Cascade Financial (CASB) 10-Q 2006 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED September 30, 2006

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR TRANSITION PERIOD FROM ______________TO_________________

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	(IRS Employer
incorporation or organization)	Identification No.)
2828 Colby Avenue
Everett, Washington	98201
(Address of principal executive offices)	(Zip Code)
(425) 339-5500
(Registrant's telephone number, including area code)

Indicate by a 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 periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety days. Yes þ No ¨

Indicate by a check mark whether the registrant is large accelerated filer, an accelerated filer, or a non-accelerated filer, (as defined in Rule 12b-2 of the Act).

Large Accelerated Filer ¨ Accelerated Filer þ Non-Accelerated Filer ¨

Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class	Outstanding as of October 31, 2006
Common Stock ($.01 par value)	12,087,202

1

CASCADE FINANCIAL CORPORATION

FORM 10-Q

For the Quarter EndedSeptember 30, 2006

INDEX

		PAGE
PART I — Financial Information:
Item 1	— Financial Statements:
	— Condensed Consolidated Balance Sheets	3
	— Condensed Consolidated Statements of Income	4
	— Consolidated Statements of Comprehensive Income	5
	— Condensed Consolidated Statements of Cash Flows	6
	— Notes to Condensed Consolidated Financial Statements	8
Item 2	— Management’s Discussion and Analysis of Financial Condition and Results
	of Operations	12
Item 3	— Quantitative and Qualitative Disclosures about Market Risk	24
Item 4	— Controls and Procedures	25
PART II — Other Information
Item 1	— Legal Proceedings	25
Item 1A	— Risk Factors	25
Item 2	— Unregistered Sales of Equity Securities and Use of Proceeds	26
Item 3	— Defaults Upon Senior Securities	26
Item 4	— Submission of Matters to a Vote of Security Holders	26
Item 5	— Other Information	26
Item 6	— Exhibits	26
	Signatures	27

2

PART I -- FINANCIAL INFORMATION

Item 1 - Financial Statements

CASCADE FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(dollars in thousands)

(unaudited)

	September 30,			December 31,
	2006			2005
ASSETS
Cash on hand and in banks	$	15,004		$	16,616
Interest-bearing deposits in other institutions		12,808			14,493
Securities available-for-sale		133,747			140,596
Securities held-to-maturity		97,317			95,122
Federal Home Loan Bank (FHLB) Stock		11,920			11,920
Loans, net		977,413			867,049
Goodwill and intangibles, net		26,008			26,121
Premises and equipment, net		12,016			12,270
Cash surrender value of bank-owned life insurance		17,805			17,313
Deferred tax asset		773			568
Accrued interest receivable and other assets		10,339			9,716
TOTAL ASSETS	$	1,315,150		$	1,211,784
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Deposits	$	840,106		$	795,768
Federal Home Loan Bank advances		233,000			236,000
Securities sold under agreements to repurchase		95,700			51,058
Junior subordinated debentures payable		25,353			15,212
Advance payments by borrowers for taxes and insurance		957			689
Dividends payable		967			864
Accrued interest payable, expenses and other liabilities		6,580			7,000
TOTAL LIABILITIES		1,202,663			1,106,591
Stockholders’ Equity:
Preferred stock, $.01 par value, Authorized 500,000 shares;
no shares issued or outstanding		-			-
Common stock, $.01 par value, Authorized 25,000,000 shares;
issued and outstanding 12,086,890 shares at September 30,
2006, and 12,004,734 shares at December 31, 2005		121			120
Additional paid-in capital		39,294			38,125
Retained earnings, substantially restricted		75,377			68,945
Accumulated other comprehensive (loss), net of tax		(2,305	)		(1,997	)
TOTAL STOCKHOLDERS’ EQUITY		112,487			105,193
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	1,315,150		$	1,211,784

See notes to condensed consolidated financial statements

3

CASCADE FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(dollars in thousands, except per share amounts)

(unaudited)

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2006		2005		2006			2005
Interest income:
Loans	$	18,532	$	14,949	$	51,735		$	42,253
Securities available-for-sale		1,675		1,310		5,099			4,003
Securities held-to-maturity		1,151		1,061		3,418			3,228
FHLB stock dividends		-		-		-			49
Interest-earning deposits		38		71		179			124
Total interest income		21,396		17,391		60,431			49,657
Interest expense:
Deposits		7,683		4,860		20,465			12,706
FHLB advances and repurchase agreements		3,238		2,890		9,447			8,817
Junior subordinated debentures		519		305		1,355			873
Total interest expense		11,440		8,055		31,267			22,396
Net interest income		9,956		9,336		29,164			27,261
Provision for loan losses		300		250		850			745
Net interest income after provision for loan losses		9,656		9,086		28,314			26,516
Other income:
Gain on sale of loans		97		241		177			705
Gain on sale of securities available-for-sale		-		-		-			13
Net (loss) gain on sale of REO		-		-		(27	)		33
Checking service fees		911		801		2,529			2,344
Other service fees		281		252		898			672
BOLI		195		194		572			572
Other		132		76		365			492
Total other income		1,616		1,564		4,514			4,831
Other expenses:
Salaries and employee benefits		3,275		3,039		9,525			9,217
Option expense		73		-		212			-
Occupancy		866		823		2,607			2,453
Marketing		263		193		789			546
Data processing		99		187		305			503
Prepayment fees on FHLB advances		-		37		-			110
Other		1,773		1,393		4,822			4,172
Total other expenses		6,349		5,672		18,260			17,001
Income before provision for federal income taxes		4,923		4,978		14,568			14,346
Provision for federal income taxes		1,609		1,634		4,755			4,716
Net income	$	3,314	$	3,344	$	9,813		$	9,630
Net income per common share, basic	$	0.27	$	0.28	$	0.81		$	0.80
Weighted average number of shares outstanding, basic		12,078,088		11,979,563		12,051,238			11,972,201
Net income per share, diluted	$	0.27	$	0.27	$	0.79		$	0.78
Weighted average number of shares outstanding, diluted		12,366,497		12,310,925		12,358,862			12,315,409
Dividends declared per share	$	0.08	$	0.072	$	0.23		$	0.20

See notes to condensed consolidated financial statements

4

CASCADE FINANCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in thousands)

(unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006		2005				2006			2005
Net Income	$	3,314	$	3,344			$	9,813		$	9,630
Increase in unrealized gain (loss) on securities
available-for-sale, net of tax expense (benefit)
of $859 and $(537) for the three months
ended September 30, 2006, and 2005, respectively,
and $(166) and $(322) for the nine months
ended September 30, 2006, and 2005, respectively.		1,596		(998	)			(308	)		(598	)
Increase in unrealized gain on swaps
Available-for-sale, net of tax expense
of $0 and $0 for the three months ended
September 30, 2006, and 2005, respectively,
and $0 and $114 for the nine months
ended September 30, 2006, and 2005, respectively.		-		-				-			212
Less reclassification adjustment for (loss) on
securities included in net income, net of tax (benefit)
of $0 and $0 for the three months ended
September 30, 2006, and 2005, respectively,
and $0 and $(4) for the nine months ended
September 30, 2006, and 2005, respectively.		-		-				-			(8	)
Less reclassification adjustment for (loss) on swaps
included in net income, net of tax (benefit)
of $0 and $0 for the three months ended
September 30, 2006, and 2005, respectively, and
$0 and $(96) for the nine months ended
September 30, 2006, and 2005, respectively.		-		-		-		-			(179	)
Comprehensive Income	$	4,910	$	2,346			$	9,505		$	9,057

See notes to condensed consolidated financial statements

5

CASCADE FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands, unaudited)

	Nine Months Ended September 30,
	2006			2005
Cash flows from operating activities:
Net income	$	9,813		$	9,630
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization of premises and equipment		1,468			1,384
Provision for losses on loans		850			745
Increase in cash surrender value of bank-owned life insurance		(492	)		(498	)
Amortization of retained servicing rights		7			-
Amortization of core deposit intangible		106			197
Deferred federal income taxes		(39	)		468
Deferred loan fees, net of amortization		(4	)		382
Stock-based compensation		163			-
Net gain on sales of securities available-for-sale		-			(13	)
Net (loss) gain on sales of real estate owned, investment property and
other repossessed assets		-			(33	)
Federal Home Loan Bank stock dividend received		-			(49	)
Net (increase) decrease in accrued interest receivable and other assets		(932	)		766
Net increase in accrued interest payable, expenses and other liabilities		(136	)		435
Net cash provided by operating activities		10,804			13,414
Cash flows from investing activities:
Loans originated, net of principal repayments		(110,922	)		(69,917	)
Purchases of securities held-to-maturity		(3,744	)		(5,054	)
Principal repayments on securities held-to-maturity		1,549			5,046
Principal repayments on securities available-for-sale		12,091			18,857
Purchases of securities available-for-sale		(5,716	)		(20,000	)
Proceeds from sales of securities available-for-sale		-			1,519
Purchases of premises and equipment		(1,407	)		(1,244	)
Proceeds from sales/retirements of premises and equipment		191			29
Proceeds from loan participations sold		(289	)		(2,536	)
Net cash used in investing activities		(108,247	)		(73,300	)
Subtotal, carried forward	$	(97,443	)	$	(59,886	)

See notes to condensed consolidated financial statements

6

CASCADE FINANCIAL CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands, unaudited)

	Nine Months Ended
	September 30,
	2006			2005
Subtotal, brought forward	$	(97,443	)	$	(59,886	)
Cash flows from financing activities:
Proceeds from issuance of common stock		754			621
Dividends paid		(2,638	)		(2,299	)
Repurchase of common stock		(528	)		(789	)
Net increase in deposits		44,338			78,061
Net (decrease) increase in Federal Home Loan Bank advances		(3,000	)		13,000
Net increase (decrease) in securities sold under agreements to repurchase		44,642			(388	)
Proceeds from Trust Preferred Securities issued		10,310			-
Net increase in advance payments by borrowers for taxes and insurance		268			429
Net cash provided by financing activities		94,146			88,635
Net (decrease) increase in cash and cash equivalents		(3,297	)		28,749
Cash and cash equivalents at beginning of period		31,109			13,029
Cash and cash equivalents at end of period	$	27,812		$	41,778
Supplemental disclosures of cash flow information—cash paid during the period for:
Interest	$	32,694		$	26,074
Federal income taxes		5,200			4,445
Supplemental schedule of noncash investing activities:
Mark-to-market on securities available-for-sale		474			882
Tax benefit of non-qualified options exercised		284			201
Retirement of common stock in retained earnings		-			(43	)
Dividends declared		(2,739	)		(2,395	)

See notes to condensed consolidated financial statements

7

CASCADE FINANCIAL CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2006

(unaudited)

1.Presentation of Financial Information

The accompanying financial information is unaudited and has been prepared from the consolidated financial statements of Cascade Financial Corporation (the “Corporation”), and its subsidiary, Cascade Bank (the “Bank” or “Cascade). All significant intercompany balances have been eliminated in the consolidation. In the opinion of management, the financial information reflects all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial condition, results of operations, and cash flows of the Corporation pursuant to the requirements of the SEC for interim reporting. Operating results for the nine months ended September 30, 2006, are not necessarily indicative of the results that may be expected for the year ended December 31, 2006.

Certain information and footnote disclosures included in the Corporation’s financial statements for the year ended December 31, 2005, have been condensed or omitted from this report. Accordingly, these statements should be read with the financial statements and notes thereto included in the Corporation’s December 31, 2005 Annual Report on Form 10-K.

2.Commitments and Contingencies

In the normal course of business there are various commitments to fund loans. Management does not anticipate any material loss as a result of these commitments.

Periodically there have been various claims and lawsuits against the Corporation or the Bank, 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 incidental to the Corporation’s and the Bank’s business. In the opinion of management no material loss is expected from any such pending lawsuits.

3.Trust Preferred Securities (Junior Subordinated Debentures)

On March 30, 2006, Cascade Capital Trust III issued $10 million in par value trust preferred securities. These securities have a fixed coupon of 6.65% for the first 5 years and then float at 3-month LIBOR plus 1.40% for the remaining 25 years. In accordance with FIN 46R, the Trust is not consolidated in the Corporation’s financial statements. The Corporation fully and unconditionally guaranteed the trust preferred securities.

8

4.Stockholders’ Equity

a)Earnings Per Share

The following table presents the computation of basic and diluted net income per share for the three and nine-month period ended September 30:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2006		2005		2006		2005
	(dollars in thousands, except share and per share amounts)
Numerator:
Net income	$	3,314	$	3,344	$	9,813	$	9,630
Denominator:
Denominator for basic net income per share-
Weighted average shares		12,078,088		11,979,563		12,051,238		11,972,201
Effect of dilutive securities:
Stock options		288,409		331,362		307,624		343,208
Denominator for diluted net income per share-
Weighted average shares and assumed
conversion of dilutive stock options		12,366,497		12,310,925		12,358,862		12,315,409
Basic net income per share	$	0.27	$	0.28	$	0.81	$	0.80
Diluted net income per share	$	0.27	$	0.27	$	0.79	$	0.78

For the quarters ended September 30, 2006, and 2005, there were anti-dilutive options to purchase shares of 216,569 and 142,226 respectively, excluded from the above calculation. For the nine-month periods ended September 30, 2006, and 2005, there were anti-dilutive options to purchase shares of 186,669 and 152,798 respectively, excluded from the above calculation.

b)Dividends

On September 27, 2006, the Corporation announced its seventeenth consecutive quarterly cash dividend payment. The dividend was $0.08 per share and was paid on October 25, 2006, to shareholders of record as of October 11, 2006.

