National Penn Bancshares (NPBC) 10-Q 2005 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

________

FORM 10-Q

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
	THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended:September 30, 2005
OR
[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
	THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from: ______________ to _________________

NATIONAL PENN BANCSHARES, INC.

(Exact Name of Registrant as Specified in Charter)

Pennsylvania
(State or Other Jurisdiction of Incorporation)
000-22537-01	23-2215075
(Commission File Number)	(IRS Employer Identification No.)
Philadelphia and Reading Avenues, Boyertown, PA	19512
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s telephone number, including area code: (610) 367-6001

N/A

(Former Name or Former Address, if Changed Since Last Report)

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 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No .

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.) Yes X No .

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

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

Class	Outstanding at November 4, 2005
Common Stock (no stated par value)	(No.) Shares 43,599,025

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TABLE OF CONTENTS

Part I - Financial Information.			Page
	Item 1.	Financial Statements	3
	Item 2.	Management’s Discussion and Analysis of
		Financial Condition and Results of Operation	13
	Item 3.	Quantitative and Qualitative Disclosures About
		Market Risk	28
	Item 4.	Controls and Procedures	28
Part II - Other Information.
	Item 1.	Legal Proceedings	29
	Item 2.	Unregistered Sales of Equity Securities
		and Use of Proceeds	30
	Item 3.	Defaults Upon Senior Securities	31
	Item 4.	Submission of Matters to a Vote of
		Security Holders	31
	Item 5.	Other Information	31
	Item 6.	Exhibits	31
Signatures			32
Exhibits			33

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEET

(Dollars in thousands, except share data)

	September 30,			December 31,
	2005			2004
	(Unaudited)
ASSETS
Cash and due from banks	$	102,001		$	85,118
Interest bearing deposits in banks		5,430			8,776
Total cash and cash equivalents		107,431			93,894
Investment securities held to maturity (fair value approximates $111,856 and		113,573			90,967
$90,621 for 2005 and 2004, respectively)
Investment securities available for sale, at fair value		1,015,648			1,098,836
Loans and leases held for sale		25,028			11,801
Loans and leases, less allowance for loan and lease losses of $56,255
and $57,590 in 2005 and 2004, respectively		2,930,374			2,805,048
Premises and equipment, net		51,673			53,719
Accrued interest receivable		18,756			17,823
Bank owned life insurance		81,884			79,545
Goodwill		187,693			186,945
Other intangibles		16,682			18,462
Unconsolidated investments under the equity method		3,813			3,854
Other assets		22,152			17,899
Total assets	$	4,574,707		$	4,478,793
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Non-interest bearing	$	512,718		$	515,901
Interest-bearing		2,779,332			2,627,292
Total deposits		3,292,050			3,143,193
Securities sold under repurchase agreements and federal funds purchased		408,206			504,051
Short-term borrowings		5,723			10,000
Long-term borrowings		248,631			229,926
Subordinated debt		127,063			127,063
Accrued interest payable and other liabilities		48,035			36,435
Total liabilities		4,129,708			4,050,668
Shareholders’ equity
Preferred stock, no stated par value; authorized 1,000,000 shares, none issued		-			-
Common stock, no stated par value; authorized 62,500,000 shares,
issued and outstanding 2005 - 43,548,941; 2004 - 43,138,498 net of shares
in Treasury: 2005 - 18,658; 2004 - 109,950		364,730			362,007
Retained earnings		71,200			48,485
Accumulated other comprehensive income		9,548			19,915
Treasury stock, at cost		(479	)		(2,282	)
Total shareholders’ equity		444,999			428,125
Total liabilities and shareholders’ equity	$	4,574,707		$	4,478,793

The accompanying notes are an integral part of these statements.

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NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF INCOME

(Dollars in thousands, except per share data)

	Three Months Ended				Nine Months Ended September 30,
	September 30,
	2005		2004		2005		2004
INTEREST INCOME
Loans and leases, including fees	$	49,764	$	41,967	$	141,366	$	111,976
Investment securities
Taxable		8,990		7,830		27,156		21,756
Tax-exempt		3,500		3,305		10,474		9,731
Federal funds sold		-		13		2		37
Deposits in banks		54		18		140		32
Total interest income		62,308		53,133		179,138		143,532
INTEREST EXPENSE
Deposits		16,455		9,883		41,762		26,251
Securities sold under repurchase agreements and federal funds purchased		3,481		1,682		11,102		4,821
Short-term borrowings		44		10		94		29
Long-term borrowings		4,855		4,393		14,336		11,437
Total interest expense		24,835		15,968		67,294		42,538
Net interest income		37,473		37,165		111,844		100,994
Provision for loan and lease losses		750		1,225		2,450		4,188
Net interest income after provision for loan and lease losses		36,723		35,940		109,394		96,806
NON-INTEREST INCOME
Wealth management income		2,188		2,228		6,727		6,307
Service charges on deposit accounts		4,199		4,084		12,065		11,087
Cash management and electronic banking fees		1,934		1,695		5,606		4,812
Other service charges and fees		1,516		892		4,346		3,096
Gain on sale of building		-		-		922		-
Insurance commission and fees		1,545		937		5,436		2,686
Mortgage banking income		1,720		1,057		4,015		3,285
Bank owned life insurance income		799		1,188		2,645		2,950
Net gains (losses) on sale of investment securities		181		100		790		(96	)
Equity in undistributed net earnings of affiliates		-		(3)		-		126
Total non-interest income		14,082		12,178		42,552		34,253
NON-INTEREST EXPENSES
Salaries, wages and employee benefits		18,565		17,633		55,253		47,888
Net premises and equipment		4,403		4,323		13,010		11,957
Advertising and marketing expenses		1,249		813		3,875		3,099
Fraud investigation expenses		150		-		1,351		-
Other operating expenses		7,139		7,267		20,175		18,857
Total non-interest expense		31,506		30,036		93,664		81,801
Income before income taxes		19,299		18,082		58,282		49,258
Income tax expense		4,492		4,349		14,786		11,977
NET INCOME	$	14,807	$	13,733	$	43,496	$	37,281
PER SHARE OF COMMON STOCK
Net income per share - basic	$	0.34	$	0.32	$	1.00	$	0.93
Net income per share - diluted	$	0.34	$	0.31	$	0.99	$	0.91
Dividends paid in cash	$	0.16	$	0.15	$	0.48	$	0.43

The accompanying notes are an integral part of these statements.

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NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

NINE MONTHS ENDED SEPTEMBER 30, 2005									Accumulated
(Dollars in thousands)									Other
	Common Stock					Retained			Comprehensive			Treasury						Comprehensive
	Shares			Value		Earnings			Income			Stock			Total			Income
Balance at December 31, 2004		34,510,798		$	362,007	$	48,485		$	19,915		$	(2,282	)	$	428,125			-
Net income		-			-		43,496			-			-			43,496		$	43,496
Cash dividends declared		-			-		(20,781	)		-			-			(20,781	)		-
5-for-4 stock split		8,712,484			-		-			-			-			-			-
Shares issued under stock-based plans		409,417			2,723		-			-			3,971			6,694			-
Other comprehensive loss, net of
reclassification adjustment and taxes		-			-		-			(10,367	)		-			(10,367	)		(10,367	)
Total comprehensive income		-			-		-			-			-			-		$	33,129
Treasury shares purchased		(83,758	)		-		-			-			(2,168	)		(2,168	)
Balance at September 30, 2005		43,548,941		$	364,730	$	71,200		$	9,548		$	(479	)	$	444,999

Components of Other	September 30, 2005
Comprehensive Income	Before tax			Tax (expense)			Net of tax
	amount			benefit			amount
Unrealized losses on securities	$	(15,160	)	$	5,306		$	(9,854	)
Unrealized holding losses arising during period
Less: Reclassification adjustment for gains realized in net income		790			(277	)		513
Other comprehensive losses, net	$	(15,950	)	$	5,583		$	(10,367	)

NINE MONTHS ENDED SEPTEMBER 30, 2004										Accumulated
(Dollars in thousands)										Other
	Common Stock						Retained			Comprehensive			Treasury						Comprehensive
	Shares			Value			Earnings			Income			Stock			Total			Income
Balance at December 31, 2003		24,284,506		$	272,534		$	25,770		$	19,595		$	(86	)	$	317,813			-
Net income		--			--			37,281			--			--			37,281		$	37,281
Cash dividends declared		--			--			(18,286	)		--			--			(18,286	)		-
5-for-4 stock split		6,904,415																		-
Shares issued under stock-based plans		510,344			(1,078	)		--			--			9,247			8,581			-
Shares issued for acquisition of Peoples
First, Inc. and Pennsurance, Inc.		3,130,094			88,461			--			--			--			88,461			-
Other comprehensive loss, net of
reclassification adjustment and taxes		--			--			--			(15,280	)		--			(710	)		(710	)
Total comprehensive income		--			--			--			--			--			--		$	36,571
Treasury shares purchased		(307,283	)		--			--			--			(9,455	)		(10,099	)
Balance at September 30, 2004		34,522,076		$	359,917		$	44,765		$	4,315		$	(294	)	$	423,041

Components of Other	September 30, 2004
Comprehensive Income	Before tax			Tax (expense)		Net of tax
	amount			benefit		Amount
Unrealized losses on securities
Unrealized holding losses arising during period	$	(1,764	)	$	416	$	(1,348	)
Less: Reclassification adjustment for losses realized in net income		(96	)		34		(62	)
Change in the fair value of cash flow hedges		(576	)		--		(576	)
Other comprehensive income, net	$	(1,092	)	$	382	$	(710	)

The accompanying notes are an integral part of these statements.

