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 March 31, 2011.

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

Commission file number 0-25286

CASCADE FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Washington		91-1661954
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer 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 check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety days. Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding twelve months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer ¨ Accelerated Filer ¨ Non-Accelerated Filer ¨ Smaller Reporting Company þ

Indicate by 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 May 12, 2011
Common Stock ($.01 par value)	12,271,529

CASCADE FINANCIAL CORPORATION

FORM 10-Q

For the Quarter Ended March 31, 2011

INDEX

		PAGE
PART I — Financial Information:
Item 1	— Financial Statements:
	— Condensed Consolidated Balance Sheets	3
	— Condensed Consolidated Statements of Operations	4
	— Condensed Consolidated Statements of Stockholders’ Equity	5
	— Condensed Consolidated Statements of Comprehensive Loss	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	34

Item 3	— Quantitative and Qualitative Disclosures about Market Risk	61

Item 4	— Controls and Procedures	63

PART II — Other Information:
Item 1	— Legal Proceedings	64
Item 1A	— Risk Factors	64
Item 6	— Exhibits	65
	—Signatures	65

PART I –– FINANCIAL INFORMATION

Item 1 – Financial Statements

CASCADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

	March 31,			December 31,
(Dollars in thousands, except share and per share amounts)	2011			2010
Assets
Cash on hand and in banks	$	4,486		$	3,871
Interest-earning deposits in other financial institutions		108,794			127,464
Securities available-for-sale, fair value		232,277			234,606
Securities held-to-maturity, amortized cost		52,419			53,912
Federal Home Loan Bank (FHLB) stock		11,920			11,920
Loans, net		950,483			967,661
Real estate owned (REO)		32,311			34,412
Premises and equipment, net		13,127			13,325
Cash surrender value of bank owned life insurance (BOLI), net		25,736			25,489
Prepaid FDIC insurance premiums		2,210			2,968
Accrued interest receivable		5,865			4,884
Other assets		17,577			17,822
Total assets	$	1,457,205		$	1,498,334

Liabilities
Deposits	$	1,069,087		$	1,107,554
FHLB advances		159,000			159,000
Securities sold under agreements to repurchase		145,000			145,000
Junior subordinated debentures		15,465			15,465
Junior subordinated debentures, fair value		1,500			1,500
Accrued interest payable, expenses, and other liabilities		12,508			11,363
Total liabilities		1,402,560			1,439,882

Commitments and contingencies (Note 9)

Stockholders’ Equity
Preferred stock, no par value. Authorized 38,970 shares;		37,607			37,488
Series A (liquidation preference $1,000 per share); issued and outstanding 38,970 shares at March 31, 2011 and December 31, 2010
Preferred stock, $.01 par value. Authorized 500,000 shares; no shares issued or outstanding		-			-
Common stock, $.01 par value. Authorized 65,000,000 shares; issued and outstanding 12,271,529 shares at March 31, 2011 and December 31, 2010		123			123
Additional paid-in capital		43,942			43,932
Accumulated deficit		(21,253	)		(17,965	)
Accumulated other comprehensive loss		(5,774	)		(5,126	)
Total stockholders’ equity		54,645			58,452
Total liabilities and stockholders’ equity	$	1,457,205		$	1,498,334
(See Notes to Condensed Consolidated Financial Statements)

CASCADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months Ended March 31,
(Dollars in thousands, except share and per share amounts)	2011			2010
Interest Income
Loans, including fees	$	13,918		$	16,166
Securities available-for-sale		1,210			2,472
Securities held-to-maturity		419			417
Interest-earning deposits		65			76
Total interest income		15,612			19,131
Interest Expense
Deposits		2,851			4,251
FHLB advances		1,273			2,565
Securities sold under agreements to repurchase		2,127			2,131
FRB TAF borrowing		-			2
Junior subordinated debentures		537			495
Total interest expense		6,788			9,444
Net interest income		8,824			9,687
Provision for loan losses		2,550			31,290
Net interest income (loss) after provision for loan losses		6,274			(21,603	)
Other Income
Checking service fees		1,209			1,263
Other service fees		252			233
Increase in cash surrender value of BOLI, net		247			237
Gain on sales of securities available-for-sale, net		-			25
Gain on calls of securities held-to-maturity, net		-			3
Gain on sale of loans		-			26
Other		111			125
Total other income		1,819			1,912
Other Expenses
Compensation & employee benefits		3,411			3,680
Occupancy & equipment		932			1,016
FDIC insurance premiums		771			853
Business insurance		341			376
REO expenses, write-downs & losses on sales of REO		2,587			994
Contract services		529			200
Information services		411			392
Legal		374			162
B&O tax		248			263
Other		1,136			1,301
Total other expenses		10,740			9,237
Loss before provision for income taxes		(2,647	)		(28,928	)
Provision for income taxes		-			3,211
Net loss		(2,647	)		(32,139	)
Dividends on preferred stock		522			499
Accretion of issuance discount on preferred stock		119			112
Net loss attributable to common stockholders	$	(3,288	)	$	(32,750	)
(See Notes to Condensed Consolidated Financial Statements)

CASCADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)

(Unaudited)

	Three Months Ended March 31,
(Dollars in thousands, except share and per share amounts)	2011			2010
Loss per common share, basic	$	(0.27	)	$	(2.69	)
Weighted average number of common shares outstanding, basic		12,271,529			12,165,167

Loss per common share, diluted	$	(0.27	)	$	(2.69	)
Weighted average number of common shares outstanding, diluted		12,271,529			12,165,167

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited)

			Common
(Dollars in thousands, except share and per share amounts)	Preferred Stock		Shares		Amount		Additional Paid-In Capital		Accumulated Deficit			Accumulated Other Comprehensive Loss			Total Stockholders’ Equity
Balances at December 31, 2010	$	37,488		12,271,529	$	123	$	43,932	$	(17,965	)	$	(5,126	)	$	58,452
Dividends declared - Preferred stock ($13.39 per share)		-		-		-		-		-522			-			-522
Stock compensation expense		-		-		-		10		-			-			10
Net loss		-		-		-		-		-2,647			-			-2,647
Accretion of discount on preferred stock		119		-		-		-		-119			-			-
Other comprehensive loss		-		-		-		-		-			-648			-648
Balances at March 31, 2011	$	37,607		12,271,529	$	123	$	43,942	$	(21,253	)	$	(5,774	)	$	54,645

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited)

	Three Months Ended March 31,
(Dollars in thousands)	2011			2010
Net loss	$	(2,647	)	$	(32,139	)
Unrealized gain on cash flow hedging instruments		310			-
Unrealized holding (loss) gain on securities available-for-sale, net oftax provision of $0 and $1,287		(958	)		2,386
Reclassification adjustment for gain on securities available-for-saleincluded in net loss, net of tax benefit of $0 and $9		-			(16	)
Comprehensive loss	$	(3,295	)	$	(29,769	)

(See Notes to Condensed Consolidated Financial Statements)

CASCADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Three Months Ended March 31,
(Dollars in thousands)	2011			2010
Cash flows from operating activities:
Net loss	$	(2,647	)	$	(32,139	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization of premises and equipment		429			515
Provision for losses on loans		2,550			31,290
REO write-downs		1,990			706
Increase in cash surrender value of BOLI		(247	)		(237	)
Amortization of retained servicing rights		4			6
Amortization of core deposit intangible		35			35
Deferred federal income taxes		-			(9,861	)
Deferred loan fees, net of amortization		(55	)		297
Gain on sale of loans		-			(26	)
Origination of loans held-for-sale		-			(1,159	)
Proceeds from sales of loans held-for-sale		-			1,435
Stock compensation expense		10			16
Net gain on sales of securities available-for-sale		-			(25	)
Net gain on calls of securities held-to-maturity		-			(3	)
Net loss (gain) on sales of REO		282			(8	)
Net change in accrued interest receivable and other assets		293			11,738
Net change in accrued interest payable, expenses and other liabilities		323			1,887
Net cash provided by operating activities		2,967			4,467

Cash flows from investing activities:
Loans originated, net of principal repayments		3,215			4,073
Purchases of securities available-for-sale		-			(50,015	)
Proceeds from sales of securities available-for-sale		-			28,203
Principal repayments on securities available-for-sale		1,371			6,049
Purchases of securities held-to-maturity		-			(7,663	)
Proceeds from calls on securities held-to-maturity		-			10,000
Principal repayments on securities held-to-maturity		1,493			887
Net purchases of premises and equipment		(231	)		(257	)
Proceeds from paydowns/sales of REO		11,784			2,920
REO capitalized costs		(487	)		(970	)
Net cash provided by (used) in investing activities	$	17,145		$	(6,773	)

(See Notes to Condensed Consolidated Financial Statements)

CASCADE FINANCIAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(Unaudited)

	Three Months Ended March 31,
(Dollars in thousands)	2011			2010
Cash flows from financing activities:
Proceeds from issuance of common stock	$	-		$	55
Net (decrease) increase in deposits		(38,467	)		32,484
Net decrease in Federal Reserve TAF borrowing		-			(20,000	)
Net increase in securities sold under agreements to repurchase		-			655
Net increase in advance payments by borrowers for taxes and insurance		300			328
Net cash (used in) provided by financing activities		(38,167	)		13,522
Net (decrease) increase in cash and cash equivalents		(18,055	)		11,216
Cash and cash equivalents at beginning of period		131,335			145,595
Cash and cash equivalents at end of period	$	113,280		$	156,811

Supplemental disclosures of cash flow information – cash
paid during the period for:
Interest	$	6,366		$	9,087

Supplemental schedule of non-cash investing activities:
Change in unrealized (loss) gain on securities available-for-sale		(958	)		2,370
Change in unrealized gain on interest rate caps		310			-
Dividends accrued on preferred stock		522			499
Transfers of loans to REO		11,468			11,200

(See Notes to Condensed Consolidated Financial Statements)

CASCADE FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2011

(Unaudited)

Note 1 – Basis of 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 wholly-owned subsidiaries, Cascade Bank (Cascade or the Bank), including Colby R.E., LLC and 2011 Yale Avenue East, LLC, Cascade Capital Trusts I, II and III (the Trusts). This financial information conforms to accounting principles generally accepted in the United States of America (GAAP) and to general practices within the financial institutions industry, where applicable. 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 Securities and Exchange Commission (SEC) for interim reporting. Operating results for the three months ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.

Certain information and footnote disclosures included in the Corporation’s financial statements for the year ended December 31, 2010, have been condensed or omitted from this report. Accordingly, these statements should be read in conjunction with the financial statements and notes thereto included in the Corporation’s December 31, 2010 Annual Report on Form 10-K.

The Condensed Consolidated Financial Statements have been prepared in conformity with GAAP established by the Financial Accounting Standards Board (FASB). References to GAAP issued by the FASB in these footnotes are to the FASB Accounting Standards Codification™ , sometimes referred to as the Codification or ASC. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses for the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term are the fair value of financial instruments, evaluation of other-than-temporary impairment (OTTI), the valuation of real estate owned (REO), the allowance for loan losses, and deferred income taxes.

Recently Issued Accounting Standards

In April 2010, the FASB issued ASU 2010-18, Receivables (Topic 310) - Effect of a Loan Modification When the Loan Is Part of a Pool that is Accounted for as a Single Asset. This ASU clarifies that modifications of loans that are accounted for within a pool under Topic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. No additional disclosures are required with this ASU. The amendments in this ASU are effective for modifications of loans accounted for within pools under Topic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. The amendments are to be applied prospectively and early application is permitted. Upon initial adoption of the guidance in this ASU, an entity may make a onetime election to terminate accounting for loans as a pool under Topic 310-30. This election may be applied on a pool-by-pool basis and does not preclude an entity from applying pool accounting to subsequent acquisitions of loans with credit deterioration. The adoption of this ASU did not have a material impact on the Corporation's Consolidated Financial Statements.

