The following discussion is intended to assist in understanding the financial condition and results of the Corporation. The information contained in this section should be read with the unaudited condensed consolidated financial statements and accompanying notes included in this Quarterly Report, and the December 31, 2008 audited consolidated financial statements and accompanying notes included in our recent Annual Report on Form 10-K.

Forward-Looking Statements
Certain of the statements contained herein that are not historical facts are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995, that are subject to risks and uncertainties that could cause actual results to differ materially from those projected. 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 of the Corporation of an FFIEC policy that provides guidance on the reporting of delinquent consumer loans and the timing of associated credit charge-offs for financial institution subsidiaries; and the resolution of legal proceedings and related matters. In addition, the banking industry in general is subject to various monetary and fiscal policies and regulations, which include those determined by the Federal Reserve Board, the Federal Deposit Insurance Corporation, and state regulators, whose policies and regulations could affect the Corporation's results. These and other important factors, including those discussed in our December 31, 2008 Form 10-K, filed with the Securities and Exchange Commission, under the headings "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business," and those discussed in this Form 10-Q under Part II, Item 1A "Risk Factors" below, may cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. These statements are representative only on the date hereof, and the Corporation undertakes no obligation to update any forward-looking statements made.

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

Selected Financial Data

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

                                              At or for the three           At or for the six
                                                 months ended                  months ended
                                                   June 30,                      June 30,
                                              2009           2008          2009           2008
Return on average assets (2)                    (5.33 )%        0.96 %       (3.26 )%        0.84 %
Return on average equity (2)                   (60.08 )        11.57        (34.78 )        10.01
Average stockholders' equity to average
assets                                           8.86           8.27          9.37           8.37
Other expenses to average assets (1) (2)         2.49           1.90          2.21           1.89
Efficiency ratio                               166.33          53.07        108.96          53.35
Efficiency ratio (excluding goodwill
charge)                                         76.63          53.07         66.92          53.35
Average interest-bearing assets to
average interest-bearing liabilities           104.77         111.60        106.27         111.67

(1) Excludes an $11.7 million goodwill impairment charge.
(2) Annualized.

Total assets decreased 1.6% or $26.6 million to $1.61 billion at June 30, 2009, compared to $1.64 billion at December 31, 2008. Net loans, i.e. net of deferred loan fees and the allowance for loan losses, decreased 3.2% or $39.7 million to $1.20 billion at June 30, 2009, from $1.24 billion at December 31, 2008.

Total investment securities increased $21.9 million to $278.1 million at June 30, 2009, compared to $256.2 million at December 31, 2008. The investment portfolio is concentrated in securities issued by Government Sponsored Enterprises (GSEs, e.g. FNMA or FHLMC) as well as mortgage-backed pass-through securities and collateralized mortgage obligations backed by pools of single family residential mortgages (known collectively as MBS). All investment purchases during the six months ended June 30, 2009, were rated AAA in terms of credit quality by Moody's and/or Standard & Poors. All MBS and GSE debt securities in the portfolio as of June 30, 2009, were also rated AAA.

During the quarter the available-for-sale portfolio grew by $31.5 million and the held-to-maturity portfolio declined by $38.0 million. $36.1 million of the decline was a result of calls of agency notes and $1.9 million represented pay downs on MBS. Purchases resulting from the proceeds from calls, in addition to the incremental purchases, were all designated available-for-sale to increase flexibility in managing the portfolio.

(Dollars in
thousands)                                                     June 30, 2009
                                         Gross            Gross           Gross            Gross
                                       unrealized      unrealized       unrealized      unrealized
                                         gains            gains           losses          losses
                       Amortized       less than        more than       less than        more than          Fair
                          cost           1 year          1 year           1 year          1 year           value
Securities
available-for-sale
MBS                    $   48,502     $        529     $         -     $       (532 )   $      (182 )   $  48,317
Agency notes              171,465              529               -           (2,560 )             -       169,434
US Treasury note           10,079               94               -                -               -        10,173
Total                  $  230,046     $      1,152     $         -     $     (3,092 )   $      (182 )   $ 227,924