On April 25, 2006, the Corporation declared a 5-for-4 stock split payable on May 19, 2006, to shareholders of record as of May 5, 2006. Certain share and per share amounts have been restated to reflect the 5-for-4 stock split.

 c)Stock-based Compensation

Effective January 1, 2006, the Corporation adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) using the modified-prospective-transition method. Under this transition method, compensation cost in 2006 includes the cost for options granted prior to but not vested as of December 31, 2005, and options granted and vested in 2006. Therefore results for prior periods have not been restated.

9

The adoption of SFAS No. 123(R) resulted in compensation expense of approximately $212,000 for the nine months ended September 30, 2006. There was no tax benefit recorded for the nine months ended September 30, 2005.

The Corporation previously accounted for its stock option plan in accordance with the provisions of APB No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. As such, compensation expense was recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. As none of the Corporation’s stock option grants have ever been granted at a price less than market value, no compensation cost has been recognized for its stock option plans.

Changes in total options outstanding for the nine months ended September 30, 2006, are as follows:

	Options			Weighted- Average Exercise Price per Share		Weighted- Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value
Outstanding on December 31, 2005		732,253		$	7.72		5.85	$	-
Granted		96,037			15.00		9.99		-
Exercised		(48,748	)		5.14		-		-
Forfeited/Canceled		-			-		-		-
Outstanding on March 31, 2006		779,542		$	8.78		6.21	$	5,054,421
Granted		-			-		-		-
Exercised		(19,739	)		4.87		-		-
Forfeited/Canceled		(6,233	)		9.04		-		-
Outstanding on June 30, 2006		753,570		$	8.88		6.00	$	4,995,360
Granted		10,000			16.15		9.99
Exercised		(52,014	)		5.63		-
Forfeited/Canceled		(263	)		15.92		-
Outstanding on September 30, 2006		711,293			9.22		6.00	$	5,099,279
Exercisable on September 30, 2006		384,336		$	6.70		4.64	$	3,724,305

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

There were 106,037 options granted during the nine month period ended September 30, 2006. The unrecognized share-based compensation cost related to stock option expense at September 30, 2006, is $541,265, which will be recognized over the estimated average life of the options of approximately five years.

10

Options are granted to certain employees and directors at prices equal to the market value of the stock on the dates the options were granted. The options granted have a term of 10 years from the grant date. Incentive stock options granted to employees vest over a five year period. Non-qualified options granted to directors vest over a four year period. Compensation expense is recorded as if each vesting portion of the award is a separate award. We have estimated the fair value of all stock option awards as of the date of the grant by applying a Black-Scholes pricing valuation model. The application of this valuation model involves assumptions that are judgmental and sensitive in the determination of compensation expense. Key assumptions used in determining the fair value of options granted during the nine months ended September 30, 2006, are as follows:

Expected price volatility	24.0	%
Risk-free interest rate	4.5	%
Dividend yield on underlying stock	2.0	%
Weighted-average expected life in years	5.1

The total options authorized were 1,303,493. There were 10,000 options granted during the three months ended September 30, 2006. The total intrinsic value of options exercised during the nine months ended September 30, 2006, was $1,205,200. The total intrinsic value of options exercised during the nine months ended September 30, 2005, was $857,300.

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

SFAS 123(R) requires the recognition of stock-based compensation for the number of awards that are expected to vest. As a result, for most awards, recognized stock compensation expense was reduced by estimated forfeitures primarily based on historical forfeiture rates of 6.19%. Estimated forfeitures will be continually evaluated in subsequent periods and may change based on new facts and circumstances.

The following pro forma disclosures present the Corporation’s consolidated net income and diluted earnings per share, determined as if the Corporation had recognized compensation expense for its employee stock options based on the estimated fair value of the option at the date of grant amortized over the vesting period of options:

	Three Months Ended September 30, 2005		Nine Months Ended September 30, 2005
Net income	(dollars in thousands, except per share amounts)
As reported	$	3,344	$	9,630
Less FAS 123 compensation costs		35		119
Pro forma	$	3,309	$	9,511
Net income per common share
Basic
As reported	$	0.28	$	0.80
Pro forma		0.28		0.79
Diluted
As reported	$	0.27	$	0.78
Pro forma		0.27		0.78

11

5.Recently Issued Accounting Standards

In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)." This Statement improves financial reporting by requiring an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. This Statement also improves financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. An employer with publicly traded equity securities is required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures as of the end of the fiscal year ending after December 15, 2006. The requirement to measure plan assets and benefit obligations as of the date of the employer's fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. SFAS No. 158 is not expected to have a material impact on the Company.

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements. Accordingly, this Statement does not require any new fair value measurements. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. SFAS No. 157 is not expected to have a material impact on the Company.

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

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, and the December 31, 2005 audited consolidated financial statements and accompanying notes included in our recent Annual Report on Form 10-K.

This section contains 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. Those factors include, but are not limited to: the impact of national and regional economic trends on small business loan demand in the Puget Sound area; loan delinquency rates; the Bank’s ability to continue to attract quality commercial business; interest rate movements; changes in the demographic make-up of the Bank’s market area; fluctuation in demand for the Bank’s products and services; the Corporation’s ability to attract and retain qualified people, and other factors. These factors should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. The Corporation shall not be responsible to update any such forward-looking statements. For a discussion of factors that could cause actual results to differ, and for certain mandated SEC guide 3 information that has not materially changed since the audited statements, please see the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2005.

12

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 nineteen branches located in Snohomish and King Counties (Washington).

Financial Statement Contingency

In October 2003, Cascade Financial Corporation initiated an interest rate swap with a notional amount of $10 million to hedge the fair value of $10 million of Junior Subordinated Debentures (Trust Preferred Securities), which the Company had issued in March 2000. The swap has been accounted for as a fair value hedge under Paragraph 68 of FAS 133 (commonly referred to as the “short cut method”).

The Company has become aware that, in light of recent informal technical interpretations, the short cut method may not be the proper method of accounting for interest rate swaps hedging such debt instruments. Due to the lack of definitive pronouncements on this issue, we have inquired of the SEC’s Office of Chief Accountant for guidance concerning the accounting treatment.

For the quarter ended September 30, 2006, we have continued to account for the interest rate swap as fair value hedge. For the quarter ended September 30, 2006, the fair value on the interest rate swap was a loss of $421,000 (pre-tax), which was an adjustment to the carrying value of the Junior Subordinated Debentures. We would have recognized the loss through our income statement if the interest rate swap did not meet the requirements of FAS 133’s short cut method of accounting.

