      IIItem
      5.
            Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
            28Item
      6.
            Selected
      Financial Data
            30Item
      7.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operation
            30Item
      7A.
            Quantitative
      and Qualitative Disclosures About Market Risk
            30Item
      8.
            Financial
      Statements and Supplementary Data
            30Item
      9.
            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
            30Item
      9A.
            Controls
      and Procedures
            30Item
      9B.
            Other
      Information
            32PART
      IIIItem
      10.
            Directors,
      Executive Officers and Corporate Governance
            33Item
      11.
            Executive
      Compensation
            34Item
      12.
            Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
            34Item
      13.
            Certain
      Relationships and Related Transactions, and Director
      Independence
            34Item
      14.
            Principal
      Accountant Fees and Services
            34PART
      IVItem
      15.
            Exhibits
      and Financial Statement Schedules
            35


3


FORWARD
LOOKING STATEMENTS




In
addition to historical information, this Form 10-K contains certain
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 ("PSLRA"). This statement is included for the
express purpose of availing Cascade Financial Corporation of the protections of
the safe harbor provisions of the PSLRA. The forward-looking statements
contained herein are subject to factors, risks and uncertainties that may cause
actual results to differ materially from those projected.




Certain
of the statements contained herein that are not historical facts are
forward-looking statements within the meaning of the Private Securities Reform
Act.  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, portfolio
growth, the credit performance of the portfolios, including bankruptcies, 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 on 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 by 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.  These statements are representative only
on the date hereof, and the Corporation undertakes no obligation to update any
forward-looking statements made. Readers should carefully review the risk
factors described in this and other documents the Corporation files from time to
time with the Securities and Exchange Commission.  There can be no
assurance that any of the strategies described in this Form 10-K will be
implemented, or if implemented, achieve the amounts described or within the time
periods currently estimated.





Item
1.  Business




General




Cascade
Financial Corporation (the “Corporation”) is a bank holding company incorporated
in the state of Washington that was formed in 1994.  The consolidated
entity includes the Corporation and its wholly owned subsidiaries.  At
December 31, 2008, the Corporation’s wholly owned subsidiaries were Cascade Bank
(“Cascade” or the “Bank”), Cascade Capital Trust I, II, and III. The executive
offices of the Corporation are located at 2828 Colby Avenue, Everett, Washington
98201.  The telephone number is (425) 339-5500 and the website is
www.cascadebank.com.
Information on the website is not part of this Report.




The Bank
has been serving the people of Snohomish and King Counties since 1916 when it
was organized as a mutual savings and loan association.  On September
15, 1992, the Bank completed its conversion from a federal mutual to a federal
stock savings bank. In July 2001, the Bank converted from a federal stock
savings bank to a Washington state commercial bank.




The
Corporation was organized on August 18, 1994, for the purpose of becoming the
holding company for Cascade Bank. The reorganization was completed on November
30, 1994, on which date the Bank became the wholly-owned subsidiary of the
Corporation, and the stockholders of the Bank became stockholders of the
Corporation. Subsequent to the acquisition of Cascade, the primary activity of
the Corporation has been holding the stock of the Bank. Accordingly, the
information set forth in this report, including financial statements and related
data, relates primarily to the Bank.




In July
of 2001, the Corporation elected to be treated as a financial holding company
under the supervision of the Federal Reserve Board. In May of 2003, the
Corporation transferred its state of domicile from Delaware, which it had
maintained since its formation as a holding company in 1994, to
Washington.  Following this conversion, the Corporation changed its
fiscal year end from June 30 to December 31 to align its reporting period with
those of its commercial bank peers.


4


In June
of 2004, the Corporation completed the acquisition of Issaquah Bancshares
(“Issaquah”).  Issaquah Bank, the only operating subsidiary of
Issaquah, was merged into Cascade Bank.




The
Corporation conducts its business from its main office in Everett, Washington,
and twenty other full-service offices in the greater Puget Sound Region. At
December 31, 2008, the Corporation had total assets of $1.6 billion, total
deposits of $1.0 billion and total equity of $160.1 million.




The Bank,
a full-service commercial bank, offers a wide range of products and
services.  The deposits of the Bank are insured by the Federal Deposit
Insurance Corporation (“FDIC”), up to the limits specified by law.




Market
Area




Headquartered
in Everett, Washington, the Corporation serves its customers from twenty-one
full-service offices, twelve in Snohomish County, eight in King County, and one
in Skagit County. In 2007, the Bank opened a loan production office in
Burlington, Washington, in Skagit County. Located in the center of the western
Washington region, Snohomish and King Counties have experienced significant
growth in recent years.




Our
market area in King County includes the growing cities east of Seattle and Lake
Washington. This area’s economy has been dominated by Microsoft and the Boeing
Company, with other high technology companies also playing an important
role.




Everett
is the homeport of the Navy’s carrier, the USS Abraham Lincoln. The contribution
that the Navy makes to the economy is not as dependent on other trends. The
economy in the Corporation’s market area has been enhanced by the growth of the
health care and biotechnology industries. Snohomish County and Northeast King
County are home to numerous biotechnology companies.




As a
gateway to Asia, the Bank’s market area has also benefited from the continued
expansion of world trade.  Economic weakness in either the United
States or Asia could reduce that trade. Such slowdowns in the international flow
of goods and services could prove detrimental to the economy of the market area
and potentially the quality of our loan portfolios.




Business
Strategy




The
Corporation’s business plan is to increase the Bank’s emphasis on commercial
banking. The Corporation is pursuing the following strategies:




·
            Increasing
      the percentage of its assets consisting of business and commercial real
      estate loans with higher risk-adjusted returns, shorter maturities and
      rates more sensitive to interest rate
  fluctuations;




·
            Aggressively
      managing the credit administration of the Bank’s loan
      portfolio;




·
            Increasing
      deposits by attracting lower cost transaction accounts (such as checking,
      savings and money market accounts) through an enhanced branch network,
      customer service center, online banking and an augmented treasury
      management program;




·
            Maintaining
      cost-effective operations by efficiently offering products and
      services;




·
            Maintaining
      its capital position at or above the “well-capitalized” (as defined for
      regulatory purposes) level;




·
            Exploring
      prudent means to grow the business internally and through acquisitions;
      and




·
            Searching
      for additional sources of fee-based
revenue.




The
primary objectives of these strategies are to enhance shareholder value measured
through increasing returns, and to increase the opportunity for quality earning
asset growth, deposit generation, and fee-based income
activities.  However, the shift in emphasis to commercial banking does
inherently contain additional risks (See “LOAN PORTFOLIO” below).


5


Competition




The Bank
competes for both loans and deposits. The Puget Sound metropolitan area has a
high density of financial institutions, including major national banks, several
local community banks, and credit unions.




The
Bank’s primary focus for loans is small to medium sized businesses, builders and
developers, and real estate investors in the Puget Sound area.  The
major competitors for the Bank in these loan markets are large commercial and
community banks. The large banks often compete on the basis of competitive
pricing, while the community banks compete on the basis of local decision
making, loan structuring flexibility, and promises of a higher level of service.
The general pricing remains very intense as financial institutions scramble to
meet their growth goals.




The
Bank’s competitors for retail loans, which include residential real estate and
consumer loans, are numerous, including banks, mortgage bankers, captive finance
subsidiaries of automobile companies, etc. Cascade has made a conscious decision
to de-emphasize consumer lending in that intense competition has led to very low
margins combined with relatively high credit risk.




On the
deposit side, geographic location is still the primary factor in choosing a bank
for the checking account relationship.  As a result, the Bank’s
competition for checking deposits comes primarily from the large institutions
with a broad network of locations.  Online Banking continues to be an
important convenience service to attract checking customers from larger banks.
Community banks, savings institutions, as well as other non-banking financial
institutions, provide the greatest competition for the various savings vehicles
such as money market deposit accounts and certificates of deposit.




In
addition to competition from other banking institutions, the Bank continues to
experience competition from non-banking companies such as credit unions,
financial services companies and brokerage firms. Many credit unions, including
a large one in Cascade’s market area, have expanded their eligible membership by
amending their charters.




LOAN
PORTFOLIO




General.The Bank
originates business, real estate and consumer loans.  Total loans,
which are net of construction loans in process, equaled $1.26 billion at
December 31, 2008. Total loans were adjusted by deferred loan fees and the
allowance for loan losses for a net loan balance of $1.24 billion. At December
31, 2008, $485.1 million or 39% of total loans consisted of business banking
loans; $406.5 million or 32% were real estate construction loans; $123.0 million
or 10% of loans consisted of commercial real estate; $30.8 million or 2% were
consumer loans; $126.1 million or 10% of the Bank’s loans consisted of loans
secured by one-to-four family residential properties; and $86.9 million or 7%
consisted of multifamily loans.  Total loans secured by first liens on
residential real estate were $213.0 million or 17% of total
loans.  The Bank sells almost all of its 30 year fixed-rate loans and
the vast majority of its 15 year fixed-rate loans in the secondary mortgage
market.  The Bank had non-mandatory forward commitments totaling
$127,000 and $0 to sell loans into the secondary market at December 31, 2008 and
December 31, 2007, respectively.


6


Loan Portfolio
Analysis.The following table sets forth the Bank’s loan
portfolio by type of loan and by type of collateral at the dates
indicated.




At
      December 31,(Dollars
      in thousands)
                
                2008
                
                
                2007
                
                
                2006Amount
                
                
                Percent
                
                
                Amount
                
                
                Percent
                
                
                Amount
                
                
                PercentType
      of LoanReal
      estate mortgageResidential
      (1)
                
                $
                126,089
                
                
                
                10.02
                %
                
                $
                98,384
                
                
                
                8.88
                %
                
                $
                91,256
                
                
                
                9.03
                %Multifamily
                
                
                86,864
                
                
                
                6.90
                
                
                
                11,397
                
                
                
                1.03
                
                
                
                34,719
                
                
                
                3.44Commercial
      real estate
                
                
                122,951
                
                
                
                9.77
                
                
                
                120,421
                
                
                
                10.87
                
                
                
                119,298
                
                
                
                11.81Construction
      (2)
                
                
                406,505
                
                
                
                32.31
                
                
                
                381,810
                
                
                
                34.44
                
                
                
                295,087
                
                
                
                29.20Business
                
                
                485,060
                
                
                
                38.55
                
                
                
                468,453
                
                
                
                42.28
                
                
                
                442,391
                
                
                
                43.78Consumer
      (3)
                
                
                30,772
                
                
                
                2.45
                
                
                
                27,688
                
                
                
                2.50
                
                
                
                27,686
                
                
                
                2.74Total
      loans
                
                $
                1,258,241
                
                
                
                100.00
                %
                
                $
                1,108,153
                
                
                
                100.00
                %
                
                $
                1,010,437
                
                
                
                100.00
                %Less:Deferred
      loan fees, net
                
                
                3,069
                
                
                
                
                
                
                
                3,724
                
                
                
                
                
                
                
                3,434Allowance
      for loan losses
                
                
                16,439
                
                
                
                
                
                
                
                11,653
                
                
                
                
                
                
                
                10,988Total
      loans, net
                
                $
                1,238,733
                
                
                
                
                
                
                $
                1,092,776
                
                
                
                
                
                
                $
                996,015Type
      of CollateralReal
      estate mortgageOne-to-four
      family (4)
                
                $
                557,760
                
                
                
                44.33
                %
                
                $
                501,762
                
                
                
                45.28
                %
                
                $
                402,415
                
                
                
                39.83
                %Multifamily
                
                
                86,864
                
                
                
                6.90
                
                
                
                11,397
                
                
                
                1.03
                
                
                
                34,719
                
                
                
                3.44Commercial
      real estate
                
                
                122,951
                
                
                
                9.77
                
                
                
                120,421
                
                
                
                10.87
                
                
                
                119,298
                
                
                
                11.81Land
      loans
                
                
                4,407
                
                
                
                0.35
                
                
                
                3,984
                
                
                
                0.36
                
                
                
                5,094
                
                
                
                0.50Other
                
                
                486,259
                
                
                
                38.65
                
                
                
                470,589
                
                
                
                42.46
                
                
                
                448,911
                
                
                
                44.42Total
      loans
                
                $
                1,258,241
                
                
                
                100.00
                %
                
                $
                1,108,153
                
                
                
                100.00
                %
                
                $
                1,010,437
                
                
                
                100.00
                %Less:Deferred
      loan fees, net
                
                
                3,069
                
                
                
                
                
                
                
                3,724
                
                
                
                
                
                
                
                3,434Allowance
      for loan losses
                
                
                16,439
                
                
                
                
                
                
                
                11,653
                
                
                
                
                
                
                
                10,988Total
      loans, net
                
                $
                1,238,733
                
                
                
                
                
                
                $
                1,092,776
                
                
                
                
                
                
                $
                996,015At
      December 31,2005
                
                
                2004Amount
                
                
                Percent
                
                
                Amount
                
                
                PercentType
      of Loan
                
                (Dollars
      in thousands)Real
      estate mortgageResidential
      (1)
                
                $
                89,422
                
                
                
                10.15
                %
                
                $
                102,429
                
                
                
                12.70
                %Multifamily
                
                
                52,057
                
                
                
                5.91
                
                
                
                92,372
                
                
                
                11.45Commercial
      real estate
                
                
                141,109
                
                
                
                16.02
                
                
                
                178,704
                
                
                
                22.15Construction
      (2)
                
                
                171,964
                
                
                
                19.52
                
                
                
                110,977
                
                
                
                13.76Business
                
                
                394,034
                
                
                
                44.75
                
                
                
                292,117
                
                
                
                36.21Consumer
      (3)
                
                
                32,160
                
                
                
                3.65
                
                
                
                30,125
                
                
                
                3.73Total
      loans
                
                $
                880,746
                
                
                
                100.00
                %
                
                $
                806,724
                
                
                
                100.00
                %Less:Deferred
      loan fees, net
                
                
                3,443
                
                
                
                
                
                
                
                2,695Allowance
      for loan losses
                
                
                10,254
                
                
                
                
                
                
                
                9,563Total
      loans, net
                
                $
                867,049
                
                
                
                
                
                
                $
                794,466




7




At
      December 31,(Dollars
      in thousands)
                
                2005
                
                
                2004Amount
                
                
                Percent
                
                
                Amount
                
                
                PercentType
      of CollateralReal
      estate mortgageOne-to-four
      family (4)
                
                $
                279,652
                
                
                
                31.76
                %
                
                $
                231,504
                
                
                
                28.70
                %Multifamily
                
                
                52,057
                
                
                
                5.91
                
                
                
                92,372
                
                
                
                11.45Commercial
      real estate
                
                
                141,109
                
                
                
                16.02
                
                
                
                178,704
                
                
                
                22.15Land
      loans
                
                
                6,007
                
                
                
                0.68
                
                
                
                3,546
                
                
                
                0.44Other
                
                
                401,921
                
                
                
                45.63
                
                
                
                300,598
                
                
                
                37.26Total
      loans
                
                $
                880,746
                
                
                
                100.00
                %
                
                $
                806,724
                
                
                
                100.00
                %Less:Deferred
      loan fees, net
                
                
                3,443
                
                
                
                
                
                
                
                2,695Allowance
      for loan losses
                
                
                10,254
                
                
                
                
                
                
                
                9,563Total
      loans, net
                
                $
                867,049
                
                
                
                
                
                
                $
                794,466




(1)
            Includes construction loans
      converted to permanent loans(2)
            Includes land
      loans(3)
            Includes home equity loans and
      home equity lines of credit (“HELOC”)(4)
            Includes residential home
      equity loans, HELOC’s and construction
loans





At
December 31, 2008, deferred fees were $3.1 million and the allowance for loan
losses was $16.4 million.




