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                 At or for the
                                              Three Months Ended            Nine Months Ended
                                                September 30,                  September 30,
                                              2009          2008           2009           2008
Return on average assets (1)                     0.40 %       (1.69 )%       (2.02 )%       (0.03 )%
Return on average common equity (1)(2)           6.77        (20.69 )       (30.08 )        (0.39 )
Average stockholders' equity to average
assets                                           8.16          8.22           8.96           8.32
Other expenses to average assets (1)             1.94          6.30           3.14           3.40
Efficiency ratio                                56.41        161.61          63.39          92.66
Average interest-bearing assets to
average interest-bearing liabilities           102.42        109.24         104.96         110.56

(1) Annualized
(2) Excludes preferred stock.

Total assets increased 0.6% or $9.7 million to $1.65 billion at September 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 2.9% or $36.0 million to $1.20 billion at September 30, 2009, from $1.24 billion at December 31, 2008.

Total assets grew because the increase in interest-earning deposits more than offset the decline in net loans. Interest-earning deposits, which were all held at the Federal Reserve Bank, increased to $69.8 million as of September 30, 2009 compared to $10.9 million as of December 31, 2008. Cash in banks declined by $7.5 million over that time period as the Bank transferred its check clearing operations from a correspondent bank to the Federal Reserve Bank.

Total investment securities increased $24.8 million to $281.0 million at September 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 nine months ended September 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 September 30, 2009, were also rated AAA.

During the quarter, the available-for-sale portfolio grew by $14.2 million and the held-to-maturity portfolio declined by $11.3 million. Of this decline, $10.0 million was a result of calls of agency notes and $1.3 million represented paydowns 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.

Management evaluates securities and FHLB stock for other-than-temporary impairment quarterly. Consideration is given to: (1) whether the Bank expects to recover the amortized cost basis of the security, (2) the timely payment of principal 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, and (5) the Bank's intent and ability to retain a security for a period of time sufficient to allow for any anticipated recovery in fair value. The Corporation had no OTTI losses for the three months ended September 30, 2009, and $17.3 million for the three months ended September 30, 2008. The Corporation recognized $858,000 in OTTI losses for the nine months ended September 30, 2009 and $17.3 million for the nine months ended September 30, 2008.

At September 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 and the equity ownership rights are more limited than would be the case for a public company because of the Federal Housing Finance Agency's (FHFA) 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 FHFA 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 September 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 this 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.

Residential loans held in the Bank's portfolio are secured by single family residences. The Bank also originates longer term fixed rate residential loans, but sells most of those loans into the secondary market on a best efforts, servicing released basis. Beginning in 2009, the Bank has originated and holds loans generated under its Builder Loan Program, which offers attractive terms to qualified buyers of houses from builders financed by the Bank. As of September 30, 2009, the Bank held $33.1 million of these loans.

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)                      September                            December 31,
                                             30, 2009        % of Portfolio          2008          % of Portfolio
Business                                   $    473,546                 38.5 %   $    485,060                 38.6 %
R/E construction(1)                             284,888                 23.1          406,505                 32.3
Commercial R/E                                  193,652                 15.7          122,951                  9.8
Multifamily                                      84,029                  6.8           86,864                  6.9
Home equity/consumer                             31,455                  2.6           30,772                  2.4
Residential(2)                                  163,151                 13.3          126,089                 10.0
Total loans                                $  1,230,721                100.0 %   $  1,258,241                100.0 %
Deferred loan fees                               (3,204 )                              (3,069 )
Allowance for loan losses                       (24,749 )                             (16,439 )
Loans, net                                 $  1,202,768                          $  1,238,733

(1) Real estate construction loans are net of 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 $36.0 million to $1.20 billion as of September 30, 2009, compared to $1.24 billion at December 31, 2008. Total originations exceeded payoffs by $9.3 million. However, the transfer from the loan portfolio of $9.6 million to REO, net charge-offs of $27.2 million and an increase in the allowance for loan losses of $8.3 million resulted in the lower net loan balance.

Within the portfolio, reclassifications from the construction portfolio to commercial real estate of $59.6 million, multifamily of $6.8 million and residential of $6.2 million combined with charge-offs of $26.3 million, transfers of $9.6 million to REO, and payoffs of $13.1 million, reduced the construction portfolio by $121.6 million. In those cases, the reclassified loans were secured by projects that had been completed and have begun to generate sufficient cash flow to justify the reclassifications.