Selected Financial Data

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

	At or for the three months ended September 30,						At or for the nine months ended September 30,
	2006			2005			2006			2005
Return on average assets		1.02	%		1.15	%		1.04	%		1.13	%
Return on average stockholders’ equity		12.05			13.12			12.23			13.09
Average stockholders’ equity to average assets		8.45			8.74			8.52			8.60
Other expenses to average assets		1.97			1.95			1.93			1.98
Efficiency ratio		54.87			52.04			54.22			52.98
Average interest-bearing assets to
average interest-bearing liabilities		111.77			112.31			111.79			111.94

13

CHANGES IN FINANCIAL CONDITION

Total assets increased 8.5% or $103.4 million to $1.32 billion at September 30, 2006, compared to $1.21 billion at December 31, 2005. Net loans, i.e. net of deferred loan fees and the allowance for loan losses, increased 12.7% or $110.4 million to $977.4 million at September 30, 2006, from $867.0 million at December 31, 2005.

Total investment securities decreased $4.6 million to $243.0 million at September 30, 2006, compared to $247.6 million at December 31, 2005. There has been limited activity in the portfolio. This decrease represents payments on the mortgage back securities (MBS) and collateralized mortgage obligations (CMO) portfolios. The investment portfolio is concentrated in the 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, 2006, were rated AAA in terms of credit quality by Moody’s and/or Standard & Poors. All MBS and GSE securities in the portfolio as of September 30, 2006, are rated AAA.

(Dollars in thousands)	SEPTEMBER 30, 2006
Securities available-for-sale	Amortized Cost		Gross Unrealized Gains Less Than 1 Year		Gross Unrealized Gains More Than 1 Year		Gross Unrealized Losses Less Than 1 Year			Gross Unrealized Losses More Than 1 Year			Fair Value
MBS	$	41,511	$	33	$	2	$	(104	)	$	(693	)	$	40,749
Agency notes		95,783		-		-		(65	)		(2,720	)		92,998
	$	137,294	$	33	$	2	$	(169	)	$	(3,413	)	$	133,747
Securities held-to-maturity		Amortized Cost		Gross Unrealized Gains Less Than 1 Year		Gross Unrealized Gains More Than 1 Year		Gross Unrealized Losses Less Than 1 Year			Gross Unrealized Losses More Than 1 Year			Fair Value
MBS	$	25,692	$	6	$	-	$	(23	)	$	(936	)	$	24,739
Agency notes		70,850		-		-		(43	)		(2,220	)		68,587
Corporate/other		775		-		-		-			-			775
	$	97,317	$	6	$	-	$	(66	)	$	(3,156	)	$	94,101
(Dollars in thousands)	DECEMBER 31, 2005
Securities available-for-sale		Amortized Cost		Gross Unrealized Gains Less Than 1 Year		Gross Unrealized Gains More Than 1 Year		Gross Unrealized Losses Less Than 1 Year			Gross Unrealized Losses More Than 1 Year			Fair Value
MBS	$	47,847	$	16	$	14	$	(71	)	$	(383	)	$	47,423
Agency notes		95,822		-		-		(2,258	)		(391	)		93,173
	$	143,669	$	16	$	14	$	(2,329	)	$	(774	)	$	140,596
Securities held-to-maturity		Amortized Cost		Gross Unrealized Gains Less Than 1 Year		Gross Unrealized Gains More Than 1 Year		Gross Unrealized Losses Less Than 1 Year			Gross Unrealized Losses More Than 1 Year			Fair Value
MBS	$	23,830	$	-	$	8	$	(188	)	$	(601	)	$	23,049
Agency notes		70,827		-		-		(376	)		(1,845	)		68,606
Corporate/other		465		-		-		-			-			465
	$	95,122	$	-	$	8	$	(564	)	$	(2,446	)	$	92,120

14

We currently hold 28 securities in our available-for-sale portfolio and 20 securities in our held-to-maturity portfolio that have had an unrealized loss for more than one year. The losses are due to increases in interest rates and are not related to credit deterioration. If rates were to move downward in the future, the market value of these securities would rise accordingly. We have the ability to hold the investments for a period of time we believe to be sufficient for a market price recovery. Therefore, we do not consider any portion of these investments to be other-than-temporarily impaired.

At September 30, 2006, the Bank held Federal Home Loan Bank (FHLB) of Seattle stock of $11.9 million. In December 2004, the FHLB of Seattle suspended its practice of repurchasing stock that was not needed to support outstanding advances and announced it would not repurchase any stock until further notice. On April 5, 2005, the FHLB of Seattle submitted a proposed business and capital plan to its regulator, the Federal Housing Finance Board. In May 2005, the Finance Board accepted the Seattle bank’s three-year plan. To meet the Finance Board’s conditions under the three-year plan, the Seattle bank’s board adopted a resolution that suspends dividends on all classes of stock. Although the Seattle bank showed a modest profit for the first six months of 2006, it anticipates a period of low profitability or losses that may last up to three years.

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 where the borrower is the primary tenant of the property. Real estate construction loans are primarily extended to builders and developers of single family, residential real estate. The vast majority of these projects focus on entry-level homes and/or first trade-up homes. Commercial real estate loans fund small, non-owner occupied buildings.

Retail loans consist of residential, home equity and consumer loans. Residential loans, held in the Bank’s portfolio, are generally adjustable rate loans secured by single family residences. The Bank also originates longer term fixed rate residential loans, but sells almost all of those loans into the secondary market on a best efforts, servicing released basis. Home equity and consumer loans, which are primarily second mortgages on the borrower’s primary residence, comprise ---77.1% of the home equity and consumer portfolio. The balance of this category is non-residential, e.g. automobiles, credit cards, or boats. Multifamily loans are usually adjustable rate loans secured by mortgages on properties with five or more units.

Net loans increased by $110.4 million to $977.4 million as of September 30, 2006, compared to $867.0 million at December 31, 2005. In keeping with the Bank’s evolution to a commercial bank, loans more closely associated with a commercial bank, i.e. business, real estate construction, and commercial real estate loans, grew $125.8 million to $826.9 million as of September 30, 2006, compared to $701.1 million as of December 31, 2005. The Company has emphasized construction lending as it provides the most favorable trade-off between risk and returns.

Retail loans decreased $3.7 million as consumer loans decreased $2.9 million to $29.2 million and residential loans decreased by $739,000 to $94.7 million. Multifamily loans decreased $11.0 million to $41.1 million. The intense pricing pressure and the commodity like nature of these loans have rendered them less attractive assets.