Business Loans.Business
banking loans increased from $468.5 million at December 31, 2007, to $485.1
million at December 31, 2008. Unsecured business banking loans totaled $29.8
million at December 31, 2008, compared to $25.3 million as of December 31, 2007.
The Bank’s business banking loan portfolio consists primarily of commercial
business loans to small and medium sized businesses operating in Snohomish and
King Counties. These loans are generally secured by real estate, receivables,
equipment, other assets of the business and personal property, and the personal
guarantee of the borrower. These loans typically have variable-rate terms or
fixed-rates with maturities of up to five years. The Bank also offers secured
and unsecured operating Lines of Credit. Business banking loans are underwritten
by the Bank on the basis of the borrower's cash flow, ability to service debt
from earnings, and the underlying collateral value. The borrower is generally
required to provide the Bank with financial statements, tax returns, current
financial information on any and all guarantors, and other reports that show
trends in their financial condition; and to update this information annually.
Business banking loans also include owner occupied real estate loans with terms
comparable to the Bank’s commercial real estate loans. In addition, as business
banking activity increases, the Bank expects to expand its lower cost deposit
franchise through the growth of commercial checking as a source of
funding.




Business
banking loans are inherently sensitive to conditions in the economy. The
collateral securing these loans may depreciate over time, may be difficult to
appraise and may fluctuate in value based on the success of the business. In the
case of loans secured by accounts receivable, the availability of funds for the
repayment of such loans may be substantially dependent on the ability of the
borrower to collect amounts due from its customers. Accordingly, the repayment
of a business loan depends primarily on the successful operation of the
borrower's business and creditworthiness of the borrower (and any guarantors),
while liquidation of collateral is a secondary and potentially insufficient
source of repayment.




Construction
Loans.The Bank originates construction loans to fund the
building of one-to-four family homes either to borrowers as custom construction
loans or to builders as speculative construction loans. Construction loans
generally have maturities of 12-18 months.  The interest rates charged
on construction loans are typically indexed to the prime rate and vary depending
on the characteristics of the loan, particularly the credit risk inherent in the
project and/or the financial strength of the borrower. All construction loans
require approval by various levels of Bank personnel, depending on the size of
the loan. At December 31, 2008 and December 31, 2007, the Corporation’s
construction loans were $406.5 million or 32.3% of the total loan portfolio and
$381.8 million or 34.4% of the total loan portfolio, respectively. The
construction loans are net of loans in process of $60.8 million at December 31,
2008, and $151.4 million at December 31, 2007. Of the total net construction
loans, $401.7 million was to builders and developers, including $131.4 million
for land acquisition and development.  An additional $1.8 million was
to individuals for custom home construction and $3.0 million was for lot
purchases. The Bank’s maximum outstanding commitment to one builder at December
31, 2008, totaled $21.5 million involving one construction project, which is
performing in accordance with the loan terms.


8


Construction
loans involve higher credit risks because loan funds are advanced upon the
security of the project under construction that is of uncertain value before
completion. The Bank’s risk of loss on a construction loan is dependent largely
upon the accuracy of the initial estimate of the property’s value at completion
of construction or development and the estimated cost (including interest) of
the construction.  If the estimate of construction costs proves to be
inaccurate, the Bank may be required to advance additional funds to complete the
development.  If upon completion of the project, the estimate of the
marketability of the property is inaccurate, the borrower may be unable to sell
the completed project in a timely manner or obtain adequate proceeds to repay
the loan.  Delays may arise from labor problems, material shortages
and other unpredictable contingencies in completing the
project.  Furthermore, if the estimate of value of a completed project
is inaccurate, the Bank may be confronted with a project with a value that is
insufficient to assure full repayment.As a result, these loans
may involve the disbursement of substantial funds with repayment dependent, in
part, on the success of the ultimate project rather than the ability of the
borrower or guarantor to repay principal and interest.




Commercial Real Estate
Loans.Commercial real estate loans totaled $123.0 million or
9.8% of the Bank’s total loans at December 31, 2008, compared to $120.4 million
or 10.9% of the portfolio at December 31, 2007. All commercial real estate loans
are secured by properties in western Washington, mainly in the Puget Sound
Region. Improved property including office buildings and small commercial
business properties, such as strip shopping centers, secure the Bank’s
commercial real estate loans. These loans are primarily adjustable-rate with a
maximum term until reset on the interest rate of five years. At December 31,
2008, the largest commercial real estate loan in the Bank’s portfolio was $10.2
million, which is performing according to its terms.




Commercial
real estate loans are also sensitive to local economic conditions.  An
economic slowdown can lead to increased vacancies that would lower the
borrower’s ability to service the debt.  Commercial real estate loans
also have a degree of interest rate risk in that if rates fall, borrowers may
refinance, and if rates rise, the Bank could experience a squeeze on net
interest margin if the Bank does not properly fund these loans, which often have
a fixed-rate for the initial five years of the loan.




Multifamily Loans.Multifamily loans totaled $86.9 million or 6.9% of the total loan
portfolio at December 31, 2008. The multifamily portfolio is principally
comprised of small to medium-size apartment projects with loan-to-value ratios
usually up to 75%. All new loan originations are in the Puget Sound Region and
have adjustable interest rates.




Multifamily
residential and commercial real estate lending affords the Bank an opportunity
to receive interest at rates higher than those generally available from
one-to-four family mortgage loans. However, loans secured by such properties
usually are greater in amount and may involve a greater degree of risk than
individual one-to-four family residential mortgage loans. Because payments on
loans secured by multifamily residential and commercial properties are often
dependent on the successful operation and management of the properties,
repayment of such loans may be affected by adverse conditions in the real estate
market or the economy.




One-to-Four Family Residential
Loans.At December 31, 2008, residential loans totaled $126.1
million or 10.0% of the total loan portfolio. Residential lending consists
primarily of first mortgage loans secured by single-family residential
properties located principally in Snohomish and King Counties. The Bank
originates both fixed-rate and adjustable-rate mortgages (“ARMs”) with
maturities up to 30 years. ARM loans are generally held in the Bank’s
portfolio.  Newly originated ARMs have interest rates that adjust
based on the One Year Constant Maturity Treasury Index after an initial
fixed-rate period. Borrower demand for ARMs versus fixed-rate mortgage loans is
a function of the level of interest rates, the shape of the yield curve, and the
differences between the interest rates and loan fees offered for fixed-rate
mortgage loans and the rates and loan fees for ARMs.




Fixed-rate
residential loans are generally sold and the servicing released to one of the
Bank’s correspondents.  The loans are sold on a “best efforts”
basis.  The Bank no longer packages its loans to sell as
mortgage-backed securities.  The Bank had $1.2 million in loans held
for sale at December 31, 2008, and $129,000 in loans held for sale at December
31, 2007. Loans held for sale are not material and therefore the Bank does not
include them as a separate line item on the balance sheet.




The
Bank’s conforming residential loans meet the Federal Home Loan Mortgage
Corporation's underwriting standards with respect to credit, borrower debt
ratios and documentation. The Bank’s nonconforming residential loans are those
that do not conform to agency underwriting guidelines, due to the size of the
loan, as a result of credit histories, debt-to-income ratios, reliance on the
borrower's stated income, non-owner occupied property, rural property, or other
exceptions from agency guidelines. The Bank does not offer subprime
loans.


9


Consumer
Loans.The Bank’s consumer loan activities take three forms:
home equity loans or lines of credit, installment loans, and Visa card loans.
Home equity loans are secured by a junior lien in priority on the borrower's
home. Such loans may have a combined loan-to-value ratio of up to 90% of the
value of the home securing the loan. Home equity loans are fixed amount loans,
which may have fixed or floating interest rates. Home equity lines of credit can
be drawn upon at any time by the customer up to a specific
amount.  These loans are at a floating-rate with a floor on that rate.
The balance outstanding for both types of home equity loans increased to $25.2
million at December 31, 2008, as compared to $21.6 million at December 31, 2007.
At December 31, 2008 and December 31, 2007, the total amount of unused lines of
credit were $19.0 million and $20.4 million, respectively.  The second
category of consumer loans are installment loans in which boats, automobiles,
and recreational vehicles serve as collateral.  This portfolio was
$5.6 million at December 31, 2008, as compared to $6.1 million outstanding at
December 31, 2007. Since installment loans are secured by depreciating assets,
any repossessed collateral for a defaulted loan is unlikely to provide an
adequate source of repayment of the outstanding loan balance. The remaining
deficiency often does not warrant further substantial collection efforts against
the borrower. Consumer loan collections are dependent on the borrower’s
continuing financial ability, and are more likely to be adversely affected by
job loss, divorce, illness or personal bankruptcy.




The Loan Maturity
Table




The
following table sets forth information at December 31, 2008 regarding the dollar
amount of loans maturing in the Bank’s portfolio based on their contractual
terms to maturity, but does not include scheduled payments or potential
prepayments. Loan balances do not include deferred loan
fees.  Construction loans are net of loans in process.




(Dollars
      in thousands)
                    
                    Due
      in one
                      year
      or less
                    
                    
                    Due
      in one
                      to
      five years
                    
                    
                    Due
      after
                      five
      years
                    
                    
                    Total
                    
                    
                    With
      variable or adjustable rate (for maturities of more than one
      year)
                    
                    
                    With
      fixed rate
                      (for
      maturities
                      of
      more than
                      one
      year)Business
                    
                    $
                    120,483
                    
                    
                    $
                    156,976
                    
                    
                    $
                    207,601
                    
                    
                    $
                    485,060
                    
                    
                    $
                    167,413
                    
                    
                    $
                    197,164Construction
                    
                    
                    221,422
                    
                    
                    
                    156,448
                    
                    
                    
                    28,635
                    
                    
                    
                    406,505
                    
                    
                    
                    171,727
                    
                    
                    
                    13,356Commercial
      real estate
                    
                    
                    3,350
                    
                    
                    
                    35,605
                    
                    
                    
                    83,996
                    
                    
                    
                    122,951
                    
                    
                    
                    116,928
                    
                    
                    
                    2,673Multifamily
                    
                    
                    10,067
                    
                    
                    
                    47,933
                    
                    
                    
                    28,864
                    
                    
                    
                    86,864
                    
                    
                    
                    47,710
                    
                    
                    
                    29,087Consumer
                    
                    
                    1,388
                    
                    
                    
                    10,062
                    
                    
                    
                    19,322
                    
                    
                    
                    30,772
                    
                    
                    
                    18,802
                    
                    
                    
                    10,582Residential
                    
                    
                    12,117
                    
                    
                    
                    1,505
                    
                    
                    
                    112,467
                    
                    
                    
                    126,089
                    
                    
                    
                    106,979
                    
                    
                    
                    6,993




Asset
Quality




Banking
regulations require that each insured institution review and classify its assets
regularly. In addition, bank examiners have the authority to identify problem
assets and, if appropriate, require them to be adversely classified. There are
three classifications for problem assets: substandard, doubtful and loss.
Substandard assets must have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
sufficient weaknesses that make collection or payment in full, based on
currently existing facts, conditions and values, questionable. An asset
classified loss is considered uncollectible and of such little value that its
continuance as an asset of the institution is not warranted.  Assets
classified as substandard or doubtful require the institution to establish
allowances for loan losses. If an asset, or portion thereof, is classified loss,
the insured institution must either establish specific allowances for loan
losses in the amount of 100% of the portion of the asset classified loss or
charge-off such amounts. The Bank uses two other asset classification categories
for potential problem loans. They are watch and special mention. Borrowers with
declining earnings, strained cash flow, increasing leverage and/or weakening
market fundamentals that indicate above average risk are classified as
watch.  Loans on special mention represent borrowers who exhibit
potential credit weaknesses or trends deserving Bank management’s close
attention.




Cascade
established the Credit Administration Division in 2001 to help assure that the
Bank maintains the quality of its loan portfolio. Management has comprehensive
monthly and annual review procedures for identifying and classifying assets for
weaknesses. Reserves are maintained for assets classified as substandard or
doubtful. The objective of these review procedures is to identify any trends and
determine the levels of loss exposure to evaluate the need for an adjustment to
the reserve accounts.





Delinquencies.A
report containing delinquencies of all loans is reviewed monthly by the Asset
Review Committee and periodically by the Board of
Directors.  Procedures taken with respect to delinquent loans differ
depending on the particular circumstances of each loan.  The Bank’s
general procedures provide that when a loan becomes delinquent, the borrower is
contacted, usually by phone, within 30 days.  When the loan is over 30
days delinquent, the borrower is usually contacted in
writing.  Typically, the Bank will initiate


10
 foreclosure
or other corrective action against the borrower when principal and interest
become 90 days or more delinquent.  In most cases, interest income is
reduced by the full amount of accrued and uncollected interest on loans once
they become 90 days delinquent, go into foreclosure or are otherwise determined
to be uncollectible. Once interest has been paid to date or management considers
the loan fully collectable, it is returned to accrual status.  An
allowance for loss is established when, in the opinion of management, the fair
value less sales costs of the property collateralizing the loan is less than the
outstanding principal and the collectability of the loan’s principal becomes
uncertain. It is intended that the Bank’s allowance for loan losses be adequate
to cover known potential and reasonably estimated unknown losses. At December
31, 2008, and December 31, 2007, the Bank had $40.3 million and $1.5 million,
respectively, of loans held on a non-accrual basis.





Allowance for Loan
Losses/Nonperforming Loans




Management
provides for possible loan losses by maintaining an allowance. The level of the
allowance is determined based upon judgments regarding the size and nature of
the loan portfolio, including concentrations of collateral type, historical loss
experience, the financial condition of borrowers, the level of nonperforming
loans, trends in asset classification and anticipated general economic
conditions. Additions to the allowance are charged to expense. Loans are charged
against the allowance when management believes the collection of principal is
unlikely.  The provision for loan losses increased $5.8 million to
$7.2 million for the year ended December 31, 2008. Increases in the allowance
for loan losses made through provisions were primarily a result of loan growth,
awareness of the greater risk inherent in business lending, the impact of the
economic climate on the loan portfolio, and the continued weakening in the local
housing market.




Management
measures the reasonableness of the allowance for loan losses by utilizing a loan
grading system to determine risk in the loan portfolio and by considering the
results of credit reviews. The loan portfolio is separated by quality and then
by loan type. Loans of acceptable quality are evaluated as a group, by loan
type, with a loss rate assigned to the total loans in each type, but unallocated
to any individual loan. A loss rate is also assigned to adversely classified
loans under $1.0 million, but at a higher rate due to the greater risk of
loss.  Adversely classified loans in excess of $1.0 million are
individually analyzed to determine an estimated loss amount. Past due and
impaired loans are actively managed to minimize the potential loss. Although
management has allocated a portion of the allowance to the loan categories using
the method described above, the adequacy of the allowance must be considered as
a whole. Loan concentrations, terms, and basic underlying assumptions remain
substantially unchanged but the Bank does project a slow down in the economy and
the pace of financial activity.


11


The
following table presents information with respect to the Bank’s nonperforming
assets and restructured loans at the dates indicated.




(Dollars
      in thousands)
                    
                    December
      31,2008
                    
                    
                    2007
                    
                    
                    2006Nonperforming
      loans:Business
                    
                    $
                    1,149
                    
                    
                    $
                    1,522
                    
                    
                    $
                    731Construction
                    
                    
                    38,972
                    
                    
                    
                    —
                    
                    
                    
                    —Residential
                    
                    
                    155
                    
                    
                    
                    —
                    
                    
                    
                    —Consumer
      loans
                    
                    
                    2
                    
                    
                    
                    1
                    
                    
                    
                    120Total
      nonperforming loans
                    
                    
                    40,278
                    
                    
                    
                    1,523
                    
                    
                    
                    851Real
      estate owned and repossessed assets
                    
                    
                    1,446
                    
                    
                    
                    —
                    
                    
                    
                    —Total
      nonperforming assets
                    
                    $
                    41,724
                    
                    
                    $
                    1,523
                    
                    
                    $
                    851Restructured
      loans
                    
                    $
                    910
                    
                    
                    $
                    334
                    
                    
                    $
                    115Total
      nonperforming loans to net loans
                    
                    
                    3.20
                    %
                    
                    
                    0.14
                    %
                    
                    
                    0.08
                    %Total
      nonperforming loans to total assets
                    
                    
                    2.46
                    
                    
                    
                    0.11
                    
                    
                    
                    0.06Total
      nonperforming assets to total assets
                    
                    
                    2.55
                    
                    
                    
                    0.11
                    
                    
                    
                    0.06




The
Bank’s nonperforming assets at December 31, 2008, consisting of nonperforming
loans and other real estate owned, totaled $41.7 million or 2.55% of total
assets. This is an increase from $1.5 million or 0.11% of total assets at
December 31, 2007, and an increase from $851,000 or 0.06% of total assets at
December 31, 2006.