(Dollars in thousands)                                                 June 30, 2009
                                                 Gross             Gross             Gross            Gross
                                               unrealized       unrealized        unrealized        unrealized
                                                 gains             gains            losses            losses
                               Amortized       less than         more than         less than        more than          Fair
                                 cost            1 year           1 year            1 year            1 year          value
Securities held-to-maturity
MBS                           $    17,581     $        394     $          20     $           -     $        (41 )   $   17,954
Agency notes                       19,887               45                 -                (1 )              -         19,931
Corporate/other                       775                -                 -                 -                -            775
Total                         $    38,243     $        439     $          20     $          (1 )   $        (41 )   $   38,660



                                                                       December 31, 2008
                                                   Gross             Gross             Gross            Gross
                                                 unrealized        unrealized        unrealized      unrealized
                                                   gains             gains             losses          losses
                                 Amortized       less than         more than         less than        more than         Fair
                                   cost            1 year            1 year            1 year          1 year          value
Securities available-for-sale
MBS                             $    42,250     $        288     $            -     $       (281 )   $      (405 )   $   41,852
Agency notes                         81,149              368                  -             (145 )             -         81,372
Corporate/other                       1,294                -                  -             (840 )             -            454
Total                           $   124,693     $        656     $            -     $     (1,266 )   $      (405 )   $  123,678




                                                                   December 31, 2008
                                                Gross            Gross            Gross           Gross
                                              unrealized       unrealized      unrealized       unrealized
                                                gains            gains           losses           losses
                              Amortized       less than        more than        less than       more than         Fair
                                 cost           1 year           1 year          1 year           1 year          value
Securities held-to-maturity
MBS                           $   20,484     $        195     $         14     $      (139 )   $         (9 )   $  20,545
Agency notes                      99,335              442                -            (396 )              -        99,381
Corporate/other                      775                -                -               -                -           775
Total                         $  120,594     $        637     $         14     $      (535 )   $         (9 )   $ 120,701

In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. This FSP amends the other-than-temporary impairment guidance in U.S. GAAP for debt securities. The goal is to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities.

Certain securities shown above currently have fair values less than amortized cost, and therefore, contain unrealized losses. In the opinion of management, these securities are considered only temporarily impaired due to changes in market interest rates and/or the widening of market spreads subsequent to the initial purchase of the securities or to disruptions to credit markets. Since all these securities are rated AAA, this temporary impairment is not due to concerns regarding the underlying credit of the issuers or the underlying collateral.

Management evaluates securities and FHLB stock for other-than-temporary impairment at least on an annual basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to: (1) whether we expect to recover the amortized cost basis of the security, (2) the timely payment of principle and interest as due, (3) the financial condition and near term prospects of the issuer, (4) the length of time and extent to which the fair value has been less than cost, (5) our intent and ability to retain a security

As of June 30, 2009, the Bank held five securities in its available-for-sale portfolio and one in its held-to-maturity portfolio that have had an unrealized loss for more than one year. We have the intent and ability to hold the investments below market value for the period of time management believes to be sufficient for a market price recovery. All securities held in the portfolio are currently rated AAA. We hold no securities that are backed by sub-prime loans or collateralized debt obligations.

At June 30, 2009, the Bank held FHLB of Seattle stock with a par value of $11.9 million. The Corporation does not anticipate any impairment charges associated with these instruments. According to the AICPA Audit Guide, FHLB stock does not have readily determinable fair value for purposes of FASB Statement of Position 01-6, Accounting by Certain Entities (Including Entities with Trade Receivables) that Lend to or Finance the Activities of Others, and the equity ownership rights are more limited than would be the case for a public company because of the FHFA's oversight role in budgeting and approving dividends. FHLB stock is generally viewed as a long-term investment and as a restricted investment security, which is carried at cost. Thus, when evaluating FHLB stock for impairment, its value should be determined based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value.