In July 2010, the FASB issued ASU 2010-20, Receivables (Topic 310) – Amendments to Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The amendments require an entity to provide enhanced or additional disclosures that facilitate financial statement users’ evaluation of the nature of credit risk inherent in the entity’s portfolio of financing receivables, how that risk is analyzed and assessed in arriving at the allowance for credit losses, and the changes and reasons for those changes in the allowance for credit losses. This guidance requires that the enhanced and additional reporting disclosures must be disaggregated by portfolio segment. It is likely that this ASU will have the greatest effect on financial institutions. This ASU is effective for interim and annual reporting periods ending on or after December 15, 2010. The adoption of this ASU requires significant additional disclosures in the Corporation’s financial statements.

In December 2010, the FASB issued ASU 2010-29, Business Combinations (Topic 805) -Disclosure of Supplementary Pro Forma Information for Business Combinations. This update clarifies that if comparative financial statements are presented in disclosure of supplementary pro forma information for a business combination, revenue and earnings of the combined entity should be disclosed as though the business combination occurred as of the beginning of the comparable prior annual reporting period only. Additionally, supplemental pro forma disclosures should include a description of the nature and amount of material, nonrecurring pro forma adjustments included in the reported pro forma revenue and earnings. This update is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The adoption of this ASU did not have a material impact on the Corporation’s Consolidated Financial Statements.

In December 2010, the FASB issued ASU 2010-28, Intangibles-Goodwill and Other (Topic 350) - When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. The amendments in this update modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors indicating that an impairment may exist. The qualitative factors are consistent with the existing guidance, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. For public entities, the amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. The adoption of this ASU did not have a material impact on the Corporation’s Consolidated Financial Statements.

In January 2011, the FASB issued ASU 2011-01, Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. This ASU temporarily delays the effective date of the disclosures about troubled debt restructurings in Update 2010-20 for public entities. The delay is intended to allow the Board time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. Currently, that guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011. However, the Corporation has included the disclosures required by this ASU.

In April, 2011, FASB issued ASU 2011-02, Receivables (Topic 310) - A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This update to Topic 310 - Receivables, provides guidance for evaluating whether a restructuring constitutes a troubled debt restructuring. The ASU indicates that the creditor's evaluation must separately conclude that both the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. The amendments also further clarify the guidance on a creditor's evaluation of whether a concession has been granted and whether a debtor is experiencing financial difficulties. The amendments in this update are effective for the first interim or annual period beginning on or after June 15, 2011. Early adoption is permitted. This also requires that the disclosures deferred by ASU 2011-01 be reported for interim and annual periods beginning on or after June 15, 2011. The adoption of this ASU did not have a material impact on the Corporation's Consolidated Financial Statements.

In May 2011, the FASB issued ASU 2011-03, Transfers and Servicing (Topic 860) - Reconsideration of Effective Control for Repurchase Agreements. The ASU is intended to improve financial reporting of repurchase agreements (repos) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. In a typical repo transaction, an entity transfers financial assets to a counterparty in exchange for cash with an agreement for the counterparty to return the same or equivalent financial assets for a fixed price in the future. FASB Topic 860, Transfers and Servicing, prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repo agreements. That determination is based, in part, on whether the entity has maintained effective control over the transferred financial assets. The amendments to the Codification in this ASU are intended to improve the accounting for these transactions by removing from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets. The guidance in this ASU is effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted.

Note 2 – Regulatory Actions, Recent Events and Going Concern Considerations

While we have begun to see initial signs of improvement in the overall economy, we continue to operate in a difficult environment and have been significantly impacted by the unprecedented credit and economic market turmoil, as well as the recessionary economy that began in the latter part of 2007. Deterioration in real estate markets in our primary geographic market areas of Snohomish, King, Pierce and Skagit counties in western Washington and related declines in property values in those markets over the past three years has led to the recognition of significant credit costs, which has negatively impacted our operating results, capital position and overall financial condition.

Regulatory Actions

FDIC Consent Order. On July 20, 2010, the Board of Directors of the Bank stipulated to the entry of a Consent Order with the FDIC and the Washington State Department of Financial Institutions (DFI), effective July 21, 2010 (FDIC Order). Under the terms of the FDIC Order, the Bank cannot pay any cash dividends or make any payments to its stockholders without the prior written approval of the FDIC and the Washington State DFI. Other material provisions of the FDIC Order require the Bank to:

·	review the qualifications of the Bank’s management;

·	provide the FDIC with 30 days written notice prior to adding any individual to the Board of Directors of the Bank or employing any individual as a senior executive officer;

·	increase director participation and supervision of Bank affairs;

develop a capital plan and increase Tier 1 leverage capital to 10% of the Bank’s average total assets and increase total risk-based capital to 12% of the Bank’s risk-weighted assets by November 18, 2010, and maintain such capital levels, in addition to maintaining a fully funded allowance for loan losses satisfactory to the regulators;

eliminate from its books, by charge-off or collection, all loans classified as “loss” and all amounts in excess of the fair value of the underlying collateral for assets classified as “doubtful” in the Report of Visitation dated February 16, 2010 that have not been previously collected or charged-off, by July 30, 2010;

·	reduce the amount of loans classified “substandard” and “doubtful” in the Report of Visitation that have not previously been charged off to not more than 130% of the Bank’s Tier 1 capital and allowance for loan losses, within 180 days;

·	eventually reduce the total of all adversely classified loans by collection, charge-off or sufficiently improving the quality of adversely classified loans to warrant removing any adverse classification, as determined by the regulators;

·	formulate a written plan to reduce the Bank’s levels of nonperforming assets and/or assets listed for “special mention” by the Bank to an acceptable level and to reduce the Bank’s concentrations in commercial real estate and acquisition, development and construction loans;

·	develop a three-year strategic plan and budget with specific goals for total loans, total investment securities and total deposits, and improvements in profitability and net interest margin, and reduction of overhead expenses;

·	submit a written plan for eliminating the Bank’s reliance on brokered deposits, in compliance with FDIC’s rules;

·	eliminate and/or correct all violations of law set forth in the Report of Visitation and the Report of Examination dated May 18, 2009, and ensure future compliance with all applicable laws and regulations;

·	implement a comprehensive policy for determining the adequacy of the allowance for loan losses satisfactory to the regulators and remedy any deficiency in the allowance in the calendar quarter discovered by a charge to current operating earnings;

·	refrain from extending additional credit with respect to loans charged-off or classified as “loss” and uncollected;

·	refrain from extending additional credit with respect to other adversely classified loans, without the prior approval of a majority of the directors on the Bank Board or its loan committee, and without first collecting all past due interest;

·	implement a liquidity and funds management policy to reduce the Bank’s reliance on brokered deposits and other non-core funding sources; and

·	prepare and submit periodic progress reports to the FDIC and the Washington State DFI.

The FDIC Order will remain in effect until modified or terminated by the FDIC and the Washington State DFI. A complete copy of the FDIC Order was filed as Exhibit 10.1 to the Form 8-K filed by the Corporation with the SEC on July 21, 2010.

FRB Written Agreement. Additionally, based on an examination concluded on March 11, 2010, the Corporation entered into a Written Agreement (FRB Agreement) with the FRB of San Francisco on November 4, 2010. Under the FRB Agreement, the Corporation cannot do any of the following without prior written approval of the FRB:

·	declare or pay any dividends;

·	make any distributions of principal or interest on junior subordinated debentures or trust preferred securities;

·	incur, increase or guarantee any debt; or

·	redeem any outstanding stock.

The FRB Agreement also requires the Corporation to:

·	take steps to ensure that the Bank complies with the FDIC Order;

·	submit a written capital plan that provides for sufficient capitalization of both the Corporation and the Bank within 60 days, and notify the FRB no more than 45 days after the end of any quarter in which any of the Corporation’s capital ratios fall below the approved plan’s minimum ratios;

·	submit a written cash flow projection plan for 2011 within 60 days;

comply with FRB regulations governing affiliate transactions, as well as submit a written plan to reimburse the Bank for all payments made by the Bank in violation of sections 23A and 23B of the Federal Reserve Act or to collateralize the loan made by the Bank to the Corporation in accordance with the requirements of sections 23A and 23B of the Federal Reserve Act;

·	comply with notice and approval requirements of the Federal Deposit Insurance Act (FDI Act) related to the appointment of directors and senior executive officers or change in the responsibility of any current senior executive officer;

·	comply with restrictions on paying or agreeing to pay certain indemnification and severance payments without prior written approval; and

·	submit a quarterly process report to the FRB.

Based on our most recent examination, the FRB staff recently advised us that in its opinion, the Corporation has not complied with all of the requirements of the FRB Agreement. The FRB found that we were not in compliance with the requirement to serve as a source of strength for the Bank, as a result of our failure to raise additional capital to support the Bank’s higher risk profile as a result of the levels of non-performing loans and OREO, continuing losses and declining capital levels. The FRB also criticized the capital plan we submitted on January 4, 2011, which called for raising approximately $90.0 million in additional capital, for failing to address the adequacy of the Bank’s capital, taking into account the level of adversely classified loans, the results of loan portfolio stress tests, the Bank’s risk profile, the adequacy of the allowance for loan losses, current and projected asset growth, and projected earnings, as required in the FRB Agreement. Finally, the FRB staff cited the Corporation’s failure to correct an alleged violation of Regulation W of the Federal Reserve Board of Governors, under Sections 23A and 23B of the Federal Reserve Act, related to a $430,000 loan by the Bank to the Corporation. The FRB observed that the outstanding debt owed to the Bank remains unpaid and uncollateralized, and that the Corporation would be unable to correct the violation until additional capital is raised to reimburse the Bank.

The Board of Directors is committed to taking all actions necessary to meet each of the requirements of the FRB Agreement and the FDIC Order. The Board of Directors is working diligently to comply with the requirement to raise capital, and on March 4, 2011, the Corporation announced that the Corporation, the Bank and Opus Bank entered into a definitive agreement, providing for Opus Bank to acquire the Corporation and the Bank, and for the merger of the Bank into Opus Bank. See “Proposed Merger” below.

Proposed Merger

On March 4, 2011, the Corporation announced that the Corporation, the Bank and Opus Bank entered into a definitive agreement, providing for Opus Bank to acquire the Corporation and the Bank, and for the merger of the Bank into Opus Bank. Opus Bank is a California-chartered bank with its executive offices located in Irvine, California. According to the terms of the merger agreement, Opus Bank will pay approximately $16.25 million to retire the Corporation’s $39.0 million in preferred stock and the associated warrant issued to the United States Department of the Treasury (the Treasury) under the Treasury’s Capital Purchase Program, and $5.5 million in cash to the holders of the Corporation’s common stock. The purchase price for the Corporation’s common stock represents approximately $0.45

per share outstanding. In addition, Opus Bank will assume all of the Corporation’s obligations with respect to the trust preferred securities issued by the Corporation’s trust subsidiaries. The proposed transaction is subject to the approval of the Corporation’s shareholders at a special meeting of shareholders to be held on May 31, 2011, the approval of federal and state regulatory authorities, and other customary conditions. The parties expect to close the transaction in the latter part of the second quarter of 2011. Notwithstanding this, there are no assurances that the Corporation, the Bank and Opus Bank will be able to successfully close the proposed merger.