Loans are
generally placed on non-accrual when they become past due over 90 days or when
the collection of interest or principal is considered unlikely.  Loans
past due over 90 days, that are not on non-accrual status, must be well secured
by tangible collateral and in the process of collection. The Bank does not
return a loan to accrual status until it is brought current with respect to both
principal and interest and future principal and interest payments are no longer
in doubt.




Nonperforming
loans increased to $40.3 million at December 31, 2008, compared to $1.5 million
at December 31, 2007, and $851,000 at December 31, 2006. The increase in
nonperforming loans from December 31, 2007 to December 31, 2008, is due to
increases in nonperforming real estate, construction and development loans.
Management believes that the allowance for losses on loans is adequate to
provide for losses that may be incurred on nonperforming loans.




Real
estate owned (REO) includes property acquired by the Bank through
foreclosure.  REO is carried at the lower of the estimated fair value
or the principal balance of the foreclosed loans.  Real estate owned
and repossessed assets totaled $1.4 million at December 31, 2008, $0 at December
31, 2007, and $0 at December 31, 2006. The REO as of December 31, 2008 consists
of three single family residences.




Interest
income that would have been recognized for the years ended December 31, 2008,
December 31, 2007, and December 31, 2006, had non-accrual loans been current in
accordance with their contractual terms, amounted to $871,742, $111,249, and
$27,175, respectively.


12


The
following tables set forth information regarding changes in the Bank’s allowance
for loan losses for the most recent five years.




(Dollars
      in thousands)
                        
                        Years
      Ended December 31,2008
                        
                        
                        2007
                        
                        
                        2006
                        
                        
                        2005
                        
                        
                        2004Balance
      at beginning of period
                        
                        $
                        11,653
                        
                        
                        $
                        10,988
                        
                        
                        $
                        10,254
                        
                        
                        $
                        9,563
                        
                        
                        $
                        7,711Issaquah
      Bank balance at June 2004
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        1,395Charge-OffsBusiness
      banking
                        
                        
                        1,212
                        
                        
                        
                        288
                        
                        
                        
                        47
                        
                        
                        
                        1
                        
                        
                        
                        310Construction/land
                        
                        
                        1,941
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —Residential
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        116
                        
                        
                        
                        34Consumer
      and other
                        
                        
                        632
                        
                        
                        
                        390
                        
                        
                        
                        367
                        
                        
                        
                        403
                        
                        
                        
                        97Recoveries:
                        
                        
                        (1,282
                        )
                        
                        
                        (135
                        )
                        
                        
                        (148
                        )
                        
                        
                        (266
                        )
                        
                        
                        (223
                        )Net
      charge-offs (recoveries):
                        
                        
                        2,503
                        
                        
                        
                        543
                        
                        
                        
                        266
                        
                        
                        
                        254
                        
                        
                        
                        218Provision
      for loan losses
                        
                        
                        7,240
                        
                        
                        
                        1,350
                        
                        
                        
                        1,000
                        
                        
                        
                        945
                        
                        
                        
                        675Transfers
      to (from) off-balance sheetcommitments
                        
                        
                        (49
                        )
                        
                        
                        142
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —Balance
      at end of period
                        
                        
                        16,439
                        
                        
                        
                        11,653
                        
                        
                        
                        10,988
                        
                        
                        
                        10,254
                        
                        
                        
                        9,563Average
      total loans outstanding
                        
                        $
                        1,183,072
                        
                        
                        $
                        1,046,093
                        
                        
                        $
                        955,692
                        
                        
                        $
                        854,684
                        
                        
                        $
                        691,372Ratio
      of net charge-offs during the period to average loans
      outstanding
                        
                        
                        0.21
                        %
                        
                        
                        0.05
                        %
                        
                        
                        0.03
                        %
                        
                        
                        0.03
                        %
                        
                        
                        0.03
                        %Ratio
      of allowance for loan losses to average loans outstanding
                        
                        
                        1.39
                        
                        
                        
                        1.11
                        
                        
                        
                        1.15
                        
                        
                        
                        1.20
                        
                        
                        
                        1.38Ratio
      of allowance for loan losses to total loans outstanding
                        
                        
                        1.31
                        
                        
                        
                        1.05
                        
                        
                        
                        1.09
                        
                        
                        
                        1.16
                        
                        
                        
                        1.19







A
material estimate that is particularly susceptible to significant change relates
to the determination of the allowance for losses on loans and the valuation of
real estate acquired in connection with foreclosures or in satisfaction of
loans. In connection with the determination of the estimated losses on loans and
foreclosed assets held for sale, management obtains independent appraisals for
significant properties.




While
management uses available information to recognize losses on loans, further
reductions in the carrying amounts of loans may be necessary based on changes in
local economic conditions. In addition, regulatory agencies, as an integral part
of their examination process, periodically review the estimated losses on loans.
Such agencies may require the Bank to recognize additional losses based on their
judgment about information available to them at the time of their
examination.




Certain
loans may meet the criteria of troubled debt restructuring as defined in
Statement of Financial Accounting Standards (“SFAS”) No. 114 and No. 118, Accounting by Creditors for
Impairment of a Loan, and Accounting by Creditors for
Impairment of a Loan-Income Recognition and Disclosures,
respectively.


13


The
following tables set forth information concerning the Bank’s allocation of the
allowance for loan losses and the percentage of loans in each category to total
loans at the dates indicated.




December
      31,(Dollars
      in thousands)
                            
                            2008
                            
                            
                            2007
                            
                            
                            2006Amount
                            
                            
                            %
                            
                            
                            Amount
                            
                            
                            %
                            
                            
                            Amount
                            
                            
                            %Business
                            
                            $
                            3,193
                            
                            
                            
                            38.55
                            %
                            
                            $
                            3,824
                            
                            
                            
                            42.28
                            %
                            
                            $
                            7,221
                            
                            
                            
                            43.78
                            %Construction
                            
                            
                            4,341
                            
                            
                            
                            32.31
                            
                            
                            
                            2,050
                            
                            
                            
                            34.44
                            
                            
                            
                            194
                            
                            
                            
                            29.20Commercial
      real estate
                            
                            
                            610
                            
                            
                            
                            9.77
                            
                            
                            
                            605
                            
                            
                            
                            10.87
                            
                            
                            
                            2,159
                            
                            
                            
                            11.81Multifamily
                            
                            
                            149
                            
                            
                            
                            6.90
                            
                            
                            
                            16
                            
                            
                            
                            1.03
                            
                            
                            
                            271
                            
                            
                            
                            3.44Consumer
                            
                            
                            333
                            
                            
                            
                            2.45
                            
                            
                            
                            326
                            
                            
                            
                            2.50
                            
                            
                            
                            605
                            
                            
                            
                            2.74Residential
                            
                            
                            253
                            
                            
                            
                            10.02
                            
                            
                            
                            205
                            
                            
                            
                            8.88
                            
                            
                            
                            255
                            
                            
                            
                            9.03Unallocated
                            
                            
                            7,560
                            
                            
                            
                            —
                            
                            
                            
                            4,627
                            
                            
                            
                            —
                            
                            
                            
                            283
                            
                            
                            
                            —Total
      allowance for loan losses
                            
                            $
                            16,439
                            
                            
                            
                            100.00
                            %
                            
                            $
                            11,653
                            
                            
                            
                            100.00
                            %
                            
                            $
                            10,988
                            
                            
                            
                            100.00
                            %





The
provision for loan losses for the year ended December 31, 2008, totaled $7.2
million compared to $1.4 million for the year ended December 31, 2007, and $1.0
million for the year ended December 31, 2006. The increase in the provision for
loan losses for the twelve-month period ended December 31, 2008, was primarily a
result of loan growth, awareness of the greater risk inherent in business
lending, the impact of the economic climate on the loan portfolio, and the
continued weakening in the local housing market. Adversely classified loans
increased to $87.3 million at December 31, 2008, from $29.1 million at December
31, 2007.




ASSET AND LIABILITY
MANAGEMENT ACTIVITIES




The
Bank’s Asset/Liability Management Committee (“ALCO”) has the responsibility to
measure and monitor interest rate risk, the liquidity position, and capital
adequacy. The Bank uses a variety of tools to measure, monitor, and manage
interest rate risk. The Audit and Finance Committee of the Board of Directors
reviews the interest rate risk management activities of the Bank on a regular
basis and has established policies and guidelines on the amount of risk deemed
acceptable.  The impact on the Bank’s net interest income and the fair
value of its capital are modeled under different interest rate scenarios. The
Board, through the Asset/Liability Management Policy, has established guidelines
for the maximum negative impact that changes in interest rates have on the
Bank’s net interest income, the fair value of equity and adjusted capital/asset
ratios under certain interest rate shock scenarios. Cascade uses a simulation
model to measure rate risk and the impact on net interest income, the fair value
of equity, and the fair value capital/asset ratio. In general, the Bank seeks to
manage its rate risk through its balance sheet. The Bank focuses on originating
more interest rate sensitive assets, such as variable-rate loans, while reducing
its long-term, fixed-rate assets through the sale of long-term residential
mortgages in the secondary market. The vast majority of the loans that the Bank
keeps in its portfolio have rate repricing periods of five years or less. The
Bank often uses FHLB advances to fund its intermediate term assets.




Using
standard interest rate shock methodology (an instantaneous uniform change in
interest rates at all maturities), the Bank is well within the guidelines
established by the Board of Directors for the changes in fair value of equity
and the adjusted capital/asset ratios. The Bank’s fair value of equity decreases
21.3% in a down 200 bp shock scenario and 1.2% in an up 200 bp shock, within the
established guideline of a maximum 30% decline. The adjusted capital/asset ratio
is 11.5% in the up 200 bp scenario and 11.9% in the down 200 bp scenario, both
above the 5% minimum established guideline. The net interest income increases
1.8% in the up 200 bp scenario and decreases 5.6% in the down 200 bp shock
scenario well within the guideline of a 10% decline.




To manage
the rate risk in the investment portfolio, limits have been established on the
final maturity of securities and limits have been initiated on the price
volatility of mortgage-backed securities (“MBS”) (including collateralized
mortgage obligations (“CMO”)). Additionally, the Bank extends the maturities of
its liabilities by offering long-term deposit products to customers, and
obtaining longer term FHLB advances. As of December 31, 2008, all of the $249.0
million in advances had original maturities greater than one year and $239.0
million have remaining maturities greater than one year.




The Bank
has used interest rate swaps to control the amount of its interest rate risk. In
April 2007, the Bank terminated its $10.0 million in notional principal swaps
used to hedge certificates of deposit. In December 2006, the Bank terminated its
$10.0 million swap used to hedge its initial issuance of Trust Preferred
Securities when it became likely that the changes in the fair value of the swap
would need to be marked to market through the income statement due to a change
in the accounting rules.


14


Another
major component of asset/liability management is liquidity management. The Board
of Directors has also established liquidity parameters that seek to assure the
Bank will have sufficient liquidity to meet all its customer needs for funding
and/or deposit withdrawals. Liquidity levels are monitored by the ALCO with
liquidity analysis reports presented to the Board on a regular basis. The Bank
seeks to diversify its funding sources to assure it maintains adequate
liquidity. The ALCO also monitors and reports to the Board on the capital
position of the Bank and the Corporation. Both seek to remain “well-capitalized”
under FDIC and Federal Reserve guidelines.




The
balance sheets and the section of Management’s Discussion and Analysis titled
“Average Balances and an Analysis of Average Rates Earned and Paid” contained in
the Annual Report are incorporated herein by reference.




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




Year
      Ended December 31,
                
                
                Year
      Ended December 31,2008
      Compared to Year Ended
                  December
      31, 2007
                  Increase
      (Decrease) Due to
                
                
                2007
      Compared to Year Ended
                  December
      31, 2006
                  Increase
      (Decrease) Due to(Dollars
      in thousands)Rate
                
                
                Volume
                
                
                Mix
                
                
                Net
                
                
                Rate
                
                
                Volume
                
                
                Mix
                
                
                NetInterest-earning assetsResidential
      loans
                
                $
                (74
                )
                
                $
                809
                
                
                $
                (10
                )
                
                $
                725
                
                
                $
                406
                
                
                $
                (219
                )
                
                $
                (16
                )
                
                $
                171Multifamily
      loans
                
                
                (128
                )
                
                
                2,285
                
                
                
                (206
                )
                
                
                1,951
                
                
                
                401
                
                
                
                (1,621
                )
                
                
                (227
                )
                
                
                (1,447
                )Commercial
      real estate loan
                
                
                (372
                )
                
                
                (31
                )
                
                
                1
                
                
                
                (402
                )
                
                
                268
                
                
                
                (1,781
                )
                
                
                (49
                )
                
                
                (1,562
                )Construction
      loans
                
                
                (8,103
                )
                
                
                4,702
                
                
                
                (1,266
                )
                
                
                (4,667
                )
                
                
                21
                
                
                
                10,685
                
                
                
                12
                
                
                
                10,718Consumer
      loans
                
                
                (299
                )
                
                
                119
                
                
                
                (17
                )
                
                
                (197
                )
                
                
                16
                
                
                
                (191
                )
                
                
                (1
                )
                
                
                (176
                )Business
      banking loans
                
                
                (2,457
                )
                
                
                1,542
                
                
                
                (112
                )
                
                
                (1,027
                )
                
                
                602
                
                
                
                2,107
                
                
                
                41
                
                
                
                2,750Total
      loans
                
                
                (11,433
                )
                
                
                9,426
                
                
                
                (1,610
                )
                
                
                (3,617
                )
                
                
                1,714
                
                
                
                8,980
                
                
                
                (240
                )
                
                
                10,454Securities
      held-for-trading
                
                
                —
                
                
                
                (1,884
                )
                
                
                —
                
                
                
                (1,884
                )
                
                
                —
                
                
                
                1,884
                
                
                
                —
                
                
                
                1,884Securities
      available-for-sale
                
                
                333
                
                
                
                1,047
                
                
                
                72
                
                
                
                1,452
                
                
                
                272
                
                
                
                (2,094
                )
                
                
                (85
                )
                
                
                (1,907
                )Securities
      held-to-maturity
                
                
                666
                
                
                
                2,632
                
                
                
                388
                
                
                
                3,686
                
                
                
                380
                
                
                
                (384
                )
                
                
                (32
                )
                
                
                (36
                )Daily
      interest-earning deposits
                
                
                (806
                )
                
                
                (667
                )
                
                
                472
                
                
                
                (1,001
                )
                
                
                26
                
                
                
                777
                
                
                
                79
                
                
                
                882Total
      net change in income on
                  interest-earning
      assets
                
                $
                (11,240
                )
                
                $
                10,554
                
                
                $
                (678
                )
                
                $
                (1,364
                )
                
                $
                2,392
                
                
                $
                9,163
                
                
                $
                (278
                )
                
                $
                11,277Interest-bearing
liabilitiesInterest-bearing
      deposits
                
                $
                (10,625
                )
                
                $
                3,449
                
                
                $
                (829
                )
                
                $
                (8,005
                )
                
                $
                4,269
                
                
                $
                2,043
                
                
                $
                332
                
                
                $
                6,644FHLB
      advances
                
                
                (598
                )
                
                
                1,394
                
                
                
                (81
                )
                
                
                715
                
                
                
                (420
                )
                
                
                (554
                )
                
                
                21
                
                
                
                (953
                )Other
      borrowings
                
                
                1,529
                
                
                
                1,466
                
                
                
                441
                
                
                
                3,436
                
                
                
                435
                
                
                
                1,019
                
                
                
                127
                
                
                
                1,581Total
      net change in expenses on
                  interest-bearing
      liabilities
                
                $
                (9,694
                )
                
                $
                6,309
                
                
                $
                (469
                )
                
                $
                (3,854
                )
                
                $
                4,284
                
                
                $
                2,508
                
                
                $
                480
                
                
                $
                7,272Net
      increase in net interestincome
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                2,490
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                4,005





15




Year
      Ended December 31,2006
      Compared to Year Ended
                  December
      31, 2005
                  Increase
      (Decrease) Due to(Dollars
      in thousands)Rate
                
                
                Volume
                
                
                Mix
                
                
                NetInterest-earning assetsResidential
      loans
                
                $
                58
                
                
                $
                (354
                )
                
                $
                (4
                )
                
                $
                (300
                )Multifamily
      loans
                
                
                111
                
                
                
                (2,110
                )
                
                
                (47
                )
                
                
                (2,046
                )Commercial
      real estate loans
                
                
                407
                
                
                
                (1,488
                )
                
                
                (55
                )
                
                
                (1,136
                )Construction
      loans
                
                
                1,915
                
                
                
                6,114
                
                
                
                1,148
                
                
                
                9,177Consumer
      loans
                
                
                192
                
                
                
                (91
                )
                
                
                (7
                )
                
                
                94Business
      banking loans
                
                
                1,648
                
                
                
                5,670
                
                
                
                399
                
                
                
                7,717Total
      loans
                
                
                4,331
                
                
                
                7,741
                
                
                
                1,434
                
                
                
                13,506Securities
      available-for-sale
                
                
                486
                
                
                
                614
                
                
                
                53
                
                
                
                1,153Securities
      held-to-maturity
                
                
                87
                
                
                
                167
                
                
                
                2
                
                
                
                256Daily
      interest-earning deposits
                
                
                15
                
                
                
                (71
                )
                
                
                (3
                )
                
                
                (59
                )Total
      net change in income oninterest-earning
      assets
                
                $
                4,919
                
                
                $
                8,451
                
                
                $
                1,486
                
                
                $
                14,856Interest-bearing
liabilitiesInterest-bearing
      deposits
                
                $
                8,905
                
                
                $
                497
                
                
                $
                860
                
                
                $
                10,262FHLB
      advances
                
                
                257
                
                
                
                (92
                )
                
                
                (3
                )
                
                
                162Other
      borrowings
                
                
                (603
                )
                
                
                3,158
                
                
                
                (987
                )
                
                
                1,568Total
      net change in expenses oninterest-bearing
      liabilities
                
                $
                8,559
                
                
                $
                3,563
                
                
                $
                (130
                )
                
                $
                11,992Net
      increase in net interestincome
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                2,864




There
were no loans 90 days or more past due and still accruing as of December 31,
2008. There was $420,000 in accrued interest on loans 90 days or more past due
as of December 31, 2007, and no interest accrued on loans 90 days or more past
due at December 31, 2006.