15

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

Types of Loans	September 30,			% of			December 31,			% of
(Dollars in thousands)	2006			Portfolio			2005			Portfolio
Business	$	440,586			44.4	%	$	394,034			44.8	%
Real estate construction(1)		241,951			24.4			165,957			18.8
Commercial real estate		144,313			14.5			141,109			16.0
Retail(2)		123,937			12.5			127,589			14.5
Multifamily real estate		41,070			4.2			52,057			5.9
Total loans	$	991,857			100.0	%	$	880,746			100.0	%
Deferred loan fees		(3,439	)					(3,443	)
Allowance for loan losses		(11,005	)					(10,254	)
Loans, net	$	977,413					$	867,049

___________________

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

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

Deposits, Other Borrowings, and Shareholder Equity

Checking account deposits increased as the Bank continued to focus its branch activities on deposit generation in general and checking/transaction accounts in particular. In June 2005, the Bank launched its High Performance Checking (HPC) program to accelerate deposit growth. As of September 30, 2006, HPC accounts held $34.8 million of checking deposits. Total deposits increased by $44.3 million from $795.8 million at December 31, 2005, to $840.1 million at September 30, 2006. The increase occurred in Money Market Deposit Accounts (MMDA) and checking accounts as the Bank chose to let some CDs balances run off, rather than pay higher rates offered in the deposit market.

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

(Dollars in thousands)	September 30,		% of			December 31,		% of
	2006		Deposits			2005		Deposits
Checking accounts	$	137,466		16.4	%	$	120,468		15.1	%
Savings & MMDA		262,206		31.2			196,790		24.8
CDs		440,434		52.4			478,510		60.1
	$	840,106		100.0	%	$	795,768		100.0	%

FHLB of Seattle advances decreased by $3.0 million from $236.0 million at December 31, 2005, to $233.0 million at September 30, 2006. Securities sold under agreements to repurchase increased $44.6 million to $95.7 million for the nine months ended September 30, 2006. The Bank used structured advances and repurchase agreements to obtain lower rates.

On March 30, 2006, Cascade Financial Corporation issued $10 million in par value junior subordinated debentures (Trust Preferred Securities). The proceeds from the issuance were invested in Cascade Bank, which used the increased capital for general corporate purposes.

16

Stockholders’ equity increased by $7.3 million from $105.2 million at December 31, 2005, to $112.5 million at September 30, 2006. The increase is primarily attributable to the retention of net income for the period less dividend payments. The Corporation’s seventeenth consecutive cash dividend, which was declared September 27, 2006, reduced stockholders’ equity by $967,000. Accumulated other comprehensive income decreased by $300,000 due to a mark-to-market adjustment of the available-for-sale securities portfolio, to a negative $2.3 million as of September 30, 2006.

Asset Quality

Non-performing assets (non-performing loans, real estate owned and other repossessed property) totaled $112,000 and $2.1 million at September 30, 2006, and December 31, 2005, respectively. Non-performing loans, which are those on non-accrual, those that are ninety days past due, and those that management otherwise has serious reservations about their collectibility, decreased to $112,000 at September 30, 2006, compared to $2.0 million at December 31, 2005. Of the $112,000, $79,000 were business and construction loans, $24,000 were residential, and $9,000 were consumer loans. There was no real estate owned (REO) and other repossessed assets as of September 30, 2006, compared to $101,000 at December 31, 2005.

At September 30, 2006, the Bank’s allowance for loan losses totaled $11.0 million compared to $10.3 million at December 31, 2005. The allowance for loan losses was 1.11% of total loans outstanding at September 30, 2006, compared to 1.16% at December 31, 2005. The allowance for loan losses was 9,826% of non-performing loans at September 30, 2006. The allowance for loan losses is maintained at a level sufficient to provide for losses based on management’s evaluation of known and inherent risks in the portfolio. This evaluation includes analyses of the financial condition of the borrower, the value of the collateral securing selected loans, consideration of historical loss experience and management’s projection of trends affecting credit quality. The increase in the allowance is primarily attributable to the continued emphasis on business and construction lending, and an increase in the portfolio of these loan types. Management believes that the allowance for losses on loans is adequate to provide for losses that may be incurred on non-performing loans.

During the quarter ended September 30, 2006, loan charge-offs equaled $96,000 while recoveries were $63,000 resulting in net charge-offs of $33,000. For the nine months ended September 30, 2006, net charge-offs equaled $99,000.

The following table provides summary information concerning asset quality as of and for the quarters ended September 30, 2006, and December 31, 2005, respectively:

	September 30, 2006			December 31, 2005
Non-performing loans to total assets		0.01	%		0.16	%
Non-performing loans to total loans outstanding		0.01			0.23
Non-performing assets to total assets		0.01			0.17
Allowance for loan losses to non-performing loans		9,826			516
Allowance for loan losses to total loans		1.11			1.16
Net charge-offs to total loans		0.00			0.00

17

RESULTS OF OPERATIONS

Comparison of the Three and Nine Months Ended September 30, 2006, and 2005

General

Net income was flat at $3.3 million for the three months ended September 30, 2006, compared to $3.3 million during the comparable period in 2005. Diluted net income per share was $0.27 for the quarter ended September 30, 2006, and $0.27 per share for the quarter ended September 30, 2005. Net interest income before provision for loan losses increased $700,000 to $10.0 million for the three months ended September 30, 2006. Other income remained flat at $1.6 million for the quarter ended September 30, 2006. Other expense increased $600,000 to $6.3 million for the quarter ended September 30, 2006, as compared to the quarter ended September 30, 2005.

Net income for the nine months ended September 30, 2006, was $9.8 million compared with $9.6 million during the comparable period in 2005. Net income per diluted share was $0.79 for the nine months ended September 30, 2006, compared with $0.78 in 2005.

Net Interest Income

Net interest income increased 6.6% or $700,000 to $10.0 million for the three months ended September 30, 2006, compared to $9.3 million for the three months ended September 30, 2005. Net interest income for the nine months ended September 30, 2006 and 2005 was $29.2 and $27.3 million, respectively. Average interest earning assets increased $128.0 million or 11.0% to $1.29 billion for the three months ended September 30, 2006, compared to the same periods in 2005. Average total loans (including loans held for sale) increased $106.5 million to $974.8 million and average investment securities increased $22.1 million to $242.5 million for the three months ended September 30, 2006, compared to the same quarter of the prior year.

	At or for the						At or for the
	three months ended						nine months ended
	September 30,						September 30,
(dollars in thousands)	2006			2005			2006			2005
Average interest earning assets	$	1,220,900		$	1,094,529		$	1,190,362		$	1,076,419
Average interest bearing liabilities		1,092,375			974,559			1,064,794			961,628
Yield on interest earning assets		6.95	%		6.33	%		6.79	%		6.16	%
Cost of interest bearing liabilities		4.15			3.28			3.93			3.11
Net interest spread		2.80			3.05			2.86			3.05
Net interest margin		3.24			3.41			3.28			3.38

The net interest margin decreased 17 basis points to 3.24% for the three months ended September 30, 2006, compared to the same quarter the prior year. The yield on interest earning assets increased 62 basis points to 6.95% for the three months ended September 30, 2006, compared to 6.33% for the three months ended September 30, 2005. The cost of funds increased 87 basis points to 4.15% for the three months ended September 30, 2006, compared to 3.28% for the same period in 2005. For the nine months ended September 30, 2006, the net interest margin decreased 10 basis points from 3.38% to 3.28%.