Going Concern Considerations

The consolidated financial statements have been prepared assuming that the Corporation will continue as a going concern. The Corporation and the subsidiary Bank were considered “under-capitalized” as of March 31, 2011. Due to market conditions discussed above and other factors, there is uncertainty about the Corporation’s ability to satisfy regulatory requirements, including restoration of the Bank to capital levels stipulated in the FDIC Order issued by the FDIC and Washington State DFI in July 2010. The FDIC Order required the Bank to develop a capital plan and increase Tier 1 leverage capital to 10% of the Bank’s average total assets and increase total risk-based capital to 12% of the Bank’s risk-weighted assets. The additional capital required to satisfy the requirements of the FDIC Order as of March 31, 2011 was approximately $65.0 million. In addition, the Corporation entered into a Written Agreement with the FRB of San Francisco on November 4, 2010 which required the Corporation to take steps to ensure that the Bank complies with the FDIC Order.

As a part of its most recent capital raising efforts launched late in 2009, the Corporation engaged a highly qualified investment banking firm with expertise in the financial services sector to assist with a review of all strategic opportunities available to the Corporation. On March 4, 2011, the Corporation announced that it had entered into a definitive agreement, providing for Opus Bank to acquire the Corporation and the Bank, and for the merger of the Bank into Opus Bank. See “Proposed Merger” above.

During the second quarter of 2009, the Corporation suspended payment of a quarterly cash dividend and, effective with the fourth quarter of 2009, dividend payments on trust preferred securities were deferred in accordance with provisions of the related indentures. Efforts to improve the Bank’s capital levels through improved internal equity generation were also initiated in conjunction with various cost cutting measures implemented by the bank but elevated loan charge-offs, REO write-downs, legal expenses, foreclosure expenses and FDIC insurance premiums have precluded the Corporation from improving capital levels to date.

During 2009 and 2010, as a result of declining real estate values, the Corporation took decisive actions to address the deterioration in the construction and land acquisition and development sectors of the loan portfolio resulting from a general and severe deterioration in residential real estate valuations and sales activity. Loan charge-offs of $56.3 million were recognized during 2010, of which over 78% were related to construction and land acquisition and development loans. Loan charge-offs of $34.7 million were recognized during 2009, of which over 87% were related to construction and land acquisition and development loans. Although additional loan loss provisions and charge-offs will likely be recognized during 2011, the Company does not expect the other segments of the portfolio will suffer from extreme losses and, accordingly, that the regulatory capital levels will not be impacted by the same magnitude in 2011 as they were in the previous two years. Loan charge-offs were $2.9 million for the first quarter of 2011.

Despite the restrictions on issuance and renewal of brokered certificates of deposit, which became effective in July 2010, the Bank maintained an adequate liquidity position as of March 31, 2011 through the strength of its core deposit base, issuance of promotional rate retail certificates of deposit and benefit of the recently increased FDIC deposit insurance limits. Additionally, the reduction in loans and the liquidity generated from the sale of foreclosed assets have contributed significantly to the Bank’s liquidity position.

As noted above, the Bank sustained significant credit losses in 2009 and 2010 as a result of the impact of the recession and the related deterioration in the real estate markets on its loan portfolios, more specifically the real estate construction portfolio. While the Bank’s credit losses are not likely to continue at the same level as in 2010, the Bank’s nonperforming assets and related costs remain elevated and continuing losses remain a risk. The losses sustained since 2009 have reduced the capital levels at the Corporation and the Bank significantly and resulted in an accumulated deficit of $21.3 million for the Corporation as of March 31, 2011. Although the Corporation is working diligently to close the proposed merger transaction described above, there are no assurances that the transaction will be closed as anticipated. If the Corporation is not able to close the proposed merger transaction, failure to meet the requirements under the FDIC Order or the FRB Agreement exposes the Corporation and

the Bank to additional restrictions and regulatory actions. Despite all of our efforts to restore the financial condition of the Corporation and the Bank, there remains uncertainty, which raises substantial doubt about the ability of the Corporation to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Note 3 - Investment Securities

The following table presents the amortized cost, unrealized gains, unrealized losses and fair value of available-for-sale and held-to-maturity securities at March 31, 2011 and December 31, 2010:

	March 31, 2011
(Dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Securities available-for-sale
Mortgage-backed securities	$	68,928	$	11	$	(3,247	)	$	65,692
Agency notes & bonds		116,633		-		(6,282	)		110,351
US treasury notes		56,316		43		(125	)		56,234
Total	$	241,877	$	54	$	(9,654	)	$	232,277

Securities held-to-maturity
Mortgage-backed securities	$	23,644	$	601	$	(440	)	$	23,805
Agency notes & bonds		28,000		-		(1,522	)		26,478
Other		775		-		-			775
Total	$	52,419	$	601	$	(1,962	)	$	51,058

	December 31, 2010
(Dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Securities available-for-sale
Mortgage-backed securities	$	70,270	$	10	$	(3,077	)	$	67,203
Agency notes & bonds		116,632		-		(5,513	)		111,119
US treasury notes		56,346		-		(62	)		56,284
Total	$	243,248	$	10	$	(8,652	)	$	234,606
Securities held-to-maturity
Mortgage-backed securities	$	25,137	$	755	$	(383	)	$	25,509
Agency notes & bonds		28,000		-		(1,216	)		26,784
Other		775		-		-			775
Total	$	53,912	$	755	$	(1,599	)	$	53,068

The amortized cost and estimated fair value of investment securities are shown in the following table by contractual or expected maturity at March 31, 2011. During certain interest rate environments, some of these securities may be called for redemption by their issuers prior to the scheduled maturities.

	March 31, 2011
(Dollars in thousands)	Amortized Cost		Fair Value		Yield
Securities available-for-sale (AFS)
Agency and US Treasury:
Due after one through five years	$	72,816	$	72,187		0.93	%
Due after five through ten years		100,091		94,356		2.81
Due after ten years		42		42		0.00
Subtotal		172,949		166,585		2.00
Mortgage-backed securities:
Due less than one year		55		55		4.50
Due after one through five years		385		396		4.86
Due after five through ten years		68,488		65,241		3.07
Subtotal		68,928		65,692		3.08
Total securities AFS	$	241,877	$	232,277		2.30	%

Securities held-to-maturity (HTM)
Agency:
Due less than one year	$	28,000	$	26,478		2.31	%
Due after ten years		775		775		7.50
Subtotal		28,775		27,253		2.45
Mortgage-backed securities:
Due less than one year		34		34		5.01
Due after one through five years		10,331		10,876		4.59
Due after five through ten years		13,279		12,895		4.14
Subtotal		23,644		23,805		4.34
Total securities HTM	$	52,419	$	51,058		3.33	%

No investment securities were pledged to the FHLB at March 31, 2011. The fair value of investment securities pledged to the FHLB at December 31, 2010, totaled $15.9 million. The fair value of investment securities pledged to fund repurchase agreements was $210.9 million at March 31, 2011 and $212.9 million at December 31, 2010.

The following table presents gross unrealized losses and the fair value of available-for-sale and held-to-maturity securities at March 31, 2011 and December 31, 2010:

	March 31, 2011
	Fair Value		Gross Unrealized Losses Less Than 1 Year			Fair Value		Gross Unrealized Losses More Than 1 Year		Total
(Dollars in thousands)	Fair Value		Gross Unrealized Losses Less Than 1 Year			Fair Value		Gross Unrealized Losses More Than 1 Year		Fair Value		Unrealized Losses
Securities available-for-sale
Mortgage-backed securities	$	65,296	$	(3,247	)	$	-	$	-	$	65,296	$	(3,247	)
Agency notes & bonds		110,218		(6,282	)		-		-		110,218		(6,282	)
US Treasury notes		21,207		(125	)		-		-		21,207		(125	)
Total	$	196,721	$	(9,654	)	$	-	$	-	$	196,721	$	(9,654	)

Securities held-to-maturity
Mortgage-backed securities	$	5,990	$	(440	)	$	-	$	-	$	5,990	$	(440	)
Agency notes & bonds		26,478		(1,522	)		-		-		26,478		(1,522	)
Total	$	32,468	$	(1,962	)	$	-	$	-	$	32,468	$	(1,962	)

	December 31, 2010
	Fair Value		Gross Unrealized Losses Less Than 1 Year			Fair Value		Gross Unrealized Losses More Than 1 Year		Total
(Dollars in thousands)	Fair Value		Gross Unrealized Losses Less Than 1 Year			Fair Value		Gross Unrealized Losses More Than 1 Year		Fair Value		Unrealized Losses
Securities available-for-sale
Mortgage-backed securities	$	66,668	$	(3,077	)	$	-	$	-	$	66,668	$	(3,077	)
Agency notes & bonds		110,987		(5,513	)		-		-		110,987		(5,513	)
US Treasury notes		56,284		(62	)		-		-		56,284		(62	)
Total	$	233,939	$	(8,652	)	$	-	$	-	$	233,939	$	(8,652	)

Securities held-to-maturity
Mortgage-backed securities	$	6,046	$	(383	)	$	-	$	-	$	6,046	$	(383	)
Agency notes & bonds		26,784		(1,216	)		-		-		26,784		(1,216	)
Total	$	32,830	$	(1,599	)	$	-	$	-	$	32,830	$	(1,599	)

The Corporation had no securities in its available-for-sale portfolio or held-to-maturity portfolio with unrealized losses greater than one year at March 31, 2011 or December 31, 2010. Available-for-sale securities had unrealized losses less than one year of $9.7 million and held-to-maturity securities had unrealized losses less than one year of $2.0 million Securities having fair values less than amortized cost and containing unrealized losses are evaluated periodically by the Corporation for other-than-temporary impairment. The Corporation does not intend to sell the securities nor does it anticipate being required to sell these securities. In the analysis for March 31, 2011, the Corporation determined that the decline in value was temporary and related to the change in market interest rates since purchase. All investment securities were rated AAA for credit quality by at least one major rating agency. The decline in value was not related to any company or industry specific event. The Corporation anticipates full recovery of par value with respect to these securities at maturity or sooner in the event of a more favorable market interest rate environment.

As of March 31, 2011 and December 31, 2010, the Corporation was required to maintain 71,550 shares, of $100 par value FHLB stock. As a member of the FHLB system, the Bank is required to maintain a minimum level of investment in FHLB stock based on specific percentages of its outstanding mortgages, total assets, or FHLB advances. The Bank’s minimum required investment in FHLB stock was $7.2 million at March 31, 2011 and December 31, 2010. The Bank may request redemption at par value of any stock in excess of the minimum required investment. Stock redemptions are at the discretion of the FHLB.

At March 31, 2011, 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. The 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 is 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 FHLB has the ability to hold the securities until maturity. The FHLB has 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 FHLB 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 FHLB. 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 FHLB has a very high degree of government support. Based on the above, the Corporation has determined there is no impairment of the FHLB stock investment as of March 31, 2011.

Note 4 - Loans and Allowance for Loan Losses

A summary of loans at March 31, 2011 and December 31, 2010, follows:

(Dollars in thousands) Loans	March 31, 2011			December 31, 2010
Business	$	392,233		$	400,047
R/E construction(1)
Spec construction		23,033			25,303
Land acquisition & development/land		57,235			54,142
Commercial R/E construction		2,332			2,333
Total R/E construction		82,600			81,778
Commercial R/E		190,191			201,885
Multifamily		89,461			89,350
Home equity/consumer		29,270			29,964
Residential		196,389			194,677
Total loans	$	980,144		$	997,701
Deferred loan fees		(3,879	)		(3,934	)
Allowance for loan losses		(25,782	)		(26,106	)
Loans, net	$	950,483		$	967,661

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

The allowance for loan losses (ALLL) is an estimate of the total potential principal loss inherent in the loan portfolio as of the reporting date. The ALLL is maintained based on a review of several factors. These factors include delinquency trends, level and trend of adversely classified loans, historical loss experience, additional management judgment, peer group and industry review, impaired loan analyses and qualitative (Q) factors. These Q factors include regional/local economic trends, health of the real estate market, loan and collateral concentrations, size of borrowing relationships, change in loan delinquencies and charge-offs and changes in classifications.