INVESTMENT
PORTFOLIO




The Board
of Directors, through the Asset/Liability Management Policy, sets the investment
policy of the Bank. This policy mandates that investments will be made based on
the safety of the principal amount, interest rate risk, liquidity requirements
of the Bank, and the return on the investment. The Bank’s policy does not permit
the purchase of non-investment grade securities. The policy permits the
investment in various types of assets permissible under FDIC regulation
including:  United States Treasury obligations, securities of
government sponsored enterprises, mortgage-backed securities (“MBS”) including
collateralized mortgage obligations (“CMOs”), state and municipal government
bonds, deposits at the FHLB-Seattle, certificates of deposit of federally
insured institutions, investment grade corporate bonds and Federal funds.
Subject to various restrictions, the Bank may also invest part of its assets in
commercial paper and mutual funds, if those assets conform to FDIC
regulations.




Investment
securities increased 10.4% to $256.2 million at December 31, 2008, from $232.0
million at December 31, 2007. MBS (including CMOs) available-for-sale increased
from $25.4 million to $42.0 million as of December 31, 2008. Agency notes
available-for-sale also increased from $57.4 million to $81.4 million. MBS
(including CMOs) held-to-maturity decreased from $22.5 million to $20.5 million
as of December 31, 2008. Agency notes held-to-maturity also decreased from
$114.0 million to $99.3 million for the year ended December 31,
2008.


16


The
following tables set forth the Bank’s securities available-for-sale at the dates
indicated.




December
      31, 2008
                
                December
      31, 2007
                
                December
      31, 2006Estimated
                
                
                Percent
      of
                
                Estimated
                
                
                Percent
      of
                
                Estimated
                
                
                Percent
      of(Dollars
      in thousands)
                
                Fair
      Value
                
                
                Portfolio
                
                Fair
      Value
                
                
                Portfolio
                
                Fair
      Value
                
                
                PortfolioMBS
                
                $
                41,852
                
                
                
                30.86
                %
                
                $
                25,427
                
                
                
                26.83
                %
                
                $
                37,747
                
                
                
                26.48
                %Agency
      notes
                
                
                81,372
                
                
                
                60.01
                
                
                
                57,433
                
                
                
                60.60
                
                
                
                92,909
                
                
                
                65.16FHLB
      stock
                
                
                11,920
                
                
                
                8.80
                
                
                
                11,920
                
                
                
                12.57
                
                
                
                11,920
                
                
                
                8.36Corporate/other
                
                
                454
                
                
                
                0.33
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —Total
                
                $
                135,598
                
                
                
                100.00
                %
                
                $
                94,780
                
                
                
                100.00
                %
                
                $
                142,576
                
                
                
                100.00
                %







The
following table sets forth the contractual or expected maturities and weighted
average yields of the Bank’s securities available-for-sale at December 31,
2008.




Less
      Than One Year
                
                
                One
      to Five Years
                
                
                Five
      to Ten Years
                
                
                Over
      Ten YearsEstimated
                
                
                
                
                
                Estimated
                
                
                
                
                
                Estimated
                
                
                
                
                
                Estimated(Dollars
      in thousands)
                
                Fair
      Value
                
                
                Yield
                
                
                Fair
      Value
                
                
                Yield
                
                
                Fair
      Value
                
                
                Yield
                
                
                Fair
      Value
                
                
                YieldMBS
                
                $
                22,345
                
                
                
                4.32
                %
                
                $
                19,507
                
                
                
                5.40
                %
                
                $
                —
                
                
                
                —
                %
                
                $
                —
                
                
                
                —
                %Agency
      notes
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                5.03
                
                
                
                71,458
                
                
                
                5.09
                
                
                
                9,914
                
                
                
                6.05FHLB
      stock
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                11,920
                
                
                
                —Corporate/other
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                454
                
                
                
                —Total
                
                $
                22,345
                
                
                
                
                
                
                $
                19,507
                
                
                
                
                
                
                $
                71,458
                
                
                
                
                
                
                $
                22,288







The
following table sets forth amortized cost and estimated fair values for the
Bank’s securities held-to-maturity at the dates indicated.




December
      31, 2008
                  
                  
                  December
      31, 2007
                  
                  
                  December
      31, 2006Amortized
                  
                  
                  Fair
                  
                  
                  %
      of
                  
                  
                  Amortized
                  
                  
                  Fair
                  
                  
                  %
      of
                  
                  
                  Amortized
                  
                  
                  Fair
                  
                  
                  %
      of(Dollars
      in thousands)
                  
                  Cost
                  
                  
                  Value
                  
                  
                  Portfolio
                  
                  
                  Cost
                  
                  
                  Value
                  
                  
                  Portfolio
                  
                  
                  Cost
                  
                  
                  Value
                  
                  
                  PortfolioMBS
                  
                  $
                  20,484
                  
                  
                  $
                  20,545
                  
                  
                  
                  16.99
                  %
                  
                  $
                  22,556
                  
                  
                  $
                  21,941
                  
                  
                  
                  16.44
                  %
                  
                  $
                  25,218
                  
                  
                  $
                  24,338
                  
                  
                  
                  26.04
                  %Agency
      notes
                  
                  
                  99,335
                  
                  
                  
                  99,381
                  
                  
                  
                  82.37
                  
                  
                  
                  113,907
                  
                  
                  
                  113,579
                  
                  
                  
                  83.00
                  
                  
                  
                  70,853
                  
                  
                  
                  68,423
                  
                  
                  
                  73.16Corporate/other
                  
                  
                  775
                  
                  
                  
                  775
                  
                  
                  
                  0.64
                  
                  
                  
                  775
                  
                  
                  
                  775
                  
                  
                  
                  0.56
                  
                  
                  
                  775
                  
                  
                  
                  775
                  
                  
                  
                  0.80Total
                  
                  $
                  120,594
                  
                  
                  $
                  120,701
                  
                  
                  
                  100.00
                  %
                  
                  $
                  137,238
                  
                  
                  $
                  136,295
                  
                  
                  
                  100.00
                  %
                  
                  $
                  96,846
                  
                  
                  $
                  93,536
                  
                  
                  
                  100.00
                  %







The
following table sets forth the contractual or expected maturities and weighted
average yields of the Bank’s securities held-to-maturity at December 31,
2008.




Less
      Than One Year
                
                
                One
      to Five Years
                
                
                Five
      to Ten Years
                
                
                Over
      Ten YearsEstimated
                
                
                
                
                
                Estimated
                
                
                
                
                
                Estimated
                
                
                
                
                
                Estimated(Dollars
      in thousands)
                
                Fair
      Value
                
                
                Yield
                
                
                Fair
      Value
                
                
                Yield
                
                
                Fair
      Value
                
                
                Yield
                
                
                Fair
      Value
                
                
                YieldMBS
                
                $
                —
                
                
                
                —
                %
                
                $
                —
                
                
                
                —
                %
                
                $
                8,552
                
                
                
                4.69
                %
                
                $
                11,993
                
                
                
                4.80
                %Agency
      notes
                
                
                —
                
                
                
                —
                
                
                
                5,059
                
                
                
                4.25
                
                
                
                46,944
                
                
                
                6.00
                
                
                
                47,378
                
                
                
                5.97Corporate/other
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                775
                
                
                
                —Total
                
                $
                —
                
                
                
                
                
                
                $
                5,059
                
                
                
                
                
                
                $
                55,496
                
                
                
                
                
                
                $
                60,146




For
further information concerning the Bank’s securities portfolio, see Note 3 of
the Notes to the Consolidated Financial Statements contained in the Annual
Report listed in Item 15.




DEPOSITS




The
Bank’s primary source of funds is customer deposits. In addition to checking
accounts, the Bank offers a variety of interest-bearing accounts designed to
attract both short-term and longer-term deposits from customers.
Interest-bearing accounts earn interest at rates established by Bank management
based on competitive market factors and the Bank’s need for funds.


17


Deposits
increased to $1.0 billion at December 31, 2008, from $904.4 million at December
31, 2007, an increase of 11.3% during this period. Deposits at December 31,
2006, were $855.4 million. The market for retail deposits remains fiercely
competitive. Previously, the Bank paid rates at the higher end of the
competitive range of financial institutions in its market area. In an attempt to
lower the absolute and relative cost of funds, the Bank modified its deposit
pricing strategy by pricing its deposits in the middle of that
range.




The
following table sets forth the average balances for each major category of
deposits and the weighted average interest rate paid for deposits during the
years ended December 31, 2008, 2007, and 2006.




Average
      Deposits by Type(Dollars
      in thousands)
                
                December
      31, 2008
                
                
                December
      31, 2007
                
                
                December
      31, 2006Amount
                
                
                Rate
                
                
                Amount
                
                
                Rate
                
                
                Amount
                
                
                RateNoninterest-bearing
      demand deposits
                
                $
                88,185
                
                
                
                —
                %
                
                $
                87,284
                
                
                
                —
                %
                
                $
                80,457
                
                
                
                —
                %Interest-bearing
      demand deposits
                
                
                72,817
                
                
                
                1.65
                
                
                
                51,021
                
                
                
                1.46
                
                
                
                45,039
                
                
                
                1.46Money
      market deposit
                
                
                297,312
                
                
                
                2.46
                
                
                
                284,843
                
                
                
                4.32
                
                
                
                229,788
                
                
                
                3.70Savings
                
                
                10,888
                
                
                
                0.49
                
                
                
                13,261
                
                
                
                0.50
                
                
                
                14,748
                
                
                
                0.51Time
      certificates
                
                
                497,114
                
                
                
                3.75
                
                
                
                444,726
                
                
                
                4.97
                
                
                
                446,437
                
                
                
                4.33$
                966,316
                
                
                
                
                
                
                $
                881,135
                
                
                
                
                
                
                $
                816,469




The
following table indicates the amount of the Bank’s jumbo certificates of deposit
by time remaining until maturity at December 31, 2008. Jumbo certificates of
deposit require minimum deposits of $100,000 and rates paid on such accounts are
negotiable.




Maturity
      Period
                  
                  Jumbo
      Certificates of Deposit(Dollars
      in thousands)Three
      months or less
                  
                  $
                  272,123Over
      three through six months
                  
                  
                  132,838Over
      six through twelve months
                  
                  
                  37,949Over
      twelve months
                  
                  
                  19,357Total
                  
                  $
                  462,267




The flow
of deposits is influenced significantly by general economic conditions, changes
in money market conditions and prevailing interest rates. In addition, there is
strong competition for customer dollars from other financial institutions,
mutual funds and non-bank corporations, such as securities brokerage companies
and other diversified companies.  The Bank’s deposits are obtained
primarily from the areas in which its branches are located.  The Bank
relies primarily on customer service and longstanding relationships with
customers to attract and retain these deposits. In the coming year, the Bank
will focus on its deposit gathering activities, especially the growth in demand
deposits through its High Performance Checking program. In January 2007 the Bank
launched its Business High Performance Checking Program to accelerate deposit
growth. In the event the Bank were liquidated, certain depositors would be
entitled to full payment of their deposit accounts prior to any payment being
made to the shareholders.




BORROWINGS




The Bank
relies on advances from the Federal Home Loan Bank of Seattle (FHLB-Seattle) to
supplement its supply of funds. Advances from the FHLB-Seattle are typically
secured by the Bank’s first mortgage residential loans, investment securities
and other eligible mortgages secured by real estate.FHLB advances were
$249.0 million at December 31, 2008, compared to $231.0 million at December 31,
2007, a 7.8% increase. FHLB advances were $243.0 million at December 31,
2006.




The Bank
participates in the Federal Reserve term auction facility (TAF) and had an
outstanding balance of $40.0 million at December 31, 2008.




The Bank
enters into repurchase agreements with its authorized dealers. Repurchase
agreements are accounted for as borrowings by the Bank and are secured by
designated investments, primarily the notes of federal agencies and
mortgage-backed securities guaranteed by those agencies. The proceeds of these
transactions are used to meet the cash flow


18
 and
interest rate risk management needs of the Bank. These agreements have 8-10 year
final maturities.  The counterparties have the right to terminate
these agreements and may if rates dramatically increase.  Repurchase
agreements increased to $146.4 million at December 31, 2008, from $120.6 million
at December 31, 2007.




Cascade
Bank has established Fed funds borrowing lines with three of its correspondent
banks. Cascade used each of these lines during the year. The Bank also has a
line of credit with the Federal Reserve Bank of San Francisco. As of December
31, 2008, there were no outstanding balances in any of these lines.




The
following table sets forth certain information regarding borrowings by the Bank
at the end of, and during, the periods indicated.




(Dollars
      in thousands)
                
                December
      31,2008
                
                
                2007
                
                
                2006Weighted
      average rate on:Securities
      sold under agreements to repurchase
                
                
                5.19
                %
                
                
                3.23
                %
                
                
                1.49
                %FHLB
      advances
                
                
                4.27
                
                
                
                4.27
                
                
                
                4.76Year
      ended December 31,2008
                
                
                2007
                
                
                2006Maximum
      amount of borrowings outstanding at any month end:Securities
      sold under agreements to repurchase
                
                $
                147,740
                
                
                $
                120,625
                
                
                $
                96,007FHLB
      advances
                
                
                287,500
                
                
                
                264,790
                
                
                
                256,000Approximate
      average borrowings outstanding with respect to:Securities
      sold under agreements to repurchase
                
                $
                124,211
                
                
                $
                107,516
                
                
                $
                81,284FHLB
      advances
                
                
                256,898
                
                
                
                226,124
                
                
                
                237,888Approximate
      weighted average rate paid on:Other
      interest-bearing liabilities*
                
                
                4.92
                %
                
                
                3.77
                %
                
                
                3.36
                %FHLB
      advances
                
                
                4.26
                
                
                
                4.53
                
                
                
                4.71*
      Including Trust Preferred Securities.