18

The yield on assets increased as the rates rose and loans increased as a percentage of earning assets and prime based loans repriced upward as short-term rates continued to increase. Funding costs also rose as the rates paid on deposits rose with the level of short-term interest rates. Most of our deposit growth occurred in a MMDA product, which is offered to municipalities and is subject to weekly repricing based upon money market rates.

Provision for Loan Losses

Cascade’s provision for loan losses was $300,000 for the three months and $850,000 for the nine months ended September 30, 2006. The provision was $250,000 and $745,000 for the same periods in 2005, respectively. The provision is based on the size and composition of the portfolio, and management’s evaluation of known and inherent risks in the portfolio, as well as Cascade’s loss experience. The provision was larger in 2006 due to the overall growth in the portfolio.

Other Income

Other income remained flat at $1.6 million for the three months ended September 30, 2006, and 2005. Other income was $4.5 million and $4.8 million for the nine months ended September 30, 2006, and September 30, 2005, respectively. For the three months ended September 30, 2006, checking fee income grew to $911,000 compared to $801,000 for the same period in the prior year. Gain on sale of loans decreased $144,000 from $241,000 to $97,000 for the three months ended September 30, 2006. Other service fee income increased $29,000 to $281,000 for the quarter. There was no gain on the sale of investment securities for the quarter ended September 30, 2006, and September 30, 2005.

While the Corporation is pursuing many avenues to augment its other (non-interest) income, it will continue to focus on replacing the gain on sale of securities and loans, which enhanced earnings in prior years, with additional service fees and net interest income.

Other Expense

Other expense was $6.3 million for the three months and $18.3 million for the nine months ended September 30, 2006, compared with $5.7 million for the three months and $17.0 million for the nine months ended September 30, 2005.

Salary and employee benefit expenses and option expenses increased $309,000 to $3.3 million during the three months ended September 30, 2006, compared to the same quarter last year. A large portion of that increase can be attributed to the expensing of employee stock options, which is required beginning this year. Option expense was $73,000 and $212,000 for the three and nine months ended September 30, 2006. Salary and employee benefit expenses were $9.5 million for the nine months ended September 30, 2006, and $9.2 million for the nine month period in 2005. The remaining other operating expense categories totaled $3.0 million for the three months ended and $8.5 for the nine months ended September 30, 2006. For the same period in 2005, other operating expenses were $2.6 million and $7.8 million, respectively.

19

Federal income tax expenses decreased by $25,000 to $1.6 million, a decrease of 1.5% during the three months ended September 30, 2006, compared to the same period last year. For the three months ended September 30, 2006, the Corporation’s effective tax rate was 33%. For the nine months ended September 30, 2006, income tax expense was $4.8 million compared to $4.7 million in 2005, with an effective tax rate of 33%. Tax benefits related to bank-owned life insurance and interest on tax-exempt loans accounted for the difference from the “expected” Federal income tax rate of 35% during each of the periods.

Segment Results

The following is a summary of selected operating segment information for the three and nine month periods ended September 30, 2006, and 2005. The Corporation manages its operations and prepares management reports with a primary focus on its various business units. The accounting policies of the individual units are the same as those of the Corporation. The Corporation allocates centrally provided services to the business units based upon estimated usage of those services. The income property category includes commercial real estate and multifamily lending. All amounts are in thousands.

For the three months ended September 30, 2006

	BUSINESS		CONS- TRUCTION		INCOME PROPERTY		RETAIL		ADMIN- ISTRATION			TOTAL
Condensed Income Statement
Net interest income after provision for loan losses	$	3,853	$	3,870	$	1,124	$	340	$	469		$	9,656
Other income		88		9		-		1,193		326			1,616
Other expense		387		82		82		581		5,217			6,349
Contribution before overhead		3,554		3,797		1,042		952		(4,422	)		4,923
Support transfer		1,865		1,148		835		574		(4,422	)		—
Income before provision for federal income tax		1,689		2,649		207		378		—			4,923
Provision for federal income taxes		552		866		68		123		—			1,609
Net income	$	1,137	$	1,783	$	139	$	255	$	—		$	3,314

For the three months ended September 30, 2005

	BUSINESS		CONS- TRUCTION		INCOME PROPERTY		RETAIL		ADMIN- ISTRATION			TOTAL
Condensed Income Statement
Net interest income after provision for loan losses	$	3,858	$	2,420	$	1,718	$	432	$	658		$	9,086
Other income		16		3		231		1,031		283			1,564
Other expense		381		94		170		544		4,483			5,672
Contribution before overhead		3,493		2,329		1,779		919		(3,542	)		4,978
Support transfer		1,571		572		855		544		(3,542	)		—
Income before provision for federal income tax		1,922		1,757		924		375		—			4,978
Provision for federal income taxes		631		577		303		123		—			1,634
Net income	$	1,291	$	1,180	$	621	$	252	$	—		$	3,344

20

For the nine months ended September 30, 2006

	BUSINESS		CONS- TRUCTION		INCOME PROPERTY		RETAIL		ADMIN- ISTRATION			TOTAL
Condensed Income Statement
Net interest income after provision for loan losses	$	11,235	$	10,230	$	3,437	$	1,330	$	2,082		$	28,314
Other income		253		49		—		3,272		940			4,514
Other expense		1,017		271		271		1,687		15,014			18,260
Contribution before overhead		10,471		10,008		3,166		2,915		(11,992	)		14,568
Support transfer		5,115		2,822		2,403		1,652		(11,992	)		—
Income before provision for federal income tax		5,356		7,186		763		1,263		—			14,568
Provision for federal income taxes		1,478		2,345		248		414		—			4,755
Net income	$	3,608	$	4,841	$	515	$	849	$	—		$	9,813

For the nine months ended September 30, 2005

	BUSINESS		CONS- TRUCTION		INCOME PROPERTY		RETAIL		ADMIN- ISTRATION			TOTAL
Condensed Income Statement
Net interest income after provision for loan losses	$	11,023	$	5,947	$	6,145	$	1,334	$	2,067		$	26,516
Other income		54		12		623		2,998		1,144			4,831
Other expense		1,150		322		698		1,703		13,128			17,001
Contribution before overhead		9,927		5,637		6,070		2,629		(9,917	)		14,346
Support transfer		3,894		1,470		2,978		1,575		(9,917	)		—
Income before provision for federal income tax		6,033		4,167		3,092		1,054		—			14,346
Provision for federal income taxes		1,983		1,369		1,016		348		—			4,716
Net income	$	4,050	$	2,798	$	2,076	$	706	$	—		$	9,630

Interest income is assigned based upon the loans held by that line of business. Investment income is assigned to Administration. Interest expense is allocated based upon the Corporation’s cost of funds and the average maturity of the line of business’s assets. Overhead is allocated on the basis of average total assets.