The allowance consists of general and specific components. To determine the general component of the allowance, for loans not identified as impaired, the loan portfolio is separated by loan type and then by risk rating. The loan types are as follows: business and business real estate (combined below, but analyzed separately), real estate construction, commercial real estate, multifamily, home equity/consumer and residential. A loss factor based on a two-year historical loss average has been used. However, for the first quarter of 2011, the one-year loss factor was used for the real estate construction loan category because management believes it is more representative of the current market environment for those loan types. Historical losses are then adjusted to incorporate Q factors as noted above. Specific Q factors are assigned to each loan type based on the risks identified in each segment of the loan portfolio. Management has also added an additional management judgment factor after thorough analysis of the historical trends and Q factors as well as the breakdown between special mention and pass loans.

For the specific portion of the reserve, loans identified as impaired are reviewed individually to determine if specific reserves are needed. A few smaller dollar loans are grouped and reviewed in pools. Any portion of the ALLL that is not allocated to the general or specific components of the reserve is considered to be unallocated.

Loan risk ratings are a critical part of the ALLL process. Credit administration management actively reviews loan risk ratings as part of their ongoing review of credits. Classified Loan Status Reports are reviewed monthly by the Asset Review Committee. At March 31, 2011, substantially all of the substandard loans were individually reviewed for impairment.

The total allowance reflects management’s estimate of loan losses inherent in the loan portfolio and management considers the allowance of $25.8 million adequate to cover loan losses at March 31, 2011.

The following table presents the changes in the allowance for loan losses by type:

(Dollars in thousands)	Three Months Ended March 31, 2011
Allowance for Loan Losses	Business			R/E Construction			Commercial R/E			Multi- family			Home Equity/ Consumer			Residential			Unallocated		Total
Balance at beginning of period	$	9,437		$	10,591		$	2,745		$	1,410		$	642		$	1,281		$	-	$	26,106
Net charge-offs		(1,103	)		(1,253	)		51			-			(266	)		(303	)		-		(2,874	)
Provision for losses		874			1,604			(249	)		(224	)		308			157			80		2,550
Ending balance	$	9,208		$	10,942		$	2,547		$	1,186		$	684		$	1,135		$	80	$	25,782

Loans individually evaluated for impairment	$	33,034		$	28,772		$	45,547		$	11,138		$	400		$	4,057		$	-	$	122,948
Loans evaluated in a group for impairment *		-			-			-			-			655			345			-		1,000
Total impaired		33,034			28,772			45,547			11,138			1,055			4,402			-		123,948
Loans not impaired		359,199			53,828			144,644			78,323			28,215			191,987			-		856,196
Total loans	$	392,233		$	82,600		$	190,191		$	89,461		$	29,270		$	196,389		$	-	$	980,144

* Small dollar, homogeneous loans

A loan is considered impaired when, based on current information and events, the Bank determines that it is probable it will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. When the Bank identifies a loan as impaired, it measures the impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, the Bank uses the current fair value of the collateral, less selling costs, instead of discounted cash flows. If the Bank determines that the value of the impaired loan is less than the recorded investment in the loan, it either recognizes an impairment reserve as a specific component to be provided for in the allowance for loan losses or charges-off the impaired balance on collateral dependent loans if it is determined that such amount represents a confirmed loss. The combination of the general allowance calculation and the specific reserve on impaired loans resulted in the total allowance for loan losses.

At March 31, 2011, the recorded investment in loans classified as impaired totaled $123.9 million. Included in this total are $33.9 million in impaired loans with a corresponding specific reserve (included in the allowance for loan losses) of $6.6 million. The remaining $90.0 million in impaired loans are considered collateral dependent and have been written-down to their estimated net realizable value. At December 31, 2010, the total recorded investment in impaired loans was $144.0 million, including $40.0 million that had a corresponding specific reserve of $5.8 million.

At March 31, 2011 and December 31, 2010, impaired loans of $69.0 million and $63.8 million, respectively, were classified as performing troubled debt restructured (TDR) loans. The restructurings were granted in response to borrower financial difficulty, and generally provide for a temporary modification of loan repayment terms. In order for a restructured loan to be considered performing and on accrual status, the loan’s collateral coverage generally will be greater than or equal to 100% of the loan balance (net of specific reserves as applicable), the loan is current on payments, and the borrower must either prefund an interest reserve or have demonstrated the ability to make payments from a verified source of cash flow.

The following table shows the recorded investment, unpaid principal balance and specific reserve for impaired loans:

	March 31, 2011
(Dollars in thousands)	Recorded Investment (Loan Balance Less Charge-Off)		Unpaid Principal Balance (Gross of Charge-off)		Specific Reserve
Impaired Loans With No Specific Reserve
Business	$	24,288	$	25,066	$	-
R/E construction
Spec construction		14,467		19,562		-
Land acquisition & development/land		2,944		4,652		-
Total R/E construction		17,411		24,214		-
Commercial R/E		41,080		41,111		-
Multifamily		2,967		2,967		-
Home equity/consumer		325		401		-
Residential		3,954		4,101		-
Total		90,025		97,860		-

Impaired Loans With Specific Reserve
Business		8,746		8,777		1,486
R/E construction
Land acquisition & development/land		11,361		11,361		3,225
Total R/E construction		11,361		11,361		3,225
Commercial R/E		4,467		4,467		1,154
Multifamily		8,171		8,171		712
Home equity/consumer		420		536		47
Residential		758		759		12
Total		33,923		34,071		6,636

Total Impaired Loans
Business		33,034		33,843		1,486
R/E construction
Spec construction		14,467		19,562		-
Land acquisition & development/land		14,305		16,013		3,225
Total R/E construction		28,772		35,575		3,225
Commercial R/E		45,547		45,578		1,154
Multifamily		11,138		11,138		712
Home equity/consumer		745		937		47
Residential		4,712		4,860		12
Total	$	123,948	$	131,931	$	6,636

	December 31, 2010
(Dollars in thousands)	Recorded Investment (Loan Balance Less Charge-Off)		Unpaid Principal Balance (Gross of Charge-off)		Specific Reserve
Impaired Loans With No Specific Reserve
Business	$	27,435	$	28,315	$	-
R/E construction
Spec construction		14,753		19,410		-
Land acquisition & development/land		4,303		4,303		-
Total R/E construction		19,056		23,713		-
Commercial R/E		51,472		52,812		-
Multifamily		2,976		2,976		-
Home equity/consumer		244		244		-
Residential		2,808		3,055		-
Total		103,991		111,115		-

Impaired Loans With Specific Reserve
Business		12,184		12,218		1,215
R/E construction
Spec construction		875		875		-
Land acquisition & development/land		12,144		13,615		2,416
Total R/E construction		13,019		14,490		2,416
Commercial R/E		4,483		4,483		1,148
Multifamily		8,186		8,186		886
Home equity/consumer		804		817		17
Residential		1,332		1,332		119
Total		40,008		41,526		5,801

Total Impaired Loans
Business		39,619		40,533		1,215
R/E construction
Spec construction		15,628		20,285		-
Land acquisition & development/land		16,447		17,918		2,416
Total R/E construction		32,075		38,203		2,416
Commercial R/E		55,955		57,296		1,148
Multifamily		11,162		11,162		886
Home equity/consumer		1,048		1,060		17
Residential		4,140		4,387		119
Total	$	143,999	$	152,641	$	5,801

The following tables show summarized information on impaired loans:

(Dollars in thousands) Impaired loans	March 31, 2011		December 31, 2010
Impaired loans without a specific reserve	$	90,025	$	103,991
Impaired loans with a specific reserve		33,923		40,008
Total impaired loans	$	123,948	$	143,999

Allowance for loan losses related to impaired loans	$	6,636	$	5,801
Total nonperforming loans		35,191		48,098
Total loans past-due ninety days or more and still accruing		145		-

Performing TDR loans	$	69,006	$	63,773
Nonperforming TDR loans		31,568		30,399
Total TDR loans	$	100,574	$	94,172

Federal regulations provide for the classification of loans as substandard, doubtful and loss. A substandard asset is inadequately protected by the current net worth and paying capacity of the debtor or the collateral pledged. These assets have well defined weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loans classified doubtful have the same concerns as substandard but with additional likelihood that collection or liquidation in full, based on existing facts, conditions and values, is highly questionable and improbable. Loans designated loss should be fully charged-off since these loans are determined to be uncollectible and of such little value that their continuance as assets is not warranted.

The Bank uses an additional seven categories to describe loans that are not classified. These categories include special mention and watch loans, which include borrowers with declining earnings, strained cash flow and downward trends requiring close management attention. Loans considered pass include five separate categories of loans from substantially risk free to average risk.

The following table shows the loan portfolio by loan classification and type of loan:

	March 31, 2011
(Dollars in thousands)	Doubtful		Substandard		Special Mention/Watch		Pass		Total
Business	$	-	$	32,616	$	93,206	$	266,411	$	392,233
R/E construction
Spec construction		-		14,467		7,401		1,165		23,033
Land acquisition & development/land		-		11,454		27,123		18,658		57,235
Commercial R/E construction		-		-		-		2,332		2,332
Total R/E construction		-		25,921		34,524		22,155		82,600
Commercial R/E		-		45,547		33,342		111,302		190,191
Multifamily		-		11,138		21,760		56,563		89,461
Home equity/consumer		-		946		124		28,200		29,270
Residential		-		3,918		7,230		185,241		196,389
Total	$	-	$	120,086	$	190,186	$	669,872	$	980,144

	December 31, 2010
(Dollars in thousands)	Doubtful		Substandard		Special Mention/Watch		Pass		Total
Business	$	337	$	39,321	$	67,905	$	292,484	$	400,047
R/E construction
Spec construction		-		15,628		8,104		1,571		25,303
Land acquisition & development/land		128		16,319		23,310		14,385		54,142
Commercial R/E construction		-		-		-		2,333		2,333
Total R/E construction		128		31,947		31,414		18,289		81,778
Commercial R/E		-		55,955		30,665		115,265		201,885
Multifamily		-		11,161		17,506		60,683		89,350
Home equity/consumer		-		1,532		427		28,005		29,964
Residential		-		3,684		7,934		183,059		194,677
Total	$	465	$	143,600	$	155,851	$	697,785	$	997,701

The following table includes an aging analysis of the recorded investment of past-due loans by type as of March 31, 2011 and December 31, 2010, and shows the amount of loans that are current by type. The table excludes performing/nonperforming status and is calculated based on days delinquent. As of March 31, 2011, there were $8.8 million in nonperforming loans that were not past due.