Junior Subordinated Debentures
Payable (Trust Preferred Securities).On March 1, 2000, $10.3
million of 11% Capital Securities due March 1, 2030, were issued by a wholly
owned business Trust whose common equity is 100% owned by Cascade Financial
Corporation. The Trust exists for the exclusive purposes of issuing and selling
the capital securities, using the proceeds from the sale of the capital
securities to acquire junior subordinated debentures 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.  At December 31,
2003, as a result of the adoption of FIN 46R, the Trust was deconsolidated and
all periods in the consolidated financial statements have been restated to
reflect this change. The $10.3 million of junior subordinated debentures issued
by the Corporation to the Trust were reflected as junior subordinated debentures
payable in the consolidated balance sheet at December 31, 2004. The Trust will
redeem the trust preferred securities when the junior subordinated debentures
are paid at maturity or upon any earlier redemption of the junior subordinated
debentures.





Prior to
December 31, 2003, the Trust was consolidated and was included in liabilities in
the consolidated balance sheet. The common securities and debentures, along with
the related income effects, were eliminated in the consolidated financial
statements.





On
December 15, 2004, Cascade Financial Corporation issued $5.2 million of 5.82%
Capital Securities due January 7, 2035. The proceeds from the issuance were
invested in Cascade Bank, which used the increased capital for general corporate
purposes.





On March
30, 2006, Cascade Financial Corporation issued $10.3 million of 6.50% Capital
Securities due June 15, 2036. The proceeds from the issuance were invested in
Cascade Bank, which used the increased capital for general corporate
purposes.


19


Subsidiary
Activity




The
Corporation has four subsidiaries:  Cascade Bank, Cascade Capital
Trust I, II, and III. The activities of the Corporation are primarily conducted
through the Bank.  Accordingly, this Form 10-K principally discusses
the Bank’s operations.




Cascade
Capital Trust I was formed for the exclusive purpose of issuing Trust Preferred
Securities and common securities and using the proceeds to acquire junior
subordinated debentures issued by the Corporation.  The junior
subordinated debentures total $10.2 million, have an interest rate of 11.00%,
mature on March 1, 2030, and are the sole assets of Cascade Capital Trust
I.  The junior subordinated debentures are pre-payable, in whole or in
part, at the Corporation’s option on or after March 1, 2010, at declining
premiums to maturity. Proceeds totaling approximately $9.2 million from the
issuance of the junior subordinated debentures were used to increase the capital
level of the Bank.




Cascade
Capital Trust II incorporates the same structure for the same purposes as
Cascade Capital Trust I.  The junior subordinated debentures issued
under Cascade Capital Trust II equal $5.2 million and have a rate of 5.82% for
the first 5 years of the security, and floats at the three-month LIBOR plus 190
bp thereafter. The securities are callable at par on a quarterly basis beginning
January 7, 2010.




Cascade
Capital Trust III incorporates the same structure for the same purposes as
Cascade Capital Trust I and II. The junior subordinated debentures issued under
Cascade Capital Trust III equal $10.3 million and have a rate of 6.50% for the
first 5 years of the security, and floats at the three-month LIBOR plus 140 bp
thereafter. The securities are callable at par on a quarterly basis beginning
June 15, 2011.




Personnel




At
December 31, 2008, the Corporation had 216 full-time equivalent
employees.  The Corporation believes that employees play a vital role
in the success of a service company and that the Corporation’s relationship with
its employees is good.  The employees are not represented by a
collective bargaining unit.




REGULATION




Introduction/General




The
following generally refers to certain statutes and regulations affecting the
Corporation and the Bank.  This provides only a brief summary of the
regulations impacting the Corporation and is not complete.  This
discussion is qualified in its entirety by the statutes and
regulations.  In addition, some statutes and regulations exist which
impact the Corporation but are not referenced below.




The
Corporation is subject to extensive regulation, supervision and examination.
Such regulation and supervision govern the activities in which the institution
can engage and are intended primarily for the protection of the insurance fund
and depositors. Regulatory authorities have been granted extensive discretion in
connection with their supervisory and enforcement activities, which are intended
to strengthen the financial condition of the banking industry, including the
imposition of restrictions on the operation of an institution, the
classification of assets by the institution and the adequacy of an institution’s
allowance for loan losses.  Any change in such regulation and
oversight could have an adverse material impact on the Corporation, Cascade and
their respective operations.




The
Corporation




The
Corporation is a bank holding company that has elected to be treated as a
financial holding company with the Board of Governors of the Federal Reserve
Board (the “FRB”).  The Bank Holding Company Act of 1956 (“BHCA”), as
amended, subjects the Corporation and its subsidiaries to supervision and
examination by the FRB.  The Corporation files quarterly and annual
reports of operations with the FRB.




Bank Holding Company
Regulation.In general, the BHCA limits bank holding company
business to owning or controlling banks and engaging in other banking-related
activities. Bank holding companies must obtain the FRB's approval before they:
(1) acquire direct or indirect ownership or control of any voting shares of any
bank that results in total ownership or control, directly or indirectly, of more
than 5 percent of the voting shares of such bank; (2) merge or consolidate with
another bank holding company; or (3) acquire substantially all of


20
 the
assets of any additional banks. Subject to certain state laws, such as age and
contingency restrictions, a bank holding company that is adequately capitalized
and adequately managed may acquire the assets of both in-state and out-of-state
banks. With certain exceptions, the BHCA prohibits bank holding companies from
acquiring direct or indirect ownership or control of voting shares in any
company that is not a bank or a bank holding company unless the FRB determines
that the activities of such company are incidental or closely related to the
business of banking. If a bank holding company is well-capitalized and meets
certain criteria specified by the FRB, it may engage de novo in certain
permissible non-banking activities without prior FRB
approval.




The
Change in Bank Control Act of 1978, as amended, requires a person (or group of
persons acting in concert) acquiring "control" of a bank holding company to
provide the FRB with 60 days prior written notice of the proposed acquisition.
Following receipt of this notice, the FRB has 60 days within which to issue a
notice disapproving the proposed acquisition, but the FRB may extend this time
period for up to another 30 days. An acquisition may be completed before
expiration of the disapproval period if the FRB issues written notice of its
intent not to disapprove the transaction. In addition, any "company" must obtain
the FRB's approval before acquiring 25% (5% if the "company" is a bank holding
company) or more of the outstanding shares or otherwise obtaining control over
the Corporation.




Financial Holding Company
Election/Affiliations.  In 2001, the Corporation elected to be
treated as a financial holding company with the FRB, as permitted under the
Gramm-Leach-Bliley Financial Services Modernization Act (the “GLB”). This
election allows the Corporation to conduct activities that previously were
unavailable to bank holding companies, provided that notice requirements are
generally required before engaging in any such activities.




In a
change from previous law, bank holding companies are in a position to be owned,
controlled or acquired by any company engaged in financially related activities,
so long as such company meets certain regulatory requirements. To the extent the
legislation permits banks, securities firms and insurance companies to
affiliate, the financial services industry may experience further consolidation.
This consolidation could result in a growing number of larger financial
institutions that offer a wider variety of financial services than the
Corporation currently offers and that can aggressively compete in the markets
currently served by the Corporation.




Transactions with
Affiliates.  The Corporation and its subsidiaries are deemed
affiliates within the meaning of the Federal Reserve Act, and transactions
between affiliates are subject to certain restrictions. Accordingly, the
Corporation and its subsidiaries must comply with Sections 23A and 23B of the
Federal Reserve Act (Reg W). Generally, Sections 23A and 23B (1) limit the
extent to which a financial institution or its subsidiaries may engage in
"covered transactions" with an affiliate, as defined, to an amount equal to 10%
of such institution's capital and surplus and an aggregate limit on all such
transactions with all affiliates to an amount equal to 20% of such capital and
surplus, and (2) require all transactions with an affiliate, whether or not
"covered transactions," to be on terms substantially the same, or at least as
favorable to the institution or subsidiary, as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and other similar types of
transactions.




Tying Arrangements. The
Corporation and its subsidiaries are prohibited from engaging in certain tying
arrangements in connection with any extension of credit, sale or lease of
property or furnishing of services. For example, with certain exceptions,
neither the Corporation nor its subsidiaries may condition an extension of
credit on either a requirement that the customer obtain additional services
provided by it or an agreement by the customer to refrain from obtaining other
services from a competitor.




State Law Restrictions.As a
Washington corporation, the Corporation is subject to certain limitations and
restrictions as provided under applicable Washington corporate
laws.




Securities Registration and
Reporting.  The Corporation’s common stock is registered as a
class with the SEC under the Securities Exchange Act of 1934 and thus the
Corporation is subject to the periodic reporting and proxy solicitation
requirements and the insider-trading restrictions of that Act. The periodic
reports, proxy statement, and other information filed by the Corporation under
that Act, can be inspected and copied at, or obtained from, the Washington, D.C.
office of the SEC. In addition, the securities issued by the Corporation are
subject to the registration requirements of the Securities Act of 1933 and
applicable state securities laws unless exemptions are available.




The
Corporation is listed on the NASDAQ/Global Select Market. As such, it is subject
to the listing and reporting requirements of NASDAQ. Failure to meet these
requirements could lead to a delisting of the Corporation’s stock.


21


Disclosure Controls and
Procedures.The Sarbanes-Oxley Act of 2002 and related
rulemaking by the SEC, which affect corporate disclosure and financial reporting
reform, generally require public companies to focus on their disclosure controls
and procedures. As a result, public companies such as the Corporation now must
have disclosure controls and procedures in place and make certain disclosures
about them in their periodic SEC reports (i.e., Forms 10-K and 10-Q)
and their chief executive and chief financial officers must certify in these
filings that they are responsible for developing and evaluating disclosure
controls and procedures and disclose the results of an evaluation conducted by
them within the 90-day period preceding the filing of the relevant report, among
other things.




Dividends. The FRB has issued
a policy statement on the payment of cash dividends by bank holding companies
which expresses the FRB’s view that a bank holding company should pay cash
dividends only to the extent that the Corporation’s net income for the past year
is sufficient to cover both the cash dividend and a rate of retention consistent
with the Corporation’s capital needs.  The FRB also indicated that it
would be inappropriate for a company experiencing serious financial problems to
borrow to pay dividends.




Capital Requirements. The FRB
has established capital adequacy guidelines for bank holding companies that
generally parallel the capital requirements the FDIC has for the Bank. The FRB
regulations provided that capital standards will be applied on a consolidated
basis in the case of a bank holding company with more than $150 million in total
consolidated assets.  The Corporation’s total risk-based capital must
equal 8% of risk-weighted assets and 4% must consist of Tier 1
capital.




Stock Repurchases.Bank
holding companies, except for certain “well-capitalized” and highly rated
companies, are required to give the FRB prior written notice of any purchase or
redemption of its outstanding equity securities if the gross consideration for
the purchase or redemption is equal to or greater than 10% of consolidated net
worth during the preceding twelve months. The FRB may disapprove any such
purchase or redemption if it determines that the proposal would constitute an
unsafe or unsound practice.




Capital Purchase Program
Requirements. As an issuer of preferred stock to the U.S. Treasury under
its Capital Purchase Program, which itself was a component of the Troubled Asset
Relief Program, the Corporation agreed to certain terms and conditions. The
issuance agreements established limitations on executive pay, requirements that
the Corporation’s incentive/bonus programs do not encourage senior executive
officers to take unnecessary and excessive risk, and provides for a claw back of
previously paid bonuses if such payments are to be found based on materially
inaccurate financial statements.  In addition, participation in the
program required a modification of existing employment and/or change of control
agreements with senior executive officers.





Cascade
Bank




General. Applicable federal
and state statutes and regulations governing a bank's operations relate, among
other matters, to capital requirements, investments, loans, legal lending
limits, mergers and consolidations, borrowings, issuance of securities, payment
of dividends, establishment of branches, and dealings with affiliated persons.
The Federal Deposit Insurance Corporation ("FDIC") has authority to prohibit
banks under its supervision from engaging in what it considers to be unsafe or
unsound practices in conducting their business. Cascade Bank is a state-charted
commercial bank subject to extensive regulation and supervision by both the
Washington Department of Financial Institutions (“DFI”) and the FDIC. The
federal laws that apply to Cascade Bank regulate, among other things, the scope
of its business, its investments, the timing of the availability of deposited
funds and the nature and amount of collateral for loans. The laws and
regulations governing Cascade Bank generally have been promulgated to protect
depositors and not to protect shareholders of such institutions or their holding
companies.




CRA.The Community
Reinvestment Act requires that, in connection with examinations of financial
institutions within their jurisdiction, the FRB or the FDIC evaluates the record
of the financial institutions in meeting the credit needs of their local
communities, including low and moderate income neighborhoods, consistent with
the safe and sound operation of those banks. These factors are also considered
in evaluating mergers, acquisitions, and applications to open a branch or
facility. The four possible ratings of meeting community credit needs are
outstanding, satisfactory, needs to improve and substantial
noncompliance.  Cascade Bank received a “satisfactory” CRA rating at
the last examination.




Standards for Safety and
Soundness.  The federal banking regulatory agencies have
prescribed, by regulation, standards for all insured depository institutions and
depository institution holding companies relating to: (i) internal controls,
information systems and internal audit systems; (ii) loan documentation; (iii)
credit underwriting; (iv) interest rate risk exposure; (v) asset growth;
(vi) asset quality; (vii) earnings; and (viii) compensation, fees and
benefits (“Guidelines”).  The Guidelines set forth the safety and
soundness standards that


22
 the
federal banking agencies use to identify and address problems at insured
depository institutions before capital becomes impaired.  If a federal
banking agency determines that a financial institution fails to meet any
standard prescribed by the Guidelines, the agency may require the bank to submit
to the agency an acceptable plan to achieve compliance with the
standard.  Management is not aware of any conditions relating to these
safety and soundness standards which would require the submission of a plan of
compliance.




Insider Credit Transactions.
Cascade Bank is also subject to certain restrictions imposed by the Federal
Reserve Act on extensions of credit to executive officers, directors, principal
shareholders, or any related interests of such persons. Extensions of credit (i)
must be made on substantially the same terms, including interest rates and
collateral, and follow credit underwriting procedures that are not less
stringent than those prevailing at the time for comparable transactions with
persons not covered above and who are not employees; and (ii) must not involve
more than the normal risk of repayment or present other unfavorable features.
Cascade Bank is also subject to certain lending limits and restrictions on
overdrafts to such persons. A violation of these restrictions may result in the
assessment of substantial civil monetary penalties on the affected bank or any
officer, director, employee, agent, or other person participating in the conduct
of the affairs of Cascade Bank, the imposition of a cease and desist order, and
other regulatory sanctions.




FDICIA. Under the Federal
Deposit Insurance Corporation Improvement Act of 1991 (the "FDICIA"), each
federal banking agency has prescribed, by regulation, non-capital safety and
soundness standards for institutions under its authority. These standards cover
internal controls, information systems, internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth,
compensation, fees and benefits, such other operational and managerial standards
as the agency determines to be appropriate, and standards for asset quality,
earnings and stock valuation. An institution that fails to meet these standards
must develop a plan acceptable to the agency, specifying the steps that the
institution will take to meet the standards. Failure to submit or implement such
a plan may subject the institution to regulatory sanctions. Management of the
Corporation believes that Cascade Bank meets all such standards, and therefore,
does not believe that these regulatory standards materially affect the
Corporation's business operations currently.




Loans to One
Borrower.  Cascade Bank is subject to limitations on the
aggregate amount of loans that it can make to any one borrower, including
related entities. Applicable regulations generally limit loans to one borrower
to 20% of unimpaired capital and surplus. At December 31, 2008, the Bank had no
borrowers with balances in excess of the loans-to-one-borrower
limit.