Liquidity and Sources of Funds

The Bank monitors its liquidity position to assure that it will have adequate resources to meet its customers’ needs. Potential uses of funds are new loans; the disbursement of construction loans in process; draws on unused business lines of credit and unused consumer lines of credit; the purchase of investment securities; deposit withdrawals; and repayment of FHLB advances. As of September 30, 2006, Cascade had $119.7 million of construction loans in process, $67.8 million in unused business lines of credit, $37.2 million in unused consumer lines of credit including credit cards and $17.7 million in other undisbursed commitments. Recent history indicates construction lines will be funded at 67% of commitments at any point in time. Historically, the Bank’s business customers use 50% of their lines at any given time. About 45% of the home equity lines of credit are drawn upon at any point in time. Cash flows from operations contribute to liquidity as well as proceeds from maturities of securities and customer deposits. As indicated on the Corporation’s condensed Consolidated Statement of Cash Flows, net cash from operating activities for the nine months ended September 30, 2006, contributed $10.5 million to liquidity compared to $13.4 million for the nine months ended September 30, 2005.

21

Funding needs are met through existing liquidity balances, deposit growth, FHLB-Seattle advances and other borrowings, as well as the repayment of existing loans and the sale of loans. Cascade maintains balances in FHLB deposits, which equaled $12.8 million as of September 30, 2006, and $22.5 million at September 30, 2005.

Subject to the availability of eligible collateral and certain requirements, the Bank’s credit line with the FHLB-Seattle is 35% of total assets or up to approximately $459.9 million at current asset levels. At September 30, 2006, the Bank had $233.0 million in advances and an unused line of credit from the FHLB-Seattle of approximately $226.9 million. The Bank also uses reverse repurchase agreements (securities sold under agreements to repurchase) to provide a flexible source of funding. At September 30, 2006, the Bank had $96.0 million in reverse repurchase agreements outstanding. Securities that could be pledged to secure additional funding at the FHLB-Seattle or the repurchase market were $37.1 million at the end of the quarter and $45.4 million as of December 31, 2005. Commercial real estate loans totaling $357.6 million are being used as a source of collateral at the FHLB. The Bank also has a total of $33.0 million in Fed funds lines with its correspondent banks and a $16.0 million line of credit at the Federal Reserve Bank of San Francisco, none of which were used during the quarter.

Capital Resources

The Corporation’s usual main source of capital is the retention of its net income. The Corporation also receives capital through the exercise of stock options granted to employees and directors. The Corporation permits employees and directors to tender shares of Cascade’s stock, which they have held for a minimum of six months, to exercise options.

The Board of Directors authorized a stock repurchase program of up to 375,000 shares of the Corporation’s stock at its May 2006 meeting. The repurchase program does not obligate the Corporation to acquire any specific number of shares. The main focus of the program is to attempt to offset the dilution created by the exercise of stock options and other stock grants; see Part II - Other Information, Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds.

On March 30, 2006, Cascade Capital Trust III issued $10 million in par value junior subordinated debentures (Trust Preferred Securities). These securities have a fixed coupon of 6.65% for the first 5 years and then float at 3-month LIBOR plus 1.40% for the remaining 25 years. Cascade Capital Trust III is a statutory business trust created for the exclusive purposes of issuing and selling capital securities and utilizing sale proceeds to acquire junior subordinated debt issued by Cascade Financial Corporation. Accordingly, the junior subordinated debentures are the sole assets of the Trust, and payments under the junior subordinated debentures will be the sole revenues of the Trust. All of the common securities of the Trust are owned by the Corporation.

On December 15, 2004, Cascade Capital Trust II issued $5 million in par value junior subordinated debentures. These securities have a fixed coupon of 5.82% for the first 5 years and then float at 3-month LIBOR plus 1.90% for the remaining 25 years. The structure of Cascade Capital Trust II is identical to Cascade Capital Trust III.

22

On March 1, 2000, Cascade Capital Trust I issued $10 million par value trust preferred securities. The structure of Cascade Capital Trust I is identical to Cascade Capital Trust III. In keeping with the adoption of FIN 46R, the Corporation’s balance sheet has replaced “trust preferred securities” with “junior subordinated debentures payable,” although there have been no changes in terms of the underlying obligations. The Trust has been deconsolidated upon adoption of FIN 46R at December 31, 2003, and did not have a significant impact on the Corporation’s financial condition or results of operations.

Capital Requirements

Cascade Bank is subject to regulatory capital requirements. Cascade Bank is in full compliance with all capital requirements established by the FDIC and the Washington State Department of Financial Institutions. The Bank’s regulatory capital requirements are expressed as a percentage of assets. To be adequately capitalized, the Bank must hold capital equal to 4% of its assets and 8% of its risk-weighted assets. As of September 30, 2006, for the purposes of this calculation, the Bank’s average total assets and total risk-weighted assets were $1.26 billion and $1.11 billion respectively. The related excess capital amounts as of September 30, 2006, are presented in the following table (dollars in thousands):

	Adequately Capitalized					Well Capitalized
Core capital	Amount		Percentage			Amount		Percentage
Tier 1 (Core) capital	$	112,780		8.92	%	$	112,780		8.92	%
Less: Minimum requirement		50,548		4.00			75,600		6.00
Excess	$	62,232		4.92	%	$	37,180		2.92	%
Risk-based capital		Amount		Percentage			Amount		Percentage
Risk-based capital	$	123,785		11.18	%	$	123,785		11.18	%
Less: Minimum requirement(1)		88,568		8.00			111,000		10.00
Excess	$	35,217		3.18	%	$	12,785		1.18	%
(1) Based on risk-weighted assets.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) was signed into law on December 19, 1991. Among other things, the FDICIA provides the FDIC, effective December 19, 1992, with broad powers to take “prompt corrective action” to resolve problems of insured depository institutions. The actions the FDIC can take depend upon whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Under FDIC guidelines, Cascade Bank is a “well capitalized” institution as of September 30, 2006, which requires a core capital to assets of at least 6% and a risk-based capital to assets of at least 10%.

The Corporation, as a bank holding company regulated by the Federal Reserve, is also subject to capital requirements that are similar to those for Cascade Bank. As of September 30, 2006, the Corporation is “well capitalized” under Federal Reserve guidelines with a Tier 1 ratio of 9.00% and a risk-based ratio of 11.26%.