(Dollars in thousands)	March 31, 2011
Age Analysis of Past Due Loans	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days Past Due		Total Past Due		Current		Total Loans
Business	$	7,609	$	14	$	2,451	$	10,074	$	382,159	$	392,233
R/E construction		181		-		10,553		10,734		71,866		82,600
Commercial R/E		11,458		-		-		11,458		178,733		190,191
Multifamily		-		-		-		-		89,461		89,461
Home equity/consumer		523		-		176		699		28,571		29,270
Residential		4,345		-		315		4,660		191,729		196,389
Total	$	24,116	$	14	$	13,495	$	37,625	$	942,519	$	980,144

(Dollars in thousands)	December 31, 2010
Age Analysis of Past Due Loans	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days Past Due		Total Past Due		Current		Total Loans
Business	$	1,949	$	160	$	2,474	$	4,583	$	395,464	$	400,047
R/E construction		254		619		11,537		12,410		69,368		81,778
Commercial R/E		-		-		10,962		10,962		190,923		201,885
Multifamily		167		-		-		167		89,183		89,350
Home equity/consumer		95		157		697		949		29,015		29,964
Residential		1,087		744		796		2,627		192,050		194,677
Total	$	3,552	$	1,680	$	26,466	$	31,698	$	966,003	$	997,701

The following table shows the loan portfolio by performing and nonperforming status by type of loan as of March 31, 2011 and December 31, 2010:

	March 31, 2011
(Dollars in thousands)	Performing		Nonperforming		Total
Business	$	389,415	$	2,818	$	392,233
R/E construction
Spec construction		14,531		8,502		23,033
Land acquisition & development/land		54,628		2,607		57,235
Commercial R/E construction		2,332		-		2,332
Total R/E construction		71,491		11,109		82,600
Commercial R/E		172,233		17,958		190,191
Multifamily		89,461		-		89,461
Home equity/consumer		28,524		746		29,270
Residential		193,829		2,560		196,389
Total	$	944,953	$	35,191	$	980,144

	December 31, 2010
(Dollars in thousands)	Performing		Nonperforming		Total
Business	$	395,700	$	4,347	$	400,047
R/E construction
Spec construction		15,598		9,705		25,303
Land acquisition & development/land		51,294		2,848		54,142
Commercial R/E construction		2,333		-		2,333
Total R/E construction		69,225		12,553		81,778
Commercial R/E		173,533		28,352		201,885
Multifamily		89,350		-		89,350
Home equity/consumer		28,916		1,048		29,964
Residential		192,879		1,798		194,677
Total	$	949,603	$	48,098	$	997,701

The following table includes the number of TDR loans and the recorded investment as of March 31, 2011 and December 31, 2010. The outstanding balances at March 31, 2011 are net of $5.0 million in charge-offs. The Bank is committed to fund the undisbursed balance on TDR loans, totaling $152,000 as of March 31, 2011.

(Dollars in thousands)	March 31, 2011				December 31, 2010
TDR Loans	Number of Loans		Outstanding Balance		Number of Loans		Outstanding Balance
Business		24	$	22,493		25	$	19,614
R/E construction		11		27,582		12		30,373
Commercial R/E		7		37,484		4		32,238
Multifamily		4		8,610		4		8,619
Home equity/consumer		3		294		1		244
Residential		8		4,111		5		3,084
Total		57	$	100,574		51	$	94,172

Note 5 – Real Estate Owned (REO)

REO includes real estate acquired in settlement of loans. REO is recorded at the lower of carrying amount or fair value, based upon an appraisal, less estimated costs to sell. Developments and improvements related to the property are capitalized. Any losses recorded at the time a foreclosure occurs are classified as a charge-off against the allowance for loan losses. Losses that result from the ongoing periodic valuation of these properties, are charged to expense in the period identified. Revenue and expenses from operations and subsequent adjustments to the carrying amount of the property are included in noninterest expense in the statement of operations.

The following table presents real estate owned activity for the periods presented:

	Three Months Ended March 31,
(Dollars in thousands)	2011			2010
Beginning balance	$	34,412		$	18,842
Transfers to REO		11,468			11,200
Capitalized costs		487			970
Paydowns/sales		(11,784	)		(2,920	)
Write-downs/losses		(2,272	)		(698	)
Ending balance	$	32,311		$	27,394

Note 6 - Junior Subordinated Debentures

On March 1, 2000, the Corporation issued $10.3 million of 11.0% junior subordinated debentures. In turn, Cascade Capital Trust I, a wholly owned business trust whose common equity is 100% owned by the Corporation, issued trust preferred securities underlying the debentures. The Trust exists for the exclusive purpose of issuing the trust preferred securities underlying the junior subordinated debentures issued by the Corporation, and engaging in only those other activities necessary, advisable or incidental to the above. The Corporation used the proceeds for general corporate purposes including stock repurchases and investment in the Bank. The junior subordinated debentures will mature on March 1, 2030, unless redeemed prior to such date if certain conditions are met.

On December 15, 2004, the Corporation issued $5.2 million in junior subordinated debentures. In turn, Cascade Capital Trust II, a wholly owned business trust whose common equity is 100% owned by the Corporation, issued trust preferred securities underlying the debentures. The Trust exists for the exclusive purpose of issuing the trust preferred securities underlying the junior subordinated debentures issued by the Corporation, and engaging in only those other activities necessary, advisable or incidental to the above. These debentures had a fixed coupon of 5.82% for the first five years and as of January 7, 2010, float at the three-month LIBOR plus 1.90% for the remaining twenty-five years. The coupon rate on the debentures was 2.20% as of March 31, 2011. The debentures were callable at par after the first five years.

On March 30, 2006, the Corporation issued $10.3 million in junior subordinated debentures. In turn, Cascade Capital Trust III, a wholly owned business trust whose common equity is 100% owned by the Corporation, issued trust preferred securities underlying the debentures. The Trust exists for the exclusive purpose of issuing the trust preferred securities underlying the junior subordinated debentures issued by the Corporation, and engaging in only those other activities necessary, advisable or incidental to the above. These debentures have a fixed coupon of 6.65% for the first five years and as of June 15, 2011, float, if not called, at the three-month LIBOR plus 1.40% for the remaining twenty-five years.

The junior subordinated debentures issued by the Corporation incorporate the same structure and are considered Tier 1 capital for regulatory purposes, subject to FRB restrictions.

The Corporation applied fair value accounting to the junior subordinated debentures issued by Cascade Capital Trust I. The change in fair market value of the junior subordinated debentures is recorded as a component of other income. The Corporation determines the fair value by using a discounted cash flow model. The discount rate is determined using a risk free interest rate approximating the remaining maturity of the debentures combined with a credit and liquidity spread determined based upon quotes from brokers and from valuations by holders of Cascade Capital Trust I, which were obtained from public filings. The bonds are assumed to be outstanding until maturity. For the quarter ended March 31, 2011, there was no change in the fair value of the junior subordinated debentures. The fair value was $1.5 million at March 31, 2011 and December 31, 2010. The fair value option was not selected for the junior subordinated debentures issued in connection with Cascade Capital Trust II and III, which are reported at the combined book value of $15.5 million.

During the fourth quarter of 2009, FDIC restrictions prohibited dividend payments from the Bank to the holding company, which in turn led the Corporation to defer the payment of interest on the Trust Preferred Securities. Under the terms of each instrument deferral of payments is permitted without triggering an event of default. Generally, during any deferral period, the Corporation is prohibited from

paying any dividends or distributions on, or redeem, purchase or acquire, or make a liquidation payment with respect to the Corporation’s capital stock, or make any payment of principal or interest on, or repay, repurchase or redeem any debt securities of the Corporation that rank pari passu in all respects with, or junior to, the specific instrument. In addition, during any deferral period, interest on the trust preferred securities is compounded from the date such interest would have been payable.

Note 7 – Derivatives and Hedging

In the fourth quarter of 2010, the Bank entered into derivative contracts to add stability to net interest income and to manage its exposure to changes in interest rates. The Bank sought to minimize the volatility that changes in interest rates have on its variable-rate debt by entering into interest rate cap agreements. The Bank purchased a series of interest rate caps from two different major financial institutions based on their credit rating and other factors. Both counterparties provide cash collateral to the Bank on the majority of the fair value of the cap to significantly mitigate credit risk of these transactions. The Bank purchased interest rate caps designated as cash flow hedges to protect against movements in interest rates above the caps’ strike rate, which is tied to three month LIBOR. The interest rate caps have an aggregate notional amount of $159.0 million, strike rates of 1.29% and a maturity date of October 20, 2015. The Bank formally documented the relationship between the hedging instruments and hedged items, as well as its risk management objective and strategy before initiating the hedge. The caps were used to hedge the variable cash flows associated with variable rate FHLB advances that reprice based upon three month LIBOR on the same day that the rate caps reprice. The fair value of the interest rate caps is based on derivative valuation models using market data inputs as of the valuation date that can generally be verified and do not typically involve significant management judgments. (Level 2 inputs). The valuation is performed on each reporting date to determine if the hedge was effective over the reporting period, using the hypothetical derivative method, by comparing the actual changes in the hedged item to a “perfectly effective” hypothetical interest rate cap. If the ratio of the change in fair value of the actual cap to the change in fair value of the hypothetical cap falls between the effectiveness parameters the hedge will be considered to have been effective. The March 31, 2011 valuations showed the hedge to be “perfectly effective” and resulted in a mark-to-market gain on the interest rate caps totaling $3.8 million, which is included in accumulated other comprehensive loss. As of January 1, 2011, the Bank began amortizing the cost of the interest rate caps. The expense is reclassified into earnings. As of March 31, 2011, approximately $1,000 had been expensed.

The following table presents the notional value, strike rate, and fair value and collateral held at March 31, 2011:

(Dollars in thousands) Derivatives	March 31, 2011			December 31, 2010
Notional Value	$	159,000		$	159,000
Strike Rate		1.29	%		1.29	%
Fair Value	$	9,042		$	8,732
Cash Collateral		7,790			7,620

Note 8 - Income Taxes

At March 31, 2010, the Corporation assessed whether it was more likely than not that it would realize the benefits of its deferred tax asset. The Corporation determined that the negative evidence associated with a cumulative three-year loss, entering into an FDIC Order (see Note 2) with its regulators, and credit deterioration in its loan portfolio outweighed the positive evidence. Therefore, during the first quarter in 2010, the Corporation established a full valuation allowance against its deferred tax asset. The valuation allowance totaled $26.7 million at March 31, 2011, with net operating loss carryforwards accounting for $17.9 million of deferred tax assets.

In the future, the Corporation’s effective tax rate could be adversely affected by several factors, many of which are outside of the Corporation’s control. The effective tax rate is affected by the proportion of revenues and income before taxes in the various domestic jurisdictions in which the Corporation operates. Further, the Corporation is subject to changing tax laws, regulations and interpretations in multiple jurisdictions in which the Corporation operates, as well as the requirements, pronouncements and rulings of certain tax, regulatory and accounting organizations. The Corporation estimates its annual effective tax rate each quarter based on a combination of actual and forecasted results of subsequent quarters. Consequently, significant changes in its actual quarterly or forecasted results may impact the effective tax rate for the current or future periods. In addition, the Corporation will not receive a tax benefit for any future losses as long as it is required to maintain a valuation allowance on its deferred tax assets. The Corporation will not be able to recognize the tax benefits on current and future losses until it can show that it is more likely than not that it will generate enough taxable income in future periods to realize the benefits of its deferred tax asset and loss carryforwards.

Note 9 – Commitments and Contingencies

Lease Commitments

The Bank leases space for various branches. These leases run for a period ranging from 2 to 10 years and allow for established rent increases each year. Generally, these leases require the Bank to pay all taxes, maintenance and utility costs, as well as maintain certain types of insurance.

Rental expenses charged to operations were approximately $229,000 and $230,000 for the three months ended March 31, 2011 and 2010, respectively.

Loan Commitments

Commitments to extend credit under lines of credit/loans in process are agreements to lend to a customer as long as there is no violation of any condition established in the loan documents. Unfunded commitments totaled $82.5 million at March 31, 2011, and $81.9 million at December 31, 2010. Commitments generally have fixed maturity dates. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, other real estate including residential, multifamily and land, and income-producing commercial properties.