 (Dollars in
thousands)          Balance at                                                                                                    Balance at
                   September 30,     Net New Loans                                                                               December 31,
Loans                  2009           - Payments        Reclassifi-cations (2)       Transfers to REO       Charge-offs (1)          2008            Change
Business           $     473,546     $     (10,918 )   $                      -     $                -     $            (596 )   $     485,060            (2.4 )%
R/E construction         284,888           (13,097 )                    (72,607 )               (9,623 )             (26,290 )         406,505           (29.9 )
Commercial R/E           193,652            11,119                       59,582                      -                     -           122,951            57.5
Multifamily               84,029            (9,646 )                      6,811                      -                     -            86,864            (3.3 )
Home
equity/consumer           31,455               994                            -                    (10 )                (301 )          30,772             2.2
Residential              163,151            30,848                        6,214                      -                     -           126,089            29.4
Total loans        $   1,230,721     $       9,300     $                      -     $           (9,633 )   $         (27,187 )   $   1,258,241            (2.2 )
Deferred loan
fees                      (3,204 )             569                         (704 )                    -                     -            (3,069 )           4.4
Allowance for
loan losses              (24,749 )         (36,175 )                        686                      -                27,179           (16,439 )          50.6
Loans, net         $   1,202,768     $     (26,306 )   $                    (18 )   $           (9,633 )   $              (8 )   $   1,238,733            (2.9 )

(1) Excludes negative now accounts totaling $193,000 and recoveries of $201,000.

(2) Transferred $18,000 to off-balance sheet general valuation allowance.

Income Taxes

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

that includes the enactment date. These calculations are based on many complex factors including estimates of the timing of reversals of temporary differences, the interpretation of federal income tax laws, and a determination of the differences between the tax and the financial reporting basis of assets and liabilities. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax liabilities.

The Corporation maintains significant net deferred tax assets for deductible temporary differences, the largest of which relates to the allowance for loan losses which is approximately 86% of the Corporation's deferred tax assets. For income tax return purposes, only net charge-offs are deductible, not the provision for loan losses. This deferred tax asset has almost doubled this year due to increased levels of reserves for delinquent and non-accruing loans brought about by the downturn in the local residential real estate market and the nation wide recession.

Under GAAP, a valuation allowance is required on deferred tax assets if it is "more likely than not" that the deferred tax asset will not be realized. The determination of the realization of the deferred tax assets is highly subjective and dependent upon judgment concerning management's evaluation of both positive and negative evidence, including income and losses in recent years, the forecast of future income, applicable tax planning strategies, and assessments of the current and future economic and business conditions. The Corporation considers both positive and negative evidence regarding the ultimate realization of deferred tax assets.

Positive evidence includes the existence of taxes paid in available carry-back years and the probability that taxable income will be generated in future periods. A portion of the increase in this year's deferred tax assets will be offset against available carry-back income from 2007 and 2008. The Corporation will have approximately $5 million in carry-back potential available from the 2008 tax year to use in future years after using a portion of the carry-backs in the current year. The Corporation has a long history of profitability including over $90 million in earnings in the last 10 years. The Corporation's cumulative GAAP negative loss for the last three years is caused by the current year which is the first year in almost twenty years that the Corporation has reported a net loss. GAAP earnings are negatively impacted by the Corporation's $11.7 million goodwill impairment charge taken in the second quarter of 2009 which has no federal income tax impact. Excluding this charge, the Corporation's three year cumulative GAAP position would be positive. Further, the Corporation had regulatory ratings sufficient to receive TARP funds in 2009, and remains well capitalized to date. However, past performance is no indication of future performance by the Corporation.

At September 30, 2009, the Corporation has a $10.4 million current tax asset. The receivable is the result of tax carry-backs that the Corporation will recognize due to losses that have been recorded in 2009 and to OTTI charges taken in 2008 on Fannie Mae and Freddie Mac preferred stock. On September 7, 2008, the U.S. Treasury, the Federal Reserve and the Federal Housing Finance Agency (FHFA) announced that FHFA was placing Fannie Mae and Freddie Mac under conservatorship and would eliminate dividends on Fannie Mae and Freddie Mac common and preferred stock. The Corporation recorded a pre-tax OTTI charge of $17.3 to third quarter 2008 earnings and an additional charge of $858,000 in the first quarter of 2009. The sale of Fannie Mae and Freddie Mac preferred stock during the year will allow the Corporation to recover more than $6.3 million in taxes for the 2009 tax return and accounts for a large portion of the current tax asset.