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NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

	Nine Months Ended September 30,
	2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	43,496		$	37,281
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan and lease losses		2,450			4,188
Depreciation and amortization		6,749			3,705
(Accretion) amortization of premiums and discounts on investment securities, net		(1,330	)		752
Investment securities (gains) losses, net		(790	)		96
Mortgage loans originated for resale		(218,324	)		(100,500	)
Sale of mortgage loans originated for resale		207,879			102,540
Gain on sale of mortgage loans originated for resale		(2,782	)		(2,040	)
Gain on sale of bank building		(922	)		-
Changes in assets and liabilities
(Increase) decrease in accrued interest receivable		(933	)		(1,118	)
Increase (decrease) in accrued interest payable		3,624			(1,339	)
(Increase) decrease in other assets		(1,009	)		1,368
Increase (decrease) in other liabilities		7,976			5,374
Net cash provided by operating activities		46,084			50,307
CASH FLOWS FROM INVESTING ACTIVITIES
Cash paid in excess of cash equivalents for business acquired		(698	)		(32,408	)
Proceeds from maturities of investment securities held to maturity		8,537
Purchase of investment securities held to maturity		(31,120	)		(50,273	)
Proceeds from sales of investment securities available for sale		18,971			42,300
Proceeds from maturities of investment securities available for sale		172,588			160,475
Purchase of investment securities available for sale		(122,183	)		(248,461	)
Net increase in loans		(128,901	)		(181,901	)
Purchases of premises and equipment		(4,526	)		(4,735	)
Proceeds from the sale of bank building		3,600			-
Net cash used in investing activities		(83,732	)		(315,003	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in interest and non-interest bearing demand deposits       and savings accounts		(223,778	)		248,151
Net increase (decrease) in certificates of deposits		372,635			83,531
Net increase (decrease) in securities sold under agreements to repurchase
and federal funds purchased		(95,845	)		(115,808	)
Net increase (decrease) in short-term borrowings		(4,277	)		-
Proceeds from new long-term borrowings		33,500			50,000
Repayments of long-term borrowings		(14,795	)		(15,018	)
Issuance of subordinated debentures		-			61,857
Shares issued under stock-based plans		6,694			8,581
Purchase of treasury stock		(2,168	)		(10,099	)
Cash dividends		(20,781	)		(18,286	)
Net cash provided by financing activities		51,185			292,909
Net increase (decrease) in cash and cash equivalents		13,537			28,213
Cash and cash equivalents at beginning of year		93,894			98,397
Cash and cash equivalents at September 30	$	107,431		$	126,610
The accompanying notes are an integral part of these statements.

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NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

1. BASIS OF PRESENTATION

The accompanying unaudited consolidated condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. The financial information included herein is unaudited; however, such information reflects all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary to a fair statement of the results for the interim periods. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

Certain categories within the non-interest income section of the consolidated statements of income were clarified for the three and nine months ended September 30, 2005 and 2004. As a result, amounts related to wealth management income, cash management and electronic banking fees, other service charges and fees, and insurance commission and fees within this section for the three and nine months ended September 30, 2004 were appropriately recategorized. Comparable amounts for the first, second, third and fourth quarters of 2004 are (in thousands):

	Three Months Ended
	Mar. 31, 2004		June 30, 2004		Sept. 30, 2004		Dec. 31, 2004
Wealth management income	$	1,967	$	2,112	$	2,228	$	2,185
Cash management and electronic banking fees		1,434		1,683		1,695		1,762
Other service charges and fees		1,088		1,116		832		1,091
Insurance commissions and fees		851		898		937		1,111

The results of operations for the nine-month period ended September 30, 2005 are not necessarily indicative of the results to be expected for the full year.

2. ACQUISITIONS AND DISPOSITIONS

Proposed Acquisition of Nittany Financial Corporation

On September 7, 2005, National Penn Bancshares, Inc. announced the execution of a definitive merger agreement under which National Penn Bancshares would acquire Nittany Financial Corporation (“Nittany”), parent company of Nittany Bank, in a stock and cash transaction valued at approximately $96.5 million. Nittany is a financial services company, with $326.5 million in assets, headquartered in State College, Centre County, Pennsylvania. Its Nittany Bank subsidiary operates four community offices in State College and one in Bellefonte. Nittany Financial also has $310 million under management through two of its subsidiaries, Vantage Investment Advisors, LLC, and Nittany Asset Management, Inc.

Under the terms of the merger agreement, which was unanimously approved by the boards of directors of both companies, Nittany shareholders will be entitled to exchange each share of Nittany common stock for 1.58 shares of National Penn common stock or $42.43 in cash. The five-for-four stock split that National Penn announced on August 24, 2005 with an effective date of September 30, 2005, results in an adjusted exchange ratio of 1.975 shares of National Penn common stock. This exchange ratio is subject to further adjustment as set forth in the definitive agreement based on changes in the market price of National Penn common stock. Nittany shareholders may elect to receive cash, National Penn common stock or a combination of both for their Nittany shares. Additionally, the elections of Nittany shareholders are further subject to allocation procedures that are intended to result in the exchange of 30% of the Nittany shares for cash, and the remaining 70% exchanged for shares of National Penn common stock.

The transaction, anticipated to close in the first quarter of 2006, is subject to several conditions and contingencies, including approvals by the Federal Reserve Bank and the Pennsylvania Department of Banking and the affirmative vote of the shareholders of Nittany. All directors, certain executive officers and greater-than-five percent shareholders of Nittany (collectively holding approximately 40 percent of the outstanding shares of Nittany common stock) have agreed in letter agreements signed with National Penn to vote in favor of the merger. No assurance can be given that all required approvals will be obtained, that all other closing conditions will be satisfied or waived, or that the transactions will in fact be consummated.

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Insurance Agency Acquisitions

On January 3, 2005, November 30, 2004 and July 1, 2004, the Company completed the insurance agency acquisitions of Krombolz Agency, Inc., D.E. Love Associates, Inc., and Pennsurance, Inc., respectively. All agencies have retained their names and operate as divisions of National Penn Bank's insurance agency subsidiary, National Penn Insurance Agency, Inc. The transactions resulted in the issuance of 25,070 shares of the Company's common stock and cash payments totaling $3.6 million. The acquisitions resulted in the recording of approximately $4.3 million of goodwill. Each of these transactions was accounted for under the purchase method of accounting. Accordingly, the results of operations of the Company include the results of the acquired insurance agencies from the respective dates of these acquisitions.

Acquisition of Peoples First, Inc.

On June 10, 2004, the Company completed the acquisition of Peoples First, Inc. (“Peoples”), parent company of The Peoples Bank of Oxford. The Peoples Bank of Oxford, headquartered in Oxford, Pennsylvania, operated eight community offices in Chester and Lancaster Counties, Pennsylvania, and one community office in Cecil County, Maryland, at the time of acquisition.

Under the terms of the merger agreement, 2,956,288 shares of Peoples stock were each converted into 2.35156 shares of National Penn common stock, $49.54 in cash, or a combination of both, resulting in the issuance of 4,866,328 shares of National Penn common stock and payment of approximately $43.9 million in cash. The total purchase price (cash and stock) was valued at $130.8 million. In addition, outstanding stock options to purchase shares of Peoples common stock were converted into options to purchase 167,610 shares of National Penn common stock, with an exercise price of $8.96 per share. The acquisition resulted in the recording of approximately $83.1 million of goodwill and $8.5 million of other intangible assets. The Company acquired assets, loans and deposits of $455.9 million, $361.6 million, and $381.2 million, respectively. This transaction was accounted for under the purchase method of accounting. Accordingly, the results of operations of the Company include Peoples’ results from and after June 10, 2004. All National Penn share and per share information in this report has been restated for a five-for-four stock split of the Company’s common stock effective September 30, 2005.

3. LOANS

The balance of impaired loans was $10.6 million on September 30, 2005. The Company has identified a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. A specific valuation allowance of $1.6 million was allocated to a total of $2.8 million of impaired loans. Impaired loans without a specific valuation allowance were $7.8 million. The Company recognizes income on impaired loans under the cash basis when the loans are both current and the collateral on the loan is sufficient to cover the outstanding obligation to the Company. If these factors do not exist, the Company will not recognize income on such loans.

4. SHAREHOLDERS’ EQUITY

On October 26, 2005, the Company’s Board of Directors declared a cash dividend of $0.165 per share payable on November 17, 2005, to shareholders of record on November 5, 2005.

On August 25, 2005 the Company’s Board of Directors declared a five-for-four stock split of the Company’s common stock, distributable to shareholders of record on September 9, 2005, and which was distributed on September 30, 2005. All weighted average share and per share data has been retroactively restated.

On August 25, 2004, the Company’s Board of Directors declared a five-for-four stock split of the Company’s common stock, distributable to shareholders of record on September 10, 2004, and which was distributed on September 30, 2004.

On September 24, 2003, the Company’s Board of Directors authorized the repurchase of up to 1,562,500 shares of the Company’s common stock (as adjusted for the five-for-four stock split on September 30, 2005) to be used to fund the Company’s dividend reinvestment plan, stock option plans, stock-based benefit plans and employee stock purchase plan. No timetable has been set for these repurchases. As of September 30, 2005, 976,783 shares have been repurchased at an average price of $20.59 per share.

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5. EARNINGS PER SHARE

(dollars in thousands, except per share data)

Three Months Ended September 30, 2005
	Income (numerator)		Shares (denominator)		Per Share Amount
Basic earnings per share
Net income available to common stockholders	$	14,807		43,444	$	0.34
Effect of dilutive securities
Options		-		753		-
Diluted earnings per share
Net income available to common stockholders
plus assumed conversions	$	14,807		44,197	$	0.34

Nine Months Ended September 30, 2005
	Income (numerator)		Shares (denominator)		Per Share Amount
Basic earnings per share
Net income available to common stockholders	$	43,496		43,281	$	1.00
Effect of dilutive securities
Options		-		770		(0.01	)
Diluted earnings per share
Net income available to common stockholders
plus assumed conversions	$	43,496		44,051	$	0.99

Options to purchase 957,502 shares of common stock at $20.70 to $22.80 per share were outstanding for the three and nine months ended September 30, 2005. They were not included in the computation of diluted earnings per share because the option exercise price was greater than the average market price.

Three Months Ended September 30, 2004
	Income (numerator)		Shares (denominator)		Per Share Amount
Basic earnings per share
Net income available to common stockholders	$	13,733		43,058	$	0.32
Effect of dilutive securities
Options		-		790		(0.01	)
Diluted earnings per share
Net income available to common stockholders
plus assumed conversions	$	13,733		43,848	$	0.31

Options to purchase 525,220 shares of common stock at $20.70 to $21.21 per share were outstanding for the three months ended September 30, 2004. They were not included in the computation of diluted earnings per share because the option exercise price was greater than the average market price.

Nine Months Ended September 30, 2004
	Income (numerator)		Shares (denominator)		Per Share Amount
Basic earnings per share
Net income available to common stockholders	$	37,281		39,996	$	0.93
Effect of dilutive securities
Options		-		876		(0.02	)
Diluted earnings per share
Net income available to common stockholders
plus assumed conversions	$	37,281		40,872	$	0.91

Options to purchase 525,148 shares of common stock at $20.70 to $21.21 per share were outstanding for the nine months ended September 30, 2004. They were not included in the computation of diluted earnings per share because the option exercise price was greater than the average market price.

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6. SEGMENT REPORTING

SFAS No. 131, Segment Reporting, establishes standards for public business enterprises to report information about operating segments in their annual financial statements and requires that those enterprises report selected information about operating segments in subsequent interim financial reports issued to shareholders. It also established standards for related disclosure about products and services, geographic areas, and major customers. Operating segments are components of an enterprise, which are evaluated regularly by the chief operating decision-maker in deciding how to allocate and assess resources and performance. The Company’s chief operating decision-maker is the Chairman and Chief Executive Officer. The Company has applied the aggregation criteria set forth in SFAS No. 131 for its National Penn operating segments to create one reportable segment, “Community Banking.”