Interstate Banking and
Branching. The Riegle-Neal Interstate Banking and Branching Efficiency
Act of 1994 (the "Interstate Act") permits nationwide interstate banking and
branching under certain circumstances. This legislation generally authorizes
interstate branching and relaxes federal law restrictions on interstate banking.
Currently, bank holding companies may purchase banks in any state, and states
may not prohibit such purchases. Additionally, banks are permitted to merge with
banks in other states as long as the home state of neither merging bank has
"opted out." The Interstate Act requires regulators to consult with community
organizations before permitting an interstate institution to close a branch in a
low-income area. With regard to interstate bank mergers, Washington has "opted
in" to the Interstate Act and allows in-state banks to merge with out-of-state
banks subject to certain aging requirements. Washington law generally authorizes
the acquisition of an in-state bank by an out-of-state bank or bank holding
company through the acquisition of or a merger with a financial institution that
has been in existence for at least 5 years prior to the
acquisition.




Deposit Insurance. Effective
until December 31, 2009, the limit on federal deposit insurance coverage is
temporarily increased to $250,000 per depositor. On January 1, 2010, the limit
will return to $100,000 per depositor and $250,000 for Individual Retirement
Accounts through the Savings Association Insurance Fund (the "SAIF")
administered by the FDIC. All insured banks are required to pay semi-annual
deposit insurance premium assessments to the FDIC. The FDICIA included
provisions to reform the Federal Deposit Insurance System, including the
implementation of risk-based deposit insurance premiums. The FDICIA also permits
the FDIC to make special assessments on insured depository institutions in
amounts determined by the FDIC to be necessary to give it adequate assessment
income to repay amounts borrowed from the U.S. Treasury and other sources, or
for any other purpose the FDIC deems necessary. The FDIC has implemented a
risk-based insurance premium system under which banks are assessed insurance
premiums based on how much risk they present to the SAIF. Banks with higher
levels of capital and a low degree of supervisory concern are assessed lower
premiums than banks with lower levels of capital or a higher degree of
supervisory concern.




Dividends.  The
principal source of the Corporation's revenue is dividends received from Cascade
Bank. The payment of dividends is subject to government regulation, in that
regulatory authorities may prohibit banks and bank holding companies from paying
dividends that would constitute an unsafe or unsound banking practice. In
addition, a bank may not pay cash dividends if that payment could reduce the
amount of its capital below that necessary to meet minimum applicable regulatory
capital requirements. Other than the laws and


23
 regulations
noted above, which apply to all banks and bank holding companies, neither the
Corporation nor Cascade Bank is currently subject to any regulatory restrictions
on its dividends.




Capital
Adequacy.  Federal bank regulatory agencies use capital
adequacy guidelines in the examination and regulation of bank holding companies
and banks. If capital falls below minimum guideline levels, the holding company
or bank may be denied approval to acquire or establish additional banks or
non-bank businesses or to open new facilities. The FDIC and FRB use risk-based
capital guidelines for banks and bank holding companies. These are designed to
make such capital requirements more sensitive to differences in risk profiles
among banks and bank holding companies, to account for off-balance sheet
exposure and to minimize disincentives for holding liquid assets. Assets and
off-balance sheet items are assigned to broad risk categories, each with
appropriate weights. The resulting capital ratios represent capital as a
percentage of total risk-weighted assets and off-balance sheet items. The
guidelines are minimums, and the FRB has noted that bank holding companies
contemplating significant expansion programs should not allow expansion to
diminish their capital ratios and should maintain ratios well in excess of the
minimum. The current guidelines require all bank holding companies and
federally-regulated banks to maintain a minimum risk-based total capital ratio
equal to 8%, of which at least 4% must be Tier I capital. Tier I capital for
bank holding companies includes common shareholders' equity, certain qualifying
perpetual preferred stock and minority interests in equity accounts of
consolidated subsidiaries, less intangibles. At December 31, 2008, the
Corporation had Tier 1 capital equal to $160.1 million or 10.3% of average total
assets, which is $97.9 million above the minimum leverage requirement of 4% as
in effect on that date.




The FDIC
also employs a leverage ratio, which is Tier I capital as a percentage of total
assets less intangibles, to be used as a supplement to risk-based guidelines.
The principal objective of the leverage ratio is to constrain the maximum degree
to which a bank holding company may leverage its equity capital base. The FDIC
requires a minimum leverage ratio of 3%. However, for all but the most highly
rated bank holding companies and for bank holding companies seeking to expand,
the FDIC expects an additional cushion of at least 1% to 2%.




FDICIA
created a statutory framework of supervisory actions indexed to the capital
level of the individual institution. Under regulations adopted by the FDIC, an
institution is assigned to one of five capital categories depending on its total
risk-based capital ratio, Tier I risk-based capital ratio, and leverage ratio,
together with certain subjective factors. Institutions which are deemed to be
"undercapitalized" depending on the category to which they are assigned are
subject to certain mandatory supervisory corrective actions. The Corporation
does not believe that these regulations have any material effect on its
operations currently.




Reference
is made to Note 12 of the Notes to the Consolidated Financial Statements in the
Annual Report, which is listed as an exhibit under Item 15, for additional
information concerning regulatory capital.




The FDIC
risk-based requirement requires financial institutions to have total capital of
at least 8% of risk-weighted assets. Total capital consists of Tier I capital
and supplementary capital.  Supplementary capital consists of certain
permanent and maturing capital instruments that do not qualify as Tier I capital
and general valuation loan and lease loss allowances up to a maximum of 1.25% of
risk-weighted assets. Supplementary capital may be used to satisfy the
risk-based requirement only to the extent of Tier I capital.




In
determining the amount of risk-weighted assets, all assets, including certain
off-balance sheet items, are multiplied by a risk weight, ranging from 0% to
100%, based on the risk inherent in the type of asset.  For example,
prudently underwritten permanent one-to-four family first lien mortgage loans
not more than 90 days delinquent and having a loan-to-value ratio of not more
than 80% at origination, unless insured to such ratio by an insurer approved by
FNMA or FHLMC, have been assigned a risk weight of 50%.




On
December 31, 2008, the Bank had total risk-based capital of approximately $177.3
million, including $160.8 million in Tier I capital and $16.5 million in
qualifying supplementary capital (the allowance for loan losses), and
risk-weighted assets of $1.33 billion, or total capital of 13.32% of
risk-weighted assets. This amount was $70.8 million above the 8% requirement in
effect on that date.




FDIC
capital requirements are designated as the minimum acceptable standards for
banks whose overall financial condition is fundamentally sound.  The
FDIC regulations state that if the FDIC determines that conditions so warrant,
it may impose a greater capital standard on a particular
institution.


24


Management
believes that the Bank will continue to meet its minimum capital requirements in
the foreseeable future. However, if circumstances were to materially and
adversely impact the future earnings of the Bank, the ability of the Bank to
meet its capital requirements could be impaired.




Prompt Corrective Action.
Federal statutes establish a supervisory framework based on five capital
categories: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized. An
institution’s category depends upon where its capital levels are in relation to
relevant capital measures. In order to be adequately capitalized, an institution
must have a total risk-based capital ratio of not less than 8%, a Tier 1
risk-based capital of not less than 4%, and a leverage ratio of not less than
4%.  Any institution which fails to meet these levels will be
considered undercapitalized.




Undercapitalized
institutions are subject to certain prompt corrective action requirements,
regulatory controls and restrictions, which become more extensive as an
institution becomes more severely undercapitalized.  Failure by an
institution to comply with applicable capital requirements will result in
restrictions on their activities and lead to enforcement actions, including the
issuance of a capital directive to ensure the maintenance of adequate capital
levels.  Banking regulators will take prompt corrective action with
respect to depository institutions that do not meet minimum capital
requirements.




At
December 31, 2008, Cascade was a “well-capitalized” institution under the prompt
corrective action regulations of the FDIC and the Federal Reserve
Board.




TAXATION




Federal
Taxation




The
Corporation reports its income on a fiscal year basis using the accrual method
of accounting and is subject to federal income taxation in the same manner as
other corporations with some exceptions, including particularly Cascade’s
reserve for bad debts as discussed below.  In 2001, the Corporation’s
fiscal year was changed to the calendar year.  The following
discussion of tax matters is intended only as a summary and does not purport to
be a comprehensive description of the tax rules applicable to the Bank or the
Corporation.




Tax Bad Debt
Reserves




The
reserve method of accounting for bad debt reserves was repealed for tax years
beginning after December 31, 1995. As a result, the Bank is no longer able to
calculate its deduction for bad debts using the percentage-of-taxable-income
method.  Instead, Cascade is required to compute its deduction based
on specific charge-offs during the taxable year.




Distributions




To the
extent that the Bank makes “non-dividend distributions” to the Corporation that
are considered as made (i) from the reserve for losses as of June 30, 1988, or
(ii) from the supplemental reserve for losses on loans (“Excess Distributions”),
then an amount based on the amount distributed will be included in Cascade’s
taxable income.  Non-dividend distributions include distributions in
excess of the Bank’s current and accumulated earnings and profits, distributions
in redemption of stock, and distributions in partial or complete
liquidation.  However, dividends paid out of Cascade’s current or
accumulated earnings and profits, as calculated for federal income tax purposes,
will not be considered to result in a distribution from the Bank’s bad debt
reserve.  Thus, any dividends to the Corporation that would reduce
amounts appropriated to the Bank’s bad debt reserve and deducted for federal
income tax purposes would create a tax liability for Cascade.  The
amount of additional taxable income attributable to an Excess Distribution is an
amount that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution.  Thus, if Cascade makes a “non-dividend
distribution,” then approximately one and one-half times the amount so used
would be included in gross income for federal income tax purposes.




Dividends-Received Deduction
and Other Matters




The
Corporation may exclude from its income 100% of dividends received from the Bank
as a member of the same affiliated group of corporations.  The
corporate dividends-received deduction is generally 70% in the case of dividends
received from unaffiliated corporations with which the Corporation and the Bank
will not file a consolidated tax return, except that if the Corporation or the
Bank owns more than 20% of the stock of a corporation distributing a dividend,
then 80% of any dividends received may be deducted.


25


Washington
Tax




The Bank
is subject to a business and occupation tax which is imposed under Washington
law at the rate of 1.5% of gross receipts; however, interest received on loans
secured by mortgages or deeds of trust on residential properties and interest on
obligations issued or guaranteed by the United States are not presently subject
to the tax.  On August 15, 1994, the Department of Revenue of the
State of Washington began an audit of the Corporation’s records for compliance
regarding the business and occupation tax. The Department of Revenue issued a
tax billing for approximately $148,000 of which the Corporation had accrued
$104,000 and paid $16,000. In December 2006, the Corporation settled with the
State in the amount of $95,000.




Availability of
Filings




You
may access, free of charge, copies of the following reports of the Corporation
on the SEC’s website at www.sec.gov, or the Bank’s website at
www.cascadebank.com:





1)
            Annual
      Reports on Form 10-K; and


2)
            Quarterly
      Reports on Form 10-Q; and


3)
            Current
      Reports on Form 8-K.





These
documents are generally posted within 24 hours after the Corporation files these
documents electronically with the Securities and Exchange
Commission.  The Corporation is also willing to provide electronic or
paper copies of its filings upon reasonable request.