Deposits, Other Borrowings, and Stockholders' Equity

Total deposits increased by $25.9 million to $1.03 billion at September 30, 2009, compared to December 31, 2008. The mix shifted to a greater percentage of checking account balances. 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 $140.8 million between December 31, 2008 and September 30, 2009. Of that increase, approximately $25.0 million represented the migration of municipal deposits to FDIC insured accounts from CDs and MMDAs that had exceeded the FDIC's insurance limit.

Savings and money market accounts (MMDA) decreased $75.1 million to $128.9 million at September 30, 2009 compared to December 31, 2008. Municipalities reduced their balances by $74.0 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. Total CDs decreased $39.8 million to $576.1 million as the balance on brokered CDs declined $71.9 million to $179.9 million at September 30, 2009 compared to December 31, 2008.

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

 (Dollars in thousands)            September 30, 2009       % of Deposits       December 31, 2008       % of Deposits
Checking accounts                 $            327,612                31.7 %   $           186,843                18.5 %
Savings & MMDA                                 128,918                12.5                 204,035                20.3
CDs                                            576,133                55.8                 615,904                61.2
Total                             $          1,032,663               100.0 %   $         1,006,782               100.0 %

FHLB advances were $249.0 million at December 31, 2008 and $239.0 million at September 30, 2009. Securities sold under agreements to repurchase were $146.4 million at December 31, 2008, and $147.5 at September 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 September 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.

Total stockholders' equity decreased $23.5 million from $160.1 million at December 31, 2008, to $136.6 million at September 30, 2009. The decrease in equity was due to the net loss for the period. The loss was primarily due to the $36.2 million loan loss provision that the Bank recorded during the period and an $11.7 million goodwill impairment charge.

During the nine months ended September 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 income increased to $1.6 million compared to a $660,000 loss at December 31, 2008.

Asset Quality

Nonperforming assets (nonperforming loans, REO and other repossessed assets) totaled $132.7 million and $41.7 million at September 30, 2009, and December 31, 2008, respectively. Nonperforming loans (NPLs) increased to $125.7 million at September 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 collecting all principal and interest owed within the time frame of the underlying notes. Of the $125.7 million, $100.6 million were real estate construction and land development loans, $13.5 million were commercial real estate, $8.6 million were business loans, $400,000 were residential loans, $2.1 million were multifamily, and $458,000 were consumer loans. The Bank had seven loans totaling $2.5 million at September 30, 2009, which were 90 days or more past due and still accruing.

The increase in nonperforming loans during 2009 was primarily due to the deterioration in the 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 $6.0 million. Additions for the nine months of $31.4 million were offset by $13.7 million in paydowns, $6.1 million in charge-offs and $5.6 million in transfers to REO. Included in the additions were two loans totaling $8.2 million. Nonperforming land acquisition and development loans increased by $34.0 million. Four loans added to this category during the period totaled $45.5 million. The totals were decreased by $4.0 million in paydowns, $6.2 million in charge-offs and $5.3 million in transfers to REO. Nonperforming land loans increased $15.2 million as four loans added in this category accounted for $11.5 million of the change. One loan for $12.7 million accounted for most of the increase in the commercial real estate category. Loans are placed on non-accrual status when the Corporation determines that the borrowers will not be able to make the principal and interest payments in a timely manner as required in the underlying promissory notes.

Ranging from $1.9 million to $18.5 million, the eleven loans noted above totaled $77.9 million, and accounted for most of the increase in nonperforming loans during 2009. Of the $125.7 million of nonperforming loans as of September 30, 2009, construction loans represented 80.0% percent, while commercial R/E loans accounted for 10.7%. The other designated loan categories had no significant amounts of nonperforming loans.

The Corporation conducts an ongoing evaluation of its adversely classified credits. This includes reviewing the loans on a monthly basis, monitoring the real estate market in general by focusing on sales activities, obtaining updated appraisals regarding the property in question when deemed appropriate, obtaining current financial statements from the borrowers and any guarantors when a loan is in question, assessing economic trends, and preparing an impairment analysis of the loan and relationship on at least a quarterly basis. From this analysis, . . .