The Company’s community banking segment consists of commercial and retail banking. The community banking business segment is managed as a single strategic unit, which generates revenue from a variety of products and services provided by National Penn Bank. For example, commercial lending is dependent upon the ability of National Penn Bank to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk. This situation is also similar for consumer and residential mortgage lending.

The Company has also identified several other operating segments. These operating segments within the Company’s operations do not have similar characteristics to the community banking operations and do not meet the quantitative thresholds requiring separate disclosure. These non-reportable segments include National Penn Investors Trust Company, National Penn Life Insurance Company, National Penn Leasing Company, FirstService Capital, Inc., National Penn Insurance Company, and the Parent and are included in the “Other” category.

The accounting policies used in this disclosure of operating segments are the same as those described in the summary of significant accounting policies. The consolidating adjustments reflect certain eliminations of intersegment revenues, cash and investment in subsidiaries.

Reportable segment-specific information and reconciliation to consolidated financial information is as follows:

	Community
(Dollars in thousands)	Banking		Other			Consolidated
As of and for the Nine Months Ended September 30, 2005
Total assets	$	3,993,867	$	580,840		$	4,574,707
Total deposits		3,292,050		-			3,292,050
Net interest income (loss)		115,599		(3,755	)		111,844
Total non-interest income		30,425		12,127			42,552
Total non-interest expense		81,830		11,834			93,664
Net income (loss)		45,835		(2,339	)		43,496
As of and for the Nine Months Ended September 30, 2004
Total assets	$	3,755,335	$	583,921		$	4,339,256
Total deposits		3,149,658		----			3,149,658
Net interest income (loss)		104,544		(3,550	)		100,994
Total non-interest income		24,891		9,362			34,253
Total non-interest expense		72,769		9,032			81,801
Net income (loss)		39,976		(2,695	)		37,281

7. STOCK BASED COMPENSATION

The Company accounts for stock options under SFAS No. 123, Accounting forStock-BasedCompensation, as amended by SFAS No. 148, which contains a fair value-based method of valuing stock-based compensation that entities may use, which measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period, which is usually the vesting period. Alternatively, SFAS No. 123 permits entities to continue accounting for employee stock options and similar equity instruments under Accounting Principles Board (APB) Opinion 25, Accounting forStock Issued to Employees. Entities that continue to account for stock options using APB Opinion 25 are required to make pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been applied.

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At September 30, 2005, the Company had two stock-based employee compensation plans. The Company accounts for these plans under recognition and measurement principles of APB No. 25, Accounting forStock Issued to Employees, and related interpretations. Stock-based employee compensation costs are not reflected in net income, as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation (in thousands, except per share amounts). Not included in these computations are substitute options issued in the course of bank acquisitions that are accounted for at fair value through the application of purchase accounting requirements. These results are not necessarily indicative of the results to be expected for the year ended December 31, 2005.

		Three Months Ended September 30,
		2005			2004
Net income, as reported		$	14,807		$	13,733
Less: stock based compensation costs determined under fair value- based method for all awards			(301	)		(256	)
Net income, pro forma		$	14,506		$	13,477
Earnings per share of common stock - basic	As reported	$	0.34		$	0.32
	Pro forma		0.34			0.31
Earnings per share of common stock - diluted	As reported	$	0.34		$	0.31
	Pro forma		0.33			0.31

		Nine Months Ended September 30,
		2005			2004
Net income, as reported		$	43,496		$	37,281
Less: stock based compensation costs determined under fair value- based method for all awards			(905	)		(794	)
Net income, pro forma		$	42,591		$	36,487
Earnings per share of common stock - basic	As reported	$	1.00		$	0.93
	Pro forma		0.99			0.91
Earnings per share of common stock - diluted	As reported	$	0.99		$	0.91
	Pro forma		0.97			0.89

The Company granted options for 26,875 shares in the first nine months of 2005. The Company granted options for 19,970 shares in the first nine months of 2004. The fair value of each option grant is estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted average assumptions used for grants in 2005 and 2004: dividend yield of 3.20%; expected volatility of 26.00%; risk-free interest rates for each plan of 4.18% and 4.19%; and expected life of 6.50 years in 2005 and 2004.

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In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123(R) (SFAS123R), Share-Based Payment, which requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost will be recognized over the period during which an employee is required to provide service in exchange for the award - the requisite service or vesting period. The grant-date fair value of employee share options and similar instruments will be estimated using option pricing models. Staff Accounting Bulletin No. 107, “Share-Based Payment,” (SAB 107), issued March 29, 2005, expresses views of the SEC staff regarding the application of SFAS123R. Among other things, SAB 107 provides interpretive guidance related to the interaction between SFAS123R and certain SEC rules and regulations, as well as provides the staff’s views regarding the valuation of share-based payment arrangements, for public companies. On April 14, 2005, the SEC adopted a new rule amending the effective dates of SFAS 123R for public companies by issuing Release 33-8568. The new rule allows registrants to implement SFAS 123R at the beginning of their next fiscal year, instead of the next interim period, that begins after June 15, 2005. SFAS123R will therefore be effective for the Company beginning the first quarter of 2006. The anticipated annual impact on the Company is expected to be similar to the amounts disclosed in this Footnote.

8. SUBORDINATED DEBT

As of September 30, 2005, the Company has established four statutory business trusts, NPB Capital Trust II, NPB Capital Trust III, NPB Capital Trust IV, and NPB Capital Trust V. In each case, the Company owns all the common capital securities of the trust. These trusts issued preferred capital securities to investors and invested the proceeds in the Company through the purchase of junior subordinated debentures issued by the Company. These debentures are the sole assets of the trusts.

· The $65.2 million of debentures issued to NPB Capital Trust II August 20, 2002 mature on September 30, 2032, and bear interest at the annual fixed rate of 7.85%.

· The $20.6 million of debentures issued to NPB Capital Trust III February 20, 2004 mature on April 23, 2034, and bear interest at a floating rate (three month LIBOR plus a margin of 2.75%).

· The $20.6 million of debentures issued to NPB Capital Trust IV March 25, 2004 mature on April 7, 2034, and bear interest at a floating rate (three month LIBOR plus a margin of 2.75%).

· The $20.6 million of debentures issued to NPB Capital Trust V April 7, 2004 mature on April 7, 2034, and bear interest at a floating rate (three month LIBOR plus a margin of 2.75%).

Based on current interpretations of the banking regulators, all the foregoing junior subordinated debentures qualify under the risk-based capital guidelines of the Federal Reserve as Tier 1 capital, subject to certain limitations. In each case, the debentures are callable by National Penn, subject to any required regulatory approvals, at par, in whole or in part, at any time after five years. In each case, the Company's obligations under the junior subordinated debentures and related documents, taken together, constitute a full, irrevocable and unconditional guarantee on a subordinated basis by the Company of the obligations of the trusts under the preferred securities.

In December 2003, the FASB issued a revised interpretation, FIN 46(R), Consolidation of Variable Interest Entities, the provisions of which had to be applied to certain variable interest entities by March 31, 2004. The Company adopted the provisions under the revised interpretation in the first quarter of 2004. FIN 46(R) required National Penn to deconsolidate NPB Capital Trust II as of March 31, 2004. FIN 46(R) precludes consideration of the call option embedded in the trust preferred securities when determining if the Company has the right to a majority of NPB Capital Trust II’s expected residual returns. Accordingly, the Company deconsolidated NPB Capital Trust II at the end of the first quarter of 2004, which resulted in an increase in outstanding debt of $2.7 million.

On March 3, 2005, the Federal Reserve issued guidance on the regulatory capital treatment of the trust-preferred securities as a result of the adoption of FIN 46(R). The rule retains the current maximum percentage of total capital permitted for trust preferred securities at 25%, but enacts other changes to the rules governing trust preferred securities that affect their use as part of the collection of entities known as “restricted core capital elements”. The rule takes effect March 31, 2009; however, a five year transition period leading up to that date would allow bank holding companies to continue to count trust preferred securities as Tier 1 Capital after applying FIN-46(R). Management has evaluated the effects of the rule and does not anticipate a material impact on its capital ratios.

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9. EMPLOYEE BENEFIT PLANS

Net periodic defined benefit pension expense for the nine months ended September 30, 2005 and 2004

included the following components:

	September 30, 2005			September 30, 2004
Service cost	$	1,592,150		$	1,178,832
Interest cost		1,093,870			949,380
Expected return on plan assets		(1,302,602	)		(1,165,172	)
Amortization of prior service cost		(3,566	)		(15,115	)
Amortization of unrecognized net actual loss		167,316			81,392
Net periodic benefit expense	$	1,547,168		$	1,029,317

We currently expect to contribute approximately $1.8 million to our pension plan for plan year 2005. No contributions to the plan were required in the nine months ended September 30, 2005.

10. NEW ACCOUNTING PRONOUNCEMENTS

FASB Staff Position No. 03-1-a

FASB Proposed Staff Position (FSP) 03-1-a would have established new rules for accounting for permanent write-downs of certain available for sale investments under the previously published EITF 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments. Specifically, FSP 03-1-a would have required permanent impairments to be accounted for through earnings, as opposed to current requirements to reflect market adjustments through equity. On July 1, 2005, the FASB made a decision not to adopt the accounting changes proposed by FSP 03-1-a. The FASB is expected to issue a final FSP re-titled FSP FAS 115-1, to supersede EITF 03-1, which will be effective for other-than-temporary impairment analyses beginning in periods after September 15, 2005.

11. LITIGATION

As previously disclosed by National Penn in its Annual Report on Form 10-K for 2004 at Item 1. “Business-Recent Developments,” National Penn’s financial results for 2004 included a pre-tax special charge for fraud loss of $6.7 million, for losses attributable to a fraudulent loan and deposit scheme perpetrated by a former loan officer and discovered by National Penn in January 2005. Third quarter 2005 financial results include pre-tax expenses of $198,000 for legal, auditing and other investigation-related expenses in the investigation of the loan fraud discovered in January 2005. National Penn anticipates that it will continue to incur legal and other investigation-related expenses in future periods.

As previously reported in National Penn’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005, after an exhaustive investigation lasting over three and one-half months, on April 18, 2005, National Penn filed a complaint against the former loan officer and others, including certain customers and two additional former employees. The complaint seeks to recover all losses, costs and expenses arising out of the transactions examined during the investigation. (National Penn Bank v. Edward G. and Jayne Mawhinney et al., Court of Common Pleas, Philadelphia County, March Term 2005 No. 001789) (the “Mawhinney Litigation”).

On November 2, 2005, without admission of liability or fault by any party, National Penn and certain of the defendants in the Mawhinney Litigation agreed to a settlement. Under the terms of the settlement, (A) the parties agreed, among other things, that National Penn and the settling defendants each would discontinue their respective actions against the other with prejudice, and (B) the settling defendants paid approximately $3.5 million to National Penn against losses previously recorded. National Penn continues to pursue all other available avenues, including insurance, to recover its losses and cooperate with law enforcement authorities in their investigation.