Under Federal Housing Finance Agency Regulations, a Federal Home Loan Bank that fails to meet any regulatory capital requirement may not declare a dividend or redeem or repurchase capital stock in excess of what is required for members' current loans. Moody's Investors Service's (Moody's) current assessment of the FHLB's portfolios indicates that the true economic losses embedded in these securities are significantly less than the accounting impairments would suggest and are manageable given the FHLB's capital levels. According to Moody's, the large difference between the expected economic losses and the mark-to-market impairment losses for accounting purposes is attributed to market illiquidity, de-leveraging and stress in the credit market in general. Furthermore, Moody's believes that the FHLBs have the ability to hold the securities until maturity. The FHLBs have access to the U.S. Government-Sponsored Enterprise Credit Facility, a secured lending facility that serves as a liquidity backstop, substantially reducing the likelihood that the FHLBs would need to sell securities to raise liquidity and, thereby, cause the realization of large economic losses. In addition, the Federal Reserve has begun to purchase direct debt obligations of Freddie Mac, Fannie Mae and the FHLBs. Moody's has stated that their AAA senior debt rating and Prime-1 short-term debt rating are likely to remain unchanged based on expectations that the FHLBs have a very high degree of government support. Based on the above, the Corporation has determined there is not an other-than-temporary impairment on the FHLB stock investment as of June 30, 2009.

Loan Portfolio

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

Home equity loans are primarily second mortgages on the borrower's primary residence. Consumer loans are non-residential, i.e. automobiles, credit cards or boats.

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

(Dollars in thousands)                                                             December 31,
                                           June 30, 2009       % of Portfolio          2008          % of Portfolio
Business                                  $       467,923                 38.2 %   $    485,060                 38.6 %
R/E construction(1)                               296,931                 24.2          406,505                 32.3
Commercial R/E                                    192,886                 15.7          122,951                  9.8
Multifamily                                        91,554                  7.5           86,864                  6.9
Home equity/consumer                               30,919                  2.5           30,772                  2.4
Residential(2)                                    146,231                 11.9          126,089                 10.0
Total loans                               $     1,226,444                100.0 %   $  1,258,241                100.0 %
Deferred loan fees                                 (2,928 )                              (3,069 )
Allowance for loan losses                         (24,490 )                             (16,439 )
Loans, net                                $     1,199,026                          $  1,238,733

(1) Real estate construction loans exclude loans in process.

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

Net loans decreased by $39.7 million to $1.20 billion as of June 30, 2009, compared to $1.24 billion at December 31, 2008. Total originations exceeded payoffs by $1.0 million. However, the transfer from the loan portfolio of $9.4 million to REO, charge-offs of $23.8 million and an increase in the allowance for loan losses of $8.1 million resulted in the lower net loan total.

Within the portfolio, reclassifications from the construction portfolio to commercial real estate of $60.1 million, multifamily of $6.8 million and residential of $3.3 million combined with charge-offs of $23.8 million, transfers of $9.4 million to REO, and payoffs of $7.0 million, reduced the construction portfolio by $109.6 million. In those cases, the reclassified loans were secured by projects that had been completed and began to generate sufficient cash flow to justify the move.

 (Dollars in
thousands)         Balance at        Net new                                                                             Balance at
                    June 30,         loans -                                      Transfers                             December 31,
Loans                 2009           payments        Reclassifi-cations (2)         to REO         Charge-offs (1)          2008             Change
Business           $   467,923     $    (16,541 )   $                      -     $          -     $            (596 )   $     485,060               -4 %
R/E construction       296,931           (6,969 )                    (70,261 )         (9,384 )             (22,960 )         406,505              -27 %
Commercial R/E         192,886            9,793                       60,142                -                     -           122,951               57 %
Multifamily             91,554           (2,121 )                      6,811                -                     -            86,864                5 %
Home
equity/consumer         30,919              393                            -                -                  (246 )          30,772                0 %
Residential            146,231           16,834                        3,308                -                     -           126,089               16 %
Total loans        $ 1,226,444     $      1,389     $                      -     $     (9,384 )   $         (23,802 )   $   1,258,241               -3 %
Deferred loan
fees                    (2,928 )            475                         (334 )              -                     -            (3,069 )             -5 %
Allowance for
loan losses            (24,490 )        (32,175 )                        313                -                23,811           (16,439 )             49 %
Loans, net         $ 1,199,026     $    (30,311 )   $                    (21 )   $     (9,384 )   $               9     $   1,238,733               -3 %

(1) Excludes negative now accounts totaling $132,000 and recoveries of $123,000.