Standby letters of credit and financial guarantees written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, bond financing, and similar transactions. The Bank underwrites its standby letters of credit using its policies and procedures applicable to loans in general. Standby letters of credit are made on both an unsecured and secured basis. The Bank has not been required to perform on any standby letters of credit or financial guarantees during the past two years.

The Bank did not incur any losses on its commitments for the three months ended March 31, 2011 and 2010.

At March 31, 2011 and December 31, 2010, the following financial instruments with off-balance sheet risk were outstanding:

(Dollars in thousands)	March 31, 2011		December 31, 2010
Commitments to grant loans	$	2,015	$	2,100
Unfunded commitments under lines of credit/loans in process		82,544		81,868
Standby letters of credit and financial guarantees written		1,626		1,576
Unused commitments on bankcards		13,500		13,472
Total	$	99,685	$	99,016

Legal Contingencies

The Corporation is a defendant in various legal proceedings arising in connection with its business. It is the opinion of management that the financial position and the results of operations of the Corporation will not be materially adversely affected by the final outcome of these legal proceedings and will have no material effect on the Corporation’s Consolidated Financial Statements.

Loss Contingencies

The Bank has $50.0 million in repurchase agreements that have provisions allowing the agreements to be terminated by its counterparty. While the Bank has received no indication that the repurchase transactions will be terminated prior to maturity and the transactions are secured by securities pledged to the counterparty, management believes that the likelihood of termination of the agreements is reasonably possible. If these repurchase agreements had been terminated as of March 31, 2011, the termination fee would have been approximately $12.5 million. An additional $75.0 million in repurchase agreements have provisions allowing termination, but these agreements cannot be terminated prior to December 2012, provided the Bank offers the lender additional securities in November and December 2011. Repurchase agreements with this lender totaling $25.0 million and $50.0 million could be terminated in December 2012 and November 2013 respectively. The termination fee related to these agreements cannot be estimated because the calculation of the estimate requires knowledge of interest rates at the future termination dates in 2012 and 2013.

Significant Concentrations of Credit Risk

Concentration of credit risk is the risk associated with a lack of diversification, such as having substantial loan concentrations in a specific type of loan within the Bank’s loan portfolio, thereby exposing the Bank to greater risks resulting from adverse economic, political, regulatory, geographic, industrial or credit developments. At March 31, 2011, the Bank’s most significant concentration of credit risk was in loans secured by real estate. These loans totaled approximately $847.5 million or 86.5% of the Bank’s total loan portfolio. Real estate construction, including land acquisition and development/land, commercial real estate, multifamily, home equity and residential loans are included in the total loans secured by real estate for purposes of this calculation. There has been deterioration in the real estate market over the last three years, which has led to an increase in nonperforming loans and the allowance for loan losses.

At March 31, 2011, the Bank’s most significant concentration of credit risk within its investment portfolio was with the U.S. Government, its agencies and Government Sponsored Enterprises. The Bank’s exposure from this source of investment credit risk was $293.4 million or almost 100% of the Bank’s total investment portfolio (including FHLB stock).

Regulatory Examinations

At periodic intervals, the Washington State DFI, the FDIC, and the FRB routinely examine the Corporation’s financial statements as part of their legally prescribed oversight of the banking industry. Based on these examinations, the regulators can direct the Corporation’s financial statements be adjusted in accordance with their findings. As a result of the Bank’s FDIC Order, it is subject to more frequent examinations by regulators.

Note 10 - Stockholders’ Equity

U.S. Treasury Department’s Capital Purchase Program – TARP

On November 21, 2008, the Corporation completed its $39.0 million capital raise as a participant in the U.S. Treasury Department’s CPP. Under the terms of the transaction, the Corporation issued 38,970 shares of Series A Fixed-Rate Cumulative Perpetual Preferred Stock and a warrant to purchase 863,442 shares of the Corporation’s common stock at an exercise price of $6.77 per share.

In determining the value of the Series A Preferred Stock and the attendant warrant from the U.S. Treasury’s CPP, the Corporation apportioned the values using the relative fair value approach. The Corporation computed the present value of the preferred stock at $23.5 million assuming a ten-year life, 5% interest rate for the first five years and 9% for the second five years (the dividend that the Corporation will pay the Treasury). A discount rate of 14% was used as the approximate current cost of capital for the Corporation.

The Corporation computed a fair value of the warrants using the Black-Scholes option valuation model. The assumptions in deriving the value were a 34% volatility rate of the Corporation’s common stock, a 2.60% annual dividend rate on the Corporation’s common stock, a 2.75% risk free interest rate, which corresponded to the yield on the five year Treasury note at the time of the issuance, and an assumed life of ten years. The present value of the warrants was computed to be $1.6 million. The present value of the preferred stock represented 93.87% of the combined present value of $25.0 million of the components of the $39.0 million received or $36.6 million. The resulting value for the warrants was 6.13% of the proceeds or $2.4 million.

During the fourth quarter of 2009, FDIC restrictions prohibited dividend payments from the Bank to the holding company, which in turn led the Corporation to defer the dividend on the preferred stock. Under the terms of the preferred stock, deferral of payment is permitted without triggering an event of default. Generally, during any deferral period, the Corporation is prohibited from paying any dividends or distributions on, and may not redeem, purchase or acquire, or make a liquidation payment with respect to the Corporation’s capital stock, or make any payment of principal or interest on, or repay, repurchase or redeem any debt securities of the Corporation that rank pari passu in all respects with, or junior to, the specific instrument. In addition, during any deferral period, dividends on the preferred stock are compounded from the date such dividends would have been payable. As of March 31, 2011, the Corporation has deferred six consecutive dividend payments on the preferred stock. Under the terms of the Capital Purchase Program, the Treasury can appoint two people of its choice to the board of directors of a corporation that misses six dividend payments.

Restrictions on Dividends

The principal source of the Corporation's revenue is dividends received from the Bank. The payment of dividends is subject to government regulation, in that regulatory authorities may prohibit banks and bank holding companies from paying dividends that would constitute an unsafe or unsound banking practice. In addition, a bank may not pay cash dividends if that payment could reduce the amount of its capital below that necessary to meet minimum applicable regulatory capital requirements. In November 2008, the Corporation issued preferred stock to the U.S. Treasury. As a provision of that issuance, the Corporation cannot increase its current cash dividend without prior approval of the U.S. Treasury for three years or until November 2011. In June 2009, the Corporation announced that it would temporarily suspend its regular quarterly cash dividend on common stock to preserve capital.

The Bank was notified by the FDIC in late September 2009 that based on an off-site review of its financial information, the Bank, among other restrictions, could not pay a cash dividend to the Corporation unless it obtained a non-objection from the FDIC and the Washington State DFI. The Bank requested a non-objection and was informed orally that the request would be denied. Therefore, the Bank is unable to pay a cash dividend to the Corporation. Dividends from the Bank are the Corporation’s primary source of cash. In addition, the FDIC Order discussed in Note 2 prevents the Bank from paying any cash dividends to its stockholder without prior written approval from the regulators.

Regulatory Capital

Under a Consent Order with the FDIC and Washington State DFI, the Bank’s regulators directed the Bank to increase its overall capital levels and, in particular, required the Bank to increase its Tier 1 leverage capital to 10% of the Bank’s average total assets and total risk based capital to 12% of the Bank’s risk weighted assets by November 18, 2010. The Bank is considered “undercapitalized” under the regulatory framework for prompt corrective action and has not met the required capital ratios provided in its FDIC Order, but the Board of Directors is working diligently to comply with these requirements.

(Dollars in thousands) Cascade Bank	Actual				Minimum Requirements For Capital Adequacy				Well-Capitalized Requirements
March 31, 2011:
Total risk-based capital to risk-weighted assets	$	95,160	9.56	%	$	79,639	8.00	%	$	99,549	10.00	%
Tier I (core) capital to risk-weighted assets		82,551	8.29			39,820	4.00			59,729	6.00
Tier I (core) capital to average total assets		82,551	5.61			58,864	4.00			73,580	5.00

December 31, 2010:
Total risk-based capital to risk-weighted assets	$	97,456	9.60	%	$	81,213	8.00	%	$	101,516	10.00	%
Tier I (core) capital to risk-weighted assets		84,600	8.33			40,606	4.00			60,910	6.00
Tier I (core) capital to average total assets		84,600	5.56			60,902	4.00			76,128	5.00

The Corporation, as a bank holding company regulated by the FRB, is also subject to capital requirements that are similar to those for Cascade Bank.

(Dollars in thousands) Cascade Financial Corporation	Actual				Minimum Requirements For Capital Adequacy				Well-Capitalized Requirements
March 31, 2011:
Total risk-based capital to risk-weighted assets	$	97,841	9.83	%	$	79,592	8.00	%	$	99,490	10.00	%
Tier I (core) capital to risk-weighted assets		80,379	8.08			39,796	4.00			59,694	6.00
Tier I (core) capital to average total assets		80,379	5.46			58,893	4.00			73,617	5.00

December 31, 2010:
Total risk-based capital to risk-weighted assets	$	101,209	9.98	%	$	81,149	8.00	%	$	101,437	10.00	%
Tier I (core) capital to risk-weighted assets		84,556	8.34			40,574	4.00			60,862	6.00
Tier I (core) capital to average total assets		84,556	5.55			60,958	4.00			76,197	5.00

Note 11 - Stock-based Compensation

Compensation expense related to stock-based compensation was $10,000 and $16,000 for the three months ended March 31, 2011 and 2010, respectively. This expense is the result of the vesting of stock options previously granted but unexercised. No stock options were granted in the three months ended March 31, 2011.

Changes in total options outstanding for the three months ended March 31, 2011, are as follows:

	Options		Weighted-Average Exercise Price per Share		Weighted-Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value
Outstanding on December 31, 2010		496,209	$	10.50		3.19	$	-
Granted		-		-
Exercised		-		-
Forfeited/canceled		119,026		4.87
Outstanding on March 31, 2011		377,183	$	12.28		3.86	$	-

Exercisable on March 31, 2011		338,993	$	12.23		3.51	$	-

The unrecognized share-based compensation cost on unvested options at March 31, 2011 was $33,577, which will be recognized over the remaining average requisite service period of the options which is approximately two years.

Options were granted to certain employees and directors at prices equal to the market value of the stock at the close of trading on the dates the options were granted. The options granted have a term of ten years from the grant date. Incentive stock options granted to employees vest over a five-year period. Non-qualified options granted to directors vest over a four-year period. Compensation expense is recorded as if each vesting portion of the award is a separate award. The Bank has estimated the fair value of all stock option awards as of the date of the grant by applying a Black-Scholes option pricing valuation model. The application of this valuation model involves assumptions that are judgmental and sensitive in the determination of compensation expense. The total options authorized at March 31, 2011 were 919,912.

The Bank uses historical information for its key assumptions. Historical information is the primary basis for the selection of the expected volatility, projected dividend yield and expected lives of the options. The Bank has collected a long history of option activity and believes that this historical information presents the best basis for future projections related to expected term. 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.

The Bank is required to recognize 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.

The Bank has maintained an Employee Stock Purchase Plan (ESPP) under the terms of which 213,212 shares of common stock were authorized for issuance. In July 2010, the final 54,309 shares were issued to employees participating in the ESPP. The plan allowed employees of the Bank with three months of service the opportunity to purchase common stock through accumulated salary deductions during each offering period. On the first day of each six-month offering period (January 1 and July 1 of each year), eligible employees who elected to participate were granted options to purchase a limited number of shares and unless the participant withdrew from the plan, the option was effectively exercised on the last day of each offering period. The aggregate number of shares to be purchased in any given offering was determined by dividing the accumulated salary deduction for the period by the lower of 85% of the market price of a common share at the beginning or end of an offering period. The ESPP permitted for shares to be purchased in the open market or new shares could be issued from the Bank’s authorized but unissued shares. All of the final 54,309 shares issued in July 2010 were purchased on the open market.