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

The following discussion and analysis is intended to assist in understanding and evaluating the major changes in the earnings performance and financial condition of the Company with a primary focus on an analysis of operating results. Current performance does not guarantee and may not be indicative of similar performance in the future. These are unaudited financial statements and, as such, are subject to year end examination. In addition to historical information, this Form 10-Q contains forward-looking statements.

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Forward-looking statements in this document are subject to risks and uncertainty. Forward-looking statements include information concerning possible or assumed future results of operations by the Company. When we use words such as “believe”, “expect”, “anticipate”, or similar expressions, we are making forward-looking statements. Additional information concerning forward-looking statements is contained later on within this discussion.

The Company’s strategic plan provides for a highly profitable financial services company within the markets it serves. Specifically, management is focused on increased market penetration in selected geographic areas, and excellence in both retail and commercial lines of business. The acquisition of Peoples First, Inc. and its subsidiary, The Peoples Bank of Oxford, in second quarter 2004 was a strategic initiative by the Company in furtherance of its focused goals.

The Company recorded a 7.8% increase in third quarter 2005 net income compared to third quarter 2004, and a 16.7% increase in net income for the first nine months of 2005 compared to the first nine months of 2004. Diluted earnings per share for the three and nine-month periods ended September 30, 2005 of $.34 and $.99 increased 9.7% and 8.8%, respectively, compared to the same periods in 2004. The change in the percentage increase in net income when compared to the percentage increase in earnings per share is due to the larger number of weighted average common shares outstanding, principally resulting from the acquisition of Peoples First, Inc., which was completed on June 10, 2004. Per share results for 2004 have been restated for the five-for-four stock split effective as of September 30, 2005.

For the nine month period ended September 30, 2005, the annualized return on average shareholders’ equity and annualized return on average assets were 13.4% and 1.28% compared to 14.6% and 1.30% for the comparable period in 2004. The decrease in return on average shareholders’ equity is due primarily to the higher levels of average equity outstanding resulting from the acquisition of Peoples First, Inc. on June 10, 2004. The return on average tangible equity was 25.3% as of September 30, 2005 and 25.6% as of September 30, 2004.

Return on average tangible equity is supplemental financial information determined by a method other than in accordance with accounting principles generally accepted in the United Stated of America (“GAAP”). National Penn’s management uses this non-GAAP measure in its analysis of National Penn’s performance. Annualized net income return on average tangible equity excludes the average balance of acquisition-related goodwill and intangibles in determining average tangible shareholders’ equity. Banking and financial institution regulators also exclude goodwill and intangibles from shareholders' equity when assessing the capital adequacy of a financial institution. Management believes the presentation of this financial measure excluding the impact of these items provides useful supplemental information that is essential to a proper understanding of the financial results of National Penn, as it provides a method to assess management’s success in utilizing the company’s tangible capital. This disclosure should not be viewed as a substitute for results determined in accordance with GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies.

The following table reconciles this non-GAAP performance measure to the GAAP performance measure, return on average shareholders’ equity (dollars in thousands).

Reconciliation Table for Non-GAAP Financial Measure
	Sept 30, 2005			Sept 30, 2004
Return on average shareholders' equity (annualized)		13.4	%		14.6	%
Effect of goodwill and intangibles (annualized)		11.9	%		11.0	%
Return on average tangible equity (annualized)		25.3	%		25.6	%
Average tangible equity excludes acquisition related average goodwill and intangibles:
Average shareholders' equity	$	435,072		$	341,350
Average goodwill and intangibles		(205,252	)		(146,266	)
Average tangible equity	$	229,820		$	195,084

CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES

The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States of America (“GAAP”) and predominant practice within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.

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The Company considers that the determination of the allowance for loan and lease losses involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance for loan and lease losses is calculated with the objective of maintaining a reserve level believed by management to be sufficient to absorb estimated credit losses. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires material estimates, including, among others, expected default probabilities, loss given default, expected commitment usage, the amounts and timing of expected future cash flows on impaired loans, mortgages, and general amounts for historical loss experience. The process also considers economic conditions, uncertainties in estimating losses and inherent risks in the loan and lease portfolio. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan and lease losses may be required that would adversely impact earnings in future periods.

Goodwill is subject to impairment testing at least annually to determine whether write-downs of the recorded balances are necessary. In this testing, the Company employs general industry practices in accordance with GAAP. A fair value is determined for each reporting unit using various market valuation methodologies. If the fair values of the reporting units exceed their book values, no write-down of recorded goodwill is necessary. If the fair value of the reporting unit is less, an expense may be required on the Company’s books to write down the related goodwill to the proper carrying value. The Company tests for impairment of goodwill as of June 30 each year, and again at any quarter-end if any material events occur during a quarter that may affect goodwill. As of September 30, 2005, the Company has not identified any impairment of its goodwill. No assurance can be given that future goodwill impairment tests will not result in a charge to earnings.

The Company recognizes deferred tax assets and liabilities for the future tax effects of temporary differences, net operating loss carryforwards and tax credits. Deferred tax assets are subject to management’s judgment based upon available evidence that future realization is more likely than not. If management

determines that the Company may be unable to realize all or part of net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the expected realizable amount.

The Company has not substantively changed any aspect of its overall approach in the application of the foregoing policies. There have been no material changes in assumptions or estimation techniques utilized as compared to prior periods.

RESULTS OF OPERATIONS

Net income for the quarter ended September 30, 2005 was $14.8 million, 7.8% more than for the third quarter 2004. Net income for the nine months ended September 30, 2005 was $43.5 million, 16.7% more than for the first nine months of 2004. The Company’s performance has been and will continue to be in part influenced by the strength of the economy and conditions in the real estate market. The 2005 results include Peoples First, Inc. (acquisition date of June 10, 2004) for the full periods.

Net interest income is the difference between interest income earned on assets and interest expense paid on liabilities. Net interest income for the third quarter of 2005 was $37.5 million, which increased $308,000 or 0.8% over the $37.2 million for the third quarter of 2004. Interest income for the third quarter of 2005 increased $9.2 million as compared to the third quarter of 2004. Interest expense for third quarter 2005 increased $8.9 million. Net interest income for the first nine months of 2005 was $111.8 million, which increased $10.9 million or 10.7% over the $101.0 million for the first nine months of 2004. Interest income in 2005 increased $35.6 million due to a higher level of interest earning assets as compared to the nine months ended June 30, 2004. Interest expense in the first nine months of 2005 increased $24.8 million over interest expense for the first nine months of 2004. The increase in interest income in the first three and nine months of 2005 is due to a higher level of interest earning assets as compared to the 2004 comparable periods. For the first three and nine month periods of 2005, the increase in interest expense on deposits is attributable primarily to an increased level and volatility of interest rates paid on deposits.

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The following table presents average balances, average rates and interest rate spread information:

Average Balances, Average Rates, and Interest Rate Spread*

(Dollars in thousands)

	Nine Months Ended September 30,
	2005								2004
	Average					Average			Average					Average
	Balance		Interest			Rate			Balance		Interest			Rate
INTEREST EARNING ASSETS:
Interest bearing deposits at banks	$	8,805	$	140			2.13	%	$	5,298	$	32			0.81	%
Federal funds sold		55		2			4.86	%		6,518		38			0.78	%
Investment securities		1,167,785		43,009			4.92	%		962,015		36,499			5.07	%
Total loans and leases		2,957,545		142,879			6.46	%		2,516,991		113,142			6.00	%
Total earning assets	$	4,134,190	$	186,030			6.02	%	$	3,490,822	$	149,711			5.73	%
INTEREST BEARINGLIABILITIES:
Interest bearing deposits	$	2,569,200	$	41,762			2.17	%	$	2,176,257	$	26,251			1.61	%
Short-term borrowings		615,823		11,196			2.43	%		547,516		4,850			1.18	%
Long-term borrowings		374,984		14,336			5.11	%		303,000		11,437			5.04	%
Total interest bearing liabilities	$	3,560,007	$	67,294			2.53	%	$	3,026,773	$	42,538			1.88	%
INTEREST RATE MARGIN**			$	118,736			3.84	%			$	107,173			4.10	%
Tax equivalent interest				(6,892	)		(0.22	%)				(6,179	)		(0.24	%)
Net interest income			$	111,844			3.62	%			$	100,994			3.86	%
*   Full taxable equivalent basis, using a 35% effective tax rate.
** Represents the difference between interest earned and interest paid, divided by total earning assets.
Loans outstanding, net of unearned income, include non-accruing loans.
Fee income included.

The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the increase related to higher outstanding balances and that due to the levels and volatility of interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to:

· changes in volume (i.e., changes in volume multiplied by old rate) and

· changes in rate (i.e., changes in rate multiplied by old volume).

For purposes of this table, variance not solely due to rate or volume is allocated to the volume variance. Changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate in proportion to the relationship of the absolute dollar amounts of the change in each. The information is presented on a taxable equivalent basis, using an effective rate of 34% (in thousands).

	Nine Months Ended September, 2005 over 2004
	Volume			Rate			Total
Increase (decrease) in: Interest income:
Interest bearing deposits in banks	$	21		$	87		$	108
Federal funds sold		(38	)		2			(36	)
Investment securities		7,807			(1,297	)		6,510
Total loans and leases		19,803			9,934			29,737
Total interest income	$	27,593		$	8,726		$	36,319
Interest expense:
Interest bearing deposits	$	4,740		$	10,771		$	15,511
Short-term borrowings		605			5,741			6,346
Long-term borrowings		2,717			182			2,899
Total interest expense	$	8,062		$	16,694		$	24,756
Increase (decrease) in net interest income	$	19,531		$	(7,968	)	$	11,563

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Net interest income, on a taxable equivalent basis, increased $11.6 million in the first nine months of 2005, as compared to the same period in 2004. This increase is primarily due to a higher volume of interest earning assets.

Net interest margin, defined as net interest income divided by total interest earning assets, decreased to 3.80% during third quarter 2005 compared to 4.07% during the third quarter of 2004 and 3.87% during the first quarter of 2005. Net interest margins for the first nine months of 2005 and 2004 were 3.84% and 4.10%, respectively. The margin decline was due to continued competitive pressures and general overall margin compression between loan growth, higher-costing funding sources, and the continuing effects of a relatively flat yield curve. The net interest margin continues to be a concern in future quarters as the Company anticipates continued margin compression.

Management conducts a quarterly analysis of the loan and lease portfolios and adjusts allowance for loan and lease losses accordingly. During our quarterly analysis of the loan and lease loss allowance, we considered a variety of factors, some of which included:

· General economic conditions.

· Trends in charge-offs.

· The level of non-performing assets, including loans and leases over 90 days delinquent.

· Levels of allowance for specific classified assets.

· A review of economic sectors, for example the manufacturing industry, which may continue to create losses in the manufacturing portfolio.