Item 1A.  Risk
Factors
 The Bank,
like all financial institutions, is subject to a number of risks as it conducts
its business. The Management Committee, consisting of the Bank’s senior
officers, serves as the integrated body that oversees the management enterprise
risk bank wide. Within each division, processes are in place to ensure risk is
measured, monitored and managed within the parameters established by the
relevant Bank policies and consistent with stated goals and
strategies.
  The
discussion hereafter sets forth some of the more important risk factors that
could affect our business, financial condition or results of operations.
However, other factors, besides those discussed below or elsewhere in this or
other of our reports filed with or furnished to the SEC, also could adversely
affect our business or results. Cascade cannot assure you that the risk factors
described below or elsewhere in this document are a complete set of all
potential risks that it may face. These risk factors also serve to describe
factors which may cause our results to differ materially from those described in
forward-looking statements included herein or in other documents or statements
that make reference to this report. See “Forward-Looking
Statements.”
  Current
levels of market volatility are unprecedented.
  The
capital and credit markets have been experiencing volatility and disruption for
more than a year. In recent months, the volatility and disruption has reached
unprecedented levels. In some cases, the markets have produced downward pressure
on stock prices and credit availability for certain issuers without regard to
those issuers’ underlying financial strength. If current levels of market
disruption and volatility continue or worsen, there can be no assurance that we
will not experience an adverse effect, which may be material, on our ability to
access capital and on our business, financial condition and results of
operations.
  Recent
legislative and regulatory initiatives to address difficult market and economic
conditions may not stabilize the U.S. banking system.
  On Oct.
3, 2008, President Bush signed into law the Emergency Economic Stabilization Act
of 2008 (EESA) in response to the current crisis in the financial sector. The
U.S. Department of the Treasury and banking regulators are implementing a number
of programs under this legislation to address capital and liquidity issues in
the banking system. There can be no assurance, however, as to the actual impact
that the EESA will have on the financial markets, including the extreme levels
of volatility and limited credit availability currently
 26
 being
experienced. The failure of the EESA to help stabilize the financial markets and
a continuation or worsening of current financial market conditions could
materially and adversely affect Cascade’s business, financial condition, results
of operations, access to credit or the value of Cascade’s
securities.
  Cascade’s
issuance of securities to the United States Treasury may limit our ability to
return capital to shareholders and is dilutive to the holders of our common
stock.
  In
connection with our sale of Series A Preferred to the U.S. Treasury, Cascade
also issued to Treasury a warrant to purchase approximately 863,442 shares of
our common stock. The terms of the transaction with Treasury will result in
limitations on our ability to pay dividends and repurchase our shares. Until
November 21, 2011 or until Treasury no longer holds any shares of the Series A
Preferred, Cascade will not be able to increase dividends above current levels
($0.045 per share of common stock on a quarterly basis) nor repurchase any of
our shares without Treasury approval, with limited exceptions, most
significantly purchases in connection with benefit plans. In addition, we will
not be able to pay any dividends at all on our common stock unless we are
current on our dividend payments on the Series A Preferred. These restrictions,
as well as the dilutive impact of the warrant, may have a negative effect on the
market price of our common stock.
  Unless
Cascade is able to redeem the Series A Preferred prior to February 15, 2014, the
cost of this capital will increase substantially on that date, from 5.00%
(approximately $1.95 million annually) to 9.00% (approximately $3.16 million
annually). Depending on our financial condition at the time, this increase in
dividends on the Series A Preferred could have a negative effect on our
liquidity.
  Future
offerings of debt, which would be senior to our common stock upon liquidation,
and/or preferred equity securities which may be senior to our common stock for
purposes of dividend distributions or upon liquidation, may adversely affect the
market price of our common stock.
  In the
future, we may attempt to increase our capital resources or, if our or our
banking subsidiary’s capital ratios fall below the required minimums, we or our
banking subsidiary could be forced to raise additional capital by making
additional offerings of debt or preferred equity securities, including
medium-term notes, trust preferred securities, senior or subordinated notes and
preferred stock. Upon liquidation, holders of our debt securities and shares of
preferred stock and lenders with respect to other borrowings will receive
distributions of our available assets prior to the holders of our common stock.
Additional equity offerings may dilute the holdings of our existing stockholders
or reduce the market price of our common stock, or both. Holders of our common
stock are not entitled to preemptive rights or other protections against
dilution.
  You
may not receive dividends on the common stock.
  Holders
of our common stock are entitled to receive dividends only when, as and if
declared by our board of directors. Although we have historically declared cash
dividends on our common stock, we are not required to do so and our board of
directors may reduce or eliminate our common stock dividend in the future.
Further, the terms of the Series A Preferred limit our payment of dividends on
common stock, as described above. This could adversely affect the market price
of our common stock.
  We
may be required to make further increases in our provisions for loan losses and
to charge off additional loans in the future, which could adversely affect our
results of operations.
  We are
experiencing increasing loan delinquencies and credit losses and we increased
our provision for loan losses in 2008, which adversely affected our results of
operations. If current adverse conditions in the housing and real estate markets
and the economy continue, we expect that we will continue to experience higher
than normal delinquencies and credit losses. Moreover, if a prolonged recession
occurs we expect that it could severely impact economic conditions in our market
areas and that we could experience significantly higher delinquencies and credit
losses. As a result, we may be required to make further increases in our
provision for loan losses and to charge off additional loans in the future,
which could adversely affect our results of operations. We may elect to make
further increases in our provision for loan losses in the future, particularly
if economic conditions continue to deteriorate, which also could have a material
adverse effect on our financial condition and results of
operations.
 27
 Recent
negative developments in the financial industry and credit markets may continue
to adversely impact our financial condition and results of
operations.
  Negative
developments in the sub-prime mortgage market and the securitization markets for
such loans, and other factors, have resulted in uncertainty in the financial
markets in general and a related general economic downturn. Many lending
institutions, including us, have experienced substantial declines in the
performance of their loans, including construction and land loans, multifamily
loans, commercial loans and consumer loans. Moreover, competition among
depository institutions for deposits and quality loans has increased
significantly. In addition, the values of real estate collateral supporting many
construction and land, commercial and multifamily and other commercial loans and
home mortgages have declined and may continue to decline. Bank and bank holding
company stock prices have been negatively affected, as has the ability of banks
and bank holding companies to raise capital or borrow in the debt markets
compared to recent years. These conditions may have a material adverse effect on
our financial condition and results of operations. In addition, as a result of
the foregoing factors, there is a potential for new federal or state laws and
regulations regarding lending and funding practices and liquidity standards, and
bank regulatory agencies are expected to be very aggressive in responding to
concerns and trends identified in examinations, including the expected issuance
of formal enforcement orders. Negative developments in the financial industry
and the impact of new legislation in response to those developments could
restrict our business operations, including our ability to originate or sell
loans, and adversely impact our results of operations and financial
condition.
  We
may experience future goodwill impairment.
  Recently,
the Company’s common stock has been trading at a price below its book value,
including goodwill and other intangible assets. The valuation of goodwill 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.
  Liquidity
risk could impair our ability to fund operations and jeopardize our financial
condition.
  Liquidity
is essential to our business. An inability to raise funds through deposits,
borrowings, the sale of loans and other sources could have a substantial
negative effect on our liquidity. Our access to funding sources in amounts
adequate to finance our activities or the terms of which are acceptable to us
could be impaired by factors that affect us specifically or the financial
services industry or economy in general. Factors that could detrimentally impact
our access to liquidity sources include a decrease in the level of our business
activity as a result of a downturn in the Western Washington market in which our
loans are concentrated or adverse regulatory action against us. Our ability to
borrow could also be impaired by factors that are not specific to us, such as a
disruption in the financial markets or negative views and expectations about the
prospects for the financial services industry in light of the recent turmoil
faced by banking organizations and the continued deterioration in credit
markets.
  We
may elect or be compelled to seek additional capital in the future, but that
capital may not be available when it is needed.
  We are
required by federal and state regulatory authorities to maintain adequate levels
of capital to support our operations. In addition, we may elect to raise
additional capital to support our business or to finance acquisitions, if any,
or we may otherwise elect to raise additional capital. In that regard, a number
of financial institutions have recently raised considerable amounts of capital
as a result of a deterioration in their results of operations and financial
condition arising from the turmoil in the mortgage loan market, deteriorating
economic conditions, declines in real estate values and other factors. Should we
be required by regulatory authorities to raise additional capital, we may seek
to do so through the issuance of, among other things, our common stock or
preferred stock.
  Our
ability to raise additional capital, if needed, will depend on conditions in the
capital markets, economic conditions and a number of other factors, many of
which are outside our control, and on our financial performance. Accordingly, we
cannot assure you of our ability to raise additional capital if needed or on
terms acceptable to us. If we cannot raise additional capital when needed, it
may have a material adverse effect on our financial condition, results of
operations and prospects.
 28
 If
our allowance for loan losses is not sufficient to cover actual loan losses or
if we are required to increase our provision for loan losses, our results of
operations and financial condition could be materially adversely
affected.
  We make
various assumptions and judgments about the collectibility of our loan
portfolio, including the creditworthiness of our borrowers and the value of the
real estate and other assets serving as collateral for the repayment of many of
our loans. In determining the amount of the allowance for loan losses, we review
our loans and the loss and delinquency experience, and evaluate economic
conditions. If our assumptions are incorrect, the allowance for loan losses may
not be sufficient to cover losses inherent in our loan portfolio, resulting in
the need for additions to our allowance through an increase in the provision for
loan losses. Material additions to the allowance or increases in our provision
for loan losses could have a material adverse effect on our financial condition
and results of operations.
  In
addition, bank regulators periodically review our allowance for loan losses and
may require us to increase our provision for loan losses or recognize further
loan charge-offs. Any increase in our allowance for loan losses or loan
charge-offs as required by these regulatory authorities may have a material
adverse effect on our financial condition and results of
operations.
  Fluctuations
in interest rates could reduce our profitability and affect the value of our
assets.
  Like
other financial institutions, we are subject to interest rate risk, which is the
primary market risk affecting our financial performance. Our primary source of
income is net interest income, which is the difference between interest earned
on loans and investments and the interest paid on deposits and borrowings. We
expect that we will periodically experience imbalances in the interest rate
sensitivities of our assets and liabilities and the relationships of various
interest rates to each other. Over any defined period of time, our
interest-earning assets may be more sensitive to changes in market interest
rates than our interest-bearing liabilities, or vice versa. In addition, the
individual market interest rates underlying our loan and deposit products (e.g.,
prime) may not change to the same degree over a given time period. In any event,
if market interest rates should move contrary to our position, our earnings may
be negatively affected. In addition, loan volume and quality and deposit volume
and mix can be affected by market interest rates. Changes in levels of market
interest rates could materially and adversely affect our net interest spread,
asset quality, origination volume and overall profitability. We currently
believe that declining interest rates will adversely affect our results of
operations.
  We
principally manage interest rate risk by managing our volume and mix of our
earning assets and funding liabilities. In a changing interest rate environment,
we may not be able to manage this risk effectively. If we are unable to manage
interest rate risk effectively, our business, financial condition and results of
operations could be materially harmed.
  Changes
in the level of interest rates also may negatively affect our ability to
originate real estate loans, the value of our assets and our ability to realize
gains from the sale of our assets, all of which ultimately affect our
earnings.
  Our
investment portfolio includes securities that are sensitive to interest rates
and variations in interest rates may adversely impact our
profitability.
  Our
securities portfolio includes securities which are insured or guaranteed by U.S.
government agencies or government-sponsored enterprises, and other securities
which are sensitive to interest rate fluctuations. The unrealized gains or
losses in our available-for-sale portfolio are reported as a separate component
of stockholders’ equity until realized upon sale. As a result, future interest
rate fluctuations may impact stockholders’ equity, causing material fluctuations
from quarter to quarter. Failure to hold our securities until maturity or until
market conditions are favorable for a sale could adversely affect our financial
condition, profitability and prospects.
  Our
ability to service our debt, pay dividends and otherwise pay our obligations as
they come due is substantially dependent on capital distributions from Cascade
Bank, and these distributions are subject to regulatory limits and other
restrictions.
  A
substantial source of our income from which we service our debt, pay our
obligations and from which we can pay dividends is the receipt of dividends from
Cascade Bank. The availability of dividends from Cascade Bank is limited by
various statutes and regulations. It is possible, depending upon the financial
condition of Cascade Bank, and other factors, that the applicable regulatory
authorities could assert that payment of dividends or other payments is an
unsafe or unsound practice. If Cascade Bank is unable to pay dividends to us, we
 29
 may not
be able to service our debt, pay our obligations or pay dividends on our common
stock. The inability to receive dividends from Cascade Bank would adversely
affect our business, financial condition, results of operations and
prospects.
  Cascade’s
Controls and Procedures May Fail or be Circumvented.
  Management
regularly reviews and updates Cascade’s internal controls, disclosure controls
and procedures, and corporate governance policies and procedures. Any system of
controls, however well designed and operated, is based in part on certain
assumptions and can provide only reasonable, not absolute, assurances that the
objectives of the system are met. Any failure or circumvention of Cascade’s
controls and procedures or failure to comply with regulations related to
controls and procedures could have a material adverse effect on Cascade’s
financial condition and results of operations.
  Cascade
May be Required to Pay Significantly Higher Federal Deposit Insurance
Corporation (FDIC) Premiums in the Future.
  The Bank
may be required to pay significantly higher FDIC insurance premiums due to the
Bank’s participation in the FDIC’s Temporary Liquidity Guarantee Program and
other EESA programs and because market developments have significantly depleted
the insurance fund of the FDIC and reduced the ratio of reserves to insured
deposits. Any increase in insurance premiums will reduce the profitability of
Cascade.
  Cascade
Continually Encounters Technological Change.
  The
financial services industry is continually undergoing rapid technological change
with frequent introductions of new technology-driven products and services. The
effective use of technology increases efficiency and enables financial
institutions to better serve customers and to reduce costs. Cascade’s future
success depends, in part, upon its ability to address the needs of its customers
by using technology to provide products and services that will satisfy customer
demands, as well as to create additional efficiencies in Cascade’s operations.
Many of Cascade’s competitors have substantially greater resources to invest in
technological improvements. Cascade may not be able to effectively implement new
technology-driven products and services or be successful in marketing these
products and services to its customers. Failure to successfully keep pace with
technological change affecting the financial services industry could have a
material adverse effect on Cascade’s financial condition and results of
operations.


Item
1B.  Unresolved Staff Comments
  None




The
Corporation owns nine full service branch locations and leases twelve full
service locations. Owned offices range in size from 3,500 to 52,000 square feet
and have a total net book value at December 31, 2008, including leasehold
improvements, furniture and fixtures, of $15.5 million. The Corporation leases
approximately 5% of its main office, approximately 25% of its Marysville office,
and 50% of its Issaquah West office to non-affiliated parties.  See
Note 5 of the Notes to the Consolidated Financial Statements contained in the
Annual Report which is listed in Item 15.




Item 3.  Legal
Proceedings




The
Corporation is not engaged in any legal proceedings of a material nature at the
present time.  Periodically, there have been various claims and
lawsuits involving the Corporation and the Bank, principally as a defendant,
such as claims to enforce liens, condemnation proceedings on properties in which
the Bank holds security interests, claims involving the making and servicing of
real property loans and other issues incident to the Corporation’s
business.  In the opinion of management and the Corporation’s legal
counsel, no significant loss is expected from any of such pending claims or
lawsuits.




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




None.


30


PART
II




Item 5.  Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities





(a)
            Cascade
      Financial Corporation’s common stock is traded on the NASDAQ/Global Select
      Market under the symbol CASB. The table below indicates the high/low
      trading range of Cascade stock over the last eight quarters:


Quarter
      Ended
                
                High
                
                
                LowMarch
      31, 2007
                
                $
                18.25
                
                
                $
                16.61June
      30, 2007
                
                
                17.54
                
                
                
                15.65September
      30, 2007
                
                
                16.75
                
                
                
                14.33December
      31, 2007
                
                
                16.32
                
                
                
                12.80March
      31, 2008
                
                $
                14.36
                
                
                $
                11.88June
      30, 2008
                
                
                12.18
                
                
                
                6.51September
      30, 2008
                
                
                9.62
                
                
                
                5.62December
      31, 2008
                
                
                7.98
                
                
                
                4.89





(b)
            Cascade
      Financial Corporation has two classes of stock outstanding, which are
      preferred and common stock.  On November 24, 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 company issued 38,970 shares of Series A Fixed-Rate
      Cumulative Perpetual Preferred Stock, and a warrant to purchase 863,442
      shares of the company’s common stock at an exercise price of $6.77 per
      share.  At December 31, 2008, there were 12,071,032 common
      shares outstanding which were held of record by approximately 2,600
      shareholders.


(c)
            The
      Table below indicates the cash dividends paid on each share of its common
      stock for the past two years:





Quarter
      Ended
                  
                  Dividend
      Declared
                  
                  Record
      Date
                  Payment
      DateDecember
      2006
                  
                  $
                  0.080
                  
                  1/11/07
                  1/25/07March
      2007
                  
                  
                  0.080
                  
                  4/11/07
                  4/25/07June
      2007
                  
                  
                  0.080
                  
                  7/11/07
                  7/25/07September
      2007
                  
                  
                  0.090
                  
                  10/10/07
                  10/24/07December
      2007
                  
                  $
                  0.090
                  
                  1/10/08
                  1/24/08March
      2008
                  
                  
                  0.090
                  
                  4/11/08
                  4/23/08June
      2008
                  
                  
                  0.090
                  
                  7/14/08
                  7/28/08September
      2008
                  
                  
                  0.045
                  
                  10/15/08
                  10/29/08




31





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





32


Shareholder Return
Performance Graph





The
following graph compares the Company's cumulative shareholder return on its
common stock with the return on the NASDAQ Composite Index and a peer group of
the NASDAQ's OTC Bank Index. Total return assumes (i) the reinvestment of all
dividends and (ii) the value of the investment in the Company's common stock and
each index was $100 at the close of trading on December 31, 2003.





12/31/03
                
                
                12/31/04
                
                
                12/31/05
                
                
                12/31/06
                
                
                12/31/07
                
                
                12/31/08Cascade
      Financial Corporation
                
                
                100.00
                
                
                
                97.01
                
                
                
                91.59
                
                
                
                110.10
                
                
                
                87.72
                
                
                
                34.96NASDAQ
      Composite Index
                
                
                100.00
                
                
                
                108.57
                
                
                
                110.08
                
                
                
                120.56
                
                
                
                132.39
                
                
                
                78.72NASDAQ
      Bank Index
                
                
                100.00
                
                
                
                110.99
                
                
                
                106.18
                
                
                
                118.34
                
                
                
                91.85
                
                
                
                69.88




Item 6.  Selected
Financial Data




The
information contained in the section entitled “Selected Financial Data” of the
Annual Report listed in Item 15 is incorporated herein by
reference.




Item
7.  Management’s Discussion and Analysis of Financial Condition and
Results of Operations




The
information contained in the section entitled “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” of the Annual Report
listed in Item 15 is incorporated herein by reference.




Item
7A.  Quantitative and Qualitative Disclosures About Market
Risk




The
information contained under the section captioned “Market Risk” in the
Management’s Discussion and Analysis section of the Annual Report listed in Item
15 is incorporated herein by reference.




Item 8.  Financial
Statements and Supplementary Data




The
financial statements and supplementary data in the Annual Report listed in Item
15 is incorporated herein by reference.


33


Item 9.  Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure




None.




Item 9A.  Controls
and Procedures




(a)
            Evaluation
      of Disclosure Controls and Procedures:  An evaluation of the
      Corporation's disclosure controls and procedures (as defined in section
      13(a) - 14(c) of the Securities Exchange Act of 1934 (the "Act")) was
      carried out under the supervision and with the participation of the
      Corporation's Chief Executive Officer, Chief Financial Officer and several
      other members of the Corporation's senior management effective December
      31, 2008. The Corporation's Chief Executive Officer and Chief


Financial
      Officer concluded that the Corporation's disclosure controls and
      procedures as currently in effect are effective in ensuring that the
      information required to be disclosed by the Corporation in the reports it
      files or submits under the Act is (i) accumulated and communicated to the
      Corporation's management (including the Chief Executive Officer and Chief
      Financial Officer) in a timely manner, and (ii) recorded, processed,
      summarized and reported within the time periods specified in the Security
      and Exchange Commission’s (“the SEC’s”) rules and forms.(b)
              Changes
      in Internal Controls: In the year ended December 31, 2008, the Corporation
      did not make any significant changes in, nor take any corrective actions
      regarding, its internal controls or other factors that could significantly
      affect these controls.





Disclosure Controls and Internal
Controls.  Disclosure controls are procedures that are designed
with the objective of ensuring that information required to be disclosed in the
Corporation's reports filed under the Act is recorded, processed, summarized and
reported within the time periods specified in the SEC’s rules and
forms.  Disclosure controls are also designed with the objective of
ensuring that such information is accumulated and communicated to our
management, as appropriate to allow timely decisions regarding required
disclosure. Internal Controls are procedures which are designed with the
objective of providing reasonable assurance that (1) transactions are properly
authorized; (2) assets are safeguarded against unauthorized or improper use; and
(3) transactions are properly recorded and reported, all to permit the
preparation of financial statements in conformity with generally accepted
accounting principles.