(2) Transferred $21,000 to off-balance sheet general valuation allowance.

Deposits, Other Borrowings, and Stockholders' Equity

Total deposits decreased by $5.5 million to $1.0 billion at June 30, 2009 compared to December 31, 2008. However, the mix shifted to a greater percentage of checking account balances. Savings and money market accounts (MMDA) decreased $71.3 million. Municipalities reduced their balances by $56.1 million as the Bank sought to reduce and realign its level of public deposits in light of the $368,000 assessment paid by the Bank in the first quarter. This assessment by the Washington Public Deposit Protection Commission was used to cover the uninsured deposits associated with the failure of the Bank of Clark County. CDs decreased $34.0 million to $581.9 million as the balance on brokered CDs declined $62.1 million to $189.9 million.

Checking account deposits increased as the Bank continued to focus its sales activities on deposit generation in general and checking/transaction accounts in particular. Total checking account balances increased by $99.8 million between December 31, 2008 and June 30, 2009. Of that increase, approximately $39.0 million represented the migration of municipal deposits to FDIC insured accounts from CDs and MMDAs that had exceeded the FDIC's insurance limit.

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

                                                                                  December 31,
 (Dollars in thousands)                    June 30, 2009       % of Deposits          2008          % of Deposits
Checking accounts                         $       286,655                28.6 %   $    186,843                18.5 %
Savings & MMDA                                    132,704                13.3          204,035                20.3
CDs                                               581,937                58.1          615,904                61.2
Total                                     $     1,001,296               100.0 %   $  1,006,782               100.0 %

FHLB advances were $249.0 million at December 31, 2008 and $239.0 million at June 30, 2009. Securities sold under agreements to repurchase were $146.4 million at December 31, 2008, and $146.6 at June 30, 2009. Cascade participates in the Federal Reserve's term auction facility (TAF) and had a balance of $40.0 million at December 31, 2008 and $60.0 million at June 30, 2009. The Bank uses FHLB advances, repurchase agreements and Federal Reserve borrowings to meet the cash flow and interest rate risk management needs of the Bank.

During the six months ended June 30, 2009, no Cascade common stock was repurchased under the Board approved stock repurchase plan, which expired May 31, 2009 and was not reauthorized. Accumulated other comprehensive loss increased to $1.4 million compared to a $660,000 loss at December 31, 2008, due to a general increase in interest rates.

Asset Quality

Nonperforming assets (nonperforming loans, REO and other repossessed assets) totaled $122.3 million and $41.7 million at June 30, 2009, and December 31, 2008, respectively. Nonperforming loans (NPLs) increased to $114.4 million at June 30, 2009, compared to $40.3 million at December 31, 2008. NPLs consist of loans on non-accrual, which includes most loans that are ninety days past due, and loans that management otherwise has serious reservations about the collectibility of all principal and interest owed within the time frame of the underlying notes. Of the $114.4 million, $100.4 million were real estate construction and land development loans, $12.7 million were commercial real estate, $550,000 were business loans, $275,000 were residential loans, $250,000 were multifamily, and $216,000 were consumer loans. The Bank had two loans totaling $10.0 million at June 30, 2009, which were 90 days or more past due and still accruing. These loans are both in the process of being assumed by qualified borrowers.

The increase in nonperforming loans during 2009 was primarily due to the deterioration in real estate construction portfolio, including land acquisition and development loans and land loans. The loans were made for land acquisition and development and/or residential real estate construction projects located in the Puget Sound region of Washington State. All loans are collateralized by the property which the loan was used to develop. Nonperforming spec construction loans increased by $8.5 million. Additions for the six months of $30.1 million were offset by $9.5 million in paydowns, $7.2 million in charge-offs and $4.8 million in transfers to REO. Included in the additions were two loans totaling $10.9 million. Nonperforming land acquisition and development loans increased by $37.3 million. Four loans added to this category during the period totaled $47.0 million. The totals were decreased by $5.8 million in charge-offs and $4.6 . . .