· The overall concerns of consumer confidence associated with world events.

Based on the quarterly analysis, the Company provided $750,000 to its allowance for loan and lease losses, a decrease of $475,000 compared to the three months ended September 30, 2004. The Company maintains the allowance for loan and lease losses at a level believed adequate to absorb probable losses on existing loans and leases. The Company’s net charge-offs of $530,000 for the three months ended September 30, 2005 decreased by $714,000 compared to the $1.2 million in net charge-offs for the three months ended September 30, 2004.

For the nine months ended September 30, 2005, the Company provided $2.5 million to its allowance for loan and lease losses, a $1.7 million decrease compared to the first nine months of 2004. The Company’s net charge-offs of $3.8 million for the nine months ended September 30, 2005 increased by $1.6 million compared to the $2.2 million in net charge-offs for the first nine months of 2004.

While net charge-offs increased for the nine months ended September 30, 2005, total non-performing assets compared to total loans were .36% at September 30, 2005 compared to .48% at June 30, 2005 and .42% at December 31, 2004. Additionally, based on the Company’s internal loan risk rating system, the total of classified and criticized loans as a percentage of total loans declined to 4.10% at September 30, 2005, from 4.17% at June 30, 2005 and 4.24% at December 31, 2004. The reduction in non-performing assets was due to the active selling of non-performing assets to private investors. Overall, classified and criticized assets also declined as a result of those sales, as well as improvement in performance by several significant manufacturing credits.

The Company’s allowance for loan and lease losses decreased $1.3 million, from $57.6 million as of December 31, 2004 to $56.3 million as of September 30, 2005. The following table details the components of the change in balance of the allowance for loan and lease losses as of September 30, 2005 (in thousands):

Balance at 12/31/04	$	57,590
Charge-Offs		(5,916	)
Recoveries		2,131
Provision for loan and lease losses		2,450
Balance at 9/30/05	$	56,255

Non-interest income increased $1.9 million or 15.6% during the third quarter of 2005 compared to the same period in 2004, as a result of mortgage banking income increasing $663,000, other service charges and fees increasing $624,000, insurance commissions and fees increasing $608,000, cash management and electronic banking fees increasing $239,000, service charges on deposit accounts increasing $115,000, and a $81,000 increase in net gains on sale of investment securities. For the first nine months of 2005, non-interest income increased $8.3 million or 24.2% compared to the same period in 2004, as a result of insurance commissions and fees increasing $2.8 million, other service charges and fees increasing $1.2 million, service charges on deposit accounts increasing $978,000, a $886,000 increase in net gains on sale of investment securities, cash management and electronic

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banking fees increasing $794,000, mortgage banking income increasing $730,000, and wealth management income increasing $420,000.

Wealth management income increased in the first nine months of 2005 as a result of the combined efforts of our wealth management subsidiaries, which efforts were largely consolidated during the second quarter of 2005 into National Penn Investors Trust Company, a subsidiary of National Penn Bank. The increase in deposit fees was primarily due to an increase in the collection of fees on a larger deposit base, resulting from the Peoples First acquisition in June 2004. Insurance commissions and fees increased as a result of the addition to National Penn Insurance Agency, Inc. of three insurance agencies acquired since June 2004. The increase in non-interest income for the first nine months of 2005 also includes a one-time gain of $922,000 on the sale of the Peoples Bank of Oxford operations center in the first quarter of 2005. Third quarter 2005 mortgage banking income increased $663,000 as compared to third quarter 2004 due to increased mortgage origination volume resulting from low long-term interest rates during the third quarter of 2005. For the first nine months of 2005, mortgage banking income increased $730,000 as compared to the same period in 2004. Gains on the sale of investment securities were primarily due to the sale of equity securities in the third quarter of 2005. Non-interest income represented 19.5%, 19.0% and 18.9% of total revenues in the first three, six and nine months, respectively, excluding the gain on the sale of the operations center building in the first quarter.

Non-interest expenses increased $1.5 million or 4.9% during the third quarter of 2005, compared to third quarter 2004, to $31.5 million. Salaries, wages and benefits increased $932,000 or 5.3%, advertising and marketing expenses increased $436,000 or 53.6%, net premises and equipment increased $80,000 or 1.9%, which were partially offset by a decrease of $128,000 or 1.8% in other operating expenses. For the first nine months of 2005, as compared to the same period in 2004, non-interest expenses increased $11.9 million or 14.5% to $93.7 million. In the first nine months of 2005, salaries, wages and benefits increased $7.4 million or 15.4%, other operating expenses increased $1.3 million or 7.0%, net premises and equipment increased $1.1 million or 8.8%, and advertising and marketing expenses increased $776,000 or 25.0%, as compared to the same period in the prior year. These increases are principally due to the June 2004 acquisition of Peoples First, Inc., which is included in the first three quarters of 2005.

The first nine months of 2005 also included professional fees and related expenses of $1.4 million attributable to the investigation of the fraud discovered by National Penn in January 2005. This fraud was previously disclosed in National Penn’s Form 10-K for the fiscal year ended December 31, 2004. National Penn anticipates that it will continue to incur legal and other investigation-related expenses in the foreseeable future.

Income before income taxes increased $1.2 million or 6.7% in the third quarter of 2005 compared to the same time period in 2004. Income taxes increased $143,000 or 3.3% for the quarter ended September 30, 2005 due to a 6.7% increase in pretax income and a lower percentage of tax advantaged assets in relation to taxable assets. The Company’s effective tax rate decreased to 23.3% for the third quarter of 2005 compared to 24.1% for third quarter 2004. For the first nine months of 2005, income before income taxes increased $9.0 million or 18.3% compared to the same time period in 2004. Income taxes increased $2.8 million or 23.5% in the first nine months of 2005 as compared to the same period in 2004, due to a 23.5% increase in pretax income and a lower percentage of tax advantaged assets in relation to taxable assets. The Company’s effective tax rate increased to 25.4% for the first nine months of 2005 compared to 24.3% for the first nine months of 2004. The increase in the effective tax rate year to date in 2005 is due to the lower percentage of tax advantaged assets as mentioned above.

FINANCIAL CONDITION

At September 30, 2005, total assets were $4.57 billion, an increase of $95.9 million or 2.14% from the $4.48 billion at December 31, 2004. Net loans and leases, including loans held for sale, which totaled $2.96 billion at September 30, 2005, increased $138.6 million, or 4.92% compared to the $2.82 billion in loans and leases at December 31, 2004. Loans continue to increase at a modest pace as a result of the improving economy and the increase of capital goods spending by the Company’s business customers. Loans originated for immediate resale during the first nine months of 2005 amounted to $207.9 million.

Total cash and cash equivalents increased $13.5 million or 14.4% at September 30, 2005 when compared to December 31, 2004. Cash and due from banks increased $16.9 million, due to an increase of Federal Reserve and correspondent bank related balances as of September 30, 2005.

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For the first nine months of 2005, approximately 63.8% of the Company’s gross revenue (total interest income plus total other income or $221.7 million through September 30, 2005) was derived from interest income on loans it makes to individuals and business owners throughout its marketplace, which totaled $141.4 million.

The Company’s total loan portfolio, including loans held for sale, as of September 30, 2005 was $3.01 billion and consisted of three broad categories of loans:

· Loans to individuals to finance the purchase of personal assets or activities was $348.9 million or 11.6% of total loans.

· Residential mortgage loans for the purchase or financing of an individual’s private residence was $290.2 million or 9.6% of total loans.

· Commercial loans of $2.37 billion or 78.8% of the total loan portfolio. This includes commercial real estate, commercial construction and commercial and industrial loans.

Loans to individuals consisted primarily of loans with fixed terms and lines of credit secured by liens on the individual’s residence. The principal risk associated with these credits is the overall creditworthiness of the individual borrower. Changes in an individual’s employment or life circumstances can have an effect on the repayment of these assets.

Residential mortgage loans are extended to individuals for the purchase or financing of their residence. These loans are secured by a first lien title insured mortgage on their home. Again, the primary risk in these credits is the financial soundness of the individual borrower.

Commercial loans consist of lines of credit, term loans, mortgages, and leases extended to business owners or to individuals for business purposes. The types of business borrowers represented in the portfolio consist of manufacturing companies, wholesalers, distributors and warehouses, professional service providers, retailers, farmers and agricultural related industries, commercial real estate investors, and land developers. As of September 30, 2005, the commercial portfolio had a concentration in loans to commercial real estate investors and developers with loans outstanding to this group of $560.1 million, which loans constitute 23.6% of the commercial loan portfolio and 18.6% of the total loan portfolio.

There are numerous risks associated with commercial loans that could impact the borrower’s ability to repay on a timely basis. They include but are not limited to: the owner’s business expertise, changes in local, national, and in some cases international economies, competition, governmental regulation, and the general financial stability of the borrowing entity.

The Company attempts to mitigate these risks by making an analysis of the borrower’s business and industry history, its financial position, as well as that of the business owner. The Company will also require the borrower to provide financial information on the operation of the business periodically over the life of the loan. In addition, most commercial loans are secured by assets of the business or those of the business owner, which can be liquidated if the borrower defaults, along with the personal surety of the business owner.

All of the aforementioned loan types can be made on a floating or fixed rate basis, either of which can pose an interest rate risk to the Company as financial markets change. Interest rate risk is discussed in further detail in the Liquidity and Interest Rate Sensitivity section of this report.

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The following table shows detailed information and ratios pertaining to the Company’s loans and asset quality (dollars in thousands):

	September 30, 2005			December 31, 2004
Nonaccrual loans	$	10,562		$	11,103
Loans past due 90 or more days as to interest or principal		342			870
Total nonperforming loans		10,904			11,973
Other real estate owned		16			--
Total nonperforming assets	$	10,920		$	11,973
Total loans and leases, including loans held for sale	$	3,011,657		$	2,874,439
Average total loans and leases	$	2,957,545		$	2,596,772
Allowance for loan and lease losses	$	56,255		$	57,590
Allowance for loan and lease losses to:
Nonperforming assets		515.2	%		481.0	%
Total loans and leases		1.87	%		2.00	%
Average total loans and leases		1.90	%		2.22	%

	Nine Months Ended Sept 30,
	2005			2004
Net charge-offs	$	3,785		$	2,226
Net charge-offs (annualized) to:	$	5,047		$	2,968
Total loans and leases		0.17	%		0.11	%
Average total loans and leases		0.17	%		0.12	%
Allowance for loan and lease losses		8.97	%		5.17	%

The decrease in non-performing assets is due to decreases in both non-accrual loans and loans past due 90 days or more. Non-accrual loans decreased $541,000 from $11.1 million at December 31, 2004 to $10.6 million at September 30, 2005. This decrease was due to decreases of $2.0 million in non-accrual non-farm, non-residential real estate loans offset by increases of $513,000 in non-accrual personal loans to individuals, $480,000 in non-accrual commercial and industrial loans, $280,000 in non-accrual residential real-estate secured lines of credit, and $158,000 in non-accrual leases. Loans past due 90 days or more decreased $528,000 from $870,000 at December 31, 2004 to $342,000 at September 30, 2005. This decrease was substantially due to a decrease of $507,000 in residential real-estate secured loans past due 90 days or more. Management expects that non-performing loans may increase in the remainder of 2005 due to the impact of the rising interest rate environment on borrowers. Management reviews the loan portfolio quarterly to identify nonperforming credits. As of September 30, 2005, loans secured by non-farm, non-residential real estate and commercial and industrial loans account for 69.0% of the total non-accrual loans; residential real estate-secured loans account for 24.3% of non-accruals.