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





Management’s Report on Internal
Control over Financial Reporting.Management of Cascade
Financial Corporation is responsible for preparing the Corporation’s annual
financial statements. Management is also responsible for establishing and
maintaining effective internal control over financial reporting presented in
conformity with both accounting principles generally accepted in the United
States of America and regulatory reporting in conformity with the Federal
Financial Institutions Examination Council Instructions for Consolidated Reports
of Condition and Income (call report instructions). The Corporation’s internal
controls contain monitoring mechanisms, and actions are taken to correct
deficiencies identified.





There are
inherent limitations in the effectiveness of any internal control, including the
possibility of human error and the circumvention or overriding of controls.
Accordingly, even effective internal control can provide only reasonable
assurance with respect to financial statement preparation. Further, because of
changes in conditions, the effectiveness of internal control may vary over
time.


34


It is
also management’s responsibility to ensure satisfactory compliance with all
designated laws and regulations, and in particular, those laws and regulations
concerning loans to insiders and dividend restrictions.





Management
assessed the Corporation’s internal control over financial reporting presented
in conformity with both U.S. generally accepted accounting principles and call
report instructions as of December 31, 2008. This assessment was based on
criteria for effective internal control over financial reporting described in
Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on this assessment, management believes that, as
of December 31, 2008, the Corporation maintained effective internal control over
financial reporting presented in conformity with both accounting principles
generally accepted in the United States of America and call report
instructions.  Management also believes that there was satisfactory
compliance during 2008 with the designated laws and regulations.





The
Company’s registered public accounting firm has audited the Company’s
consolidated financial statements as of and for the year ended December 31,
2008 that are included in this annual report and issued their Report of
Independent Registered Public Accounting Firm, listed in Item 15, which includes
an attestation report on the Company’s internal control over financial
reporting. The attestation report expresses an unqualified opinion on the
effectiveness of the Company’s internal controls over financial reporting as of
December 31, 2008.








Item 9B.  Other
Information




None.


35


PART
III




Item
10.  Directors, Executive Officers and Corporate
Governance




The
information contained under the section captioned “Proposal I--Election of
Directors” contained in the Corporation’s Definitive Proxy Statement for the
Corporation’s Annual Meeting of Stockholders (the “Proxy Statement”), is
incorporated herein by reference.  Reference is made to the cover page
of this report for information regarding compliance with Section 16(a) of the
Exchange Act, and to the section therein captioned “COMPLIANCE WITH SECTION
16(A) OF THE EXCHANGE ACT”.




The
following table sets forth information with respect to the executive officers of
the Corporation and the Bank.




Name
              Age
      (a)
              PositionCarol
      K. Nelson (b)
              53
              President,
      Chief Executive Officer and Director of Cascade Bank and Cascade Financial
      CorporationRobert
      G. Disotell
              54
              Executive
      Vice President, Chief Credit OfficerSteven
      R. Erickson(b)
              53
              Executive
      Vice President, Real Estate LendingLars
      H. Johnson(b)
              55
              Executive
      Vice President, Chief Financial OfficerLeAnne
      M. Harrington
              39
              Executive
      Vice President, Chief Administrative OfficerDebbie
      E. McLeod
              43
              Executive
      Vice President, Retail
Banking





(a)      At
December 31, 2008.


(b)      Officer
of the Corporation and Bank.





The
principal occupation of each executive officer of the Corporation and Bank is
set forth in the Proxy Statement or below. There are no family relationships
among or between the executive officers listed above.




CAROL K.
NELSON was appointed Chief Executive Officer of the Company commencing May 1,
2002.  She has served as President of the Company and President and
Chief Executive Officer of the Bank since February 2001.  She was
previously Senior Vice President and Northern Region Executive of Bank of
America from 1996 to 2001.  Ms. Nelson holds a Bachelor’s degree in
Business Finance and a Master’s degree in Business Administration from Seattle
University.  Ms. Nelson serves on the Board of Directors of the
Seattle Branch of the Federal Reserve Bank of San Francisco, the Washington
Roundtable, the Washington State Major League Baseball Stadium Public Facilities
District, Premera Blue Cross and the Washington Bankers Association where she
recently concluded a successful year as chair.  She also serves as a
Trustee for Seattle University.  In 2007, Ms. Nelson was appointed to
chair the Governor’s Task Force on Homeowner Security.  Ms. Nelson
serves as Vice Chair of the Company’s Executive Committee and as a member of the
Bank’s Loan Committee.  She is a resident of Edmonds,
Washington.





ROBERT G.
DISOTELL has been employed by Cascade Bank since 1977 and has served as
Executive Vice President of the Credit Administration Division and Chief Credit
Officer since February 2001. He is responsible for managing Credit Underwriting,
Special Assets, Loan Servicing and Credit Operations including overseeing the
credit quality of the Bank’s loan portfolios.  Mr. Disotell has
managed a variety of business groups in his tenure at Cascade, including
Mortgage Banking, Secondary Marketing, Retail Banking, and Community
Reinvestment Act (CRA) activities. Mr. Disotell is a resident of Arlington,
Washington.




STEVEN R.
ERICKSON is the Executive Vice President and Commercial Banking Executive for
the Bank. He is responsible for managing commercial and income property lending
and serves as the Assistant Secretary for the Corporation. Mr. Erickson joined
Cascade in 1978. He is a member of the Board for Big Brothers and Big Sisters of
Snohomish County, Advisory Board Member for Snohomish County’s Pre-Diversion
Program, and past board member of the Boys and Girls Club of Snohomish
County.  He is a resident of Marysville, Washington.


36


LARS H.
JOHNSON is the Executive Vice President, Chief Financial Officer of the Bank and
Corporation and also serves as the corporate secretary.  Mr. Johnson
joined Cascade in April 2000.  Mr. Johnson has 33 years of financial
management experience, including 16 years with the Federal Home Loan Bank of
Seattle. He serves as Treasurer of the Downtown Everett Association. Mr. Johnson
is a resident of Edmonds, Washington.




LEANNE M.
HARRINGTON is the Executive Vice President and Chief Administrative Officer for
the Bank.  She has 22 years of banking experience starting with
Rainier Bank and Bank of America, where she served as Vice President and Region
Service Manager. Ms. Harrington joined Cascade in February 2001. She is a 2006
graduate of Pacific Coast Banking School and a member of the Board for the
Snohomish County Red Cross. Ms. Harrington is a resident of Everett,
Washington.




DEBBIE E.
McLEOD is Executive Vice President of Retail Banking for the
Bank.  Ms. McLeod joined Cascade Bank in February 2001.  She
has over 20 years of commercial banking experience and was previously Vice
President and Northern Region Sales Manager for Bank of America. Ms. McLeod is
the current Board Chair for United Way of Snohomish County and she serves on the
Board of the United Way of Skagit County. Ms. McLeod resides in Burlington,
Washington.




Item
11.  Executive Compensation




The
information contained under the section captioned “Executive Compensation” in
the Proxy Statement is incorporated herein by reference.




Item 12.  Security
Ownership of Certain Beneficial Owners and Management




(a)
              Security
      Ownership of Certain Beneficial Owners
                
                Information
      required by this Item is incorporated herein by reference to the section
      captioned “Security Ownership of Certain Beneficial Owners and Management”
      in the Proxy Statement.(b)
              Security
      Ownership of Management
                
                The
      information required by this Item is incorporated herein by reference to
      the section captioned “Security Ownership of Certain Beneficial Owners and
      Management” of the Proxy Statement.(c)
              Changes
      in Control




The
Corporation is not aware of any arrangements, including any pledge by any person
of securities of the Corporation, the operation of which may at a subsequent
date result in a change in control of the Corporation.




Item 13.  Certain
Relationships and Related Transactions, and Director
Independence




The
information required by this Item is incorporated herein by reference to the
section captioned “Transactions with Management and Others” of the Proxy
Statement.




Item
14.  Principal Accountant Fees and Services




The
information required by this Item is incorporated herein by reference to the
section captioned “INDEPENDENT AUDITORS” of the Proxy Statement.


37


PART
IV




Item
15.  Exhibits, Financial Statement Schedules




(a)
              (1)(2)
              Reports
      of Independent Registered Public Accounting Firm

                Consolidated
      Financial Statements(a)
              Consolidated Balance
      Sheets at December 31, 2008, and December 31, 2007.(b)
              Consolidated
      Statements of Income for the years ended December 31, 2008, 2007 and
      2006.(c)
              Consolidated
      Statements of Stockholders’ Equity and Comprehensive Income for the years
      ended December 31, 2008, 2007 and 2006.(d)
              Consolidated
      Statements of Cash Flows for the years ended December 31, 2008, 2007 and
      2006.(e)
              Notes to
      Consolidated Financial Statements.





All
schedules have been omitted, as the required information is either inapplicable
or contained in the Consolidated Financial Statements or related Notes contained
in the Annual Report.




Exhibit
      No.
              Exhibit3.1(i)
              Articles
      of Incorporation of Cascade Financial Corporation (incorporated by
      reference to exhibit A to the definitive proxy statement filed on March
      26, 2003 (File No. 000-25286)).3.2(i)
              Amendment
      to the Articles of Incorporation of Cascade Financial Corporation,
      including Statement of Designations for the Series A Preferred Stock
      (incorporated by reference to the registrant’s Form 8-K/A filed November
      26, 2008 (File No. 000-25286)).3.3(ii)
              Bylaws
      of Cascade Financial Corporation (incorporated by reference to the
      registrant’s registration statement on Form S-4 filed March 31, 2004 (File
      No. 333-114087)).3.4(ii)
              Amendment
      to the Bylaws of Cascade Financial Corporation (incorporated by reference
      to the Corporation’s Form 8-K filed September 27, 2005 (File No.
      0-25286)).4.1
              Form
      of Series A Preferred Stock Certificate (incorporated by reference to the
      Corporation’s Form 8-K/A filed November 26, 2008 (File No.
      000-25286)).4.2
              Warrant
      to purchase 863,442 shares of Common Stock issued on November 21, 2008
      (incorporated by reference to the registrant’s Form 8-K/A filed November
      26, 2008 (File No. 000-25286)).10.1
              Cascade
      Financial Corporation 1994 Employee Stock Purchase Plan (Incorporated by
      reference to the Corporation’s Registration Statement on Form S-4 (File
      No. 33-83200)).10.2
              Cascade
      Financial Corporation 1992 Stock Option and Incentive Plan (Incorporated
      by reference to the Corporation’s Form 10-KSB for the period ending June
      30, 1995).10.3
              Cascade
      Financial Corporation Employee Stock Ownership Plan (Incorporated by
      reference to the Corporation’s Annual Report on Form 10-KSB for the period
      ending June 30, 1995).10.4
              Cascade
      Financial Corporation 1997 Stock Option Plan (Incorporated by reference to
      Appendix E to the Prospectus included in the Corporation’s Registration
      Statement on Form S-4 (File No. 333-24203)).10.5
              Cascade
      Financial Corporation 1997 Elective Equity Plan. (Incorporated by
      reference to Exhibit 10.7 of the Corporation’s Form 10-K for the period
      ending December 31, 2001).10.8
              Cascade
      Bank Non-Qualified Deferred Compensation Plan dated February 1, 2008
      (Incorporated by reference to Exhibit 10.1 of the Corporation’s Form 8-K
      filed January 16, 2008 (File No. 000-25286)).10.9
              Letter
      Agreement, dated November 21, 2008, including Securities Purchase
      Agreement – Standard Terms, between the Company and the United States
      Department of the Treasury (Incorporated by reference to the Corporation’s
      Form 8-K/A filed November 26, 2008 (File No.
  000-25286)).10.10
              Form
      of Agreement to Amend Compensation Agreements with Senior Executive
      Officer, executed by Carol K. Nelson, Lars H. Johnson, Robert G. Disotell,
      LeAnne M. Harrington, Debbie E. McLeod, and Steven R. Erickson
      (Incorporated by reference to the Corporation’s Form 8-K/A filed November
      26, 2008 (File No. 000-25286)).13
              Cascade
      Financial Corporation December 31, 2008 Annual Report to Stockholders,
      including the Selected Financial Data and Management Discussion and
      Analysis.21
              Subsidiaries.23
              Consent
      of Independent Registered Public Accounting Firm – Moss Adams
      LLP.31.1
              Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.31.2
              Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.32
              Certification
      of Annual Report on Form 10-K pursuant to Section 906 of the
      Sarbanes-Oxley Act of
2002.
  (b)   Reports
on Form 8-K




On October 21, 2008, the Corporation
filed a Form 8-K reporting an attached press release announcing earnings
information for the third quarter ended December 31, 2008, under Items 2.02 and
9.01 of Form 8-K.





On September 9, 2008, the Corporation
filed a Form 8-K announcing the potential loss on the Company’s investments in
Fannie Mae and Freddie Mac preferred stock, under Items 8.01of Form
8-K.





On November 3, 2008, the Corporation
filed a Form 8-K announcing preliminary approval from the U.S. Treasury
Department to participate in its Capital Purchase Program under the Emergency
Economic Stabilization Act of 2008, under Items 8.01 and 9.01 of Form
8-K.


38


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





On
November 25, 2008, the Corporation filed a Form 8-K announcing that the company
had completed its $39 million capital raise as a participant in the U.S.
Department of the Treasury’s Capital Purchase Program, under Items 1.01, 3.02,
3.03, 5.02 and 5.03 of Form 8-K.





On
November 26, 2008, the Corporation filed a Form 8-K/A amending the current
report on Form 8-K reporting the Company’s participation in the U.S. Department
of the Treasury’s Capital Purchase program which was filed on November 25, 2008
but inadvertently failed to attach the required exhibits, under Item 9.01of Form
8-K/A.





On
December 19, 2008, the Corporation announced that the Company filed a shelf
registration statement on Form S-3. The shelf registration statement, when
declared effective by the SEC, registers the shares of series A preferred and
the warrant the Company issued to the U.S. Treasury on November 21, 2008 for
$38,970,000, and the 863,442 shares of common stock reserved for exercise of the
warrant, and will allow the Company to raise up to $60 million of
additional capital from time to time, through the sale of common stock,
preferred stock, senior debt securities, subordinated debt securities, purchase
contracts, units, warrants and rights, under Item 8.01 of Form S-3.





On January 27, 2009, the Corporation
filed a Form 8-K reporting an attached press release announcing earnings
information for the fourth quarter ended December 31, 2008, under Items 2.02 and
9.01 of Form 8-K.


39


SIGNATURES




Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.






CASCADE FINANCIAL
      CORPORATIONDate:  March
      12, 2009
              By:
              /s/ Carol K.
      NelsonCarol
      K. NelsonPresident and
      Chief Executive Officer








Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.




By:
                /s/ Lars H. Johnson
                
                By:
                /s/ D. R. MurphyLars
      H. Johnson
                  Executive
      Vice President
                  (Chief
      Financial Officer)
                
                
                D.
      R. Murphy
                  ChairmanDate:
                March
      12, 2009
                
                Date:
                March
      12, 2009By:
                /s/ David W. Duce
                
                By:
                /s/ Ronald E ThompsonDavid
      W. Duce
                  Director
                
                
                Ronald
      E. Thompson
                  DirectorDate:
                March
      12, 2009
                
                Date:
                March
      12, 2009By:
                /s/ Janice Halladay
                
                By:
                /s/ G. Brandt WestoverJanice
      Halladay
                  Director
                
                
                G.
      Brandt Westover
                  DirectorDate:
                March
      12, 2009
                
                Date:
                March
      12, 2009By:
                /s/ Craig Skotdal
                
                By:
                /s/ Dwayne LaneCraig
      Skotdal
                  Director
                
                
                Dwayne
      Lane
                  DirectorDate:
                March
      12, 2009
                
                Date:
                March
      12, 2009By:
                /s/ David O’Connor
                
                By:
                /s/ Richard AndersonDavid
      O’Connor
                  Director
                
                
                Richard
      Anderson
                  DirectorDate:
                March
      12, 2009
                
                Date:
                March
      12, 2009By:
                /s/ Katherine M. Lombardo
                
                By:
                /s/ Jim GaffneyKatherine
      M. Lombardo
                  Director
                
                
                Jim
      Gaffney
                  DirectorDate:
                March
      12, 2009
                
                Date:
                March
      12, 2009




40