Note 12 – Loss per Common Share

The following table presents loss per common share information:

	Three Months Ended March 31,
(Dollars in thousands)	2011			2010
Net loss	$	(2,647	)	$	(32,139	)
Dividends on preferred stock		522			499
Accretion of issuance discount on preferred stock		119			112
Net loss attributable to common stockholders	$	(3,288	)	$	(32,750	)

Weighted average number of common shares outstanding, basic		12,271,529			12,165,167
Weighted average number of common shares outstanding, diluted		12,271,529			12,165,167

Loss per common share, basic	$	(0.27	)	$	(2.69	)
Loss per common share, diluted		(0.27	)		(2.69	)

For purposes of calculating basic and diluted loss per common share, the numerator of net loss attributable to common stockholders is the same. There were outstanding options to purchase 377,183 and 586,772 shares of common stock at March 31, 2011 and 2010, respectively, which are considered anti-dilutive and have been excluded from the above calculation. Anti-dilutive options have an exercise price that is greater than the current market price of the stock. Also, as of March 31, 2011 and 2010, the warrant issued to the U.S. Treasury to purchase up to 863,442 shares of common stock was not included in the computation of diluted loss per common share because the warrant’s exercise price was greater than the average market price of common shares.

Note 13 - Fair Value Measurements

Financial Instruments

The fair value estimates presented below are subjective in nature, involve uncertainties and matters of significant judgment and, therefore, are not necessarily indicative of the amounts the Corporation could realize in a current market exchange. The Corporation has not included certain material items in its disclosure, such as the value of the long-term relationships with the Corporation’s lending and deposit customers, since this is an intangible and not a financial instrument. Additionally, the estimates do not include any tax ramifications. There may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, that could materially affect the results. For all of these reasons, the aggregation of the fair value calculations presented herein do not represent, and should not be construed to represent, the underlying value of the Corporation.

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

	March 31, 2011				December 31, 2010
(Dollars in thousands)	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Financial assets:
Cash and cash equivalents	$	113,280	$	113,280	$	131,335	$	131,335
Securities available-for-sale		232,277		232,277		234,606		234,606
Securities held-to-maturity		52,419		51,058		53,912		53,068
FHLB stock		11,920		11,920		11,920		11,920
Cash surrender value of BOLI, net		25,736		25,736		25,489		25,489
Loans, net		950,483		910,107		967,661		932,932
Interest rate caps		9,042		9,042		8,732		8,732

Financial liabilities:
Deposit accounts	$	1,069,087	$	1,051,512	$	1,107,554	$	1,095,089
FHLB advances		159,000		187,744		159,000		187,087
Securities sold under agreements to repurchase		145,000		176,227		145,000		179,450
Junior subordinated debentures		15,465		2,715		15,465		2,715
Junior subordinated debentures, fair value		1,500		1,500		1,500		1,500

Cash and Cash Equivalents. The carrying amount represents fair value.

Investment securities. Fair values are based on quoted market prices or dealer quotations when available or through the use of alternate approaches, such as matrix or model pricing, when market quotes are not readily available.

FHLB Stock. The Bank’s investment in FHLB stock is carried at par value ($100 per share), which approximates its fair value.

Cash Surrender Value of BOLI. The carrying amount of BOLI approximates its fair value, net of any surrender charges. Fair value of BOLI is estimated using the cash surrender value.

Loans. Fair values are estimated using current market interest rates to discount future cash flows for each of the different loan types. Interest rates used to discount the cash flows are based on published current market rates for similar products. Prepayment rates are based on expected future prepayment rates, or, where appropriate and available, market prepayment rates. Fair value for loans is reduced by the allowance for loan losses as a credit adjustment. The majority of impaired loans are individually analyzed each quarter for impairment and impairments are included with the credit adjustment factor. A liquidity and marketability adjustment is also used to adjust the fair value of loans. This factor discounts loans based upon type of loan and current loan classifications.

Deposits. The fair value of deposits with no stated maturity, such as checking accounts, money market deposit accounts and savings accounts, equals the amount payable on demand plus a premium based on current interest rates. The fair value of certificates of deposits is calculated based on the discounted value of contractual cash flows. The discount rate is equal to the market rate currently offered on similar products.

FHLB advances and securities sold under agreements to repurchase. The fair value is calculated based on market price quotations and confirmed with the discounted cash flow method, adjusted for market interest rates and terms to maturity.

Junior Subordinated Debentures. The fair value is calculated based on the discounted cash flow method, adjusted for market interest rates, terms to maturity, credit and liquidity risk.

Junior Subordinated Debentures, at fair value. The Corporation determines the fair value by using a discounted cash flow model. The discount rate is determined using a risk free interest rate approximating the remaining maturity of the debentures combined with a credit and liquidity spread determined based upon quotes from brokers and from valuations by holders of Cascade Capital Trust I, which were obtained from public filings. The bonds are assumed to be outstanding until maturity.

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

Financial Assets and Liabilities Carried at Fair Value on a Recurring and Non-recurring Basis

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. It also establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. In determining fair value, the Bank maximizes the use of observable inputs and minimizes the use of unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Bank’s estimates for market assumptions.

Valuation inputs refer to the assumptions market participants would use in pricing a given asset or liability using one of the three valuation techniques. Inputs can be observable or unobservable. Observable inputs are those assumptions that market participants would use in pricing the particular asset or liability. These inputs are based on market data and are obtained from a source independent of the Bank. Unobservable inputs are assumptions based on the Bank’s own information or estimate of assumptions used by market participants in pricing the asset or liability. Unobservable inputs are based on the best and most current information available on the measurement date.

All inputs, whether observable or unobservable, are ranked in accordance with a prescribed fair value hierarchy that gives the highest ranking to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1) and the lowest ranking to unobservable inputs (Level 3). Fair values for assets or liabilities classified as Level 2 are based on one or a combination of the following factors: (i) quoted prices for similar assets; (ii) observable inputs for the asset or liability, such as interest rates or yield curves; or (iii) inputs derived principally from or corroborated by observable market data.

Available-for-sale securities are priced using matrix pricing based on the securities’ relationship to other benchmark quoted prices (Level 2). Inputs to the valuation methodology include quoted prices for similar assets in active markets that are observable for the asset.

Fair values of impaired collateral dependent loans are sometimes recorded to reflect partial write-downs based on the current appraised value of the collateral or internally developed models, which contain management’s assumptions concerning the amount and timing of the cash flows associated with that loan.

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

There were no transfers between fair value categories during the three months ended March 31, 2011. The following table presents the balances of assets and liabilities measured at fair value on a recurring basis at March 31, 2011 and December 31, 2010:

	Fair Value at March 31, 2011
(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Assets
Mortgage-backed securities	$	-	$	65,692	$	-	$	65,692
Agency notes & bonds		-		110,351		-		110,351
U.S. Treasury notes		-		56,234		-		56,234
Interest rate caps		-		9,042		-		9,042
Total	$	-	$	241,319	$	-	$	241,319
Liabilities
Junior subordinated debentures	$	-	$	-	$	1,500	$	1,500
Total	$	-	$	-	$	1,500	$	1,500

	Fair Value at December 31, 2010
(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Assets
Mortgage-backed securities	$	-	$	67,203	$	-	$	67,203
Agency notes & bonds		-		111,119		-		111,119
U.S. Treasury notes		-		56,284		-		56,284
Interest rate caps		-		8,732		-		8,732
Total	$	-	$	243,338	$	-	$	243,338
Liabilities
Junior subordinated debentures	$	-	$	-	$	1,500	$	1,500
Total	$	-	$	-	$	1,500	$	1,500

The change in fair market value of the junior subordinated debentures is recorded as a component of non-operating income. The following table presents the fair value adjustments for the junior subordinated debentures, which use significant unobservable inputs (Level 3) for the periods presented:

	Fair Value Measurements Using
	Significant Unobservable Inputs
	(Level 3)
	Three Months Ended
	March 31,
(Dollars in thousands)	2011		2010
Beginning balance	$	1,500	$	3,341
Total gains recognized		-		-
Ending balance	$	1,500	$	3,341

The following table presents the balance of assets measured at fair value on a nonrecurring basis at March 31, 2011 and December 31, 2010:

	Fair Value at March 31, 2011
(Dollars in thousands)	Level 1		Level 2		Level 3		Total (1)
Impaired loans	$	-	$	-	$	117,312	$	117,312
REO		-		-		32,311		32,311
Total	$	-	$	-	$	149,623	$	149,623

	Fair Value at December 31, 2010
(Dollars in thousands)	Level 1		Level 2		Level 3		Total (1)
Impaired loans	$	-	$	-	$	138,198	$	138,198
REO		-		-		34,412		34,412
Total	$	-	$	-	$	172,610	$	172,610

(1)	Impaired loans include loans on nonaccrual, classified doubtful and/or individually analyzed for impairment, adjusted by the impairment amount. REO is disclosed at the year-end book balance.

The following table presents the total losses resulting from nonrecurring fair value adjustments for the periods presented:

	Three Months Ended March 31,
(Dollars in thousands)	2011		2010
Impaired loans (1)	$	8,321	$	28,544
REO(2)		2,272		698
Total	$	10,593	$	29,242

(1)	Total losses for loans includes the actual impairment amount, plus the allowance for loan loss write downs during the period for those loans considered impaired at March 31, 2011 and 2010.

(2)	Losses for REO are the net losses recognized during the period.

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’s operations. 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, 2010 audited Consolidated Financial Statements and accompanying notes included in our recent Annual Report on Form 10-K.

Forward Looking Statements

This report includes 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. These statements may be identified by the use of forward-looking terminology such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “should” or “will” or the negative thereof or other variations thereon or comparable terminology. We have based these forward-looking statements on our current expectations, assumptions, estimates and projections. While we believe these expectations, assumptions, estimates and projections are reasonable, such forward-looking statements are only predictions and involve known and unknown risks and uncertainties, many of which are beyond our control. These and other important factors, including those discussed below under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” 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. Some of the key factors that could cause actual results to differ from our expectations are:

·	management’s ability to raise capital to meet regulatory requirements and fund future operations;

·	management’s ability to effectively execute its business plan and strategy;

·	the credit risks of lending activities, including changes in the level and trend of loan delinquencies, collections and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;

·	changes in general economic conditions, either nationally or in our market areas;

·	the availability of and costs associated with sources of liquidity;

·	inflation, interest rates, market and monetary fluctuations;

·	legislative or regulatory changes or changes in accounting principles, policies or guidelines;

·	the possibility that we will be unable to comply with certain conditions imposed upon us in regulatory actions, which could result in the imposition of further restrictions on our operations, penalties or other regulatory actions;

·	the costs and effects of legal and regulatory developments, including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews;

·	our ability to attract and retain deposits;

·	further increases in premiums for deposit insurance;

·	the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;

·	our success at managing the risks involved in the foregoing; and

·	other risks which may be described in the Corporation’s future filings with the SEC under the Securities Exchange Act of 1934.

Given these risks and uncertainties, you are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included or incorporated by reference into this report are made only as of the date hereof. We do not undertake and specifically decline any obligation to update any such statements or to publicly announce the results of any revisions to any such statements to reflect future events or developments. In addition, we may make certain statements in future Securities and Exchange Commission (SEC) filings, in press releases and in oral and written statements that are not statements of historical fact and may constitute forward-looking statements.