Investments decreased $60.6 million or 5.1% to $1.1 billion at September 30, 2005 compared to December 31, 2004. Investment purchases during the first nine months of 2005 were $153.3 million, consisting of Treasury and municipal securities. This decrease included investment calls and maturities and the amortization of mortgage-backed securities totaling $181.1 million. During the first nine months of 2005, the Company sold approximately $18.2 million in investment securities available for sale resulting in a $790,000 gain. These transactions allowed us to re-deploy those funds into higher yielding investments.

The total of all other assets on the balance sheet at September 30, 2005 was relatively unchanged at $382.7 million as compared to $378.2 million at December 31, 2004. These assets include net premises and equipment, accrued interest receivable, bank owned life insurance, goodwill and other intangibles, unconsolidated investments, and other assets.

In 1998 and 1999, the Company invested in bank owned life insurance (BOLI) policies that provide earnings to help cover the cost of employee benefit plans. BOLI involves the purchasing of life insurance by the

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Company on a chosen group of employees. The Company is the owner and beneficiary of the policies. The Company has additional BOLI policies that have been received through several of its bank acquisitions. Cashflow from these policies will occur over an extended period of time. The Company periodically reviews the creditworthiness of the insurance companies that have underwritten the policies. The insurance companies were all rated “A+” or better as of November 2004 by A.M. Best. The earnings accruing to the Company are derived from the general account investments of the insurance companies. The policies appear on the Company’s balance sheet and are subject to full regulatory capital requirements.

As the primary source of funds, aggregate deposits of $3.29 billion at September 30, 2005 increased $148.9 million or 4.7% compared to December 31, 2004. The increase in deposits during the first nine months of 2005 was substantially due to increases in jumbo certificates of deposit of $167.5 million, non-jumbo certificates of deposit of $143.2 million, and brokered certificates of deposit of $44.1 million. These increases were offset by a net decline in various other interest-bearing deposits of $125.4 million and a decline in municipal deposits of $86.5 million for the first nine-months of 2005. Municipal deposits fluctuate as municipalities are required to move their deposits to the institution that will provide the highest rate of return on public funds. These deposits also fluctuate because municipalities receive tax revenues periodically during a year and balances run down until the next fiscal year’s receipts.

In addition to deposits, earning assets are funded to some extent through purchased funds and borrowings. These include securities sold under repurchase agreements, federal funds purchased, short-term borrowings, long-term debt obligations, and subordinated debt. In the aggregate, these funds totaled $789.6 million at September 30, 2005, and $871.0 million at December 31, 2004. The decrease of $81.4 million in purchased funds and borrowing is comprised of a $95.8 million decrease in securities sold under repurchase agreements and federal funds purchased, a decrease in short-term borrowings of $4.3 million, offset by a increase in long-term borrowings of $18.7 million. The increase in long-term borrowings is a result of funding needs due to the decline in the level of municipal deposits. Securities sold under repurchase agreements which includes short-term investment vehicles for our commercial clients and Federal Home Loan Bank overnight funds, decreased $61.3 million, while other short-term borrowings decreased $38.8 million.

Shareholders’ equity increased $16.9 million from December 31, 2004 through September 30, 2005. Common stock increased $2.7 million related to a higher number of common shares outstanding. Retained earnings increased $22.7 million due to the retention of net income, partially offset by the payment of cash dividends. Accumulated other comprehensive income decreased $10.4 million due to reduced valuation levels in the available for sale investment securities portfolio as a result of the higher interest rate environment. Cash dividends paid during the first nine months of 2005 increased $2.5 million or 13.7% to $20.8 million compared to the cash dividends paid during the first nine months of 2004. Earnings retained during the first nine months of 2005 were 52.2% compared to 51.0% during the first nine months of 2004.

REGULATORY COMPLIANCE AND INTERNAL CONTROL

Management has an effective means of monitoring existing and new regulatory developments, including developments under the Sarbanes-Oxley Act of 2002. Increased reporting and documentation requirements have resulted, and will continue to result, in increased operating costs.

LIQUIDITY AND INTEREST RATE SENSITIVITY

The primary functions of asset/liability management are to assure adequate liquidity and maintain an appropriate balance between interest-earning assets and interest-bearing liabilities.

Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. During the past year, liquidity has tightened as loan demand has improved and competition for deposits has intensified. These factors have combined to cause an increased use of wholesale funding. Wholesale funding is defined here as funding sources outside our core deposit base, such as the national jumbo CD market, correspondent bank borrowings, or brokered CD’s. At the present time, we have adequate availability of wholesale funding. Regardless of our comfort with our liquidity position at present time, we actively monitor our position and any increased use of wholesale funding increases our attention in this area.

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The Company’s main liquidity concern is that as the economy and consequently the equity markets strengthen, the Company may suffer an outflow of funds as depositors withdraw cash for re-investment in improving equity markets (disintermediation). The Company has sought to prepare for this potential by working to build its share of customers’ banking business (on the theory that even if some funds move back to the equity market, the Company will still retain a larger share than it had three years ago), growing its government banking unit, reviewing its deposit product offerings, establishing additional non-core sources of funding, maintaining a more liquid investment portfolio, and continuing to develop its capability to securitize assets.

The goal of interest rate sensitivity management is to avoid fluctuating net interest margins, and to enhance consistent growth of net interest income through periods of changing interest rates. Such sensitivity is measured as the difference in the volume of assets and liabilities in the existing portfolio that are subject to repricing in a future time period.

The following table shows separately the interest rate sensitivity of each category of interest-earning assets and interest-bearing liabilities at September 30, 2005 (in thousands).

	Repricing Periods (1)
	Within Three Months		Three Months Through One Year			One Year  Through Five Years		Over Five Years
Assets
Interest bearing deposits at banks	$	5,430	$	0		$	0	$	0
Federal funds sold		0		0			0		0
Investment securities		109,301		112,266			655,416		252,238
Loans and leases (1)		1,331,810		242,784			1,045,540		335,268
Other assets		0		0			0		484,654
	$	1,446,541	$	355,050		$	1,700,956	$	1,072,160
Liabilities and equity
Non-interest bearing deposits		5,384		11,229			131,555		364,550
Interest bearing deposits (2)		972,403		588,611			467,864		750,454
Borrowed funds		229,976		40,344			172,180		220,061
Subordinated debt		61,857		0			0		65,206
Other liabilities		0		0			0		48,035
Shareholders’ equity		0		0			0		444,999
		1,269,620		640,184			771,599		1,893,304
Interest sensitivity gap		176,921		(285,134	)		929,357		(821,144	)
Cumulative interest rate sensitivity gap	$	176,921		($108,213	)	$	821,144	$	0

_________________________________

(1)

Adjustable rate loans are included in the period in which interest rates are next scheduled to adjust rather than in the period in which they are due. Fixed-rate loans are included in the period in which they are scheduled to be repaid and are adjusted to take into account estimated prepayments based upon assumptions estimating the expected prepayments in the interest rate environment prevailing during the third calendar quarter of 2005. The table assumes prepayments and scheduled principal amortization of fixed-rate loans and mortgage-backed securities, and assumes that adjustable-rate mortgages will reprice at contractual repricing intervals. There has been no adjustment for the impact of future commitments and loans in process.

(2)

Savings and NOW deposits are scheduled for repricing based on historical deposit decay rate analyses, as well as historical moving averages of run-off for the Company’s deposits in these categories. While generally subject to immediate withdrawal, management considers a portion of these accounts to be core deposits having significantly longer effective maturities based upon the Company’s historical retention of such deposits in changing interest rate environments. Specifically, 50% of these deposits are considered repriceable within three months and 50% are considered repriceable in the over five-year category.

Interest rate sensitivity is a function of the repricing characteristics of the Company’s assets and liabilities. These characteristics include the volume of assets and liabilities repricing, the timing of the repricing, and the relative levels of repricing. Attempting to minimize the interest rate sensitivity gaps is a continual challenge in a changing rate environment. Based on the Company’s gap position as reflected in the above table, current accepted theory would indicate that net interest income would decrease in a falling rate environment and would increase in a rising rate environment. An interest rate gap table does not, however, present a complete picture of the impact of

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interest rate changes on net interest income. First, changes in the general level of interest rates do not affect all categories of assets and liabilities equally or simultaneously. Second, assets and liabilities which can contractually reprice within the same period may not, in fact, reprice at the same time or to the same extent. Third, the table represents a one-day position; variations occur daily as the Company adjusts its interest sensitivity throughout the year. Fourth, assumptions must be made to construct such a table. For example, non-interest bearing deposits are assigned a repricing interval within three months, although history indicates a significant amount of these deposits will not move into interest bearing categories regardless of the general level of interest rates. Finally, the repricing distribution of interest sensitive assets may not be indicative of the liquidity of those assets.

The Company uses financial simulation models to measure interest rate exposure. These tools provide management with extensive information on the potential impact of net income caused by changes in interest rates. Interest rate related risks such as pricing spreads, the lag time in pricing administered rate accounts, prepayments and other option risks are considered.

Gap analysis is a useful measurement of asset and liability management; however, it is difficult to predict the effect of changing interest rates based solely on this measure. Therefore, the Company supplements gap analysis with the calculation of the Economic Value of Equity. This report forecasts changes in the company’s market value of portfolio equity (“MVPE”) under alternative interest rate environments. The MVPE is defined as the net present value of the Company’s existing assets, liabilities, and off-balance sheet instruments.

The calculated estimates of change in MVPE at September 30, 2005 are as follows (dollars in thousands):

MVPE
Change in Interest Rate	Amount		% Change
(in basis points)
+300	$	657,009		(-6.96	)%
+200		671,666		(-4.89	)%
+100		681,851		(-3.45	)%
Flat Rate (base case)		706,184		0	%
-100		675,491		(-4.35	)%
-200		644,273		(-8.77	)%
-300		604,969		(-14.33	)%

Management also estimates the potential effect of shifts in interest rates on net income. The following table demonstrates the expected effect that a parallel interest rate shift would have on the Company’s net income (dollars in thousands).