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Item 3 - Quantitative and Qualitative Disclosures about Market Risk

ASSET/LIABILITY MANAGEMENT

The Bank, like other financial institutions, is subject to fluctuations in interest rates because its interest-bearing liabilities reprice on different terms than its interest-earning assets. Cascade actively monitors the inherent interest rate risk for the potential impact of changes in rates on the Bank.

The Bank uses a simulation model as its primary tool to measure its interest rate risk. A major focus of the Bank’s asset/liability management process is to preserve and enhance net interest income in likely interest rate scenarios. Further, Cascade’s Board of Directors has enacted policies that establish targets for maximum negative impact that changes in interest rates may have on the Bank’s net interest income, the fair value of equity and adjusted capital/asset ratios under certain interest rate shock scenarios. Key assumptions are made to evaluate the change to Cascade’s income and capital to changes in interest rates. These assumptions, while deemed reasonable by management, are inherently uncertain. As a result, the estimated effects of changes in interest rates from the simulation model could likely be different than actual experience.

Using standard interest rate shock (an instantaneous uniform change in interest rates at all maturities) methodology, as of September 30, 2006, the Bank is within all the guidelines established by the Board for the changes in net interest income, fair value of equity, and the adjusted capital/asset ratios. As of September 30, 2006, the Bank’s fair value of equity decreases 18.2% in the up 200 basis point scenario and 9.8% in the down 200 basis point scenario, within the established guideline of a maximum 30% decline. Using the same methodology, the adjusted capital/asset ratio is 9.4% in the up 200 basis point scenario and 9.9% in the down 200 basis point scenario, both above the 5% minimum established guideline. The net interest income decreases 4.7% in the up 200 basis point scenario and 5.1% in the down 200 basis point scenario, both are within the guideline of a 10% decline.

The Bank has sought to manage its interest rate exposure through the structure of its balance sheet. To limit its interest rate risk, the Bank has sought to emphasize its loan mix toward prime based business and construction loans. In addition to selling virtually all 15 and 30 year fixed rate loans, it also sells many of its hybrid ARM residential loans. The table below summarizes the Bank’s loan portfolio by rate type at September 30, 2006.

Type	Percentage
Variable	31%
Adjustable	40%
Fixed	29%

The Bank extends the maturity of its liabilities by offering long-term deposit products to customers, and by obtaining longer term FHLB-Seattle advances. As of September 30, 2006, the entire portfolio of $233.0 million ($25 million of which is a 3-month LIBOR adjustable) in long-term advances had original maturities greater than one year, none had original maturities of less than one year. Of the remaining $208.0 million, $4.0 million are fixed rate, $139.0 million have provisions that allow the FHLB to convert the advance to a LIBOR based, adjustable rate borrowing and $65.0 million begin as LIBOR based advances but converted to a fixed rate borrowing after a specified time.

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Item 4 - Controls and Procedures

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

An evaluation of the Registrant'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 Registrant's Chief Executive Officer, Chief Financial Officer, and several other members of the registrant's senior management as of September 30, 2006. The Registrant's Chief Executive Officer and Chief Financial Officer concluded that the Registrant's disclosure controls and procedures as then in effect were effective in ensuring that the information required to be disclosed by the Registrant in the reports it files or submits under the Act is (i) accumulated and communicated to the Registrant'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 SEC's rules and forms.

CHANGES IN INTERNAL CONTROLS

In the quarter ended September 30, 2006, the Registrant did not make any significant changes in, nor take any corrective actions regarding, its internal controls, or other factors that have materially affected or are reasonably likely to materially affect these controls.

PART II -- OTHER INFORMATION

Item 1. Legal Proceedings

The Corporation and the Bank are involved in litigation and have negotiations in progress resulting from activities arising from normal operations. In the opinion of management, none of these matters are likely to have a materially adverse effect on the Corporation’s financial position.

Item 1A. Risk Factors

There have been no material changes to the risk factors disclosed in Item 1A. Risk Factors in our Annual Report on Form 10-K for the period ended December 31, 2005, except as set forth below.

On September 18, 2006, the Company converted its core processing system. The goal of the conversion was to enhance the Company’s level of customer service and internal efficiency. The Company will need to affirm that the new system will meet all the business requirements for which it was purchased and institute sufficient internal controls to assure compliance with the mandates of Sarbanes-Oxley Section 404.

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities
		2006 PLAN		Total Number	Maximum
				of Shares Purchased	Number of Shares that
Period		Total Number	Average Price	as Part of Publicly	May Yet be Purchased
Beginning	Ending	of Shares Purchased (1)	Paid per Share	Announced Plan	Under the Plan (2)
July 1, 2006	July 31, 2006	-	$       -	-	375,000
August 1, 2006	August 31, 2006	33,300	15.58	33,300	341,700
September 1, 2006	September 30, 2006	-	-	-	341,700
Total		33,300	$15.58	33,300	341,700
1) During the period presented there were no shares purchased, which would be acquired at current market values as consideration for the exercise of fully vested options.
2) In May 2006, the Corporation announced a new stock repurchase plan to purchase up to 375,000 shares of the Corporation’s stock. The Plan will expire on May 31, 2007.

Item 3. Defaults upon Senior Securities

Not applicable

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

Not applicable

Item 5. Other information

Not applicable

Item 6. Exhibits

(a) Exhibits

3.1 (i)	Bylaws of Cascade Financial Corporation (Incorporated by reference to the Corporation’s Registration Statement on Form S-4 (File No. 33-83200)).
3.2 (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)).
3.3 (ii)	Amended and restated Bylaws of Cascade Financial Corporation (Incorporated by reference to the Corporation’s Form 8-K filed March 29, 2006 (File No. 0-25286)).
31.1	Certifications of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act.
31	Certifications of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act.
32	Certification pursuant to Section 906 of the Sarbanes-Oxley Act.

(b) Reports on Form 8-K

On July 25, 2006, the Corporation filed a Form 8-K reporting an attached press release announcing financial results for the three and six months ended June 30, 2006, under Items 2.02 and 9.01 of Form 8-K.

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(b) Reports on Form 8-k  (continued)

On September 29, 2006, the Corporation filed a Form 8-K announcing the election of two new members to the Board of Directors of the Company, under Item 5.02 and 9.01 of Form 8-K.

On October 24, 2006, The Corporation filed a Form 8-K reporting an attached press release announcing financial results for the three and nine months ended September 30, 2006, under Items 2.02 and 9.01 of Form 8-K.

SIGNATURES

Pursuant to the requirements 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 CORPORATION
November 7, 2006	/s/ Lars H. Johnson
	By:Lars H. Johnson,
	Executive Vice President  (Chief Financial Officer)

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