General

Cascade Financial Corporation (CFC or the Corporation) is a bank holding company incorporated in the state of Washington in 2003. At March 31, 2011, the Corporation’s wholly-owned subsidiaries were Cascade Bank (Cascade Bank or the Bank), and Cascade Capital Trusts I, II, and III, formed to hold trust preferred securities. Colby R.E., LLC, a subsidiary of the Bank, was incorporated in March 2009 and 2011 Yale Avenue East, LLC, a subsidiary of Colby R.E., LLC, was incorporated in May 2010. Both were formed to acquire, manage and sell properties taken in foreclosure (REO properties). The executive offices of the Corporation are located at 2828 Colby Avenue, Everett, Washington, 98201. The telephone number is (425) 339-5500 and the website is www.cascadebank.com. Information on the website is not part of this report

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

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

The Corporation conducts its business from its main office in Everett, Washington, and 21 other full-service offices in the greater Puget Sound region. At March 31, 2011, the Corporation had total assets of $1.5 billion, total deposits of $1.1 billion and total equity of $54.6 million.

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

Recent Events

Regulatory Actions and Capital Raising Efforts

The Corporation and the Bank are subject to pending regulatory actions, including an FDIC Order and a FRB Agreement, restricting our businesses and operations, and requiring us to raise additional capital. See “Stockholders’ Equity and Regulatory Matters.”

As of March 31, 2011, Cascade Bank required approximately $65.0 million in new capital to meet the minimum Tier 1 leverage ratio requirement of 10% under the FDIC Order. Since late 2009, CFC’s Board of Directors and management team have been reviewing alternatives to improve the bank’s capital position with the assistance of its financial advisor, Sandler O’Neill + Partners LP, a nationally recognized investment banking firm and expert in the banking industry. As part of its review, the Board considered a range of alternatives including potential capital infusions from private investors and financial institutions, strategic combinations and private equity transactions, and actively solicited offers from potential investors and acquirers.

Proposed Merger

On March 4, 2011, the Corporation announced that it had entered into an agreement and plan of reorganization with Opus Bank, a California state-chartered bank. The terms of this agreement provide for Opus Bank to acquire the Corporation and the Bank, and for the merger of the Bank into Opus Bank. The merger agreement with Opus Bank was unanimously approved by the Boards of Directors of the Corporation, the Bank and Opus Bank

Under the terms of the merger agreement, the Corporation’s common shareholders will receive an amount in cash of approximately $0.45 per share, which values the transaction at $5.5 million. In addition, Opus Bank has offered to purchase the $39.0 million of the Corporation’s preferred stock and the associated warrant issued to the U.S. Department of the Treasury (the Treasury) under the Capital Purchase Program for $16.25 million in cash. The Treasury has indicated its willingness to agree to sell the Corporation’s preferred stock and warrant for such cash consideration subject to the entry into definitive documentation acceptable to the Treasury in its sole discretion. Opus also agreed to assume our $25.8 million of obligations with respect to the trust preferred securities issued by the Corporation’s trust subsidiaries. Consummation of the merger is subject to approval by regulatory authorities, approval by the shareholders of the Corporation at a special meeting of shareholders to be held on May 31, 2011, and certain other conditions set forth in the merger agreement. The merger is expected to close in the latter part of the second quarter of 2011. Notwithstanding this, there are no assurances that the Corporation, the Bank and Opus Bank will be able to successfully close the proposed merger.

Financial Overview

For the three months ended March 31, 2011, we had a net loss attributable to common stockholders of $3.3 million, or $0.27 per diluted common share, compared to $32.8 million, or $2.69 per diluted common share for the three months ended March 31, 2010.

Net interest income for the three months ended March 31, 2011 was $8.8 million, compared to $9.7 million for the three months ended March 31, 2010. Other income was $1.8 million for the three months ended March 31, 2011, compared to $1.9 million for the three months ended March 31, 2010. For the three months ended March 31, 2011, total other expenses increased to $10.7 million compared to $9.2 million for the three months ended March 31, 2010. The increase was largely due to a $1.6 million increase in write-downs/losses on sales of REO.

Outlook for 2011

We face a variety of significant financial and operating challenges in 2011. These include taking all necessary actions to comply with the regulatory orders we are operating under, specifically raising capital, improving credit quality, and returning to profitability. We continue to take an aggressive stance in addressing credit issues in our loan portfolio to minimize future risks. Since 2008 we have had a Special Assets team in place to focus on managing and reducing nonperforming loans and REO properties. While we have seen progress in reducing the level of nonperforming assets, credit quality will remain an issue as long as current economic trends, including high unemployment rates and depressed real estate prices, continue.

We expect our loan portfolio balance to level off during the remaining quarters of 2011. However, we must still face the challenges of the current economic environment and flat loan demand, which will make it difficult for us to maintain our current loan portfolio balance as our existing credits pay down. Currently, we expect that interest rates will remain flat for the remainder of 2011. We based our 2011 projections, budgets and goals on these expectations. If these trends move differently than expected in either direction or speed, they could have a material impact on our financial condition and results of operations. The areas of our operations most directly impacted would be the net interest margin, loan and deposit growth and the provision for loan losses.

We will also continue our efforts to control noninterest expenses by working to achieve maximum efficiencies within our franchise. However, our noninterest expenses for 2011 will continue to be negatively affected by costs associated with higher business insurance expense, REO expense associated with the management and disposition of real estate properties acquired through foreclosure and increased FDIC insurance premiums.

The information contained in this section should be read in conjunction with the Consolidated Financial Statements and accompanying Notes to the Condensed Consolidated Financial Statements of this report.

Critical Accounting Policies and Estimates

The Corporation’s significant accounting policies and estimates are essential to understanding Management's Discussion and Analysis of Financial Condition and Results of Operations. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions, which affect the reported amounts and disclosures. Changes in these estimates and assumptions are considered reasonably possible and may have a material impact on the consolidated financial statements and thus actual results could differ from the amounts reported and disclosed herein. The following policies involve a higher degree of judgment than do our other significant accounting policies detailed in Note 1 of the Notes to the Condensed Consolidated Financial Statements.

Material estimates particularly susceptible to significant change relate to the assessment of impaired assets, the determination of the allowance for loan losses, deferred income taxes, fair value measurements and valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for loan losses and the valuation of foreclosed assets held for sale, management obtains independent appraisals for significant properties.

Investment Securities

Debt and equity securities, including mortgage-backed securities (MBS), may be classified as available-for-sale or held-to-maturity. Securities available-for-sale are carried at fair value, with unrealized gains and losses reported as a component of other comprehensive (loss) income. Investment securities held-to-maturity are carried at amortized cost or principal balance, adjusted for amortization of premiums and accretion of discounts. Amortization of premiums and accretion of discounts are calculated using a method that approximates the level yield method. The Bank has the ability, and it is management’s positive intention, to hold held-to-maturity securities until maturity. Investments with fair values that are less than the amortized cost are considered impaired. Impairment may result from either a decline in the financial condition of the issuing entity or, in the case of fixed interest rate investments, from rising interest rates. Management reviews investment securities on an ongoing basis for the presence of other-than-temporary-impairment (OTTI) or permanent impairment, taking into consideration current market conditions; fair value in relationship to cost; extent and nature of the change in fair value; issuer rating changes and trends; whether management intends to sell a security or if it is likely that the Bank will be required to sell the security before recovery of the amortized cost basis of the investment, which may be upon maturity; and other factors. For debt securities, if management intends to sell the security or it is likely that the Bank will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If management does not intend to sell the security and it is not likely that the Bank will be required to sell the security, but management does not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment related to all other factors (i.e. the difference between the present value of the cash flows expected to be collected and fair value) is recognized as a charge to other comprehensive income. Impairment losses related to all other factors are presented as separate categories within other comprehensive income. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

Allowance for Loan Losses

The allowance for loan losses is the amount which, in the opinion of management, is necessary to absorb future probable loan losses. Management’s determination of the level of the provision for loan losses is based on various judgments and assumptions, including general economic conditions, loan portfolio composition, prior loan loss experience, the evaluation of credit risk related to specific credits and market segments and monitoring results from our ongoing internal credit review staff. Subsequent recoveries, if any, are credited to the allowance.

Management and the Board review policies and procedures at least annually, and changes are made to reflect the current operating environment integrated with regulatory requirements. Partly out of these policies has evolved an internal credit risk review process. During this process, the quality grades of loans are reviewed and loans are assigned a dollar value of the loan loss reserve by degree of risk. This analysis is performed quarterly and reviewed by senior management who makes the determination if the risk is reasonable and if the reserve is adequate. This quarterly analysis is then reviewed by the Board of Directors.

Management determines the amount of the allowance for loan losses by utilizing a loan quality grading system to determine risk in the loan portfolio. The allowance consists of general and specific components. When loans are originated, they are assigned a risk rating that is reassessed periodically during the term of the loan through the Bank’s credit review process. The Bank’s loan quality grading methodology assigns a loan quality grade from 1 to 10, where a higher numerical rating represents higher risk. These loan quality-rating categories are a primary factor in determining an appropriate amount for the allowance for loan losses. The loan portfolio is separated by loan type and then by risk rating. Loans not considered impaired are evaluated as a group, by loan type, with a loss rate based on average historical losses and adjusted for qualitative (Q) factors. The Q factors include regional/local economic trends, the health of the real estate market, loan and collateral concentrations, size of borrowing relationships, trends in loan delinquencies and charge-offs and changes in loan classifications and are included in the Bank’s analysis of the allowance for loan losses. Allocations for Q factors are based upon management’s review of each of the factors and are applied to all loans included in the general valuation component of the allowance. The Q factors augment the historical loss factors utilized in assessing the allowance to reflect the potential losses embedded in the loan portfolio as real estate property values have declined and sales have slowed. After reviewing all historical and qualitative factors by loan type, management may add a management judgment factor to certain loan types if there are additional concerns in these portfolios that were not identified by using historical or other qualitative factors. Management may also include a negative adjustment to the allowance factor for certain loan types if analysis shows that the historical allowance factor overstates the allocated reserve due to the financial strength of the borrowers/guarantors, the collateral position or other factors in the related portfolio.

Management believes that the allowance for loan losses was adequate as of March 31, 2011. There is, however, no assurance that future loan losses will not exceed the levels provided for in the allowance for loan losses and could possibly result in additional charges to the provision for loan losses.

Real Estate Owned (REO)

Real estate owned includes real estate acquired in settlement of loans. Real estate owned is recorded at the lower of carrying amount or fair value, based upon an appraisal, less estimated costs to sell. Developments and improvements related to the property are capitalized. Any losses recorded at the time a foreclosure occurs are classified as a charge-off against the allowance for loan losses. Losses that result from the ongoing periodic valuation of these properties, are charged to expense in the period identified. Revenue and expenses from operations and subsequent adjustments to the carrying amount of the property are included in noninterest expense in the statement of operations.

Income Taxes

The Corporation accounts for income taxes as required by FASB ASC Topic 740, Accounting for Income Taxes, under the liability method, which requires recognition of deferred tax assets and liabilities for the expected future income tax consequences of transactions that have been included in the Consolidated Financial Statements. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. 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. 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.

Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820) – Improving Disclosures about Fair Value Measurements (ASU 10-06) establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. In determining fair value, the Bank maximizes the use of observable inputs and minimizes the use of unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Bank’s estimates for market assumptions.

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 March 31,
		2011				2010

CASCADE FINANCIAL CORP 10-Q