	September 30, 2005		September 30, 2004
Change in Interest Rates	$ Change in Net Income	% Change in Net Income	$ Change in Net Income	% Change in Net Income
(in basis points)
+300	$2,000	3.13%	$(1,604)		(2.75)%
+200	1,368	2.14%	(830)		(1.42)%
+100	732	1.15%	(179)		(0.31)%
-100	(1,325)	(2.08)%	(1,190)		(2.04)%
-200	(5,590)	(8.76)%	(5,456)		(9.36)%
-300	(13,001)	(20.37)%	(9,028)		(15.49)%

The Company uses financial derivative instruments for management of interest rate sensitivity. The Asset Liability Committee (ALCO) approves the use of derivatives in balance sheet hedging. The derivatives employed by the Company currently include forward sales of mortgage commitments. The Company does not use any of these instruments for trading purposes.

At the current level of interest rates, the Company has some exposure to a movement in rates in either direction due to the optionality of the financial instruments on both sides of the balance sheet. Optionality exists because customers have choices regarding their deposit accounts or loans. For example, if a customer has a fixed rate mortgage, he/she may choose to refinance the mortgage if interest rates decline. One way to reduce this option risk is to sell the Company’s long-term fixed rate mortgages in the secondary market. The impact of a rising or

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falling interest rate environment on net interest income is not expected to be significant to the Company’s results of operations. Nonetheless, the Company’s asset/liability management committee’s priority is to manage this optionality and therefore limit the level of interest rate risk.

OFF-BALANCE SHEET ARRANGEMENTS AND

OTHER CONTRACTUAL OBLIGATIONS AND COMMITMENTS

The Company consolidates all of its majority-owned subsidiaries. Other entities, in which there is greater than 20% ownership, but upon which the Company does not possess, nor cannot exert, significant influence or control, are accounted for by equity method accounting and not consolidated; those in which there is less than 20% ownership are generally carried at cost.

The following table sets forth the contractual obligations and other commitments representing required and potential cash outflows as of September 30, 2005 (in thousands):

	Total		Less than One Year		One to Three Years		Four to Five  Years		After Five Years
Minimum annual rentals or non- cancellable operating leases	$	25,139	$	3,502	$	5,334	$	4,093	$	12,210
Remaining contractual maturities of time deposits		1,234,586		764,080		444,356		23,509		2,641
Loan commitments		1,018,526		626,540		48,653		33,034		310,299
Long-term borrowed funds		248,631		35,344		113,196		58,984		41,107
Subordinated debentures		127,063		61,857		-		-		65,206
Letters of credit		98,206		57,732		40,401		-		73
Total	$	2,752,151	$	1,549,055	$	651,940	$	119,620	$	431,536

The Company currently does not have any off-balance sheet special purpose entities. The Company had no capital leases at September 30, 2005.

CAPITAL LEVELS

The following table sets forth the Company’s and National Penn Bank’s capital ratios:

	Tier 1 Capital to						Tier 1 Capital to Risk-						Total Capital to Risk-
	Average Assets Ratio						Weighted Assets Ratio						Weighted Assets Ratio
	Sept. 30,			Dec. 31,			Sept. 30,			Dec. 31,			Sept. 30,			Dec. 31,
	2005			2004			2005			2004			2005			2004
The Company		8.14	%		7.86	%		10.39	%		10.02	%		11.73	%		11.27	%
National Penn Bank		7.18	%		7.00	%		9.20	%		8.93	%		10.45	%		10.19	%
“Well Capitalized” institution		5.00	%		5.00	%		6.00	%		6.00	%		10.00	%		10.00	%
(under banking regulations)

The Company’s capital ratios above compare favorably to the minimum required amounts of Tier 1 and total capital to “risk-weighted” assets and the minimum Tier 1 leverage ratio, as defined by banking regulators. At September 30, 2005, the Company was required to have minimum Tier 1 and total capital ratios of 4.0% and 8.0%, respectively, and a minimum Tier 1 leverage ratio of 4.0%. In order for the Company to be considered “well capitalized”, as defined by banking regulators, the Company must have Tier 1 and total capital ratios of 6.0% and 10.0%, respectively, and a minimum Tier 1 leverage ratio of 5.0%. The Company currently meets the criteria for a well capitalized institution, and management believes that, under current regulations, the Company will continue to meet its minimum capital requirements in the foreseeable future. At present, the Company’s commitments for significant capital expenditures are within its historical norms.

The Company does not presently have any commitments for significant capital expenditures. The Company is experiencing a space shortage and is actively planning construction of an operations facility. The Company purchased a tract of land for this purpose in May 2005 for $765,000. In June 2005, the Company entered into an agreement of sale to acquire an additional tract of land nearby, at a purchase price of $1.36 million. Settlement of this purchase has not yet been scheduled. If and when this purchase is completed, the Company will

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determine how much of the total land purchased is necessary for the operations center and whether any amount should be offered for sale.

The Company is not under any agreement with regulatory authorities nor is the Company aware of any current recommendations by the regulatory authorities, which, if such recommendations were implemented, would have a material effect on liquidity, capital resources or operations of the Company.

RELATED PARTY TRANSACTIONS

The Company has no material transactions with related parties as defined in SFAS No. 57 Related Party Disclosures or with any other persons who, because of a prior relationship with the Company, i.e. former members of senior management or individuals with former management relationships with the Company, had the ability to negotiate transactions with the Company on more favorable terms to themselves than had they not had such prior relationships with the Company.

PENDING ACQUISITION OF NITTANY FINANCIAL CORPORATION

On September 7, 2005, National Penn Bancshares, Inc. announced the execution of a definitive merger agreement under which National Penn Bancshares would acquire Nittany Financial Corporation (“Nittany”), parent company of Nittany Bank, in a stock and cash transaction valued at approximately $96.5 million. Nittany is a financial services company, with $326.5 million in assets, headquartered in State College, Centre County, Pennsylvania. Its Nittany Bank subsidiary operates four community offices in State College and one in Bellefonte. Nittany Financial also has $310 million under management through two of its subsidiaries, Vantage Investment Advisors, LLC, and Nittany Asset Management, Inc.

Under the terms of the merger agreement, which was unanimously approved by the boards of directors of both companies, Nittany shareholders will be entitled to exchange each share of Nittany common stock for 1.58 shares of National Penn common stock or $42.43 in cash. The five-for-four stock split that National Penn announced on August 24, 2005 with an effective date of September 30, 2005, results in an adjusted exchange ratio of 1.975 shares of National Penn common stock. This exchange ratio is subject to further adjustment as set forth in the definitive agreement based on changes in the market price of National Penn common stock. Nittany shareholders may elect to receive cash, National Penn common stock or a combination of both for their Nittany shares. Additionally, the elections of Nittany shareholders are further subject to allocation procedures that are intended to result in the exchange of 30% of the Nittany shares for cash, and the remaining 70% exchanged for shares of National Penn common stock.

The transaction, anticipated to close in the first quarter of 2006, is subject to several conditions and contingencies, including approvals by the Federal Reserve Bank and the Pennsylvania Department of Banking and the affirmative vote of the shareholders of Nittany. All directors, certain executive officers and greater-than-five percent shareholders of Nittany (collectively holding approximately 40 percent of the outstanding shares of Nittany common stock) have agreed in letter agreements signed with National Penn to vote in favor of the merger. No assurance can be given that all required approvals will be obtained, that all other closing conditions will be satisfied or waived, or that the transactions will in fact be consummated.

FUTURE OUTLOOK

The Company’s market area, while diverse, is subject to many of the same economic forces being

experienced regionally and nationally:

· General economic conditions are expected to be conducive to loan growth in the range of six to eight percent during 2005.

· The Company anticipates that net charge-offs for all of 2005 will likely be greater than in 2004 and more in line with historical levels.

· The principal challenge faced by the Company today is to grow our earnings in light of the continuing compression of our net interest margin due to current and anticipated interest rate levels (which continue to increase the costs of deposits). In this environment, we seek to increase our net interest income principally through increased volume, including volume from mergers and acquisitions, and to increase our non-interest income.

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The Company, like many of its peers, continues to be concerned about current and near term uncertain economic conditions and their effect on its loan volume as well as its overall credit quality.

FORWARD-LOOKING STATEMENTS

From time to time, National Penn or its representatives make written or oral statements that may include "forward-looking statements" with respect to its:

· Financial condition.

· Results of operations.

· Asset quality.

· Product, geographic and other business expansion plans and activities.

· Investments in new subsidiaries and other companies.

· Capital expenditures, including investments in technology.

· Pending or completed mergers with or acquisitions of financial or non-financial companies or their assets, loans, deposits and branches, including without limitation, the pending acquisition of Nittany Financial Corporation (“Nittany”), and the revenue enhancements, cost savings and other benefits anticipated in those transactions. For further information on the pending acquisition of Nittany (the “Nittany Acquisition”), see Footnote 2 to the financial statements included in this Report in Part I, Item 1, and see Management’s Discussion and Analysis included in this Report in Part I, Item 2.

· Pending or completed sales of businesses or assets, and the benefits anticipated in those transactions.

· Other matters.

Many of these statements can be identified by looking for words such as "believes," "expects," "anticipates," "estimates", "projects" or similar words or expressions.

These forward-looking statements involve substantial risks and uncertainties. There are many factors that may cause actual results to differ materially from those contemplated by such forward-looking statements. These factors include, among other things, the following possibilities:

· Reputational risk created by the loan fraud incurred by National Penn in 2004 and/or by the results of the assessment of National Penn’s internal control over financial reporting at December 31, 2004 may have an adverse impact on business generation and retention, funding, liquidity and National Penn’s stock price. For further information, see National Penn’s Annual Report on Form 10-K for 2004, Part I, Item 1. “Business - Recent Developments”. See also Part I, Item 4. “Controls and Procedures” of this Report.

· National Penn’s unified branding campaign and other marketing initiatives may be less effective than expected in building name recognition and greater customer awareness of National Penn’s products and services.

· Seasonal deposit flows (primarily municipal deposits) may not occur as in the past. Our ability to accept these deposits may be limited by legal requirements to provide collateral for such deposits.

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· National Penn may be unable to differentiate itself from its competitors by a higher level of customer service, as intended by its business strategy.

· Expansion of National Penn’s products and services offerings may take longer, and may meet with more effective competitive resistance from others already offering such products and services, than expected.

· New product development by new and existing competitors may be more effective, and take place more quickly, than expected.

· Competitors with substantially greater resources may enter product market, geographic or other niches currently served by National Penn.

· Geographic expansion may be more difficult, take longer, and present more operational and management risks and challenges, than expected.

· Business development in newly entered geographic areas, including those entered by the Nittany Acquisition and other mergers and acquisitions, may be more difficult, and take longer, than expected.

· Competitive pressures may increase significantly and have an adverse effect on National Penn’s pricing, spending, third-party relationships and revenues.

· Customers may substitute competitors’ products and services for National Penn’s products and services, due to price advantage, technological advantages, or otherwise.

· National Penn may be less effective in cross-selling its various products and services, and in utilizing alternative delivery systems such as the Internet, than expected.

· Projected business increases following new product development, geographic expansion, including the Nittany Acquisition, and productivity and investment initiatives, may be lower than expected, and recovery of associated costs may take longer than expected.

· National Penn may be unable to retain key executives and other key personnel due to intense competition for such persons or otherwise.

· Increasing interest rates may increase funding costs and reduce interest margins, and may adversely affect business volumes.

· Growth and profitability of National Penn’s non-interest income or fee income may be less than expected, including income from wealth management, insurance agency activities and mortgage banking activities.

· General economic or business conditions, either nationally or in the regions in which National Penn will be doing business, including after completion of the Nittany Acquisition, may be less favorable than expected, resulting in, among other things, a deterioration in credit quality or a reduced demand for credit, including the resultant effect on National Penn’s loan portfolio and allowance for loan and lease losses.

· Expected synergies and cost savings from the Nittany Acquisition and other mergers and acquisitions may not be fully realized or realized as quickly as expected.

· Revenues and loan growth following the Nittany Acquisition and other mergers and acquisitions, may be lower than expected.

· Loan losses, deposit attrition, operating costs, customer and key employee losses, and business disruption following the Nittany Acquisition and other mergers and acquisitions may be greater than expected.

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· Business opportunities and strategies potentially available to National Penn after the Nittany Acquisition and other mergers and acquisitions may not be successfully or fully acted upon.

· Costs, difficulties or delays related to the integration of businesses or systems of acquired companies, including Nittany, with National Penn’s business may be greater or take longer than expected.

· Technological changes may be harder to make or more expensive than expected or present unanticipated operational issues.

· Recent and proposed legislative or regulatory changes, including changes in accounting rules and practices, and customer privacy and data protection requirements, and intensified regulatory scrutiny of the financial services industry in general, may adversely affect National Penn’s costs and business.

· Market volatility may continue in the securities markets, with an adverse effect on National Penn’s securities and asset management activities.

· There may be unanticipated regulatory rulings or developments.

· Changes in consumer spending and savings habits could adversely affect National Penn’s business.

· Negative publicity with respect to any National Penn product or service, whether legally justified or not, could adversely affect National Penn’s reputation and business.

· Various domestic or international military or terrorist activities or conflicts may have a negative impact on National Penn’s business as well as the foregoing and other risks.

· National Penn may be unable to successfully manage the foregoing and other risks and to achieve its current short-term and long-term business plans and objectives.

Because such statements are subject to risks and uncertainties, actual results may differ materially from those expressed or implied by such statements. National Penn cautions shareholders not to place undue reliance on such statements.

All written or oral forward-looking statements attributable to National Penn or any person acting on its behalf made after the date of this Report are expressly qualified in their entirety by the cautionary statements contained in this Report. National Penn does not undertake any obligation to release publicly any revisions to such forward-looking statements to reflect events or circumstances after the date of this Report or to reflect the occurrence of unanticipated events.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The information presented in the Liquidity and Interest Rate Risk section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Report is incorporated herein by reference.

Item 4. Controls and Procedures.

National Penn’s management is responsible for establishing and maintaining effective disclosure controls and procedures. Disclosure controls and procedures are defined in Securities and Exchange Commission Rule 13a-15(e) as controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods required by the SEC’s rules and forms. For National Penn, these reports are its annual reports on Form 10-K, its quarterly reports on Form 10-Q, and its current reports on Form 8-K. As of September 30, 2005, National Penn’s management, under the supervision and with the participation of National Penn’s chief executive officer and chief financial officer, evaluated National Penn’s

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disclosure controls and procedures. Based on that evaluation, the chief executive officer and the chief financial officer concluded that such disclosure controls and procedures, except for the impact of the material weakness discussed below, were effective as of September 30, 2005 to provide reasonable assurance that all material information required to be disclosed by National Penn in its reports filed under the Securities Exchange Act of 1934 is reported as required.

National Penn’s management is responsible for establishing and maintaining adequate internal control over financial reporting. As disclosed in management’s report on internal control over financial reporting filed in National Penn’s Annual Report on Form 10-K for 2004, management’s assessment of the effectiveness of National Penn’s internal control over financial reporting as of December 31, 2004 identified a material weakness in the processes for approving certain types of loans and changes to deposit account information. The identified material weakness related to the lack of effective segregation of duties and supervision in the loan underwriting and approval process in the Private Banking area at locations remote from Private Banking headquarters As a result, when combined with the failure to effectively monitor maintenance activity on deposit accounts, management concluded that there was a material weakness in internal control over financial reporting.

As previously reported in National Penn’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005, promptly following identification of the material weakness, management appointed a task force of senior officers to develop a plan of remediation. The task force completed a plan of remediation in May 2005. This plan was reviewed with and formally approved by National Penn’s executive management and the Audit Committee of the Board of Directors in late May 2005. As of September 30, 2005, the plan has been fully implemented except those aspects involving the hiring of additional personnel (which remains in process).

Also as previously reported in National Penn’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005, management believes that many of the changes made during second quarter 2005 to remediate the material weakness described above, and certain other changes made during that quarter as part of National Penn’s ongoing efforts to improve and refine its internal control over financial reporting, were changes that materially affected, or were reasonably likely to materially affect, National Penn’s internal control over financial reporting. All of these material or potentially material changes were identified in National Penn’s Quarterly Report on Form 10-Q for second quarter 2005.

During third quarter 2005, National Penn began testing the internal control changes made in the second quarter to determine their operating effectiveness, including the remedial impact on the material weakness. Further implementation and testing is expected to continue through the remainder of 2005. During third quarter 2005, there were no changes made in National Penn’s internal control over financial reporting that materially affected, or are reasonably likely to materially affect, National Penn’s internal control over financial reporting. National Penn will perform an evaluation of the effectiveness of its internal control over financial reporting in connection with its Annual Report on Form 10-K for the year ended December 31, 2005, to be filed with the Securities and Exchange Commission in early 2006.

There are inherent limitations to the effectiveness of any controls system. A controls system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that its objectives are met. Further, the design of a control system must reflect the fact that there are limits on resources, and the benefits of controls must be considered relative to their costs and their impact on the business model. National Penn intends to continue to improve and refine its internal control over financial reporting. This process is ongoing, and National Penn seeks to assure an effective internal control environment. As part of National Penn’s continuing implementation of an enterprise-wide risk management function, the design and implementation of which began in April 2004, National Penn’s Board of Directors established in third quarter 2005 a new Board standing committee, the Directors’ Risk Committee, to monitor management’s ongoing implementation of the enterprise-wide risk management function.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

As previously disclosed by National Penn in its Annual Report on Form 10-K for 2004 at Item 1. “Business-Recent Developments,” National Penn’s financial results for 2004 included a pre-tax special charge for fraud loss of $6.7 million, for losses attributable to a fraudulent loan and deposit scheme perpetrated by a former loan officer and discovered by National Penn in January 2005. Third quarter 2005 financial results include pre-tax

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expenses of $198,000 for legal, auditing and other investigation-related expenses in the investigation of the loan fraud discovered in January 2005. National Penn anticipates that it will continue to incur legal and other investigation-related expenses in future periods.

As previously reported in National Penn’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005, after an exhaustive investigation lasting over three and one-half months, on April 18, 2005, National Penn filed a complaint against the former loan officer and others, including certain customers and two additional former employees. The complaint seeks to recover all losses, costs and expenses arising out of the transactions examined during the investigation. (National Penn Bank v. Edward G. and Jayne Mawhinney et al., Court of Common Pleas, Philadelphia County, March Term 2005 No. 001789) (the “Mawhinney Litigation”).

On November 2, 2005, without admission of liability or fault by any party, National Penn and certain of the defendants in the Mawhinney Litigation agreed to a settlement. Under the terms of the settlement, (A) the parties agreed, among other things, that National Penn and the settling defendants each would discontinue their respective actions against the other with prejudice, and (B) the settling defendants paid approximately $3.5 million to National Penn against losses previously recorded. National Penn continues to pursue all other available avenues, including insurance, to recover its losses and cooperate with law enforcement authorities in their investigation.

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

Stock Repurchases

The following table provides information on repurchases by National Penn of its common stock in each month of the quarter ended September 30, 2005:

Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plan or Programs		Maximum Number of Shares that may yet be Purchased Under the Plans or Programs
July 1, 2005
through
July 31, 2005		5,688	$	20.82		5,688		618,503
August 1, 2005
through
August 31, 2005		24,661	$	21.10		24,661		593,842
September 1, 2005
through
September 30, 2005		8,125	$	20.40		8,125		585,717

1.	Transactions are reported as of settlement dates.
2.	National Penn's current stock repurchase program was approved by its Board of Directors and announced on September 24, 2003.
3.	The number of shares approved for repurchase under National Penn's current stock repurchase program is 1,562,500 (as adjusted for the five-for-four stock split on September 30, 2005).
4.	National Penn's current stock repurchase program does not have an expiration date.
5.	No National Penn stock repurchase plan or program expired during the period covered by the table.
6.	National Penn has no stock repurchase plan or program that it has determined to terminate prior to expiration or under which it does not intend to make further purchases.

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Item 3. Defaults Upon Senior Securities.

None.

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

During the quarter ended September 30, 2005, no matters were submitted to a vote of National Penn shareholders.

Item 5. Other Information.

Cash Dividend

On October 26, 2005, the Board of Directors of National Penn declared a cash dividend of $0.165 per share payable on November 17, 2005 to shareholders of record as of November 5, 2005.

Office and ATM Openings and Closings

During the third quarter 2005, National Penn Bank closed and removed the automated teller machine (ATM) from the M & G Food Mart located at 1137 Commons Boulevard in Reading (Berks County).

Item 6. Exhibits.
	10.1	Form of Letter Agreement between Nittany Financial Corporation’s directors, certain executive officers and five percent shareholders and National Penn Bancshares, Inc.  (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated September 7, 2005, filed on September 7, 2005).
	31.1	Certification of Chairman and Chief Executive Officer of National Penn Bancshares, Inc., pursuant to Commission Rule 13a-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2	Certification of Treasurer and Chief Financial Officer of National Penn Bancshares, Inc., pursuant to Commission Rule 13a-14(a) and Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1	Certification of Chairman and Chief Executive Officer of National Penn Bancshares, Inc., pursuant to Commission Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Furnished, not filed.)
	32.2	Certification of Treasurer and Chief Financial Officer of National Penn Bancshares, Inc., pursuant to Commission Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Furnished, not filed.)

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SIGNATURES

Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	NATIONAL PENN BANCSHARES, INC.
		(Registrant)
Dated: November 7, 2005		By	/s/ Wayne R. Weidner
			Wayne R. Weidner, Chairman and
			Chief Executive Officer
Dated: November 7, 2005		By	/s/ Gary L. Rhoads
			Gary L. Rhoads, Principal
			Financial Officer

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